Probably one of the main concerns for an entrepreneur considering to become an e-Resident and open a company in Estonia is understanding how taxation works. How taxes and VAT work, how to pay them, when, what about the salaries…
Most entrepreneurs -specially from Europe- come from business systems that are obscure, complex, and sometimes even unfair for starting entrepreneurs or startups. An example is the Spanish business system, where you pay a fixed fee of around 350€ every month for the privilege of having a company, even if you earn nothing that month. Or the Greek system, when sometimes you’ll have to pay an estimation of taxes for the following year in advance.
Conversely, the Estonian tax system is both transparent and easy to understand. This alone has convinced lots of location independent entrepreneurs to establish their businesses there.
But don’t be fooled: Estonia is no tax haven. If avoiding taxes is your main motivation, this is not the right place for your business. However, if you want to enjoy. being able to create and manage your business online, pay a fair amount of taxes, and get rid of red tape and bureaucratic hassle, Estonia is your heaven.
As a customer of Your Company In Estonia , all you’ll have to do is upload your sales and purchase invoices by dragging and dropping the PDF files into our e-Secure platform, and give us permission to read your bank statements for the invoice matching. We’ll take care of the rest. Sounds good?
But first, let’s talk about how taxes and VAT work in Estonia, starting with VAT, when to include it (or not) in your invoices, and how much exactly.
VAT for a company in Estonia
Estonia is an European country, and as such, subject to VAT. When you open your company in Estonia with us, as part of our ‘Company Registration’ pack, we can register you in the VIES register to get your VAT number.
Do I need a VAT number?
Your company needs an intra-community VAT number if any of these conditions apply:
- First, if your company offers services such as development, design, consulting, marketing, etc., to European clients, and earns more than 40,000 euros per year.
- Next, if you offer digital services or products (software or digital content) to European B2C customers (final consumers) from the first sale.
- Finally, if you offer digital services or products (software or digital content) to European B2B clients (company to company) and you earn more than 40,000 euros per year.
Should I register and get my VAT number right away?
If you are working with European suppliers or customers, at Your Company In Estonia, we always recommend registering and obtaining your VAT number. While you may not need it right away, most probably you will as soon as your company goes past 40.000€. A VAT number has no disadvantage for your business and, on the contrary, has many advantages.
For starters, invoicing betweren European companies with VAT numbers implies adding VAT 0% to your invoice. That greatly simplifies invoicing and you avoid VAT payments back and forth. Thus, it allows you to operate more easily in the European Union. Finally, the VAT number adds presence and reliability to your company in front of your customers and suppliers.
So, when do I have to add VAT to my invoices?
So when you are generating an invoice, should you add VAT? When, and how much? The rule is quite simple to apply once you know it, and depends on both the type of service your company offers, and the type of customer you are sending the invoice to.
Supposing you have a VAT number:
If your services require your direct intervention (such as software development, consulting, marketing, design…), then:
- If your client is B2B (a company) in Europe, with VAT number, you do not add VAT to the invoice (0%). Instead, add a clause to your bill like this: “The purchase is liable to Intra-Community supply 0%, Reverse charge”. Here is a link where you can check if the VAT of one of your customers is valid or not.
- If your customer is B2C (an individual), or B2B without VAT number, you add the Estonian VAT (20%) to the invoice.
- Finally, if your client is outside of Europe (such as in the United States), you don’t add VAT (0%).
On the contrary, if your services do not require your intervention, that is, they are automated (such as a SaaS or automated application like Netflix, or an e-Book download from your e-Commerce or website), these rules apply:
- If your customer is B2B (a company) European with valid VAT number, you add VAT (0%) and specify the same clause as above.
- On the other hand, if your client is a European business that does not have a VAT number, or an individual, you add the VAT from the country of origin of your customer. For a Spanish customer, that would be 21%, for example.
- Finally, if your client is outside of Europe, you do not add VAT (0%).
As an important exception, remember that your company is Estonian, so you will have to add the Estonian VAT (20%) for any invoice you make to another Estonian company (since it is a domestic tax exchange within the Estonian tax system).
Are there any monthly fees or taxes to be paid?
As we mentioned earlier, in some European countries, you need to pay a monthly fee to have the privilege of working as a professional or having a company. The example of Spain is probably the most significative. This tax means, obviously, a competitive disadvantage, specially for businesses that have just started.
There’s nothing like that in Estonia. In fact, while your company does not distribute salaries or dividends, you won’t have to pay a single euro in taxes. Really? Yes, let’s see how that works.
