Taxation of the profit of a permanent establishment

A non-resident’s permanent establishment in Estonia pays income tax on profit and assets both in monetary or non-monetary form taken out of the permanent establishment. Specificities arising from tax treaties are taken into account in taxation.

A permanent establishment is a business entity through which the permanent economic activity of a non-resident is carried out in Estonia. A permanent establishment is created as a result of economic activity which is geographically enclosed or has mobile nature, or as a result of economic activity conducted in Estonia through a representative authorised to enter into contracts on behalf of the non-resident.

According to the definition of permanent establishment, the existence of economic activity in Estonia is necessary for its emergence, not so much a geographically defined location. A permanent establishment is also created by activities of mobile nature and through a representative authorised to enter into contracts on behalf of a non-resident. People are usually required for economic activities to occur, but a permanent establishment can also be created through equipment or facilities operating without human assistance.

Non-resident’s income, which it derives through a permanent establishment located in Estonia, is considered to be income, which this permanent establishment could have derived if it were a distinct and separate taxpayer engaged in the same or similar activities under the same or similar conditions and dealing wholly independently of the non-resident of which it is a permanent establishment.

Obligations

In order to ascertain the income of a permanent establishment, a company must keep accurate accounting.

  • A non-resident legal person with a permanent establishment located in Estonia, pays income tax in Estonia on:
    • fringe benefits;
    • gifts, donations, costs of entertaining guests;
    • expenses and other payments not related to business;
    • profit attributed to the permanent establishment which has been taken out of the permanent establishment in monetary or non-monetary form during a period of taxation.

The aforementioned income is declared on the appropriate annexes of the form TSD.

  • A non-resident legal person with a permanent establishment in Estonia, is obliged to submit a signed annual report of the permanent establishment to the Estonian Tax and Customs Board within six months beginning from the end of a financial year.

The annual report must contain at least the following:
a) the information necessary to identify the permanent establishment: name, registry code, location in Estonia;
b) management report, which contains a description of the activities of the permanent establishment in Estonia;
c) balance sheet (report of assets and liabilities);
d) income statement (statement of income and expenses);
e)confirmation of the authorised person (signature).

Principles of tax accounting of a permanent establishment

A non-resident has to keep separate tax accounting of a permanent establishment in order to determine the taxable value to be declared. Although the tax legislation in Estonia does not regulate the accounting rules of permanent establishments, a non-resident has to keep account in a manner which enables, in reasonable time, to get an overview of expenses, income, assets and liabilities of the permanent establishment.

A non-resident legal person can keep accounts of a permanent establishment situated in Estonia according to the rules in force in the country of location, if these rules comply with internationally accepted accounting standards and enable to determine the correct tax liability in Estonia.

In order to certify the correctness of the data declared in annex 3 of the declaration form TSD, the non-resident legal person (at the request of the tax authority) has to prove at the end of each taxation period that the profit earned through the permanent establishment located in Estonia was at the use of the permanent establishment as at the end of the taxation period. This means that the balance sheet of the permanent establishment has to be compiled in a manner, which indicates that all of the earned (but not distributed) profit corresponds to actual assets (money, goods, securities, receivables etc.) in the assets section of the balance sheet.

Declaring profit taken out of a permanent establishment

Profit taken out of a permanent establishment is declared on the annex 3 of the declaration form TSD. The declaration is submitted to the Tax and Customs Board by the 10th date following the month the profit was taken out and income tax is paid to the bank account of the Tax and Customs Board by the same date.

The profit is declared in the event that the tax liability arises on the basis of the Income Tax Act and, according to a tax treaty for avoidance of double taxation, is exempt from income tax in Estonia.

If a non-resident legal person has a permanent establishment in Estonia, then as a withholding agent for income tax it is required to withhold income tax on taxable payments made to a recipient and to submit the declaration form TSD with respective annexes of taxable payments.

In order to submit declarations, the permanent establishment has to be registered in Estonia. The registry data of a branch registered in the Estonian commercial register automatically reach the database of the Tax and Customs Board.

Principles of profit taxation

Taxation of a permanent establishment of a non-resident legal person located in Estonia is based on the general principles provided in the Income Tax Act, according to which retained profit is not subject to income tax.

