Global Tax and Business Risks
Anyone who holds overseas entities for tax purposes should become more cautious due to the recent changes in tax laws. They intend to eliminate tax optimizations and require more careful assessment of business partners. Although it may not seem for Latvian taxpayers completely new, there are several aspects that need to be considered.
More sever Corporate income tax requirements
On January 1, 2019, a new provision was incorporated in the national “Corporate Income Tax (CIT) Law” imposing restrictions on tax avoidance practices according to the European Union (EU) Directive 2016/1164. The new requirements apply to EU and OECD member states.
The Article 6 of the Directive states that structures or range of the structures designed to confer tax advantages, where this is contrary to the purpose of law, should not be taken into account for purposes of CIT calculation. For the structure to be considered real (not artificial) it must be established with a reasonable commercial objective reflecting an economic reality. Therefore, entrepreneurs with the offshore structures should assess whether they do not risk to incur additional CIT or personal income tax (PIT) liabilities in Latvia or elsewhere. An implementation of the above provisions was compulsory in all EU member states by the end of 2018 (with exception of Article 5 on the Exit taxation where the deadline was set as December 31, 2019). As far as Latvia is concerned, the particular provision has been implemented in the law “On Taxes and Duties” entitling the State Revenue Service (SRS) to apply the economic substance principle over the legal form during the companies’ tax audits.
This way the profits of the foreign company (structure) controlled by a resident of Latvia that are reached by using of unjustified tax advantages may become subject to the income tax payments in Latvia. A foreign company (including permanent establishment, any foreign legal entity, a contract-related group of persons or assets) will be deemed to be controlled upon meeting one of the below criteria:
1) taxpayer either alone or together with related persons owns directly or indirectly >50% of the shares or voting rights of a foreign company; or
2) taxpayer is entitled to receive >50% of the profits of the foreign company, either alone or together with related persons.
Restriction on tax exemption of dividends
Section 9 of the Law “On Personal Income Tax” also includes limitation to apply PIT exemption on dividends paid out using a commercial company established in Latvia, foreign company or a range of structures created to avoid or reduce the PIT payments. The law defines the following conditions by which such objective could be identified:
- if the structure could be considered as artificial after assessing all facts and circumstances (applying economic substance rather than legal form);
- if dividends distributed directly from the source of origin would be subject to a higher PIT than by distributing throughout the structure or a range of structures.
Export and transaction risks
The “Law On International Sanctions and National Sanctions of Latvia” (Sanctions Law) has been introduced as a result of the terrorism and related geopolitical risks about 3 years ago. Since then it applies to both legal persons and individuals. In case of legal persons it is about trading with strategic goods such as arms, certain chemicals or equipment; import/ export embargo to North Korea, Syria, Libya and other threatening regimes[1] as well as a prohibition to deal with listed persons[2].
Recently the list of merchants subject to the Sanctions Law has been extended. As of May 1, 2019 even the lawyers and traders of real estate (or companies) including their agents will be required to introduce their internal risk management and assessment procedures/ policies, more specifically - international and national risk management systems. Whereas exporters will have to check any customer or destination for supply of the goods that are new.
In absence of internal control the supervisory body has rights to charge up to 10% of a company’s turnover or apply community services or even deprivation of liberty for company’s officials under “The Criminal Law”. This way all merchants will be forced to review their activities and assess and document the risks.
Sanctions Law may seriously affect company’s business; one example in Latvia with ABLV bank we have already seen.
Conclusions
SRS attempts to combat Latvia’s shadow economy coupled with international fighting against money laundering raises concerns about new campaigns intended toward certain businesses. In this case the presumption of innocence is unlikely to be applied.
Considering the time-frame of annual meetings it would be advisable to inform the shareholders on possible changes within the group structures, business models or customers as well as to seek additional budget to introduce company’s internal procedures and compliance in accordance with Sanctions Law.
For companies holding overseas branches and affiliates it is suggested to re-access the overall group structure, functions and risks, as well as existence of labour and other resources. The latest changes are made to increase the penalties and risks for companies either dealing with sanctioned persons or holding overseas structures, especially when lower (than Latvia) tax jurisdictions such as Cyprus or Malta are involved.
If your company needs support in assessment of overseas tax and sanction risks, please contact our specialists - tax partner Anna Vilka, e-mail: anna@bakertilly.lv or attorney at law Raimonds Plāte, e-mail: raimonds@bakertilly.lv.
[1] Specific countries and prohibitions can be found on the homepage https://www.mfa.gov.lv/arpolitika/par-eiropas-savienibas-ierobezojosiem-pasakumiem