Virtual residency
For almost 10 years now, Estonia offers an E-residency program to foreigners which allows them to create a government-issued digital identity in the country. You do not even have to be present or ever go to Estonia for it; you can simply apply for it online. The key to your E-residency is a digital ID smart card issued either by the Police and Border Guard Board in Estonia or the Estonian Embassy in your country of residency.
With your e-ID card, you can get access to Estonia’s highly advanced digital infrastructure. It allows you, for example, to open your business in Estonia and manage it from wherever you are in the world. Other services like banking, administration, accounting, tax filing and so on, can all be done completely online.
E-residency does not provide you with Estonian tax residency or citizenship and neither does it give you the right to physically enter or reside the country. It just creates the possibility to have a virtual identity and allows you to run everything online from wherever you are. This seems attractive, especially for digital nomads, investors and consultants that can basically work from anywhere.
Estonia also has a unique tax system where income tax is charged only on profit distribution. No tax is levied on any retained earnings. In other words, if you keep your profits in your company, it will not have to pay income tax.
Tax residency
While Estonia is praised for its technological innovation, high-level transparency and pro-business mindset, the new legal status of E-residency has not been considered yet in the framework of the existing bilateral agreements to avoid double taxation (DTAs). Estonia has signed tax treaties with more than 60 countries, but they do not recognize the concept of E-residency for tax purposes.
Many E-residents have incorporated Estonian companies that have no other connection to Estonia than being registered there and managed remotely by E-residents. Currently, there are well over a 100,000 E-residents registered from 180 different countries, who created more than 25,000 companies in Estonia.
If you are a digital nomad living out of your backpack and commuting between Costa Rica, Indonesia and Singapore, setting up a business as an E-resident will most likely only trigger a tax liability in Estonia. However, if you are (long-term) resident for tax purposes in another country, where you pay tax on your worldwide income (like Belgium), you should think twice when opening an Estonian company…
Applying for ‘E-residency’ in Estonia is not a way to avoid paying taxes in your own country of tax residence. On the contrary, by setting up a business in Estonia, you will become a taxpayer both in Estonia, as well as in the country where you are tax resident. E-residency does not relieve you in any way from the tax filing requirements in your home country.
If you open a company in Estonia, the latter will normally be considered an Estonian tax resident. Incorporation is the only criterion for a company’s residence in Estonia, unless the relevant DTA article overrides it and its residency moves to another country.
Estonian distribution tax
Estonian companies are not subject to a corporate income taxation (CIT), as the rest of the world knows it. Tax is not levied when profit is earned but only when it is distributed.
Profits are distributed as dividends or are deemed to be distributed, including transactions that are considered hidden profit distributions (e.g. benefits in kind, disallowed expenses, gifts, representation expenses, etc.). On the other hand, real business expenses and salaries are not subject to the distribution tax.
The standard CIT rate in Estonia is currently capped at 20% (calculated as 20/80 of the net distribution). In Estonia, resident companies are taxed on profits distributed from their worldwide income. Since a few years, regularly payable dividends are taxed at only 14% (or 14/86 of the net distribution). Dividends that are taxed at the reduced rate, will trigger an additional personal income tax of 7%.
All Estonian companies are treated the same way for tax purposes; there is no difference between a company owned/managed by a local Estonian resident or an E-resident living abroad.
Double tax risk
If you are a Belgian tax resident who established a company in Estonia, there is always a risk that the latter may be subject to the Belgian (Non-Resident) Corporate Income Tax (CIT).
If you own a company abroad, but you effectively manage it from Belgium (i.e. basically doing all the work for it from here), the Belgian tax authorities could argue that this triggers a so-called ‘Permanent Establishment’ (PE) in Belgium. If a company creates a PE in a country by doing business there that generates local revenue, the host country can impose a local CIT.
In Belgium, companies pay a 25% flat tax rate. Small and medium-sized enterprises (SMEs) can benefit from a reduced rate of 20% on the first € 100k of taxable profit (the amount above that is still taxed at 25%). This reduced rate is subject to certain conditions. While Estonian companies only pay a 20% tax upon distribution of the profits, Belgian companies pay corporate tax on earned profits instead. If you afterwards still plan to distribute your profits, you need to pay a dividend withholding tax in Belgium of (in worst case) 30%.