Taxes for a company in Estonia
Once we have discussed about VAT, it’s not time to talk about how taxes work.
For starters, good news: you will not pay any taxes for the money your company earns or re-invests. This means that all the money that goes into the bank account of your company, or is spent in justified business expenses, is virtually free of taxes.
Therefore, while your company is just generating income, growing a customers base and invoicing them, and paying your providers and suppliers, you will not have to pay anything. In comparison, in most other business systems -specially in Europe- you will be paying from minute one, plus the aforementioned monthly fee in some cases.
It is clear that the Estonian system is designed to help new business and startups, and encourage entrepreneurship and the growth of your business.
Okay, so… When do I pay taxes?
You will pay taxes when you distribute dividends or salaries. That’s it, when you send money from your company to your employees, shareholders, or to youself. It is important here to be clear about the difference between you and your company. Even if you are the only member of your company, you and your company are independent entities. The money of the company belongs to the company, not to you, and viceversa.
There are two main ways to distribute benefits from your company: salary and dividends. Let’s talk about them:
At the beginning of each fiscal year, you can pay dividends to the shareholders of your company. These dividends are subject to a 25% tax (20% of gross, which means 20/80 = 25%). A petition has been approved to lower it to 14%, which will come into force in 2019 .
These taxes are paid by your company the following month, not by you. If you were a tax resident in Estonia, you would not have to pay any extra personal tax for those dividends you receive, in Estonia.
Unfortunately, in many other European countries, receiving dividends is subject to personal taxes. That means you will have to pay taxes later on your annual tax report if you are a tax resident in France, Germany or Greece, for example. If you are a digital nomad, and don’t have any tax residence, you won’t have to pay personal taxes for these dividends.
As an example, if your company pays 10.000€ in dividends in January, it will pay an additional 2500 euros in taxes (10.000 x 20/80) in February.
To explain your salaries, it is important to understand that as a board member of your company, it is considered that you perform two different types of tasks:
First, you are a member of the board of directors of your company. You are supposed to take charge of the administrative and bureaucratic tasks of the company, schedule and take part in the board members meetings, etc.
In addition to that, you are an employee of your company, so you perform some technical tasks that add value to your company (consulting, software development, design, whatever).
Therefore, generally speaking, your salary is divided into two parts: your board member salary (salary manager) and your employee salary ( employee salary ).
How is the division made?
As a general rule, 30% for the board member salary, and 70% for your employee salary. That means that if you want to get a salary of 1000 euros a month, 300€ will go to your board member salary and 700€ will go to your employee salary.
If you are a highly qualified professional whose time is devoted mostly to your job (eg: a web developer, a designer, a video editor), you could distribute 20% to your board member salary and 80% to your salary of employee.
Why is this distribution important?
If you live outside Estonia, your employee salary is not subject to taxes there. Only the board member salary. Therefore, the less board member salary, the less taxes you will pay in Estonia.
How much does my board member salary pay then?
Your board member salary pays 25% income tax, plus 33% social tax (applied to the salary plus the income tax).
Important to note, if you can certify that you contribute social security taxes in another European country (form A1), then your board member salary does not need to pay social tax.
So is the employee salary tax free?
Not quite. You will not pay taxes in Estonia. This salary pays taxes in the country where you are a tax resident (if any). In that case, your salary will be added to your tax base, and when doing your personal annual tax report, you will pay taxes based on your overall salary, like any normal employee.
Thanks to European double-taxation agreements, you will not have to pay double taxes for your board member salary. Obviously, if you don’t have a tax residence, i.e: you are a digital nomad and you spend less than 183 in any given country per year, you won’t have to pay personal taxes on your employee salary.
Let’s see how it works with a concrete example:
Let’s say that Ana has a company called “Ana Designs OÜ” with Your Company In Estonia, and earns about 3000 euros per month. To start, Ana decides to allocate 1000 euros as her monthly salary for now.
For simplicity, Ana applies the standard salary distribution, 30/70. So 300 euros of her salary form their board member salary, and 700 are for her employee job, since she is the one doing the design work.
As Ana lives outside of Estonia, her employee salary is not taxed there. So of those 300 euros, Ana’s company will pay the following taxes:
- Income tax : 25% of 300€ = 75€.
- Social tax (Social tax) : 33% of salary + previous tax (i.e: 33% of 375€) = 123,75€
So in total, for her 1000€ salary, Ana’s company will pay 198,75€ (slightly less than 20%). At the end of the year, Ana will have 21650 euros re-invested in her company.
