This article describes the principles of planning dividends and shaping the tax-effective shareholding structure for Latvian companies.
More than a year has passed since the entry into force of the new Corporate Income Tax Act on 1 January 2018 and questions have piled up about not only distributing “old” profits but also “new” profits into dividends.
As questions are still being raised on this subject, we have prepared a summary on the taxation of profit distribution. First of all, we will consider the regulation of dividends in commercial law, then the application of corporate income tax and the application of income tax both to the retained earnings generated by 31 December 2017 and the profit generated as of 1 January 2018.
Dividend regulation in Commercial Law
Let us start with the regulation of Commercial Law, which has not changed as a result of the tax reform.
Article 161 of the Commercial Law stipulates that dividends are determined by a decision of the shareholders, they are paid to the shareholder in proportion to the nominal value of the shares held by him. Dividends are determined by a decision of the meeting of the shareholders, they are paid to the shareholder in proportion to the nominal value of the shares belonging to him, calculated and payable for the fully paid shares.
Dividends may not be determined, calculated and paid, if it is apparent from the annual report or from the review of the economic activity dividends referred to in Section 161.1 of this Law that the company’s own capital is less than fixed capital. Therefore, the payment of dividends does not require the availability of funds which can be paid out in dividends.
The Commercial Law (Part 5) determines that dividends must be paid only in cash on the basis of a decision on the distribution of profits. And (Part 6) provides for a limitation period: dividends which have not been withdrawn within 10 years should be transferred to the company, except in cases where, appropriately to the law, the limitation period is deemed to have been terminated or suspended. In the case of dividends not withdrawn at the time, if this is due to the fault of the shareholder, no interest should be paid. The decision of the shareholders of the company that the dividends may be temporarily held by the company should not be valid. The company may not claim the dividends received from the shareholder, except in the cases referred to in Section 162 of this Law.
From the Commercial Law, we conclude that dividends are payable only in cash, as well as Commercial Law incentivises the payment of dividends, which means that the rights of members to distribute dividends and to leave them at the disposal of the company are limited.
The statutes of the Latvia commercial company may provide that dividends may also be determined and calculated from profits earned during the current year period (after the end of the previous reporting year), the so-called extraordinary dividends.
The board of the commercial company should prepare an economic activity report for the period for which the extraordinary dividends are determined. The Meeting of Participants may not determine a higher proportion of the dividend payout that is determined by the Board. In any case, no more than 85% of the profits earned during the period for which they are set up may be paid in extraordinary dividends.
Corporate Income Tax
Profit realised from 2018
The first question, often asked about the profits earned in 2018, is what dividends should be declared in the distribution of profits: gross or pre-tax or net, those that remain after tax.
It must be said that the answer is that the question is not correctly worded, for the reason that retained profits are distributed under the Commercial Law. The distribution of profits therefore takes place regardless of the provisions of the Corporate Income Tax Act. The application of the tax is a secondary issue. Consequently, if an company has retained profits of EUR 100 000 in 2018, it is entitled, in accordance with the rules of the Commercial Law, to distribute all EUR 100 000 in dividends.
Section 4, Paragraph 2, first paragraph, point (a) of the corporate income tax law provides that the corporate tax taxable base includes taxable objects, including calculated dividends, including emergency dividends.
At this point, two definitions of “taxable base” and “taxable object” are almost unnoticed. The relationship between these definitions is given in the ninth paragraph of this Article, i.e. “When determining the taxable basis for the taxation period, the value of the subject to corporate income is divided by a coefficient of 0,8.”
Mathematically it can be defined by the following formula:
Tax base = tax object: 0,8
or by clarifying our question
Taxable dividend value = declared dividend: 0,8
So if you had a profit of EUR 100 000 in 2018, you can split it all into dividends and pay the tax of 25 000 = 100 000: 0.8 x 20%. And here we come to the first interesting thing that the law allows you to break down the full profits of the accounting year by paying corporate income tax on it next year. Consequently, if the company had a profit of EUR 100 000 in 2018, it may be distributed in dividends in January 2019 and thus EUR 25 000 of corporate income tax will be reflected in the 2019 profit or loss account. That means corporate income tax will cut its 2019 earnings. The shareholders’ decision therefore states that all profits of EUR 100 000 are distributed.
On the other hand, if in mid-2018 exceptional dividends were distributed, let us say EUR 80 000, and a tax of EUR 20 000 was paid, then after the end of the reporting year there is nothing to share, because the profit is 0. This means that it is more profitable to split profits by the end of the reporting year than by the middle of the reporting year.
Flow – through dividends
Dividends received by the Latvian company from a foreign company and distributed further, i.e. the so-called flowing dividends are not taxed if they are further distributed. In accordance with part 6 p .1 of the corporate Income Tax Law: “The taxable person is entitled to reduce the amount of dividends included in the taxable base during the taxation period to the extent that the taxable person has received dividends during the taxation period from the dividend payer who is a corporate tax payer in his country of residence, or such dividends from which they are deducted in the State. tax, other than dividends, received from a person located, established or established in low-tax or tax-free countries or territories.’’
Read here in detail about the taxation of the flowing dividends : here.
Profit earned by 31 December 2017
If a participant is a legal entity, there is no restriction to distribute the dividend in respect of the distribution of profits that occurred before 31 December 2017. Thus, corporation tax is considered to have been paid by submitting a declaration for 2017.
Profit earned from 1 January 2018
In accordance with Section 9 (21) of the Law On Income Tax, dividends, dividends comparable to income or notional dividends if, in respect of calculated dividends, income equivalent to dividends or notional dividends at the level of an undertaking, from the part of the profit from which dividends are paid, dividends are equivalent to income or notional dividends, if one of the following conditions is fulfilled:
- Corporate income tax has been paid in the Republic of Latvia in accordance with the Corporate Income Tax Act (this exemption does not apply if the corporate income tax has been paid in accordance with the Law On Corporate Income Tax);
- A corporate income tax has been paid in a foreign state or a tax comparable to it or a tax has been deducted in a foreign state from dividends, dividends equated to income or notional dividends, or a tax equivalent thereto has been deducted.
- p. of the Law on Income Tax. Part 3.6 states that: “For the purposes of applying points 2.1 and 2.2 of Paragraph one of this Section