If the permanent establishment of a resident of a country of a tax treaty has not arisen in Estonia within the meaning of the tax treaty, then taxation according to Estonian rules does not apply, since the tax treaty does not allow it. The provisions of tax treaties do not affect the obligation to register a permanent establishment.

In accordance with tax treaties and the Income Tax Act, Estonia has the right to tax the income of a permanent establishment of a non-resident legal person located in Estonia at the moment of distributing profit from which the costs related to earning income of the permanent establishment and management and administration costs attributed to the permanent establishment have been deducted.

A non-resident legal person is required to declare taxable profit earned through a permanent establishment located in Estonia in the taxation period when the permanent establishment cannot use it itself or earn income from it on any other basis.

Thus, the profit earned through a permanent establishment of a non-resident legal person in Estonia is not taxed in Estonia as long as the funds are in the use of the permanent establishment and immediately available to the permanent establishment (e.g. funds in a foreign bank account freely available to the permanent establishment) or invested in a way that ensures revenue for the permanent establishment.

If the customer pays for services or goods provided by a non-resident through a permanent establishment in Estonia to the non-resident's foreign bank account, and if no separate bank account is opened for the permanent establishment and it is a joint bank account of the non-resident legal person and its permanent establishment, payments to such foreign or joint bank account may not always be considered taking profits out of a permanent establishment.

If, in the situation described, instead of a permanent establishment would be an Estonian resident company, the money received in a foreign bank account would be recorded as a claim or an asset in the company's accounts, meaning that the Estonian company would have retained the claim on the charge, which it should have received from the customer on the services provided and goods sold.

Therefore, if a claim occurred or remained on a charge the permanent establishment should have received from the customer, but which was paid to the joint or foreign bank account of the non-resident, this kind of transaction is not considered taking assets out of Estonia.

If the right of a claim on the aforementioned charge occurs or remains at a permanent establishment, it is not considered taking profit out of Estonia without receiving other assets for it, because the right for a claim is also an asset. It can be concluded, that the situation is possible where a non-resident becomes liable to pay income tax on the profit earned through a permanent establishment once a financial year or only at the end of a project

In the tax accounting of a permanent establishment of a non-resident legal person the market price is usually taken into account when calculating the price and costs of transactions.

  1. If a permanent establishment of a non-resident legal person in Estonia acquires from the head office goods purchased or self-produced by the latter, a distinction must be made in determining the cost price for a permanent establishment between goods purchased by the permanent establishment for its own use or for resale.
    • If a permanent establishment buys goods from the head office with the purpose of resale, then the price of the goods transferred in the transaction between the head office and the permanent establishment must correspond to the market value, i.e. the price must be similar at which unrelated persons would transfer the same or similar goods under the same or similar conditions.

    • If goods are purchased from the head office for the use of the permanent establishment, the price of the goods may be the cost associated with the goods without any profit margin, which would occur between unrelated persons.

  2. If the non-resident legal person provides services to the permanent establishment, these services are recorded with market price (profit margin is added to the costs related to providing services), given that the non-resident could provide similar services to third parties.

    If the non-resident legal person received a service through the permanent establishment located in Estonia from a third party, we generally presume the service was provided with market price.
  3. General and administrative costs are recorded resulting from actual costs without the profit margin and attributed to the permanent establishment of a non-resident legal person on the basis of objective criteria. For example, it is possible that the general administrative costs are distributed between the permanent establishment and home office based on the ratio of the realised net turnover of the permanent establishment to the realised net turnover of the non-resident legal person.

If a non-resident is a resident of a country, with which Estonia has concluded a valid tax treaty, benefits arising the tax treaty are applied in the taxation of the permanent establishment.

It is set out in article 7 of tax treaties that it is possible to tax in Estonia the business income of a non-resident only if the business activity is carried out through a permanent establishment located in Estonia.

If a resident of a contracting state has not established a permanent establishment in Estonia in the means of a tax treaty, then profit is not taxed in Estonia, because the tax treaty does not allow it. The provisions of tax treaties do not affect the obligation to register a permanent establishment.

