In a situation where a taxpayer could choose between two transactions, the law does not require the taxpayer to choose a transaction which would bring along the largest amount of payable taxes. Taxpayers have the right to organise their activities in a manner which would entail the smallest possible tax burden and the state cannot reproach them for it. The only issue can be about distinguishing the permitted solutions of tax optimisation from obtaining dishonest tax concessions.
The Supreme Court has recently made three ground-breaking judgments (3-2-1-82-14, 3-3-1-25-15 and 3-3-1-12-15) that concern the social tax optimisation (reduction) solution that is being quite widely used in Estonia – provision of management or consultation services through companies (i.e. acting through private limited companies). Whereas all the recent court disputes have ended to the detriment of taxpayers, it is worth analysing where the boundary between permitted tax optimisation and obtaining dishonest tax concessions lies.
This kind of provision of management and consultation services through companies is actually nothing else than optimisation of social tax and social security contributions. As the social tax is not imposed on the payments of dividends and the respective tax exemption does not depend on how the profit underlying the dividends has been earned, companies have terminated ordinary agreements regulating employment relationships with their executive staff, and have instead entered into agreements on the provision of services with the private limited companies that have only just been founded by the same executives.
The tax authority has tried to reassess these dividend payments of private limited companies as concealed salary payments for years, but so far the courts have not agreed with such interpretation. However, in its most recent judgments, the Supreme Court accepted the new legal construction proposed by the tax authority – imposition of employment-related taxes on the amounts paid under agreements for management and consultation services.
The tax authority is primarily interested in requalifying the agreements for management and consultation services as employment contracts in case the parties continue performing obligations deriving from previous employment contracts, and the private limited company that provides services does not declare the salary or remuneration of a management board member, but declares only dividend payments.
It means that the tax authority has concluded that such management and consultation services are ostensible, as these services are not provided by the companies that have entered into the respective agreements, but by the management board or supervisory board members of the respective private limited companies as natural persons.
The Supreme Court confirmed such position and stated that the actual contents of the transactions may be employment relationships and board member relationships between the company and natural persons, in particular under the following circumstances:
- The companies providing services issue invoices on monthly basis and generally in the same amount;
- The companies provide services only or mostly to one recipient of the services;
- The service provided to the recipient by the members of its management board consists in consulting the recipient regarding the tasks that are performed by them as management board members; and
- The agreements for the provision of services have elements that are characteristic of employment contracts.
Naturally it does not mean that in the future additional tax obligations could be imposed solely on the basis of the fact that a legal person provides management or consultation services. The Supreme Court explained that provision of management services through companies should be regarded justified for example in the following cases:
- A separate holding company has been founded for the administration of a group of companies, and the duties of the employees of the holding company include management or consulting of the members of the whole group;
- If the management board or supervisory board members are not engaged in the managed company on daily basis and the expenses necessary for the performance of their professional duties are covered and the work equipment is provided by the company providing the services;
- If the member of the management body has been appointed for a short period of time or if he/she offers management services to many companies (especially in case of bodies substituting for the management board, like for example a liquidator or trustee in bankruptcy).
Therefore, it is basically possible to provide management and consultation services through a company, but it is legally not acceptable if an unfair tax concession is obtained through such transactions. If an unfair tax concession is not obtained, it is legal tax planning and the tax authority cannot reassess the transactions. The message given by the Supreme Court is quite clear – providing management and consultation services through one-man private limited companies will generally bring along dishonest tax concessions and is not legally permissible.