Court Judgments

A liability decision annulled

The Supreme Court of Estonia annulled a liability decision issued by the Estonian Tax and Customs Board, delivering a new judgment in the appellant’s favor.

In its liability decision, the Tax and Customs Board had held the appellant jointly and severally liable for tax arrears that had been accrued on the basis of a company’s tax returns (for value added tax, income tax and social tax) during a period when the appellant had been a member of its board. Previously, the Harju County Court had terminated the company’s bankruptcy proceedings by abatement without declaring bankruptcy.

The tax authority had stated that the appellant was to blame for the fact that the company had been stripped of assets. While operating in insolvency circumstances and adopting cash transactions, the company had continued its activities under the appellant’s leadership, thereby violating the obligation to organize its business activities and, as a result of preferential treatment of other creditors, the obligation to pay taxes. In addition, the tax authority had claimed that the company’s continued operations in insolvency circumstances and its accumulation of tax liabilities (via cash transactions) had made its actions intentional, whereas its tax arrears could have been prevented, if the appellant had used at the right time the right methods to transform the company’s operations and had avoided cash transactions.

Although the lower courts had ruled that the liability decision should be upheld, the Supreme Court was of a contrary opinion. The Administrative Law Chamber of the Supreme Court based its judgment on the following:
–  The tax authority criticizes the appellant for the continuation of the company’s operations in insolvency circumstances, for the adoption of cash transactions and for a failure to transform or to dissolve its activities. However, only the shareholders of a private limited company have the competence to decide whether to transform or dissolve a company or not (Article 176(2) of the Commercial Code).

– If the tax authority establishes during its proceedings that at a certain point in time the company was insolvent, this claim must be substantiated accordingly and should include the analysis of its board member’s explanations and documents regarding insolvency. Liability decisions must be accurate, clear and reasoned. Obligations and their legal bases, violated by the board member, must be stated specifically and unambiguously. 

– There are no legal provisions that prohibit cash transactions. In addition, the use of cash does not mean that the amount of the company’s liquid assets has been reduced, if it has not been ascertained that financial assets have been drained from the company.

– The analysis presented in the liability decision fails to prove the appellant’s intentionality. The legal obligations that the appellant violated, together with possible steps that the appellant could have taken in accordance with laws and regulations, have not been listed in the liability decision. 

Country-by-Country reporting

It is vital to keep in mind that in six months’ time after the end of a financial year all members of a multinational enterprise group that are tax residents of Estonia will have to inform the Estonian Tax and Customs Board of the reporting entity for their group’s country-by-country (CbC) report as well as of the reporting entity’s tax residency.

CbC reports are submitted by multinational groups concerning information about their revenues, profit/loss, income tax paid and accrued, share capital, retained earnings, number of employees, tangible assets, and the principal activities of their constituent entities. A CbC report includes information for every country where the group operates. A CbC report must be submitted by a group whose consolidated revenues were at least €750 million in the previous financial year.
In practice, a CbC report is generally submitted by a group’s parent entity, or another group member designated by the group. The Estonian member of a multinational enterprise group must notify the tax authority which member of the group is the reporting entity and the tax residency of such entity.

If the financial year of a group ended on 31 December 2022, the Estonian member of the group should notify the Tax and Customs Board by 30 June 2023 at the latest.

Determination and documentation of transfer pricing

After the end of a financial year, transfer prices of transactions concluded with related entities in the financial year should be reviewed and, if necessary, adjusted to ensure that the prices are at arm’s length. In addition, it must be kept in mind that transfer prices set for the upcoming financial year must reflect market conditions and guarantee an arm’s length result. 

In Estonia, transfer pricing documentation with relevant comparables to prove arm’s length pricing must be submitted to the tax authority in 60 days upon its request. However, there are several countries where specific dates have been set out in legislation for the submission of transfer pricing documentation to local tax authorities. Estonian companies whose operations extend to other countries (via subsidiaries, branches or other entities) are advised to check transfer pricing rules in the respective countries because fines for their violation can be significant. In Estonia’s neighborhood, transfer pricing documentation must be submitted by a specific date for example in Denmark and under certain conditions also in Latvia.