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How to distinguish and tax the remunerations of a shareholder, a member of the management board and an employee of a private limited company

The objective of this explanation is to provide a set of guidelines based on cases of payment of salary and dividends, existing in practice, in order to distinguish between active and passive income, and to ensure equal treatment of all taxpayers when taxing employment income with social tax and contributions.

Typical cases

  • There are cases in practice where a company's sole shareholder, management board member and employee (in one and the same person) contributes to the business of the company, including: provides services and/or sells goods. However, the company does not pay him or her salary taxable with social tax or payments or pays it at the minimum wage rate even though their contribution and the scope of the company's business assume a significantly higher salary. The low salary is compensated with a one-time or regular, often even monthly dividend payment, which, unlike employment income, is not subject to social tax or payments.
  • There have been situations where such company has no other employees, as well as situations where the company has some salaried employees other than the management board member but the management board member who is a sole shareholder, actively contributing to the company's business, receives significantly lower employment income than other employees because unlike the others he or she also receives dividend income.

  • Unfortunately, there are also a number of cases where an employee, sole shareholder and management board member(in one and the same person) does not receive salary payouts from the company but the company nevertheless declares and pays social tax on the monthly rate (500 euros per month in 2019) as if he or she were an employee to provide with health insurance.

  • There are also cases where a person is employed at another employer and being paid market rate salary there or a person is a pensioner who receives a pension while also actively contributing to his or her company's business. As the person has health insurance from employment at the other employer or from the state as a pensioner, he or she considers it unnecessary to pay himself or herself a salary from his or her company and thereby affords his or her company an unjustified competitive advantage over other similar companies.

The purpose of collecting social tax is to receive income for providing state pension insurance and health insurance. Social security functions on the principle of solidarity – social tax is paid on employment income and received funds are used for pensions and medical expenses. A person whose employment income was subject to social tax gets a benefit in exchange in case of an insured event (for example, disease, reaching pension age). When employment income is replaced by dividends, the social tax expense is saved, however social benefits are consumed at the expense of other taxpayers. The tax authority is of the opinion that this is neither justified nor fair to other taxpayers who pay social tax and contributions on salaries according to market conditions.

If a person earns monthly gross minimum wage of 540 euros, the employer's payroll expense is 722.52 euros (social tax 178.20 euros, employer's unemployment insurance premium of 4.32 euros). If the person further earns a monthly dividend for employment of, for example, 1,000 euros, the company's income tax expense on dividends amounts to 250 euros. A shareholder is entitled to dividends but dividend must not replace salary.

However, if a person were to receive a proper employment income on market conditions and according to actual contribution in the amount of 1500 euros, the employer's payroll expense would amount to 2007 euros (social tax 495 euros, employer's unemployment insurance premium of 12 euros). Comparing the expenses makes it clear that a dividend payment results in a monetary gain via tax savings but payment of dividends instead of employment income is not right.

In order to ensure uniform taxation of everyone's employment contribution and fair competition, it is important to keep in mind that for active engagement such as performance of official or work duties, corresponding management board member remuneration, employment income, service fees or other remuneration has to be paid depending on its type. Shareholders are also entitled to passive ownership income (dividends) but employment income received for employment activities have to be subject to all labour taxes.

For taxation purposes, a distinction has to be made between:

  1. employment income (incl. management board member remuneration and employment income)
  2. fringe benefits
  3. dividends

We will examine them closely below.

Management board member's remuneration

Contracts entered into in economic or professional activities are presumed to have a price (subsection 28 (1) of the Law of Obligations Act). Based on the above, unless otherwise agreed by parties, a management board member of a company can expect to have the right to remuneration for management of the company[1].

Subsection 28 (2) of the Law of Obligations Act provides that where a contract does not determine the price or a method for determining the price and the nature of the contract or other circumstances do not dictate the price or the method of determining the price, the price to be paid shall be the price generally charged at the time of entry into the contract at the place of performance of the contract for the performance of such contractual obligations or, if no such price can be determined, a price reasonable under the circumstances.

Upon establishing the procedure for remuneration of the members of the management board and the amount of fees and other benefits, and entry into contracts with the members of the management board, the shareholders or the supervisory board shall ensure that the total amount of the payments made by the private limited company to the members of the management board are in reasonable proportion to the duties of the members of the management board and the economic situation of the private limited company (subsection 1801 (2) of the Commercial Code).


The payment of salaries and other benefits is regulated by sections 29–41 of the Employment Contracts Act. Salaries are subject to income tax and social tax and, in most cases, also unemployment insurance premiums and funded pension contributions.