If the provisions of a tax treaty are more favourable than the provisions of the Income Tax Act, the provisions of the tax treaty are applied.

  • The regular income tax rate on profit taken out of a permanent establishment is 20/80.

  • Beginning from year 2019, a 14% tax rate, which is lower than the regular 20% rate, is applied on profit regularly taken out of a permanent establishment; the taxable amount is divided by 0.86.

Therefore, the income tax amount is smaller when the profit is taken out regularly compared to when the profit is assembled and distributed in a larger amount at the end of an activity.

The lower tax rate of 14/86 is calculated on profit taken out of a permanent establishment of a non-resident legal person in a calendar year, which does not exceed the average taxable profit taken out of a permanent establishment in the three previous years.

In the first years (2019, 2020) of this change in rates, the profit taxed with income tax and taken out of a permanent establishment of accordingly only one (2018) and two (2018, 2019) previous year(s) was taken into account when calculating the average profit.
The taxable profit taken out in previous three years taxed with both with rates 20/80 and 14/86 is taken into account. In order to avoid double taxation, the profit exempt from tax in Estonia is not taken into account.

If profit was not taken out in one or two previous years, it does not preclude calculating the lower tax rate in a calendar year, because even if profit taxable with income tax has been distributed only once in the previous three years, the lower tax rate is calculated on 1/3 of the profit, without the obligation to distribute profit in every calendar year. If profit taxable with income tax was not distributed in the last calendar year, 0 is taken into account for this year when calculating the average profit.

A non-resident legal person is obliged to declare the taxable profit earned through the permanent establishment located in Estonia in the taxable period, when the permanent establishment cannot use it or earn profit on it in other ways.

Therefore, the profit derived through a permanent establishment of a non-resident legal person located in Estonia is not taxed until the funds are in the use of the permanent establishment, i.e. these are immediately available to the permanent establishment (e.g. funds on a bank account in a foreign country, which the permanent establishment can freely use) or invested in a manner which ensures income to the permanent establishment.

In general, the non-resident legal person defines when the profit is distributed and records it in the tax calculation of the permanent establishment located in Estonia at the moment the part of assets which are considered profit is no longer available to the permanent establishment.

In order to identify the assets in the use of the permanent establishment, the non-resident legal person has to keep records detailed enough to show the size and use of assets of the permanent establishment. If the non-resident legal person cannot prove that the part of assets considered profit is accessible to the permanent establishment (e.g. if the non-resident legal person has distributed dividends out of profit earned by the permanent establishment or if the tax accounting shows that the permanent establishment has not received a fair charge on the use of assets belonging to it), the profit is considered to be taken out.

If a non-resident legal person has not distributed profit derived through the permanent establishment before ending the permanent establishment, when ending the permanent establishment, the profit derived through permanent establishment is considered to be distributed and the non-resident legal person is obliged to pay income tax.

The non-resident legal person submits the annex 3 of the declaration form TSD only after the profit distribution subject to income tax has taken place. If this has not happened, it is not necessary to submit the part I of annex 3 of the form TSD and declare the income and assets of the permanent establishment.

The rules related to the determination of the market value of the transfer price are applied also on the transactions made through or on the account of the permanent establishment located in Estonia of the non-resident legal person.

If a resident company is deleted from the commercial register without liquidation and the economic activities of the legal person are continued through the permanent establishment located in Estonia, the profit attributed to the permanent establishment will also include the share of the equity of the company deleted from the commercial register which exceeds the monetary and non-monetary contributions made to the equity.

Application of the low tax rate

In case of taking profit out regularly the income tax rate is lower (14/86) and the income tax amount is smaller compared to collecting profit and distributing it one time in one amount at the termination of activities of the permanent establishment.

Lower tax rate is applied on the profit taken out of the permanent establishment in a calendar year to the extent of the average profit of three previous calendar years, which has been taxed with income tax and taken out.

If profit taxed with income tax was not distributed in some previous calendar years, it does not exclude calculating the average profit of three previous calendar years and using the low tax rate in that extent. In this case, for the calendar year the profit taxable with income tax was not distributed, 0 is taken into account for calculating the average profit.

