{"id":7559,"date":"2017-10-06T08:33:56","date_gmt":"2017-10-06T08:33:56","guid":{"rendered":"http:\/\/breicis.com\/en\/?p=7559"},"modified":"2023-10-22T10:03:31","modified_gmt":"2023-10-22T10:03:31","slug":"finance-latvian-company-future","status":"publish","type":"post","link":"https:\/\/breicis.com\/en\/finance-latvian-company-future\/","title":{"rendered":"How to finance a Latvian company in future"},"content":{"rendered":"

The new Corporate Income Tax Act<\/a> into force on 1 January 2018. One of the declared goals of the corporate income tax was to facilitate the companies\u2019 capitalization and thus, \u201creinvesting\u201d of the profits earned. Therefore, the corporate income tax is payable only when the dividends are distributed or if the company incurs expenses which are considered to be profit distribution.<\/p>\n

Basically, every business may have two sources of funding, i.e. funding by use of equity (own capital) and use of borrowed capital. In theory and in practice, the funding by equity is considered as more expensive in comparison with a borrowed capital as the investor takes on bigger risks and thus expects a larger return. The borrowed capital is perceived as less risky and thus it is cheaper, it also decreases the tax burden as a deductible expense from the income taxable with the corporate income tax.<\/p>\n

Thus, with the new corporate income tax, the considerations in connection with company\u2019s funding also changes. At first, it is clear that the borrowed capital, at least partially, loses its conventional \u201ccheapness\u201d, and does not influence the taxable profit anymore, thus, in theory, the way of funding the company would not make a difference from the point of view of the investor. Does this mean that investors would further give preference to equity financing to the borrowed capital?<\/p>\n

In this article read how the new tax may influence the decision making of Latvian and foreign investors in connection with funding Latvian companies.<\/p>\n

Latvian investor\u00a0<\/strong><\/h2>\n

A Latvian investor J\u0101nis B\u0113rzi\u0146\u0161 establishes a company (the capital of establishment of which we will not take into account for simplicity). The company needs a funding of 1\u00a0000\u00a0000 euros. J\u0101nis wishes to receive a return of 10% per year from the investments, meaning, 100\u00a0000 Euros (let us assume that such a return is adequate). For evaluation of various scenarios, in each of them, we will evaluate the effective tax rate, i.e. the total tax burden against the amount the investor receives after tax (net).<\/p>\n

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  1. \n

    Investment into fixed capital<\/strong><\/h3>\n<\/li>\n<\/ol>\n

    So, if J\u0101nis invests 1\u00a0000\u00a0000 euros in the share capital of the Latvian company to ensure the required return, the company has to pay 100\u00a0000 euros in annual dividends. As a result, the payable corporate income tax is 100\u00a0000 x 20\/80, thus – 25\u00a0000 euros. Effective tax rate is 25%.<\/p>\n

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    1. \n

      Loan financing<\/strong><\/h3>\n<\/li>\n<\/ol>\n

      If 1\u00a0000\u00a0000 euros are funded as a loan, personal income tax at a rate of 20% will have to be witheld from the loan interest. Meaning, if J\u0101nis wishes for the company to pay 100\u00a0000 as interest for the loan, he will receive 80\u00a0000 (net sum) and will pay 20\u00a0000 as personal income tax. The effective tax rate will still be 25%. So far, the law ensures an equal attitude towards both the equity capital and the loan financing.<\/p>\n

      But, the two things have to be taken into account:<\/p>\n