On January 1, 2018, a new taxation act will enter into force in Estonia – the Entrepreneurial Income Simplified Taxation Act (hereinafter the “Act”). From an IT point of view, the Act will create a new and innovative automatic mechanism for natural persons in the calculation and payment of taxes. The main concept of the Act is that natural persons can set up an entrepreneurial income bank account, where the taxation amount is calculated automatically and transferred to the Tax Authority without the natural person having to physically make or authorize any transfers. However, use of this new account may be limited in practice.
Positive Aspects
The Act will simplify all taxation procedures for natural persons offering services or goods in their own name. They will not be obliged to hire accountants or maintain books, as everything will be done automatically.
How does it work? When a natural person provides services in his/her own name or sells goods, then he or she can open a specific account at a bank. Notably, the person should indicate that only the proceeds from his/her provision of services or sale of goods will be directed to that account.
After opening that bank account the person will direct the same bank to inform the Tax Authority about the income in the account. The Tax Authority then will calculate the tax amount and the bank will transfer the appropriate amount directly to the Tax Authority. Thus, the natural person does not need to hire an accountant nor submit any tax declarations to the Tax Authority. The entire process of taxation is automatic and does not need extra input from the natural person. Even the transfer of the tax will be made automatically.
The Downsides
While the concept, which is aimed at reducing administrative burdens, seems very convenient and attractive, the Act has some serious flaws as well.
First, the natural person is not entitled to deduct any costs involved in the provision of services or selling of goods. This makes it economically less attractive compared to other enterprise forms, where costs can be deducted from profits. According to the legislators, therefore, the Act may have a positive impact only for approximately 1200 natural persons.
Second, it will be available only to a small group of natural persons, as the tax rate is 20% if the services provided or goods sold do not exceed EUR 25,000. Where the supply is between 25,000 and 40,000 the tax rate is already 40%, and once the supply exceeds EUR 40,000 per calendar year the person is required to register as a company and to register as VAT-liable. Thus, the beneficiaries actually constitute a relatively small group.
Third, if there are mistaken transfers to the entrepreneurial income account, then these would still be automatically taken into account and taxes would be paid from these amounts. In order to get these mistaken amounts back, the person would need to go through the lengthy process of taxation inspection and prove to the Tax Authority that the amounts were paid in error.
Finally, one of the biggest downsides would be the fact that if the natural person is providing services to a legal person, then a risk of double taxation occurs.
All these elements may reduce the positive impact that the Act could have in the entrepreneurial activities of natural persons.
Conclusion
The entrepreneurial tax account and the simplified taxation Act will simplify the calculation and declaration of taxes for natural persons who provide services or sell goods. From an IT point of view this is clearly a new, unique, and innovative option. At the same time, this concrete act contains many substantive downsides. Therefore we strongly suggest that before a person opts to create this account, he or she make sure that all the positive and negative aspects are weighed thoroughly in order to avoid any negative surprises.
By Annika Vait, Partner, and Epp Lumiste, Attorney at Law, Law Firm Alterna
This Article was originally published in Issue 4.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.
