Taxation of dividends

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) (subsection 2 of § 18 of the Income Tax Act).

The resident company pays income tax at the rate of 22/78 on the distribution of profit or dividends (basis: subsection 1 of § 50 and subsections 1 and 1¹ of § 4 of the Income Tax Act).

Income tax calculated on a dividend and possible exemptions and deductions (subsection 1¹ of § 50) and subsection 5 of § 54) 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).

As a general rule, a company pays dividends in cash, but in practice there are also situations where the money is not transferred but dividend debt is converted into a long-term interest-bearing loan liability. For example, a private limited company does not make a distribution of dividends in cash and a shareholder does not grant a loan in cash, but the private limited company and the shareholder enter into a loan agreement on the basis of which the dividend debt is converted into a loan and the private limited company repays the loan to the shareholder with interest.

Such a situation is subject to income tax. The date of the source document (certifying the economic transaction in company's accounts, e.g. a loan agreement concluded with a shareholder) and the accounting entry (when the company considers the dividend debt to have been paid and records the loan liability to the shareholder) should be considered as the date of payment (disbursement) of the dividend. The company is required to declare and pay income tax on the basis of form TSD Annex 7 and INF 1 by the 10th day of the calendar month following the month in which the dividend was paid.

In practice, there are also situations where a company makes a dividend payment in a non-monetary form, e.g. securities, real estate or other assets, and the date of the dividend decision, the date of transfer of the real right of ownership of the property and the date of transfer of the rights related to the possession of the property are in different calendar months.

The tax authority is of the opinion that the date of payment (distribution) of the non-monetary dividend should be deemed to be the date of transfer of assets, i.e. the date of transfer of ownership. Here, too, the date of the source document certifying the economic transaction (e.g. a contract for the transfer of securities, real estate or other assets) and accounting entry on which the company deems the assets to have been transferred is important. In other words, the moment when, for example, the assets of a private limited company decrease and the assets of a shareholder increase.

The position of the tax authority is based on the judgments of the administrative chamber of the Supreme Court (RKHK 3-3-1-28-16 pt. 11, RKHK 3-3-1-78-16 pt. 24), from which it follows that the prerequisite for classifying a payment as a dividend of a shareholder of a company is the making of a payment in monetary or non-monetary form to that person. It follows from the judgement that the disbursement can be identified in a situation where the assets of the company decrease and the assets of the shareholder increase.

Non-monetary dividends are taxable at fair value. The guidelines of the Accounting Standards Board entitled “Financial Instruments” (RTJ 3, pt. 54) provide that if dividends are not paid in cash but are paid by the transfer of other assets, the dividend liability is recorded at the fair value of the assets transferred when the dividends are declared. At the reporting date and the date of the transfer of assets, the fair value of the assets is measured and, if modified, the balance sheet value of the dividend liability is adjusted. The effect of changes in fair value shall be reported as an adjustment to “Retained earnings”. When assets are transferred, the difference between the balance sheet amount of the assets transferred and the balance sheet amount of the dividend liability is recorded in the income statement.

Therefore, the tax authority also considers the date of payment (distribution) of the non-monetary dividend to be the date of transfer of ownership, i.e. the moment when, for example, the assets of a private limited company decrease and the assets of a shareholder increase. The company is required to declare and pay income tax on the fair value of the assets on the 10th day of the calendar month following the month in which the non-monetary dividend was paid, in accordance with form TSD Annex 7 and INF 1.

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 (subsection 68 of § 61 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, Israel and North Macedonia are the states, the residents of which will receive dividend payments at a tax rate of 5%).

A resident company declares dividend payments in form TSD Annex 7 and form INF 1.

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-services environment 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-services environment e-MTA (select in the menu: 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.

As in paying dividends at a standard tax rate, the exemption method can be applied until December 31, 2024 to a dividend taxed at a lower tax rate, 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.

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) (in Estonian).

When redistributing dividends taxed at a lower tax rate, it is important to find out whether the securities in the nominee account, i.e. the holding on the basis of which the dividend payment is made, belong to a legal person or a natural person.

If the securities in the nominee account are held by a natural person, income tax of 7% must be withheld upon payment or redistributing of dividends taxed at a lower tax rate (14/86).

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.