Belgium has a DTA with Estonia to protect you against the risk of being taxed twice on the same earnings, but the fact that you already paid the distribution tax in Estonia does not mean that the Belgian tax authorities cannot tax you anymore.
You should be aware of the potential pitfalls when incorporating abroad and understand the risk of double taxation when doing business internationally.
Double tax relief
- Dividends
If you take out a dividend from your Estonian company, you are automatically subject to a 20% distribution tax. Although a tax treaty is in place, the dividend will also trigger an additional 30% dividend tax in Belgium. The treaty itself provides a legal basis for this type of ‘double’ taxation.
The DTA normally also includes a maximum tax rate that can be applied in the source country, the so-called ‘preferential rate’. Unfortunately, the reduced withholding tax rate (WHT) as stipulated in the DTA with Estonia (i.e. 5% or 15%) will not have any effect here. The reason is that the distribution tax is not a withholding tax but a corporate income tax. The company will therefore be required to pay the full distribution tax of 20%. It is also not possible to get a credit for the distribution tax in Belgium at a personal level when filing taxes.
Example: If your Estonian company pays you a net dividend of €10,000, you will need to pay a distribution tax of €2,500 in Estonia (€10,000 x 20/80). When you receive your dividend of €10,000 on your Belgian bank account, you will be required to pay an additional dividend tax of €2,760 (€10,000 – €800 x 30%). This brings the total tax due in both countries to a hefty €5,260.
- Employee Salary
If your Estonian company pays a salary to a Belgian employee, the company is liable to withhold 20% personal income tax (PIT) and apply 33% social security contribution on the salary payment in Estonia. However, if the work is not physically performed in Estonia, no PIT nor social security contributions will apply. In that case the salary is not considered to be sourced in Estonia.
Instead, the income is taxable in the state of residence of the employee, where the latter will normally be liable for income tax due to the work physically taking place there (e.g. in Belgium). If you have a non-resident employee who does not physically work in Estonia, you do not have to report anything to the local employee register in Estonia.
In respect to social security, you normally remain subject to the social security system of your country of residence if a ‘substantial’ part of your work is performed there (>25%). If you live and work from Belgium most of the time, the Belgian social security rules will apply.
In this case the Belgian employee will be liable for the same income tax and social security charges, as if the salary was paid directly by a Belgian company or employer. A setup like this would therefore not create any real tax saving.
- Director’s Fees
Estonian rules provide that fees paid by an Estonian company to a non-resident director, as a member of the board, are always subject to 20% PIT. Most DTAs follow this logic and normally allocate the taxing rights to the country where the company is established.
If you are a Belgian resident director in an Estonian company, the Belgian tax authorities will normally accept that such fees are only taxable in Estonia (however, only to the extent you can demonstrate that you are not involved in the day-to-day management of the company, which in that case will be considered self-employed business income that could also be liable for Belgian taxes).
If you want to avoid paying 33% social security in Estonia, you should obtain an A1 certificate proving your coverage from the local competent authorities in Belgium and submit it to the Estonian tax authorities. Providing an A1 issued by the Belgian authorities, implies you are paying your social security contributions as a director in Belgium. Again, not much of an optimization here either.
Conclusion
For most Belgian tax residents who have no immediate plans of moving abroad, opening a business in Estonia as an E-resident will often not create the desired tax saving. The easiness of doing business online and getting access to a highly digitalized society aside, you should consider the adverse tax consequences before moving forward with your Estonian business setup.
As taxation mainly occurs in case of a profit distribution, taxation could potentially be avoided in the absence thereof. The financial benefit could be in the situation where income accumulates in the Estonian entity as there is no CIT due in Estonia on retained earnings.
On the condition that the place of effective management cannot be located in Belgium, corporate income could be re-invested indefinitely without incurring income tax, in Estonia nor in Belgium. However, as soon as you take the money out, it will trigger a taxation in both countries which could eventually leave you with less than half of your earnings.