Tax and Legal Newsletter - February 2016
As mentioned in the previous tax newsletter, on 29 September 2015 new Cabinet Regulations No. 548 “Regulations on corporate income tax taxation period return and advance payment calculations” were released. The regulations entered into force on 1 January 2016 and replaced Cabinet Regulations No. 981 “Regulations on corporate income tax taxation period return and advance payment calculations”.
To which taxation period do these regulations apply?
The new regulations apply to the taxation period that begins in 2015 and for subsequent periods. The advance payment calculations are filled in by calculating the advance payment for those months of the taxation period that remain after submitting the CIT return for the taxation period that begins in 2015 and for all the subsequent taxation periods.
Companies whose taxation period is other that the calendar year, for example, from 6 April 2014 to 5 April 2015, have to fill in the CIT return and advance payment forms for the taxation period which ends in 2015, by using the former regulations.
What type of changes are expected in the CIT return?
Taking into account the amendments in the Corporate Income Tax Law that were made since 20 December 2011, the CIT return has been supplemented with new (or updated existing) rows/annexes, as well as certain rows/annexes have been deleted:
• Essential changes are introduced in the filling requirements of the CIT return’s Appendix No. 2 “Transactions with related parties”. Namely, Appendix No. 2 has to be filled in only by those taxpayers:
- whose transactions with related parties are conducted at prices that are not arm’s length prices, or
- for transactions where prices are arm’s length and these exceed EUR 5 000.
• Appendix No. 3 is supplemented, defining partnership members, their investment and taxable income;
• Row No. 71.5 and Appendix No. 4 that refer to the transfer of losses within the group are excluded;
• Rows No. 7.2 and 7.3 on the interest and intellectual property payments to non-residents are excluded. Row No. 35 is specified with respect to the taxable income adjustments, when dividends are received from companies that are registered in offshore territories;
• In rows No. 3 and 78 (previously 71) one no longer has to distinguish information about the transactions with securities and their respective losses. In addition, there are specifications in the rows No. 10, 11 and 12 in the sections on the increase of taxable income and row No. 51 (previously 47) in the section on the decrease of taxable income with respect to securities transactions.
• In rows No. 4 and 41 of the CIT return that disclose depreciation one no longer has to distinguish information about intangible assets. While rows No. 26 and 63 indicate the need for the taxable income adjustments for research and development expenses.
• Row No. 22 indicates an increase in the taxable income by pledged property’s maintenance expenditure and real estate tax payments, which are paid by a credit institution;
• Row No. 23 indicates an increase in the taxable income by the divided share of excess of agricultural services cooperative partnerships and forestry services cooperative partnerships which meet certain criteria and is subject to CIT;
• Row No. 24 indicates expenditure amount that is related to the income obtained by universities, colleges and scientific institutions, if that income is not taxed with CIT;
• Row No. 56 indicates a decrease in taxable income by the amount, by which according to the court decision during a legal protection process or out-of-court legal protection process financial obligations are written-off or diminished, if these financial obligations are included in the taxpayer’s taxable income and are not shown in taxpayer’s expenses;
• Row No. 57 indicates a decrease in the taxable income by the amount of income that is obtained from disposal of publicly traded European Union or European Economic Zone securities (including interest payments that are gained from bonds), which are not stocks;
• Row No. 58 indicates a decrease in the taxable income by the amount of late payments or fines, that is deleted according to law on Law on Tax Support Measures;
• Row No. 59 indicates an amount received as an excess share from a cooperative partnership and forestry services cooperative partnership and that is included in the profit and loss statement for the taxation period;
• Row No. 60 indicates income of universities and colleges, which is obtained as a payment for ensuring professional secondary education, vocational training and higher education programs;
• In row No. 61 universities indicate income from publicly performed and exhibited works, that have been created during the study process as part of an organized artistic creativity;
• In row No. 62 universities, colleges and scientific institutions indicate income from conducting independent researches.
For many companies the financial year has ended, therefore in this article we will provide a brief insight into the effective legal regulations regarding profit distribution, emphasizing those provisions that should be complied with by the Management Board and the shareholders when deciding on the distribution of dividends.
Rights to dividends
A share gives a shareholder the right to take part in the management of a Company, in the distribution of profit and in the division of assets in case of the liquidation of the company, as well as to other rights provided for by law and the articles of association (Article 186(3) of the Commercial Law). Dividends are determined by decision of the shareholder's meeting, and distributed in proportion to the nominal value of the shares held by the respective shareholder.