The tax authority also assumes for salaries under an employment contract that the customary salary for performance of duties as per the contract has to be paid, or in the absence thereof, a reasonable salary according to circumstances. A customary salary may be a salary commonly paid for performance of duties similar to those specified in a specific employee's employment contract or a customary regional salary for performance of such duties.

We recommend using public data sources for determining the customary salaries paid in various industries. For example, we publish on our web page "Business statistics by local authorities" (in Estonian) various business statistics that we update monthly. Publication of statistics gives employers an opportunity to compare salaries, revenue, number of employees, etc. with companies of the same industry across local governments and counties or nationally and helps to ensure fair competition and improves Estonian business transparency.

The statistics are based on data declared to the Estonian Tax and Customs Board.

Information on commonly paid salaries may also be found from the web page of Statistics Estonia regarding information on average salary, which the Statistics Estonia collects, analyses and regularly publishes.

Fringe benefits

Non-monetary employment-related benefits granted to management board members or employees, which have a monetary value for the employee, have to be deemed and taxed as fringe benefits. The price of a fringe benefit is the common value of a benefit granted to an employee, defined in section 65 of the General Part of the Civil Code Act as the usual value of an object or average local selling price (market price).

Fringe benefits are also subject to income tax and social tax.


A shareholder is entitled to dividends but the dividend may not replace salary. Management board members and employees have to receive management board member remuneration or salaries for their employment-related work. If a management board member receives remuneration and/or an employee receives salary duly corresponding to the management board member’s duties or employee’s duties and the company's financial condition, the shareholder is entitled to as much in dividends as the company’s profit allows.

Dividends or salary?

Tallinn Circuit Court made a decision on 4 March 2009 (decision 3-08-364 concerning OÜ Wasp Project) ) over a dispute on the principle as to how large is a company's discretion over the nature of distributions in a situation where a single natural person is the company's shareholder, manager and employee.

The Circuit Court determined that companies have to be treated equally on tax liabilities. Granting tax advantages to companies, where employee-shareholders are paid salaries in amounts significantly below the labour market rates for such jobs, is undue. Dividends may be deemed salary income if a management board member is not paid remuneration or an employee is not paid salary under employment contract at all or these are paid in very small amounts. Payment of dividends to shareholders is completely legal. However, in cases where a shareholder participates actively in the substantive business of a company and this results in corporate profits, the result of paying unduly low salaries for such work is aimed at reducing tax liabilities and leads to questions as to the applicability of section 84 of the Taxation Act.

Section 84 of the Taxation Act provides that if it is evident from the content of a transaction or act that the transaction or act is performed for the purposes of tax evasion, conditions that correspond to the actual economic content of the transaction or act apply upon taxation.

The purpose of the economic substance identification as contained in section 84 of the Taxation Act is to avoid a situation where tax liabilities arise merely based on the legal form that transaction counterparties assign to the transaction. The condition for leaving aside the legal form of a transaction for taxation purposes is that parties have selected a legal form inappropriate to the economic substance of a transaction for purposes of tax evasion, thereby achieving the same economic result but more favourable taxes.[2]

The Circuit Court determined that the size of tax liabilities have to be predictable. A company has to have a point of reference to use for evaluation of how much the salary of an employee who is a shareholder should be for the tax authority to accept it. The tax authority cannot obligate all companies, despite the salary flexibility of the labour market, to pay at least the average salary to shareholders. There is no reasonable explanation for why the salary of an employee who is a shareholder has always to be such a fixed value if a below-average salary paid for the same work on the labour market is competitive.

Therefore, a shareholder does not always have to receive a salary calculated based on the average rate or at a fixed rate because salaries are dependent upon industry and region, as well as a specific company's financial condition, a person's job or duties, experience, skills, education or other circumstances.

The statistics published on the websites of the Estonian Tax and Customs Board and Statistics Estonia are a point of reference to help estimate whether the salary assigned to a shareholder by a company approximates the average salary paid in the same industry and region. However, significantly lower salaries have to be justified.

If shareholder(s) are concurrently in a management board member's and/or employee's role, the salary is at or approximates the commonly paid level in its industry, the tax authority does not see any tax risk and sees no reason to reclassify dividends to salary. However, if a sole shareholder or shareholders receive significantly lower salaries compared to the level commonly paid in their industry and distribute company profits as dividends, it entails a tax risk that requires detailed analysis as to whether payment of a significantly lower salary or minimum wage is justified or not. If it is determined that a paid dividend has replaced salary, the tax authority has a basis for reclassification of dividend income to salary and applying social tax and payments.[3] Reclassification also has to take into account the potential period selection issue. If dividends are paid infrequently or as a one-off, there may be a need to determine which period's unpaid salary the dividend replaced. If dividends are paid frequently or, for example, monthly, the view is likely to be that with high probability such dividend replaces the same period's unpaid salary.

