A Latvian company to invest in stocks
If you invest in stocks and consider where to create an investment vehicle, a Latvian company could be a good tool. There are advantages for each type of investor which we have divided into the following categories: traders, value investors, and investors in dividend aristocrats.
As of 1 January 2018, Latvia has introduced a new corporate income tax system. According to the new tax system the companies pay corporate income tax only when they pay out dividends or similar amounts to their shareholders. This means that the payment of the tax is postponed until the distribution of the profits. The Latvian company can reinvest undistributed profits in unlimited amounts and times. And there is more – a special tax exemption for long-term investors.
Let us discuss in which situations a Latvian company can be used for traders, value investors and investors in dividend companies.
To trade for stock traders
For daily stock traders, the advantage is quite straightforward. The Latvian company does not pay tax on investment and trading results, no matter how they are. A trader may invest in Latvian company funds for trading. The company may trade for unlimited time without paying tax. Only when an investor decides to take out the dividends, the Latvian company will pay 20% tax out of the gross dividends.
This is a certain advantage, compared with the individual traders. The individual traders have to pay capital gains tax (20%) each time he/she receives capital gain. The capital losses are deductible. The Latvian company instead pays 20% only out of the gains only when the gains are distributed. Or in case the company is going to be liquidated.
The advantages to investing in stocks here are as follows.
(1) The trader can reinvest all the trade gains without paying a tax. So this means that it has more funds to reinvest, including tax saved.
(2) The trader benefits from the time value of the tax. The net present value of the tax payable in the future is lower than if the tax would be paid now. So the longer the investor trades, the lesser he/she is going to pay in tax.
To invest in stocks for value investors
A value stock usually relates to a company whose shares are traded at a lower price compared to its fundamental ratios such as price-to-book or price-to-earnings ratio due to the skeptical attitude of the market towards them. By buying underpriced value stocks for the, an investor hopes that the company will regain its position and undertakes the underlying risks.
The value investors have different targets than the traders. Usually, they invest in stocks that are traded at or below their intrinsic value. Also the investment period is usually long-term, compared to traders. The Latvian corporate income tax has provided certainly a great tool for long-term investors. If the stocks are held for more than 36 months, the capital gains are exempt. This means that the Latvian company is entitled to distribute the capital gains as dividends without paying a tax.
So if we compare a trader with a long-term investor then the difference may be explained by the following example.
A trader buys stocks for 1000$ and after a month sells the stock for 2000$ then again buys for 2000$ and gain after a month sells for 4000$. Those transactions do not trigger a corporate income tax payment. However, if the trader decides to distribute capital gain (3000 $) as dividends, he will pay 20% out of them as a tax.
If a Latvian company buys stocks for 1000$ holds them for three years and then sells for 4000$, then it is entitled to distribute 3000 $ as dividends tax-free.
To invest in growth stocks
A growth stock relates to a company that is expected to grow at a faster pace than its peer companies. During the growth phase these companies pay little or no dividends at all. The growth stocks are usually sold at prices exceeding its fundamental ratios such as price-to-earnings. It is considered that the rapid growth rate in the future will compensate the overpriced acquisition of the stocks. The investors usually invest in growth stocks to generate capital gains upon the sale of the stocks in the future.
For growth stocks the long-term strategy is even more important than for traders or value investors. Therefore, the capital gain exemption from the corporate income tax, if the shares are held for more than 36 months, may appear to be a very attractive tax incentive for investors investing in growth stocks.
To invest in stocks – dividend aristocrats
There is certainly a good reason to buy stocks that pay a generous dividend (dividend aristocrats). Especially, if the market is not moving upwards and certainly if it is declining. The Latvian corporate income tax rules exempt inbound dividends, provided that the dividend payer has paid a corporate income tax in its country. When the Latvian company further distributes them, such dividends are referred to as flow-through. A Latvian company does not pay tax on flow-through dividends.
To fully benefit from the corporate income tax system, the individual shareholder should become a tax resident in Latvia. In such a case the neither Latvian company nor the individual shareholder has to pay the tax on flow-through dividends.
As an alternative – the shareholder may choose to be a tax resident in the country where the dividend income is exempt (except, blacklisted off-shore territories). In such a case the dividends paid received by a Latvian company will pass on to the shareholder tax-free and will not be taxable also in the hands of the individual shareholder.
Each type of investor may benefit from the Latvian corporate income tax regime. Especially, if the investor has long-term goals related not only to investing but also staying in Latvia, as well. If not, well all right, still a Latvian company could be used as a tool for investing in stocks worldwide.