The thin capitalization rules in the Baltics vary between Estonia, Latvia and Lithuania. For instance Estonia does not recognize the concept of thin capitalization. Article will briefly introduce the thin capitalization rules in the three latter mentioned countries.
Thin capitalization in Latvia
In Latvia the thin capitalization rules state that deductions on interests will be disallowed to the extent that
- Average liabilities multiplied by 1.57 times the short-term interest rate exceed interest expensed to the profit and loss account.
2. Debt-to-equity ratio exceeds 4:1.
Consequently, the taxable income is increased by the larger amount resulting from these two calculations.
An example thin capitalization calculation:
Equity 100k, Debt 1m with 2 % interest rate (20k interest per annum)
Deductible interest smallest from the following
1.) 1.57 x 1, 0267 (average short term credit interest rate 2, 67% in January) = 1,611919 (rounded 1,62%)
1 000 000 x 1,0162 = 1 016 200 -> deductible amount 16 200
2.) Debt-to-equity ratio that exceeds 4:1 not deductible -> amount of debt we can use for the deduction is 400k. 400 000 x 1,02 = 408 000 -> deductible amount 8000
From the income a corporate may deduct 8000euros
These rules, however, do not apply to credit institutions which are resident in a country that has concluded a tax treaty with Latvia or to interest payments made to EEA credit institutions.
Thin capitalization in Lithuania
In Lithuania, restrictions apply to interest paid to controlling entities. A controlling entity acting as a creditor is defined as an entity which owns:
- More than 50% of the shares in the company bearing the interest
2. More than 50% of the shares are owned jointly with associated persons and the creditor’s holding is 10% or more.
Similarly to Latvia, debt-to-equity ratio of 4:1 applies hence any interest attributable to the debt in excess of this ratio is nondeductible.
Latter mentioned restrictions do not apply:
- If the paying entity can demonstrate that the same loan would have been granted under the same circumstances by a third party and;
- To financial institutions rendering leaser services
Thin capitalization in Estonia
Estonia, as said in the beginning of the article, does not recognize the concept of thin capitalization and therefore does not have any rules regarding thin capitalization. However, it is important to note that The Ministry of Finance is working on another draft of the Corporate Income Tax Law. So far we know that the draft contains several amendments such as:
- Intragroup loans (from a parent company to a subsidiary) have to be declared
- If a loan is not repaid within five years it will be regarded as a profit distribution and thus be taxed accordingly
- Detailed definition for an intragroup loan and how all obligations to the state must be met
- New general anti-abuse provisions