Estonia’s personal business account is no tax miracle

The summer of 2018 will see the introduction of a super-simple tax regime for one-man businesses – but the details of it undermine Estonia’s reputation for clever and efficient solutions, Andrei Tuch writes.

When Jüri Ratas’s left-leaning coalition took over in Estonia a year ago, the most immediate and impactful initiative was a series of changes to the country’s famously straightforward tax code. But while changes to the income tax credit have generated a lot of confusion, another policy seems on the surface to be tailor-made for the sort of skill-based small businesses that the country’s e-residency programme is trying to attract - writes estonianworld.com.

The entrepreneurship account (ettevõtluskonto) is a new concept, a special type of bank account opened for an individual person with no corporate status. Any money deposited into that account is subject to an automatic deduction of 20% (up to a total of €25,000 a year, and 40% for anything above that). The deduction goes to the tax authorities, and then the state has no more questions to you regarding that income. If at least €1,300 a month comes into the account, you are even eligible for national health insurance.

The downside is that you cannot write off your business expenses – but a professional services provider, who rents out their time, knowledge and skills, the digital nomad from the e-residency recruitment posters, wouldn’t be put off by that.

Given that e-residency is an individual, not corporate status – starting a company as an e-resident is easy but not mandatory – the self-evident question is: can an e-resident open an entrepreneurship account? Looking at the law as written, it seems that the answer is yes (and curiously, this type of account can be offered by any bank in the European Economic Area, not just in Estonia). But when you start looking into the details of how operating under this regime would work, you soon find where the other shoe has dropped.

The key aspect is a small change to the Income Tax Act, saying that an invoice paid under this scheme is not a tax-deductible business expense. (It’s often said that Estonia has no corporate income tax, but that’s not quite true: the tax on distributed profits is kept equivalent to personal income tax.) So if an individual uses an entrepreneurship account to provide services to a company, the invoice amount is taxed at 20% on the company’s end, in addition to the 20% automatic deduction on the individual’s end.

The reason for this non-obvious provision is understandable – it is a safeguard against businesses “optimising” their payroll taxes by having employees just use entrepreneurship accounts instead of employment contracts. From the viewpoint of revenue base management, it makes all the sense in the world, it’s an elegant and low-maintenance solution for preventing tax avoidance.

An additional administrative burden

However, from the policy viewpoint, it massively diminishes the impact and value of the entrepreneurship account as a concept. This company-side tax is applied selectively – yes on services, no on sales of physical goods. But as the scheme pointedly does not allow the individual to write off any material costs, it was always much less useful for a manufacturing or trading business.

As a freelance, part-time provider of professional services – in my case, translation – my fixed costs are near zero. I am happy enough swallowing the amortised cost of my computer and the electricity it uses, if in return I get a hassle-free 20% tax rate instead of the usual payroll-plus-VAT of an invoice issued through a friendly translation agency.

(Currently, a net payment of €100 to me is approximately a €217 invoice to my customer. Whether the extra money would be a reduction in my rates or would go straight into my pocket, is for me to negotiate with my customers – but an economic boon in any case.)

However, this kink in the entrepreneurship account scheme not only raises the total tax wedge on professional services to something far higher than the headline figure, it actually creates an additional administrative burden on the paying legal entity. A pre-2018 transaction may come with a high tax burden, but it has the advantage of being very simple for the customer: pay the invoice and you’re done, no more obligations on your end, and you can write off the VAT. From next year, if I suggest to a customer that I invoice them as an individual using my entrepreneurship account, they have to get their bookkeeping to represent that money differently from every other business expense. Not to mention the lack of enthusiasm on the part of Estonia’s retail banks to invest in developing these new accounts – the law does not require anyone to offer them.

Because the business-side tax does not apply to sales/purchase transactions, we may see a resurgence of “optimised” deals where I, as a translator, sell to my customer a physical CD containing a text file, and the rights to the translation are included for free.

The tax is also not applied to transactions (of any kind) between physical individuals. This was the original impetus behind the scheme – a way to legalise payments for odd jobs, like fixing a broken pipe or doing some construction work on your house. But such transactions will remain essentially untraceable to the Tax Board, and since the scheme also does not allow the plumber/builder to write off the cost of his tools and materials, there is no incentive to use the account and pay any tax at all, instead of cash-in-hand work as happens now.