When calculating the average profit, the profit taxed with both the low tax rate of 14/86 and regular rate of 20/80 is taken into account.

In order to avoid double taxation, the profit exempt from tax in Estonia, is not taken into account. Each calendar year the average profit taxed with income tax of a calendar year is recalculated.

It is not possible to transmit the average profit unused for applying the low tax rate calculated in the previous calendar year to the following years. Therefore, the more regularly and equally the permanent establishment distributes profit each calendar year, the more the low tax rate applies to the profit of the permanent establishment in the future.

Permanent establishments can view their data in the e-MTA. The profit amount, which the permanent establishment can apply the low tax rate on, is visible in the part I of the annex 3 of the declaration form TSD.

Distribution of profit assigned to the permanent establishment is declared on the code 3000 of the annex 3 of the form TSD.

  • First, in order to avoid double taxation, it is possible on code 3260 to reduce the declared profit by the tax-free amount.

  • Then, on code 3272 the share of profit is calculated on which the low tax rate of 14/86 applies.

  • If the profit amount exceeds the average profit taxed with income tax of the previous three calendar years, the share of profit is calculated on which the regular tax rate of 20/80 is applied on, on code 3273.

Income tax is not withheld on payments made by the permanent establishment and profit payments are not indicated on form INF 1.

Introducing assets into and taking out from Estonia

The value of assets introduced into Estonia for the permanent establishment is determined on the basis of the value of assets determined in the country from which the assets were introduced from. If the determined value does not reflect the market value, market value is used as the basis (§ 53 (412) of the Income Tax Act).

If the non-resident legal person (home office) transfers the assets to another permanent establishment in another country, then the determined value or the market value of the assets may be taxed in the country of the non-resident legal person (income tax upon departure).

On the annex 3 of the declaration form TSD, assets of the head office placed in the permanent establishment are declared, for which other assets or services or other equal benefit have not been received. In other words, these assets placed in a permanent establishment are declared for which no claims are submitted and no money is paid for.

If the value of the assets brought to Estonia for a permanent establishment is declared on the annex 3 of the form TSD, it enables to avoid double taxation in Estonia when assets are taken back to the head office in the future.

The definition of assets can be based on opinions set out in the decision of the Supreme Court of Estonia (RKHK 3-3-1-20-14). According to the Supreme Court, the principle arises that economic transactions between a non-resident and its permanent establishment in Estonia are taxed in the same way as they would be taxed if a non-resident had established an independent company (subsidiary) in Estonia instead of a permanent establishment (branch).

The Supreme Court found that this applies, among other things, to the granting and repayment of loans and contributions and disbursements to equity. The Supreme Court found that according to § 53 (4) of the Income Tax Act the objects of taxation are “assets taken out of a permanent establishment exceeding assets brought in for the permanent establishment”.

When comparing the financial statements of a permanent establishment and a legal person, the "assets brought in for a permanent establishment" are similar to the company's share capital (and other contributions made by shareholders).

Taking out assets from a permanent establishment can therefore be compared to payments made on a reduction in the company's share capital or contributions, the repurchase or return of shares, instalments or contributions, or otherwise to distributions from the equity and, as well as, liquidation proceeds.

Unlike dividends and other profit distributions Estonia taxes the mentioned payments beginning from year 2009 after the contributions to the equity have been deducted. Similar to the treatment of legal persons the profit of a permanent establishment is taxed when it is taken out (like dividend and other profit distribution). Taking out from Estonia the assets brought for the permanent establishment is not additionally taxed (similarly to contributions made to the equity).

1. Is a computer bought to a branch from Estonia a declarable asset?
If the computer was purchased at the expense of (the expense was made by) the branch (permanent establishment), the computer is not a declarable asset. If the computer was purchased at the expense of (the expense was made by) the head office and the branch made no expenses in relation to the purchase of the computer, then the computer is a declarable asset.

2. Are computers/machines purchased by the non-resident legal person from Finland for the branch and brought to Estonia declarable assets?
Yes, computers/machines purchased at the expense of the Finnish legal person head office, for which the branch made no expenses, are declarable assets.

