Pursuant to subsection 50 (1) of the Income Tax Act a resident company, including a general and limited partnership, pays income tax on profit distributed as dividends or other profit distributions upon payment thereof in monetary or non-monetary form, taking into account the provisions of § 501. Income tax is not charged on profit distributed by way of a bonus issue.
From 1 January 2019, regularly payable dividends will be taxed at 14% or 14/86 of the net amount of the dividends according to subsection 4 (5) and § 501 of the Income Tax Act. This means that a resident company will be able to both apply a lower (reduced) tax rate of 14/86 and a standard tax rate of 20/80.
What is a dividend and how is it taxed?
A dividend is a payment which is made from the net profit or the retained profits from previous years pursuant to a resolution of a competent body of a legal person, and the basis for which is the recipient’s holding in the legal person (ownership of shares, partnership in a general or limited partnership or membership in a commercial association, or other forms of holding pursuant to the legislation of the home country of the company). (§ 18 of the Income Tax Act)
Income tax calculated on a dividend and possible exemptions and deductions (subsections 50 (11) and 54 (5) of the Income Tax Act) are declared in Annex 7 to Form TSD, and in addition, the recipients of dividends must be declared in Form INF 1 (part I).
What are the regularly payable dividends which shall be subject to taxation at a lower tax rate in 2019 and in 2020?
A resident company is obliged to apply a lower (reduced) tax rate of 14/86:
- in 2019, on one third of the profits distributed in 2018 on which the resident company has paid income tax;
- in 2020, on one third of the profits distributed in 2018 and 2019 on which the resident company has paid income tax. (Subsection 61 (53) of the Income Tax Act)
For the purposes of applying a lower tax rate, it is irrelevant which year’s profits are paid out as dividends. The lower tax rate is applied cash-based on dividends paid in 2019.
Example of dividend taxation in 2019
The company paid dividends and made equity distributions in the sum of 9000 euros in 2018, the company had the right to apply a lower tax rate (14/86) in 2019 on 3000 euros of the dividend payment (9000 ÷ 3).
The company paid dividends in June 2019 in the sum of 4000 euros as follows:
- to legal person – 2000 euros,
- to natural person A – 1000 euros,
- to natural person B – 1000 euros.
The company had the obligation to apply first a lower tax rate (14/86) and then to apply the standard tax rate (20/80).
The company has different options for dividend taxation. For example:
- the dividend paid to the legal person in the sum of 2000 euros is paid at a lower tax rate (2000 × 14/86 = 325.58);
- the dividend paid to natural person A is to be paid at a lower tax rate (1000 × 14/86 = 162.79) and income tax of 7% has to be withhold from the dividend payment (1000 × 7% = 70). Natural person A will receive a dividend of 930 euros (1000 – 70).
- the dividend paid to natural person B in the sum of 1000 euros is to be paid at a standard rate (1000 × 20/80 = 250).There is no obligation to withhold income tax from the dividend payment for natural person B.
- the dividends paid to natural persons A and B to be taxed at a lower tax rate (1000 × 14/86 = 162.79) and income tax of 7% must be withhold from the dividend payment (1000 × 7% = 70). Natural persons A and B will receive dividends of 930 euros (1000 – 70).
- the dividend paid to the legal person in the sum of 1000 euros of the 2000 euros to be taxed at a lower tax rate (1000 × 14/86 = 162.79) and the other 1000 euros to be taxed at a standard tax rate (1000 × 20/80 = 250).
The Income Tax Act does not lay down rules as to which shareholders and in which extent have to receive dividends taxed at a lower or standard tax rate. It is important to remember that the application of a lower tax rate is mandatory! When dividends with a lower tax rate can no longer be paid, the standard tax rate is applied.
Example of dividend taxation in 2020
In 2020, the company is entitled to apply a lower tax rate (14/86) to the payment of a dividend of 4333.33 euros ((9000 + 4000) ÷ 3).
A company will pay a dividend of 2000 euros in July 2020 as follows:
- to legal person – 1000 euros,
- to natural person A – 500 euros,
- to natural person B – 500 euros.
A company will tax the dividend payout at a lower tax rate of 2000 euros (2000 < 4333.33) as follows:
- the dividend paid to a legal person in the amount of 1000 euros is 1000 × 14/86 = 162.79 euros;
- dividends paid to natural persons A and B of 500 euros will be taxed at a lower rate (500 × 14/86) and income tax of 7% (500 × 7% = 35) will be held from the dividends payment. Natural persons A and B are paid dividends of 465 euros (500 – 35).
The company will not make any further dividend payments in 2020 and thus the company will partially not use its right to pay a lower tax rate (2000 < 4333,33).
This right cannot be carried forward to the following year, that is to the year 2021.
What are the regularly payable dividends which shall be subject to taxation at a lower tax rate from 2021?
A resident company is obliged to tax the dividend at a lower tax rate of 14/86 in the fourth year, based on the average taxed dividend and equity distribution for the previous three years (subsection 4 (5) and § 501 of the Income Tax Act).
Example of dividend taxation in 2021
A company makes dividend payments:
- in 2018 in the sum of 9000 euros,
- in 2019 in the sum of 4000 euros and
- in 2020 in the sum of 2000 euros
or a total in the last three years: 15,000 euros.
The company is obliged to apply first a lower tax rate (14/86) payments of dividend 5000 euros (15,000 ÷ 3) and then to apply the standard tax rate (20/80).
How is taxed the dividend income of a natural person?
