To slightly rephrase popular wisdom, business is looking for a better tax regime, as this helps a company or group stem the outflow of funds in the form of taxes.
According to the official figures of foreign direct investment in the share capital of Latvian companies over the period from 1991 to 2012, the absolute leader is Estonia with 807 million lats, Sweden comes second with Ls 526m, including Ls 199m invested in the banking sector, the Netherlands third (Ls 401m) and Cyprus fourth (Ls 291m). Russia lies seventh with Ls 209m. Germany (12th with Ls 101.5m) and Malta (13th with Ls 101m) are treading on each other’s heels.
The actual owners of some of those foreign investments are living in Latvia, however there is no publicly available data to confirm this. Among other things, the Latvian entrepreneur prefers to invest in Latvia from another country, as this can reduce the tax charge (achieve a lower rate) and defer the tax point (to when money is paid, rather than at the time of transaction).
It is quite interesting to see Malta so high up on the list (13th out of 131 countries), right after Germany. Malta is conquering the world with its especially attractive tax regime. And Latvia has recently taken its first steps in the same direction.
In late 2011 the Latvian parliament passed significant amendments to the Corporate Income Tax (CIT) Act, which, among other things, include provisions that will enable Latvia to become an attractive country for establishing holding companies in 2013–2014.
Income arising on the disposal of any shares other than those in companies established in tax havens will no longer attract CIT as from 2013. Accordingly, losses will not be deductible for CIT purposes. The law takes “shares” to mean shares in private and public limited companies and cooperative societies, as well as other documents that create a right to receive dividends.
In fact the Latvian CIT Act is very liberal, as it does not impose a minimum shareholding percentage (10% in many countries including Malta) or a minimum shareholding period, nor any other restrictions. Even income from a 1% interest in a company’s capital held for one month (speculative income) will be exempt. Many countries classify income arising on the disposal of shares held in the short term (for less than a year) as taxable trading income. This opens up opportunities for Latvia to become an attractive country for establishing holding companies and – like Estonia, Cyprus and Malta – to attract foreign investment.
This allows a Latvian entrepreneur, who buys and sells various capital assets such as shares and properties to achieve a lower tax rate on income earned, to use the saving for new investment, and to put off paying tax to a later date. In other words, instead of paying 15% personal income tax (PIT) on capital gains when an asset is sold, he can pay 10% PIT when a private limited company he owns pays him dividends.
According to the current wording of the CIT Act, tax is payable on dividends received from Latvian companies enjoying CIT relief, such as free-port companies, from foreign (non-EEA) companies in which a Latvian taxpayer owns less than 25% of capital and voting power, and from tax havens. Only dividends received from tax havens will attract CIT as from 2013.
Only dividends paid to EU and EEA companies are currently free of withholding tax, while dividends paid to other countries are taxed at a rate of either 10% or 5%. Dividends paid to any non-residents other than tax havens will be exempt as from 2014. This amendment is especially significant if a Latvian company’s shareholder is incorporated outside the EU or EEA, for instance in Russia or the USA. Yet dividends paid by Latvian companies to tax havens will attract a higher rate (15% instead of the current 10%).
Interest and royalties paid to foreign companies will be free of tax (currently 10%/5% or 15%/5% respectively) as from 2014.
There is currently a different treatment under the CIT Act for dealings in public EEA securities (publicly traded shares and bonds as well as all types of investment fund certificates) and for dealings in all other securities (including public securities of third countries such as Russia, Ukraine and the USA). In other words, profits arising on the sale of EEA public securities are not taxable, and losses are not deductible in the year of disposal or later. “Securities” is a broader term than “shares” and includes bonds and debentures as well as shares.
As from 2013 profits arising on the disposal of any securities other than shares will become taxable and losses deductible in the year of disposal. This is in fact the complete opposite of the current arrangement: it will no longer matter whether they are public or other EEA securities, but rather whether they are shares (within the meaning of the law) or other securities (including publicly traded EEA bonds etc).
Also, the clause that allows a company to carry forward losses arising on the sale of securities for use in subsequent years will cease to apply as from 2013. This is both good news and potentially bad news. It is good news in the sense that a company’s losses arising on the disposal of all types of securities (other than shares) can be offset against taxable income generated by its other lines of business. Yet this is potentially bad news for taxpayers that have accumulated substantial losses on the sale of securities, because they can no longer be carried forward or offset against profits arising on the sale of other securities as from 2013. Those losses will be forfeited unless the Cabinet of Ministers’ rules for the application of the CIT Act include provisions that allow accumulated losses on the sale of securities to be treated as “normal” tax losses and gradually offset in subsequent years.
If you are currently contemplating how to arrange your group of companies and where to place your holding company, then it is time to add Latvia to the list of potential countries. Latvia’s key advantages are its very liberal legislation and comparatively low company formation and maintenance costs.