3. Does money transferred from the bank by a non-resident legal person to the branch to cover the operating costs of the branch have to be declared?
If the head office of the non-resident legal person transferred loan money to the branch and the branch is obliged to return the loan to the head office, then the money transferred by the head office is not a declarable asset. If the head office transferred money to the branch for covering operating costs and the branch is not obliged to return the money to the head office, then the money transferred by the head office is a declarable asset.

4. Does a loan (loan agreement, interest) given by the non-resident legal person to the branch have to be declared?
With a loan agreement, the branch is obliged to return the loan and the received loan is not a declarable asset.

5. Do the services and goods sold by the non-resident legal person to the branch have to be declared?
With sold goods and services the branch is obliged to pay for services and goods and these are not declarable assets.

6. Does asset also mean the profit earned by the branch in Estonia that has not yet been withdrawn or taken out?
Declarable assets are only the assets, which are bought to Estonia for the permanent establishment by the head office and have not been returned. The profit of a branch (permanent establishment) earned in Estonia is not declared as an asset.

The profit assigned to a permanent establishment, which has been taken out of the permanent establishment in monetary or non-monetary form, is taxed with income tax (§ 53 (4) of the Income Tax Act).

The previous is not applied to taking out assets related to financing of securities or provided as security, or if the assets are taken out to meet the prudential norms of capital requirements or liquidity management, and if the assets are placed back in Estonia within 12 months as of taking them out (§ 53 (4) of the Income Tax Act).

For the purposes of § 53 (4) of the Income Tax Act, the following are also deemed to be profits attributed to a permanent establishment:

  • difference between the market value of assets taken out and book cost at the moment of taking assets out, and

  • a positive difference between the market value of the assets specified in § 53 (412) of the Income Tax Act brought to Estonia for the permanent establishment and the value determined on the basis of the same subsection at the time of taking it out from the permanent establishment (§ 53 (413) of the Income Tax Act).

Therefore, the declaration of the value of assets brought to Estonia for a permanent establishment is necessary for the attribution and taxation of profits to a permanent establishment on the basis of § 53 (413) of the Income Tax Act.

The value of the declared assets reduces the profit attributed to the permanent establishment, which is subject to income tax.

Hereinafter, the permanent establishment located in Estonia is required to declare the new balance of the value of assets under code 3333 of annex 3 of the TSD if there is a movement of assets between the head office and the Estonian permanent establishment during a taxation period, i.e. calendar month (e.g. additional assets have been brought to Estonia for the permanent establishment or returned to the head office). If there are no changes, then code 3333 on the annex 3 of the TSD is not required to be filled in.

Permanent establishments must show on the code 3333 of annex 3 of the TSD the balance of the value of assets of the permanent establishment on a monthly basis, taking into account the change during the tax period. If the value of the assets does not change during the calendar month, code 3333 does not have to be filled in for that calendar month.

Introducing assets for the purpose of a permanent establishment and taking assets out of a permanent establishment is not deemed to be introducing or taking out assets or posting them as collateral in connection with financing securities if the assets are brought back or the collateral is released within a period of 12 months. The previous sentence also applies to assets that are introduced, taken out or posted as collateral in order to meet prudential capital requirements or for the purpose of liquidity management.

Profit on assets taken out of a permanent establishment during the taxation period is declared on the code 3000 of the declaration TSD.

On the code 3000 of annex 3 of the TSD, the following is declared:

  • usual profit attributed to a permanent establishment, which has been taken out of the permanent establishment in monetary or non-monetary form during a taxation period, and

  • profit from assets taken out of a permanent establishment during a taxation period, in which occasion there is a right to take into account and subtract the value of assets brought to Estonia for the permanent establishment, which has been declared on the code 3333 of annex 3 of the TSD.

In the e-service environment e-MTA, the balance of assets on code 3333 is not automatically subtracted from profit declared on code 3000 on the annex 3 of the TSD. If the profit is connected to assets taken out of the permanent establishment, then the permanent establishment must subtract the value of assets before declaring the profit.

Applying the tax treaties to the taxation of the profit of a permanent establishment

If a non-resident is a resident of a country, with which Estonia has concluded a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital (a tax treaty), the tax reductions and benefits arising from a tax treaty apply to the taxation of the permanent establishment.