When paying a dividend taxed at a lower tax rate to a natural person, income tax at a rate of 7% has to be withhold from the dividend payment in addition (clause 41 72) of the Income Tax Act). Income tax 7% has to be withhold on dividends paid to both resident and non-resident natural persons.
International tax treaties may exempt a non-resident natural person from paying withholding income tax on dividends:
exempt from income tax (the United Arab Emirates, Bahrain, Georgia, Jersey, Cyprus, the Isle of Man and Mexico are the states, the residents of which are exempt from income tax being deduced from their dividend payments), or
reduction of income tax rate to 5% (Bulgaria and North Macedonia are the states, the residents of which will receive dividend payments at a tax rate of 5%).
How should dividends be declared in Form TSD Annex 7 and Form INF 1?
A resident company declares dividend payments taxed at a lower rate and at a standard rate in Form TSD Annex 7 and Form INF 1.
The e-MTA will show the following current indicators necessary to be filled out on Form TSD Annex 7 “Calculation of distributed profit in order to apply lower (reduced) income tax rate”:
- amount of profit taxable by a reduced income tax rate;
- amount of profit distributed in the current calendar year (for example, in 2018);
- distributed profit taxed at a reduced income tax rate in the current calendar year;
- net balance of amount allowed to be taxed at a reduced income tax rate in the current calendar year.
The e-MTA allows companies to view their data. While taxing dividend payments, the application of lower tax rate is mandatory.
Filling TSD Annex 7, the company declares the total dividends under code 7008, the dividends paid at a lower tax rate under code 7009 and dividends paid at a standard rate under code 7010.
When submitting dividend payments under code 7008 in the e-MTA, the application of Form TSD Annex 7 will automatically distribute the dividend payments between code 7009 for the lower tax rate and code 7010 for the standard tax rate.
The dividend income of a natural person and the income tax paid on the dividend income are declared on Form INF 1. Form INF 1 indicates the dividends paid with the reduced income tax rate as “MDK” and the dividends paid with the standard tax rate as “DK” under code 13050.
The payment type “MDK” is used to declare the gross amount of dividends paid to natural persons on Form INF 1 under code 13060, the withheld income tax rate under code 13073 and the withheld income tax under code 13074.
The natural person receiving such dividends taxed at a reduced income tax rate (14/86) in the hands of the company, has to pay income tax at a rate of 7% in addition. It has to be withheld by the payer. In the case of non-resident natural persons, it is possible that due to a tax treaty, the receiver of dividends may reduce the withhold tax rate (0% or 5%) according to the country issuing his/her certificate of residency.
In the e-MTA, the application of Form INF 1 will automatically calculate the income withholding tax of 7% from the dividend income (gross) paid to a natural person.
To declare the dividend income of a non-resident in Form INF 1, the person has to have an Estonian personal identification code or a non-resident registry code issued by the Estonian Tax and Customs Board. The non-resident registry code is possible to be obtained through the e-MTA (“Registries and inquiries” > “Registration” > “Non-resident registration”) or by sending an application for registering of a non-resident recipient of payments to the Estonian Tax and Customs Board.
How to apply the exemption method for the dividends subject to a lower tax rate?
The company declares received and taxed at a lower income tax rate dividends on Form TSD Annex 7 part II under code 7210 as income type 723.1. When a company pays out the received dividends of the reduced tax rate dividends (from code 7302), these dividends have to be declared under code 7311.
As in paying dividends at a standard tax rate, the exemption method can be applied provided that the company receiving and forwarding dividends holds at least 10% shares in the dividend payer. The difference from distributing and forwarding dividends paid at a standard tax rate is grounded in the fact that if the dividend taxed at a lower tax rate is paid to a natural person, then the income tax at the tax rate of 7% has to be withheld.
How is dividend income on a nominee account taxed?
A nominee account is a securities account through which securities are held for and on behalf of another person (client).
In the case of a nominee account, the register does not include information on the persons who own the securities held in the nominee account, but the records of the nominee account holder and other data required by the Estonian Securities Register Maintenance Act are entered in the register.
The nominee account has an account operator, generally the bank.
Further information is available on the website of the Estonian Central Register of Securities (Nasdaq CSD).
When taxing a lower tax rate dividends, it is important to determine whether the securities held in the nominee account or holding, on the basis of which the payment of dividends are made, belong to a legal person or to a natural person.
If the securities held in the nominee account belong to a natural person, then paying or redistributing dividends taxed at a lower rate (14/86), has to be withheld income tax 7% in addition.
In the cases of both resident and non-resident natural persons, the income tax payable on the dividends may be considered for the purposes of declaring the individual income of the natural person. For this purpose, the recipient of the dividend payment shall be personalized and declared in accordance with the Form TSD Annex 7 and Form INF 1.
In case of a non-resident natural person, the tax agreement and the residence certificate of the recipient of dividend income submitted to the Estonian Tax and Customs Board may reduce the rate of income tax (0% or 5%, respectively) subject to withholding. To this end, the recipient of the dividend must also be personalized and declared in accordance with income tax return Annex 7 and Form INF 1.
If it is not known at the time of the dividend payment whether the securities held in the nominee account belong to a legal person or a natural person, then a further 7% income tax withholding is required for the payment of dividend with a lower tax rate.
Therefore, it is very important to inform the bank account operator and/or issuer who holds the securities in the nominee account before paying out the dividends.
Once the data is known, the payments of dividend can be immediately and correctly declared. If the information becomes known later, the issuer has the right to correct the returns about the dividend payments and to correctly declare the information with corrections in Form TSD Annex 7 and in Form INF 1.