Among other significant changes to the Latvian corporate income tax system, new requirements have been introduced for controlling related party transactions. New transfer pricing documentation requirements related to preparing Master and Local files are planned to be introduced in the nearest future.
Latvian tax reform in numbers
As of 2018, a company’s profit will be exempt from corporate income tax and 20% corporate income tax will be paid only when a company pays dividends or other payments with the aim of actual profit distribution. Since the taxable base (dividends payable) should be divided by a coefficient of 0.8, the effective tax rate will be 25% (i.e., depending on the chosen calculation base: 20% on profits or 25% on dividends).
Thus, if a company has earned EUR 100 profit and wants to calculate tax and dividends payable, then it must multiply EUR 100 by 20% tax = EUR 80 dividends. Whereas, if a company knows that it has to distribute EUR 80 dividends and wants to calculate the tax payable in addition to the dividends, it has to divide EUR 80 by 0.8 and multiply the result (EUR 100) by 20%, or it can simply multiply EUR 80 with 25% (and get the tax of EUR 20). The tax is not a withholding tax, but merely a conventional corporate tax postponed to the moment of dividend distribution.
The CIT base according to the new Latvian corporate income tax law
In the new Latvian corporate income tax system, the following payments will be considered to constitute the CIT base:
- non-business costs, e.g. costs of employees’ rest, cost of representatives’ cars, fines;
- interest payments to non-financial companies and individuals exceeding certain limits (i.e. thin capitalisation requirements; as of 2018 one existing restriction will remain – the debt ratio to equity is 4 to 1 and a new restriction will be introduced if the amount of interest paid exceeds EUR 3 million);
- if a bad debt is written off;
- transfer pricing adjustments;
- liquidation quota.
It is important to note that loans to related companies will be comparable to the payment of dividends and will be subject to CIT unless they qualify for a specific exemption. The exemption applies to the following loans:
- loans with a principal amount not exceeding retained profits as on 31.12.2017;
- loans provided by parent companies to their direct subsidiaries;
- loans issued by a company to its foreign PE;
- agricultural or forestry cooperative society loans to its members for business activities;
- issued loans if there are no retained profits as at the opening balance sheet of the current tax year;
- loan amounts not exceeding the share capital as at the beginning of the tax year, minus the loans mentioned in the following three points;
- if loans issued do not exceed received loans from unrelated parties;
- short-term loans (12 months);
- social company’s loans.
During the tax period (the tax period will be monthly as of 2018) when the loan is repaid, the company is allowed to decrease the corporate income tax base by the amount of the repaid loan. The draft law provides that the tax administration will be entitled to assess loans issued in 2017.
Preparing proper transfer pricing analysis became more important
Due to the specific features of the new Latvian corporate income tax reform, the new CIT law is aimed at ensuring that taxpayers do not extract profits by means other than dividends, thus aiming to avoid CIT payment. Any transfer pricing adjustment found to be necessary by tax authorities will lead to CIT payable. Therefore, preparing proper transfer pricing analysis will become increasingly important as of 2018.
In this respect, it should be noted that there will be changes as regards transfer pricing documentation requirements. Latvia has already introduced the country-by-country reporting regulations with the first reporting year being 2016. It is also planned (but not yet adopted by the Parliament) to introduce the Master and Local File requirements with respect to the transfer pricing documentation as of 2018.
If you would like to know more about the Latvian corporate income tax reform, visit the homepage of Sorainen, the Latvian partner firm of WTS Global.
WTS Klient Hungary is a member of the WTS Global transfer pricing consulting team. As a member of this team we endeavour to find solutions to seemingly impossible problems with the help of personal contacts, regular training and consultations, and relying on the WTS Global central TP team. Should you have questions we are happy to assist you.