The approach to permanent establishments in tax treaties differs slightly from the definition provided for in the Estonian Income Tax Act. The definition of a permanent establishment is established the article 5 of tax treaties.

Tax treaties limit the taxation rights of Estonia compared to the Income Tax Act. The “permanent establishment” means in tax treaties a certain place of business activity, through which the business activities of a company are carried out partly or  wholly.

There is an illustrative list of possible permanent establishments in the article of tax treaties that explains the meaning of a permanent establishment. When determining a permanent establishment, it is important for there to be a place of business, which is permanent and certain enough and for business activity to be carried out through it.

Therefore, a permanent establishment arises in a place, which is geographically and economically connected to the business activity of the person.

Different from the Income Tax Act, tax treaties have a separate provision for permanent establishments of construction activity.

It is usually stated that a building site, construction, installation, configuration project or supervisory activity in connection therewith constitutes a permanent establishment only if it lasts for a period laid down in the tax convention, for example more than six months.

The beginning of building activity is considered to be the beginning of a permanent establishment. If different building sites and projects are connected to each other geographically and economically forming a whole, the duration of these will be added up to determine the permanent establishment. The period of activity of the general contractor also includes the time when the subcontractors are on the building site.

Different from the Income Tax Act, tax treaties have a list of activities of a preparatory or auxiliary character, with which a permanent establishment will not be established in another country.

Therefore, it is possible that a non-resident has an existing permanent establishment, but it will not be considered a permanent establishment in the meaning of a tax treaty, because the activity of the non-resident through the named permanent establishment is considered to be of a preparatory or auxiliary character.

Similarly to the Income Tax Act, a permanent establishment is deemed to have been arisen through a representative of a non-resident. The tax treaties treat independent and dependent representatives differently. A dependent representative constitutes a permanent establishment of the non-resident, an independent representative does not. When a person who acts on behalf of a company and who is authorized and actually concludes contracts in the other contracting state on behalf of the company (and is not an independent representative), then the company is deemed to have a permanent establishment in that state for all the activities performed for the company by this person in the event that this person’s activity is not only of a preparatory or auxiliary character, which would have occurred through a fixed location of business activity and which would not turn this fixed location of business activity into a permanent establishment.

A dependent representative of a non-resident is like an extension of the non-resident in the other country. The conclusion of contracts cannot be understood as the mere fact of signing, what matters is whether and with whom the actual and essential terms are agreed. In order to determine the power to conclude a contract on behalf of a non-resident, the nature of the whole relationship between the non-resident and the representative must be taken into account. The repetition of transactions and the constancy of operations are generally important, but due to the nature of contracts, a permanent establishment may also arise from the conclusion of one contract.

A person acting as an independent representative will not establish a permanent establishment for a non-resident if the representative is acting in his/her own capacity in the ordinary course of business and is legally and economically independent of the non-resident. Owning or controlling one person does not in itself create a permanent establishment.

Depending on the specific actual circumstances, a subsidiary may (but will not automatically) establish a permanent establishment for the parent company.

According to the tax treaties, the income of a non-resident's business that is not covered elsewhere in the tax treaty may be taxed in Estonia only if the non-resident's business is carried out through a permanent establishment in Estonia (Article 7 of the tax treaties).

Tax treaties base on the assumption of an independent taxpayer, similar to § 7 (3) of the Income Tax Act, according to which, if a non-resident carries out business through a permanent establishment situated in another contracting state, profit is considered to be attributed to the permanent establishment, if this profit could have been earned by the permanent establishment as a separate company, which takes part in the same or similar business activities in the same or similar conditions and is completely independent in its relations with the non-resident whose permanent establishment it is (Article 7 (2) and (3) of the Tax Convention).

Expenses incurred in connection with a permanent establishment, including expenses incurred in connection with management and administration, may be deducted in determining the profits of a permanent establishment, regardless of the country in which the expenses incurred. Provisions on the limitation of taxation in the contracting states of income derived through a permanent establishment are often written in a protocol, which forms an integral part of a tax treaty.

Last updated: 22.11.2021

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