Report from the mBank-CASE seminar: Estonian corporate tax – lessons for Poland

The subject of the 163rd mBank-CASE seminar was Estonian corporate income tax (CIT) and its potential attractiveness for Poland. Estonia has Europe’s most competitive tax system (while Poland is second to last, in 35th place) and is also known for its pioneering approach to taxation of corporate profits. Since 2000, Estonian companies don’t pay tax on profits until they’re realized. In principle, this approach should make access to capital easier, boost companies’ investments and contribute to faster economic growth, though of course it causes a transitional (?) decline in budget revenues from this tax.

Now that the tax is well into its second decade, we can take a moment to assess it and ask how such a solution would work in Poland. We asked Dmitrij Jegorov, deputy secretary-general for tax and customs policies at the Estonian Ministry of Finance, to evaluate the tax and present the rules for how it functions. His presentation was commented on by Dr. Anna Leszczyłowska of the Poznań University of Economics and Business and Aleksander Łożykowski from the Warsaw School of Economics.

Jegorov started by presenting the rules for the how Estonian tax on corporate profits functions. In contrast to typical systems for taxing companies’ profits, in Estonia the tax accrues not at the moment the profit is attained, but – in principle – when a dividend is paid out. This general principle is accompanied by the imposition of a tax on expenses that aren’t booked as costs of doing business, including payments for representation, charitable donations above a certain limit, and personal consumption by company owners and employees. In the case of dividend payouts, the taxation base is divided by 0.8 and multiplied by a 20% tax rate. In effect, this results in the same burden as applying a 20% tax rate on the company’s pretax profit. To increase Estonia’s competitiveness, for entities that regularly pay out dividends, the basis for taxation is divided by 0.86, resulting in a tax rate of 14%. The same rules apply to all CIT payers. Taxes are settled on the 10th day of the month after the taxable event (e.g. the dividend payout).

The purpose of this solution was to increase Estonia’s investment attractiveness while simultaneously improving the situation of SMEs, which encounter barriers in accessing capital markets. Additionally, it’s better to tax payouts of money, not earning money; this psychological aspect – also an ideological one – played a role as well.

Estonian CIT shifts the payment of profit tax from the moment income is achieved (the classical system) to the moment it’s distributed (insofar as this happens). This provides an obvious incentive to leave profits in the company, to delay the tax obligation. As was to be expected, initially there was a drop in tax revenue: More profit stayed in companies, which doesn’t necessarily support effective allocation. Additionally, in the longer term, CIT revenues measured as a percentage of GDP remain low in Estonia, while to a large degree this is intentional: The point is to increase the company’s competitiveness.

Jegorov pointed out an important aspect of Estonian CIT: There was a significant simplification of reporting. There aren’t two separate reports (financial and tax); ordinary accounting is enough. This makes things much easier for taxpayers and administrators. The new system isn’t 100% resistant to fraud, but the level has fallen significantly, as has the intensity of tax audits. The general assessment of this solution is positive, so it’s no surprise that Georgia and Latvia have followed in Estonia’s footsteps.

Leszczyłowska made a quick classification of the Estonian solution: it’s an S-type tax, where the basis for taxation is the cash that the owners receive from the company. Next, using data for Estonia and relating it to Poland’s situation, she showed the influence of Estonian CIT on the structure of capital, cash and investments. The situation of Polish companies is different than in Estonia: already today, profits in Poland are retained at a higher level, and the significance of loans (measured by their share in total assets) is half as high. Also, investment financing comes mainly from companies’ own funds. So does Poland need the Estonian CIT? Is a lack of capital in companies limiting their investments?

After a brief introduction in which he brought up the advantages of the Estonian CIT, Łożykowski presented a chart from the World Bank and PwC publication Paying taxes 2019, which showed that in Estonia it takes 5 hours to calculate tax, while in Poland it takes 59. Most certainly, adopting the Estonian solution could radically simplify calculation of this tax, with benefits for both taxpayers and the government. Next he made a few initial estimates of the fiscal consequences of adopting this kind of tax in Poland. The initial drop in revenue seems to be a serious problem. He concluded his remarks with a question about the future of CIT in Poland and laid out three options: the status quo, the full Estonian model, or perhaps a hybrid or optional model?

In the discussion, the Estonian model’s effect on R&D was pointed out. In Poland we have quite a well-developed and complicated system of tax support for R&D spending. In the case of Estonia, a small country with predominantly small companies, such a solution seems ineffective. Participants stressed the benefits of the Estonian model and asked about how it is viewed politically. Our Estonian guest discussed the political conditions of the introduction of this tax in 2000 and the general consensus of a positive assessment of how it functions.

In closing the seminar, Jegorov joked that we shouldn’t introduce this solution, because it would significantly increase Poland’s investment attractiveness, with an obvious loss for Estonia.

Written by Jarosław Neneman