Thus it is critical that the status of share ownership is updated in the shareholders' register in due time, and in case shares are sold or otherwise disposed (e.g. given as a gift), an appropriate entry is made. Until the new shareholder is recorded in the register, he cannot obtain shareholder rights, including the rights to dividends. In accordance with the law, former shareholders also have no rights to dividends, even if the dividends are distributed for the period during which they held the Company's shares and controlled its business. This also applies to retained earnings, which have not been distributed in dividends before the disposal of shares. If shares are disposed, the above should be taken into account when determining the purchase price.
Dividends are calculated and distributed for fully paid shares, and they cannot be distributed, if the Company's equity is less than the share capital. The shareholder's meeting decides on the distribution of profit and dividends after the approval of the annual report.
According to the Commercial Law there are no restrictions on how often the shareholder's meeting may decide on profit distribution. In accordance with Article 180(6) of Commercial Law, if the Company has retained earnings, shareholders may request that the Management Board convenes a shareholders' meeting in order to make a decision on utilisation of profit. It means that the shareholders may decide on distribution of retained earnings in dividends several times during the reporting year, as long as the Company has retained earnings and there are no other restrictions on the distribution of dividends. Therefore, the Management Board may assess the Company's financial situation and, if necessary, propose to defer the question of profit distribution, since the shareholders do not have to decide on profit distribution at the same time as they approve the annual report - it can be done by a separate decision, when the company's financial situation and the cash flow permits.
According to effective tax legislation, dividends received by individuals are subject to an income tax rate of 10%. The deemed day of receipt of such income is the day when the income has been calculated, i.e., the decision for distribution of dividends has been passed. Thus, there is an obligation to declare the income and pay the income tax after the decision on the distribution of dividends has been passed, regardless of whether the dividends are paid or not. Dividends paid to legal entities are not subject to taxes. If dividends are distributed to legal entities or individuals, who are situated, employed, or established in low tax or tax-free zones, they are subject to withholding tax of 15%, or for interim dividends - 30%. The deduction is made and paid to the state budget when distributing the relevant dividends.
Decisions on the approval of the annual report and distribution of dividends
After the end of the reporting year the Management Board must draw up and sign the Company's financial statements, and submit them immediately to the auditor and the Supervisory Council (if applicable). After the receipt of the auditor's report and the Supervisory Council's report (if applicable) the Management Board should summon a shareholders’ meeting. If the Company has no Supervisory Council, the Management Board should summon a shareholders’ meeting after the receipt of the auditor's report. An announcement for organizing a shareholders meeting together with the annual report, the auditor's report, the Supervisory Council's report (if applicable) and the suggestion regarding profit distribution should be forwarded to all shareholders of SIA not later than two weeks before the meeting. For a joint stock company - 30 days prior the shareholder's meeting.
As mentioned above, if the Company has retained earnings, the shareholders may request that the Management Board convenes a shareholders' meeting in order to make a decision on utilisation of profit at any time after the approval of the financial statements. In this case the same provisions regarding the procedure of organizing the meeting also apply.
After the decision on profit distribution is passed, the shareholder, who is recorded in the shareholder’s register, has the right to his amount of dividends. Dividends which have not been withdrawn within 10 years, i.e., if the Company has not transferred them to the shareholder, become the Company's property. The shareholder may interrupt the statutory limitation period by making a claim to the Company regarding payment of the dividends in due time. No interest is payable on dividends which have not been withdrawn in due time because of the shareholder's fault.
Article 161¹ of Commercial Law allows for dividends to be be determined and calculated also from the profit generated during the period since the end of the previous reporting year. Not more than 85% of the profit generated during the period, for which the interim dividends are paid, can be distributed as interim dividends. The decision on distribution of dividends is passed by a shareholder's meeting on the basis of the Company's financial statement on operating activities prepared by the Management Board for the period of time for which the interim dividends are paid, as well as the proposal of the amount of income distributed as interim dividends. The financial statement on operating activities must be prepared in accordance with the provisions of the law On Preparation of Annual Reports.
The decision on distribution of interim dividends can be passed not earlier than 3 months after the previous decision of the shareholder's meeting on declaration of dividends and not later than 3 months after the end of the reporting period, for which the financial statement on operating activities has been prepared. The Management Board should confirm in the shareholder's meeting that by the day of the meeting the Company's financial situation has not significantly deteriorated and the distribution of interim dividends will not cause a risk for the performance of the Company's obligations during the remaining months of the reporting year. Interim dividends may not be distributed if the Company has tax liabilities or tax payment extensions. Consequently, companies that meet respective criteria, have the possibility to distribute dividends once in three months not only from the retained earnings, but also from the profit generated during the period between the approval of the annual reports.
