Low corporate income tax in the Baltics (Estonia, Latvia, Lithuania) and implications of the OECD treaty on BEPS

Base erosion and profit shifting (BEPS) is a term which refers to the negative effects of international companies´ tax avoidance strategies. A common way for companies to achieve BEPS is the use of transfer pricing. Transfer pricing (transfer mispricing) is the setting of the price for goods and services that are sold between related or controlled legal entities within an enterprise. This method can turn company´s profit negative and move income from the country where the value was originally created.

The proposal for broadening participation in the OECD (G20) BEPS Project was endorsed by the G20 Finance Ministers at a meeting on 26-27 February 2016 in Shanghai, China. The BEPS project has been said to be an "attempt by the world’s major economies to try to rewrite the rules on corporate taxation to address the widespread perception that the corporations don’t pay their fair share of taxes".

International tax planning and the OECD treaty

The purpose of the OECD treaty is to tackle aggressive international tax planning. One of the key elements is to ensure that products and services are taxed in the country where the value is created. The treaty also aims to increase transparency between officials in different member states and to preclude hybrid mismatches which can lead to double non-taxation. The treaty is targeted to be implemented in the domestic legislation of the member states and it will most likely have an effect on bilateral tax agreements that countries have established between each other.

OECD´s aim to tackle transfer pricing and aggressive tax planning

The new treaty can be divided into four different main categories which include: structural changes to OECD Model Treaty, aggressive tax planning and abuse, transfer pricing and remaining issues.

The first category addresses tax challenges of the digital economy (taxable presence in corporate and VAT purposes) and prevents artificial avoidance of permanent establishment (PE) status.

The key actions in the category focusing on aggressive tax planning and abuse include neutralization of the effects of hybrid mismatches, strengthening of CFC (controlled foreign corporation) rules, limitation of base erosion via interest deduction and other financial payments, prevention of treaty abuse and treaty shopping and requirement to disclose aggressive tax planning arrangements.

OECD plans to tackle abuse of transfer pricing by developing rules regarding moving intangibles within a group, transfer of risk/allocating excessive capital and other high-risk transactions. Member states also plan to re-examine documentation related to transfer pricing.

As remaining issues, the fourth category of actions is aiming to counter harmful tax practices, to make dispute resolution / mutual agreement procedure (MAP) more effective, to develop multilateral instrument to quickly change tax treaties and to collect / analyze data on BEPS and necessary actions related to the treaty.

The new treaty will have an effect on international tax planning everywhere including the Baltic region (Estonia, Latvia, Lithuania).

Corporate taxation in the Baltic States (Estonia, Latvia, Lithuania)

As it appears, international tax planning is getting more difficult for the residents of OECD countries. However it must be noted that a company can still gain significant advantages in global competition by choosing the right place of permanent establishment (fixed place of business).

According to 2014 International Tax Competitiveness Index, Estonia was the most competitive tax system in the developed world. Key drivers for Estonia’s high rank were thought to be its relatively low corporate tax rate at 21% (with no double taxation on dividend income), a nearly flat 20% income tax rate, and a territorial tax system that exempts 100 percent of foreign profits. In Latvia the flat corporate income tax rate is 15% of the taxable income. One should also notice that in Latvia there exists a special tax rate for small sized companies. Starting from January 1st, 2017 micro company tax will be 5 % that will be applicable for companies with turnover till 7000 EUR, but companies with turnover from 7001 EUR to 100 000 EUR will be subject for 8 % tax rate. Personal income tax in Latvia is based on a flat tax rate of 23%. When Lithuania joined the European Union and adapted its legislation, the country implemented a business-friendly taxation policy. The general corporate tax of Lithuania is 15% as in Latvia and the tax on dividends is 15%.

Payments of dividends in all the Baltic States between domestics companies are not subject to corporate income tax. Dividends paid to a legal entity – a resident of a European Union member state or a resident of the European Economic Area – are exempt from taxation. Dividends paid to a legal entity outside the European Union or the European Economic Area, are subject to a 10% tax payable at the time of their payment.

One of the main goals of the new BEPS regulation is that products and services are taxed in the country where the value is created. Moving production to the Baltic States hence ensures relatively low taxation for your company in the future as well. Low tax rates of the Baltic countries and their location in the European Economic Area can gain your company a competitive advantage in global markets and help your business to grow.

To find out more about BEPS and its impacts on your company´s tax strategy especially in the Baltics (Estonia, Latvia, Lithuania), please contact our lawyers at info@gencs.eu.

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In many regards, Latvian advocate Valters Gencs is the archetypal modern Baltic attorney – US educated, willing to take a commercial risk with his firm, which has been successfully operating for almost 16 years.  

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