If Ana had opted for the 20/80 distribution, justifying that most of her time is dedicated to design duties (which is quite realistic), her company would have had to pay a lot less taxes, specifically, 132,50€ in Estonia (around 13%).
So how do I do it?
If you are our customer, that’s super easy. All you need to do is to make two different transfers from the bank account of your company to your personal account. So for example, if you use a 20/80 distribution, and want to assign yourself 1000€ in salary this month, you will do two separate transfers from your company’s account:
- One transfer for 200€ whose description needs to be “Board member salary”.
- Another transfer for 800€ whose description needs to be “Employee salary”.
And that’s all. Our accountants will identify both by the description and calculate the appropriate taxes. Easy, right?
Remember to warn us before assigning yourself the first salaries, so we can register you as board member employee for your company.
Distributing employee salary only
In 2019, Estonia has approved a new legislation that allows solopreneurs and freelancers to assign themselves an employee salary only, without the need of appointing a board member salary. This is suitable for one-member companies only. In this scenario, you only pay yourself employee salary, as it’s considered that your administrative duties -specially as a customer of Your Company In Estonia– are negligible.
This has tremendous advantages if you are a digital nomad, without a personal tax residence. In that scenario, you won’t need to pay taxes for the salaries of your Estonian company. As a caveat, if you opt for an employee-only salary, you won’t be able to enjoy the Daily Allowance (see below).
Smart expenditure management
The concept of not paying taxes for the money of your company that’s reinvested, or not distributed, is quite innovative and interesting, and one of the main appeals of the Estonian business system. Let’s see how you can benefit from its advantages.
Tax-free business expenses
Yes, that’s right, all justified business expenses of your company are free of taxes. What is a justified business expense?
Basically, any expense that is relative to your activity, and does not constitute a permanent establishment to another country, to prevent that country from considering your company as a tax resident there. Let’s see some examples:
- Website expenses: hosting, domains, web design, storage fees, and any other web service that your business needs.
- Administrative tools and online or offline management software, accounting, and so on.
- Web tools, subscriptions and software that you need to develop your activity.
- Office fungible stuff.
- Public transportation for work reasons, including flights, trains, services such as Uber or Taxify, and accommodation, such as AirBnB. This includes trips to Estonia (to open your bank account).
- Payment and banking expenses, such as payment gateways for your online store, banking fees, or similar charges.
- Business meals of your customers, but only the meal of your client(s), not yours.
Examples of expenses that can not be deducted include:
- Your own car, or gas used to travel inside the same country. Traveling between countries to visit customers is a justified business expense, but not your own car, or gas. Public transport inside the same country is, however, a justified expense.
- Holidays and pleasure trips, obviously. You have to be careful if you decide to “visit a client” from the 24th to the 31st of December. Better get a written proof of meeting signed by your customer.
- Permanent offices, facilities or premises outside of Estonia.It is actually not allowed to have an office or facilities outside of Estonia for more than 6 months a year, unless you want to run into trouble with the local tax authorities.
The Daily Allowance
The Daily Allowance is an amount that you are allowed to take out of your business account, tax-free, when you do business trips. It is supposed to cover your expenses when traveling for work (such as meals, WiFi access, etc). For example, if Ana travels to a Design Summit in San Francisco, USA, for a week, she could benefit from the Daily Allowance .
In order to do this, she needs to declare (let us know about) the trip, including dates, in advance, and add the appropriate documentation (flight tickets, AirBnB receipts, tickets to the summit). Then, she can get up to 50€ the first 15 days of the month plus 32€ for the rest of the month, free of taxes.
In our example, if Ana provides the documents that justify this one week trip, she could get 7×50 = 350€ from her company’s account, without having to pay taxes for it. The concept for the transfer should ideally be “Daily Allowance – Trip xxxx”.
This only works for trips with a specific duration and a specific purpse. You can not travel to Thailand, be there for a year, then travel to another country, and claim the Daily Allowance for that year.
Out of pocket expenses
The Estonian business system is very flexible, and offers many advantages for entrepreneurs. Imagine that Ana forgets her business card on her trip to San Francisco, and needs to pay a business expense with it. What can she do?
No problem, Ana can pay that expense with her personal credit card, or even in cash, but ask for an invoice for her company, and then tell us that she paid that with her personal money. We will declare that expense as “out of pocket expenses”, and Ana can refund that money back into her personal bank account without paying taxes for it.
In this article, we explain how taxes and VAT work for a Estonian companies. The Estonian system is clear, fair and transparent, and offers many advantages to digital nomads and location independent entrepreneurs.