In situations where it is difficult to separate a person's job contribution at various related companies (for example, for groups of companies it is difficult to separate contribution in parent or subsidiary businesses), it is important that a person receives market-rate salary from at least one company (for example, a parent company).

Examples of cases
Example 1

An individual is employed full-time at his/her own or a third party's company A as an employee or management board member. He/she receives the market-rate salary in Estonia, which is declared and taxed as salary. At the same time, he/she is a sole shareholder and management board member in company B, where he/she invests in shares, rents two apartments, etc. Personal expenses are not charged to the company, the employer owns no vehicles. The company distributes dividends annually in case of profits that may be a comparable amount to an annual salary.


Regardless of the fact that a person receives a reasonable salary from full-time employment, his/her employment contribution to their company B must also be evaluated. It is understandable that a day contains 24 hours and if a person is employed full-time at his/her main job, he/she cannot contribute to company B at the same rate. Moreover, holding securities or renting out real estate may not even need day-to-day involvement. Nevertheless, a specific person's employment contribution has to be estimated using as comparison the salary at which the person would agree to perform the same job or service to an unrelated third party. This may not always be full-time or part-time employment but may also be performing services under the Law of Obligations. Even in the specific case the person may perform services to his/her own company concurrently with his/her main job and be reasonably remunerated for it (it may be several times less than their full-time pay), taxed as salary including all taxes on labour and the remainder of profits may be distributed as dividends. However, in the stated example it has to be noted that the stated activities of company B are such where a private individual normally is not subject to social tax (gains on sale of property, rent). As such types of income are not salary from active activity, this will likely not prompt a salary versus dividend type of situation and reclassification will be unnecessary.

Example 2

A person is a sole shareholder and management board member at companies A, B and C, all engaged in similar businesses. As the person acts as a general manager in companies B and C, he/she receives a proper salary from such companies corresponding to the scope of duties, also taxed as the salary. The benefits granted to the person are taxed as fringe benefits. However, the person is not paid a salary from company A because he/she is not employed there, but he/she does receive dividends.


As the person's related companies are engaged in the same or similar businesses and the person's day-to-day contributions cannot be split between different companies, it is important that the person receives the reasonable salary for employment at companies B and C, taxed with all labour taxes as the salary. If a person is not active in company A, there is no reason to reclassify the dividend of that company as the salary.

The same answer will apply to a situation where a person is a sole shareholder in company A and its subsidiaries are B and C.

Example 3

A person is a sole shareholder and management board member in company A. Company A owns subsidiaries B and C, which pay management fees to company A. Management services are performed day-to-day by the same natural person. The person is not on the management board of companies B and C. The person is employed in company A and receives salary corresponding to local conditions and work contribution and also regularly receives dividends in excess of annual salary.


If a person's salary corresponds to his/her work contribution and the person would have also worked at companies B and C or unrelated companies at the same pay, no reclassification is necessary. The person may receive dividends in excess of his/her salary but it is important that the salary was fair or reasonable and salary is not paid in the form of dividends.

Example 4

A natural person is a pensioner and management board member and owner at company A. Due to his/her pensioner status he/she havs health insurance from the state and therefore finds it unnecessary to pay himself/herself a salary. The company's revenue is attributable to the person's active business contribution. The person sometimes pays dividends from accumulated profits.


The natural person's health insurance status is not relevant to decide whether the company engages in replacement of salary with dividends or not. If a person does not receive a reasonable salary from his/her employer that he/she would likely request if he/she worked for an unrelated company, there would very likely be a need to reclassify received dividends to salary subject to social tax and payments.

Example 5

A natural person is a builder and a full-time employee at a company not owned by him/her and he/she is also a management board member and the owner in another company that he/she uses to provide building services at nights, weekends and on holidays. As the natural person receives the market rate salary from his/her main job, he/she has decided not to pay himself/herself a salary from his/her company and sometimes allocates dividends to himself/herself from accumulated profits.


The natural person's adequate income from elsewhere is not relevant to decide whether income from his/her company are dividends or the salary. Instead, the decision has to be made based on whether income is from active work and whether a market-rate salary is assigned and paid for active work. At the same time, we highlight that salary on the side does not have to correspond to the average monthly salary of the same industry or region because he/she is not employed full-time but only in evenings, weekends and holidays.



1 Even if a management board member who is an owner representing both sides has decided not to pay the management board member's remuneration, in accordance with the law, it must be taken into account that this decision may be based on a desire to replace active work salary with dividends and this is unacceptable under tax law.
2 Tallinn Circuit Court decision 3-08-364
3 For similar reasons, considering the amount of all disbursements and expenses, the tax authority has basis for reclassification of non-business related expenses and distributions made by natural persons from company assets to fringe benefits.