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Restriction on deductions from taxable income received abroad

Upon taxation of income received abroad two methods may be used: exemption method or credit method.

  1. In case of the exemption method a person is obliged to declare all income subject to income tax but without any subsequent tax liability in Estonia.
  2. Upon the credit method the income received abroad shall be taxable in Estonia but taking into account the income tax paid or withheld abroad according to the conditions specified in § 45 (2 to 6) of the Income Tax Act.
     

1. Exemption method (income to be declared in Table 8.8)


A resident natural person, who received at least 75% of his or her taxable income abroad during the period of taxation and a part of this income or gross income is exempt from income tax in Estonia, may make the deductions allowed under Chapter 4 of the Income Tax Act on his or her income taxable in Estonia in proportion to the Estonian income in the taxable gross income of the same period of taxation.

Taxable income means a person's income before deductions that is taxable in Estonia or in the country where income was derived.

Example

In 2018, a resident natural person received dividends abroad in the amount of 6000 euros which were taxed abroad and which are exempt from income tax in Estonia. In Estonia the person earned rental income in the amount of 2000 euros. The person's taxable gross income is 8000 euros, where 6000 euros of this amount were earned abroad. The proportion of deductions is calculated as follows: Estonian income is divided to gross income, hence, 2000 ÷ 8000 × 100 = 25%.
In this case the person may make deductions of up to 25% from his or her Estonian taxable income. For example, in the period of taxation, the amount of basic exemption is 6000 euros, and 25% of this amount is 1500 euros. Consequently, from the income taxable in Estonia (2000), the person may deduct the basic exemption in the amount of 1500 euros, thus leaving 500 euros taxable in Estonia.

The abovementioned restriction does not apply to the unemployment insurance premiums withheld, contributions to the mandatory funded pension withheld and mandatory social security taxes and contributions paid in a foreign state, if these are paid on account of the income subject to income tax in Estonia.
 

2. Credit method (income to be declared in Table 8.1)


A person, who has received at least 75% of his or her taxable income abroad, may select the credit method to be used with regard to the person's gross income in the period of taxation. In such case the restriction referred to in the clause above is not applicable, all income earned abroad is added to the person's Estonian income, and the income tax paid or withheld abroad (within the rate of income tax applicable in Estonia) shall be deducted from the income tax payable. It means, if the amount of income tax paid abroad is less than 20%, a person is obliged to pay in Estonia the difference of income taxes paid abroad and in Estonia. However, if the amount of income tax paid abroad exceeds 20%, in the accounting for taxation purposes only 20% shall be taken into account. Income tax overpaid in a foreign country shall not be refunded in Estonia.
 

28.12.2018