It should be noted that if the Company's performance indicators are deteriorating during the reporting year, the dividends distributed during this period may exceed the amount of profit determined when approving the relevant annual report. In this case the shareholder will have received a payment of interim dividends that exceeds the amount dividends which could approved based on the annual report. Consequently, if the shareholders chose the right to receive the dividends in advance, it is important to assess the actual amount for distribution as dividends. It should be noted that it is the liability of the Management Board to provide full details on the Company's financial position and an updated forecast for the remaining period, when submitting a proposal to the shareholders regarding the distribution of interim dividends. In accordance with Article 5 (1) of the law On Corporate Income Tax, interim dividends in excess of total net profit available for dividend distribution at the end of financial year are regarded as non-business expenses, therefore are non-deductible for taxation purposes. Namely, if the amount of dividends approved at the end of the reporting year do not reach the amount paid to the shareholder in the form of interim dividends, the difference must be declared as non-deductible expenses. The law provides a possibility to provide additional requirements in the articles of association related to interim dividends. In order to avoid a situation when the distributed interim dividends exceed the actual profit for distribution after the annual report is approved, it is advisable to include additional conditions permitting distribution of interim dividends in the articles of association.
OECD: Agreement signed for exchange of country-by-country reporting information
On 27 January Representatives of 31 countries 2016 signed the Multilateral Competent Authority Agreement (“Agreement”) for the automatic exchange of transfer pricing country-by-country reports. The Agreement is intended to allow for consistent and swift implementation of new transfer pricing reporting standards developed under Action 13 of the Organisation for Economic Co-operation and Development’s (“OECD”) base erosion and profit shifting (BEPS) project, and to allow tax administrations to understand how multinational enterprises structure their operations.
According to the OECD release, the 31 countries which signed the Agreement are: Australia, Austria, Belgium, Chile, Costa Rica, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Japan, Liechtenstein, Luxembourg, Malaysia, Mexico, the Netherlands, Nigeria, Norway, Poland, Portugal, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, and the United Kingdom.
With country-by-country reporting, tax administrations where a company operates will receive aggregate information annually, starting with 2016 accounts, relating to the global allocation of income and taxes paid, together with other indicators of the location of economic activity within a multinational enterprise (MNE) group. It will also cover information about which entities do business in a particular jurisdiction and the business activities each entity engages in. The information will be collected by the country of residence of the MNE group, and will then be exchanged through exchange of information supported by the Agreement. First exchanges will start in 2017-2018 concerning 2016 information.
Taking into account that Latvia has expressed its wish to join OECD, it is expected that the State Revenue Service will also need to follow the provisions stated in the Agreement.
EU: New anti-tax avoidance package focused on corporations
The European Commission (“EC”) on 28 January 2016 unveiled new measures to address corporation tax avoidance. The EC presented an anti-tax avoidance package that includes two legislative proposals: (1) addressing certain BEPS issues and CbyC reporting as well as (2) a common approach to tax good governance towards third countries and recommendations to address treaty abuse.
One of the EC proposals includes CbyC reporting and measures for the exchange of CbyC reports, in the form of an amendment to the current EU Directive on Administrative Cooperation under direct taxation (2011/16/EU). The CbyC rules are intended to reflect the OECD recommendations in BEPS Action 13, but would only apply to MNEs with a minimum consolidated group turnover of €750 million.
The legislative proposals will be submitted to the European Parliament for consultation and to the Council for adoption by all EU Member States. If approved, the proposal on CbyC reporting would need to be transposed into domestic law by each EU Member State by the end of 2016, and be effective from 1 January 2017.
What is the impact on taxpayers?
Transfer pricing is a primary focus of the OECD’s BEPS initiative and has been publicly described as a device that may be used by multinational companies to avoid paying taxes. Taking into account that CbyC reporting will provide tax authorities with increased visibility into the financial and operating nature of MNEs, MNEs should consider many aspects when assessing their transfer pricing, for instance:
• Where are the potentially most vulnerable points in connection with transfer pricing (e.g. continuing losses, transfer of business, risks etc.)?
• Does income reflect the economic activity of taxpayers in various jurisdictions?
• Do you have a coherent transfer pricing methodology and documentation which is acceptable in various jurisdictions?Since CbyC reporting is the initial tool for tax administrators to consider the appropriateness of intercompany pricing arrangements, it is advisable that MNEs carry out a BEPS Action 13 risk assessment to recognize the transfer pricing risks the MNEs face.
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