Accounting nuances
1. Assessment of claims value and recording of expenses
Before declaring a claim irrecoverable, the actual probability of receipt should be assessed. This can be done by checking the debtor's ability to pay and financial condition (from sources like e-Credit Information or the Business Register), and reviewing past payment patterns.
If the claim is unlikely but not irrecoverable, a markdown or discount may be applied to the claim, such as 20% or a specifically calculated amount. This markdown is recorded in the income statement under other financial expenses.
2. Timing of recording the expense
The write-off or markdown should be recognized when there is sufficient evidence of unlikely receipt (e.g., bankruptcy proceedings are completed, the claim has expired).
3. Documentation and Audit
All assessments and decisions made during the process must be documented, including justifications, payment ability analyses, and debt management measures. The write-off decision is usually under the authority of the board, who must substantiate and document the decision, either in minutes or another significant document. Generally, an email or oral decision from a board member is insufficient, as it must be accounted for with traceability and verifiability. Proper documentation helps transparently justify the loss or expense recognition in financial statements and is essential for audit control and tax administration.
4. Receipt of funds after write-off
If funds are received after an irrecoverable claim has been written off or discounted, previous entries must be correctly reversed (reducing the formerly used expense account).
Legal Nuances:
1. Legal Steps for debt collection
Before declaring a claim irrecoverbale, all reasonable steps for debt collection (warnings and collection activities) should typically be taken. If official measures are unsuccessful, a claim may be deemed irrecoverable.
2. Contract terms and collateral existence
In some cases, it might be possible to set collateral or guarantee for a claim (e.g., real estate, bonds). If the borrower no longer has the collateral or it is lost, the risk of the loan not being repaid increases.
3. Statute of limitations
Expiration affects the right to receipt and the moment of declaring the claim irrecoverable. After the deadline passes, the claim is "lost" legally, and cannot be pursued. The length of the statute of limitations depends on the type of claim and is determined by state legislation. In Estonia's civil code (TsÜS), the general statute of limitations is usually 3 years from the creation or demand of the claim but can extend up to 10 years in some cases.
Tax considerations:
When a loan is granted to a parent or subsidiary company, one must ensure it is not deemed a hidden profit allocation. According to the guidelines provided on the Estonian Tax and Customs Board website, it's necessary to monitor that the loan adheres to the standard loan conditions, such as setting a repayment term and the borrower's ability to repay the loan.
When are loan write-offs taxed?
Taxation is justified primarily when the loan agreement terms and the loan usage indicate that the loan is not intended to be repaid or repayment proves clearly impossible. A loan initially linked to business activities may become unrelated to business after subsequent modifications to the loan agreement terms (like extending the repayment deadline) and thus be subject to corporate income tax.
A granted loan may be considered hidden profit allocation if the likelihood of loan repayment is low or circumstances suggest intent to avoid or reduce tax liabilities, such as:
- Granting a loan for an unreasonably long term (over 5 years);
- An unreasonable repayment schedule;
- Repeatedly extending the repayment deadline;
- Repeatedly increasing the loan amount;
- Loan amount tied to profit size (e.g., situations where each year, a loan is given to the parent company in the same magnitude as the subsidiary’s profit);
- The borrower’s actions in using the loan amount evidently indicating repayment impossibility;
- Non-payment of dividends.
Taxation is not determined by the interest rate applied. Exceptionally, interest-free loans may be justified if the lender gains benefit from the loan transaction in another way, like a share of a joint business project profit.
According to section 50(2) of the Income Tax Act, the loan term set is rather significant. If the repayment term exceeds 48 months, the taxpayer must prove the repayment ability and intent upon the tax authority’s demand. The tax authority must give the company at least a 30-day period to present evidence.
Note that by the 20th day of the month following the quarter, business entities and permanent establishments of non-resident business entities must submit Section IV of INF 14 to the Tax and Customs Board, where resident businesses and non-resident businesses with a permanent establishment in Estonia declare the sums of loans granted and returned during the quarter under Section 56(5) of the Income Tax Act. Declare loans granted to the parent company, the same parent company's other subsidiaries (except loans given to the lending subsidiary), and loans given to shareholder or partner belonging to the group, as well as the paid interest. More detailed info about filling in INF 14 can be found on the Tax and Customs Board's website.
Under the Estonian tax system, if a loan to a parent company becomes hidden profit allocation and is taxable, the tax liability arises when such hidden profit allocation is identified. This means the tax liability does not arise at the time of granting the loan but in the reporting period when it is determined that the loan was hidden profit allocation. The hidden profit allocation that arises is declared in the corresponding month in form TSD Appendix 7, first part under code 7012, but INF 1 form is not completed.
Returned hidden profit allocation (taxed under code 7012) is declared in TSD Appendix 7, second part – "Returned hidden profit distribution and income from controlled foreign company and assets taken out." On behalf of returned amounts, dividends and equity payments can be distributed tax-free.
Contact us