Nor is the scheme useful for invoicing companies outside Estonia. Yes, you could absolutely write a contract that says, “I am responsible for all my tax obligations stemming from the receipt of this payment”, but a cornerstone of e-residency is that profit must be taxed where it’s generated, not where the recipient is registered. Estonia has – rightly – been very careful to not turn into an electronic tax haven. If a German customer pays into your Estonian entrepreneurship account, Estonia might be satisfied with taking 20% off the top, but that doesn’t mean Germany’s tax authorities are done with you.

The entrepreneurship account scheme could have been the killer feature that made e-residency a lot more attractive – if not for its practical implementation. Alas, the real world strikes again.

The opinions in this article are those of the author. The cover image is illustrative (Shutterstock).

Read more news of Tallinn on our site.

estonianworld
Estonia’spersonalbusiness notaxmiracle
If you notice an error, highlight the text you want and press Ctrl + Enter to report it to the editor
I recommend
No recommendations yet

Comments

Post your comment to communicate and discuss this article.

Society
At the Riigikogu sitting beginning at 10:00 EET on Tuesday, Prime Minister Jüri Ratas (Centre) will provide an overview of the activities of the Estonian government in the implementation of EU policies. Chairman of the European Union Affairs Committee of the Riigikogu Toomas Vitsut (Centre) will also deliver a report, and representatives of the Riigikogu's parliamentary groups will present their positions, according to a Riigikogu press release. In his rep...
Society
Chairman of the opposition Conservative People's Party of Estonia (EKRE) Mart Helme has called on Helir-Valdor Seeder, chairman of junior coalition member Pro Patria to tie the latter's support for the state budget bill to a decision by the government not to support joining the UN Global Compact on Migration. "Pro Patria still has the chance to demand from its coalition partners [the Center Party and the Social Democratic Party (SDE)] that its stances be t...
Society
Political news portal Politico published its list of the most influential people in Europe next year last week, with fifth place going to Estonia’s cybersecurity ambassador Heli Tiirmaa-Klaar. Tiirmaa-Klaar takes her place in between well-known Europeans, after Secretary General of the European Commission Martin Selmayr and in front of Ukrainian presidential hopeful Yulia Tymoshenko. Politico believes Italy’s populist interior minister Matteo Salvini will...
Society
Representatives of the transport ministries of the Baltic states, Finland and Poland who met in Tallinn on Monday were of differing opinions regarding whether to remain in summer or winter time once the practice of changing the clocks twice per year comes to an end. A recent survey indicates that more than half of Estonians would prefer permanent summer time. Estonia, Latvia, Lithuania, Finland and Poland jointly acknowledged that the agreement to end the...
Society
Ida-Viru Central Hospital is having trouble with patients not showing up to scheduled specialist appointments. To combat this issue, beginning next year, the hospital will start charging visit fees for no-show appointments as well. Last year, patients at Ida-Viru Central Hospital failed to show up for scheduled appointments a total of nearly 9,500 times, accounting for some 5% of all hospital visits, reported ETV news broadcast Aktuaalne kaamera. "Patients...
Society
Tallinn city government finds that it is not reasonable to relocate the Tallinn Bus Station to the Ülemiste district near Tallinn Airport and that it should be left in its current location on Lastekodu Street. In connection with the preparation of an architectural idea competition and the drawing up of a detailed plan for the Ülemiste terminal in the framework of the Rail Baltic railway project, the city is drawing the attention of the Ministry of Economic...
Society
A criminal investigation has been launched into the Medita Clinic, one of the largest private sector bidders in public procurement tenders in the health sector in Estonia. The Northern District Prosecutor's Office initiated the investigation in accordance with the Penal Code section concerning the transmission of false information, according to ETV investigative show Pealtnägija. The Medita Clinic was the largest private provider of specialist medical care...
Society
The Tax and Customs Board (MTA) has signed an agreement with Online accommodation and hospitality marketplace Airbnb which enables hosts to automatically report earnings. The MTA and Airbnb held a joint press conference on Wednesday, announcing the agreement's signing as well as the new system and its rationale. The main premise, according to MTA deputy director Rivo Reitmann, is to keep things simple, meaning that Airbnb hosts who declare their income in...
Society
Luminor notified its clients that as of 1 January, the bank will be closing the accounts of Estonian e-residents that fail to fulfil due diligence. Hannes Oja, head of Anti-Money Laundering at Luminor Estonia, said that based on the Money Laundering and Terrorist Financing Prevention Act, banks are required to update the data of all of their customers, writes daily Eesti Päevaleht (EPL). As a result, all existing clients have to do so themselves on a regul...