Taking into account the nature and scope of the activities carried out by the Company, the extent to which its resources are utilised, and the nature of its business, the sale of car parts to a related party undoubtedly contributes to the creation of economic added value, and this value is by no means negligible.
Client's situation
Our client – the owner of a limited liability company operating in the wholesale of car parts – was planning to opt for the flat-rate corporate tax scheme (the so-called ‘Estonian CIT’). However, given that over 50 per cent of the company’s revenue was derived from the sale of goods to a related party, the client had doubts as to whether the company met the conditions for opting for this form of taxation.
This is because, pursuant to Article 28j(1)(2)(a) g of the CIT Act, a taxpayer whose revenue is derived more than 50 per cent from transactions with related parties may not be subject to lump-sum taxation if, in connection with those transactions, no economic added value is generated or such value is negligible.
It was therefore of key importance for the resolution of the case to determine whether the business activities carried out by the Company and the transactions it conducted with a related party resulted in the creation of economic added value.
The issue
DMS TAX’s task was to prepare an application for an individual tax ruling to be submitted to the Director of the National Tax Information Service, in which it would be confirmed that the Client’s sale to a related party generates significant added value and, consequently, does not preclude the possibility of utilising the Estonian CIT scheme
Our approach
Following a detailed analysis of the Client’s business model, we submitted an application to the Director of the National Tax Information Service requesting an individual tax ruling.
In the application, we demonstrated that the revenue generated by the Company from transactions with a related party constitutes revenue from transactions which generate economic added value, and are therefore not subject to the restriction set out in section 28j(1)(2)(g) of the CIT Act.
We emphasised that the Company carries out genuine and active business activities, has the necessary assets and appropriate human resources at its disposal, independently performs all functions related to its business activities, and bears the associated economic risks. We also pointed out that the sale of goods to a related party is carried out with a margin of approximately 15–17 per cent, which confirms that the Company’s role is not limited solely to acting as an intermediary in sales.
Consequently, we have demonstrated that the transactions carried out with the related party have a genuine economic rationale and result in the creation of economic added value which cannot be regarded as negligible.
Confirmation of DMS TAX’s arguments by the Director of the National Tax Information Service – a favourable individual interpretation
The Director of the National Tax Information Service (KIS) fully agreed with the arguments we put forward. The authority confirmed that, taking into account the nature and scope of the activities carried out by the Company, the extent to which its resources are utilised and the nature of its business, the sale of car parts to a related party undoubtedly contributes to the creation of economic added value, and that this value is not negligible.
Consequently, the authority confirmed that, despite deriving over 50 per cent of its revenue from transactions with a related party, the Company is entitled to opt for the flat-rate corporate income tax scheme.
What this means
The interpretation confirms that merely exceeding the 50 per cent threshold for revenue derived from transactions with related parties does not preclude the application of Estonian CIT. What is decisive is whether the transactions in question generate economic added value.
Thanks to this interpretation, the client has gained certainty regarding the option to opt for taxation under the Estonian CIT regime and assurance regarding the planned tax settlements.