There are many goals of entrepreneurship: profitability, growth, competitiveness, customer satisfaction, innovation, social responsibility, etc. Profit can be distributed in different ways, but paying dividends is one of the most common ways. The purpose of this blog post is to give you an overview of the ways in which profit is distributed and how dividends are taxed in Estonia.
Typically, companies have a calendar year as their financial year. The annual report must be submitted to the Commercial Register within 6 months of the end of the financial year. In the case of a calendar year, the deadline is generally 30 June.
Profits can be shared in different ways
- Payment of dividends: A dividend is money that a company pays to its shareholders (owners). Dividends can be distributed to shareholders (owners) in a single payment or in multiple payments.
- Reinvestment: A company may decide to invest, or retain, its profits to increase its value in the future. Share capital (share capital) can also be increased through retained earnings.
- Share buybacks: A company may buy back its own shares to reduce their number on the market and thereby increase the value of each share or to change the circle of shareholders.
- Debt reduction: The company can use its profits to pay off debts, which improves its creditworthiness and reduces financial costs.
What you need to know about dividends
Dividends can be paid from retained earnings from previous periods after the annual report has been approved. Therefore, dividends cannot be paid in the first year of operation. In addition, it must be ensured that the share capital has been properly paid in and that the payment of dividends does not harm the company's solvency or lead to a decrease in equity below the limit permitted by law.
Dividends paid
The shareholders decide to pay dividends, but the decision itself does not yet give rise to income tax liability. Income tax is paid on dividends after the payment has been made. The payment is declared in Appendix 7 of the TSD and the details of the dividend recipients are provided in Form INF 1. Income tax must be declared and paid by the 10th of the month following the payment. Therefore, it is important to provide the information to the accountant in a timely manner.
Dividends received
Please note that dividends received must also be declared on an ongoing basis. If your company has received dividends from someone else, they must be declared. Generally, income tax has been withheld from them and the declaration remains rather informative. Therefore, if dividends are paid out from a company, they are generally already fully or partially exempt from income tax if the shareholding in the dividend payer is at least 101% of the total. If the dividend received from an Estonian company has come from a shareholding of less than 101% of the total, it cannot be distributed tax-free and additional income tax may be incurred when paid out to the owners.
How do you decide how much dividend to pay?
Deciding on the size of the dividend depends on the company's profits, financial situation and the agreement of the shareholders. Companies often have a pre-agreed dividend policy, but the decision is usually made each year based on an assessment of the company's situation.
It is important to assess the company's cash flow and financial position. The dividend payment should be sustainable and the company should be able to continue its operations and investments even after the dividend is paid.
The final decision on the payment of dividends should be made by the company's board of directors or the general meeting of shareholders (depending on what is agreed in the articles of association), taking into account the factors mentioned above. It is important to conduct a thorough analysis and, if necessary, consult an accountant or financial advisor to ensure that the decision is correct and in compliance with applicable laws and in the best interests of the company.
Taxation of profits
If you have decided to distribute profit through dividend payments, it is also important to take taxation into account.
From 1 January 2025, dividends in Estonia will be taxed at the company level at a flat income tax rate of 22/78 of the net distribution. This means that if a net dividend of 1,000 euros is paid to the owner, the company will have to pay income tax of 282.05 euros and the total cost to the company will be 1,282.05 euros. The preferential rate for regular dividends will no longer apply to new distributions.
Does a natural person pay income tax on dividends?
As a general rule, a natural person does not pay income tax on the dividend received. As an exception, however, the transitional provision must still be observed: if a dividend taxed at the lower tax rate of 14/86 is repaid until 31.12.2024, 7% income tax must be withheld when repaid to the natural person.
Holdings through multiple companies
In the case of holdings acquired through several companies, the main question is whether the dividend to be repaid is income that can be distributed tax-free (for example, a dividend received based on a holding of at least 10%) or whether the payment to the owners must be re-taxed at the company level. Upon request, the Estonian company will issue a certificate form TD to the recipient of the dividend, which certifies the taxed part of the dividends. In the case of dividends received from an Estonian company with a holding of less than 10%, double taxation may arise when repaid to the owners.
Decision to distribute dividends
The decision to distribute dividends is made in the net amount, i.e. the amount that is intended to be paid to the shareholder. This is supplemented by income tax at the company level of 22/78. If the 14/86 taxation right that was in force before 2025 has been used, income tax at the rate of 7% must be withheld in the case of a natural person receiving the dividend. You can find a sample of the approval of the annual report and the distribution of dividends here.
How to ensure that shareholders are treated equally
If a company has several shareholders, the decision on the distribution of dividends should be clearly documented and understandable to all. As a general rule, dividends are distributed in proportion to the shares, but the articles of association or an agreement between all shareholders may provide for a different distribution. In the case of different payment times, sources and tax treatments, it is worth considering before making a decision whether all shareholders will be treated equally both in terms of amount and taxation.
Summary
If you decide to distribute profits through the payment of dividends, this must be done in accordance with the relevant law and your company's articles of association. You must also consider the financial position of your company.
Profit distribution and dividend payment are an important part of a company's financial management. Paying dividends allows shareholders (members) to share in the company's success and can also be an attractive way to earn income from investments. However, it is important to remember that profit distribution and the taxation of dividends is a complex topic and it is therefore advisable to consult an accountant or tax advisor to ensure legal and tax compliance.
The author of the blog is Grow Finance tax specialist Malle Liivat, malle.liivat@grow.ee
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