How can I pay dividends?
Estonian company formation: In order to start paying dividends, you need to have:
Full share capital paid (to an Estonian bank account) and registered.
Your annual report confirmed. To prepare your annual report, we need access to your account in the business registry.
We’ll then prepare the annual report which you can later confirm. Once your annual report has been confirmed, you can pay dividends up to once per financial quarter. There are no requirements for the total amount of dividends.
When does the company pay taxes on dividends?
Your company will pay tax on dividends at the time you actually pay out the dividends. You can declare an amount of dividends that you intend to pay in your annual report, but as the amount may differ you don’t pay taxes until you make the actual payment.
The taxes should be paid to the tax authorities on the 10th day of the month after the dividend payout. As an example, if you declare that you’ll pay €5 000 in your annual report in March, but then pay out only €1 000 in April, then only €1 000 is reported to Estonian Tax authorities, and the corporate income tax of 20/80 (€250 in this case) has to be paid in May (the following month).
Who pays the taxes on dividends?
The tax subject – the person to be taxed for dividends – is the company and not the individual person (owner of the company) receiving the dividends. As a shareholder of the Estonian company, you don’t have to pay additional personal income taxes in Estonia.
However, if you aren’t a tax resident of Estonia, additional personal income taxes might apply in the country where you’re currently a tax resident. Please double check these rules in your country of tax residency.
When can I pay dividends?
Paying dividends assumes that your business has made profit in the past, i.e. dividends may be paid to the shareholders from net profit or from retained profit from previous years. In order to pay dividends, the annual report with the necessary annex needs to be reported by LeapIN and approved/signed by the owner of the company.
A standard financial year for your company via your accountant starts on January 1st and the financial year is 12 months long.
For example, if you start your company after July 1st (in Q3 or Q4 of the first year) then LeapIN consolidates this period and the next year into one financial year by default. You’d need to submit your first annual report after the end of the second financial year and you can pay dividends in the beginning of the third year at the earliest.
However if a company which was registered in Q3-Q4 of the first year earns profit during this period and wishes to pay dividends earlier, then your accountant can submit the annual report in Q1 of the second year if requested. In this case, the company can pay dividends already at the beginning of the second year.
Taxes on dividends are paid when you make the actual dividend payment (not when declaring the dividends). With your accountant, the dividend payouts can be made once per financial quarter if your annual report has been confirmed.
Paying dividends before declaring them with the annual report is not an option.
What if I don’t want to pay dividends even though I can?
If your company has earned profit, but you’d prefer not to pay dividends at the moment, based on the core principles, we can recommend the following. But it’s up to you to decide and let us know.
Option A: If your company earned profit last year (1a met), but you currently don’t have any intention to pay x EUR of it as dividends in 2018, it makes sense to declare the shareholder’s decision in the annual report as follows – ‘Not to pay out any dividends’, and not to record any additional board member salary for 2017 retroactively either. And if during the year you change your mind and would like to pay out x EUR as dividends, you’ll make a formal decision (as a shareholder), and the rest of the process will follow.
The shaky component in this case is the board member salary – if you decide to pay dividends in August (still based on the profit earned in 2017), and have not declared the board member salary for 2017 (to match the logic of dividends) in the annual report, it cannot be declared retroactively and would be considered as a salary for the contribution in 2018 instead. We don’t know whether this discrepancy would trigger an alarm for the tax authorities or not.
To clarify, the board member salary and the related taxes could be declared in the annual report i.e. the cost recognised in the company’s books (lowering the profit accordingly), but it’s a separate decision when to make these cost payments from the company’s account i.e. you can postpone the actual payments. The core principles are as follows:
Taking into account the possible dividend payment which you would make during year 2018 (if you change your mind), you decide the total sum of the board member salary which should be recorded as a cost of year 2017 in order to balance the potential dividend payment in a fair manner
We will record the sum of the board member salary + related taxes in the annual report of year 2017. The board member salary + related taxes would lower the profit of year 2017 accordingly (and lower the maximum sum to be distributed as dividends).
While the board member salary + tax costs are taken into account in the annual report, such costs do not have to be paid out immediately i.e. you can decide if and when you make the actual payments.
The board member salary + taxes are reported to the Estonian Tax Authorities only when you make the actual payment of the board member salary. For example, if you decide to pay it out in September 2018, it will be reported in October 2018, and then the relevant taxes will have to be paid as well. If you do not pay it out at all (for instance if you do not change your mind about divided payments), nothing happens, so no taxes are reported nor paid on the board member salary either. And if you do not make the payments at all, then when we compile the next annual report (about 2018) you’ll need to decide whether to cancel the recognised board member salary cost + related tax cost (which means the profit of year 2018 would increase accordingly) or still keep it in the balance just in case you’ll decide to make the payments in 2019.
Option B: You already have an approximate idea of how much you’d like to pay out as dividends in 2018, and you’ll declare the relevant shareholder’s decision in the annual report as well. And to match the possible dividend payment, we’ll also record a fair board member salary cost in the annual report of 2017 (lowering the profit of year 2017 accordingly) already, to keep it in the same period as the allocated profit. In this case no further shareholder decisions would be required during the year, and you’re free to decide when you actually make the dividend payments, the salary payment, and the related tax payments.
What are the rules for paying dividends?
There are the following rules around the process of paying dividends:
A company is allowed to pay out dividends only if:
the company has earned profit during the last financial year(s), and has not paid it all out as dividends in the previous years. For instance, if the company earned the profit of €10 000 in 2016, distributed dividends of €6 000 in 2017, earned the profit of €5 000 in 2017, the company can distribute maximum €10 000 – €6000 + €5000 = €9 000 as dividends in 2018. These sums are only officially taken into account if they’re recorded and reported in the annual report of the company. If the company wants to distribute (a part of) the accumulated profit as dividends, the company has to submit the annual report first. AND
the shareholders of the company have made an official decision to distribute x EUR as dividends.
A company is not obliged to distribute dividends, even if the company have an option to do it (see 1a). It’s up to the shareholders of the company to decide how much (out of the maximum amount) to distribute as dividends, if any. The maximum amount is limited to the sum in 1a, but the minimum is 0. And the shareholders’ decision (see 1b) determines the actual sum to be distributed.
Even if the shareholders of the company have made the decision to distribute dividends of x EUR, they can choose when the company will actually make the payments to the shareholders – The shareholders’ decision does not trigger automatic payments from the company’s account to the shareholders. And if (a part of) the sum allocated is not paid out in 3 years, it will not be lost but technically will be transferred back to the retained earnings in the company’s balance sheet, so it could be distributed as dividends again in future.
From our earlier example, in March 2018 the shareholders decide to distribute €5 000 (out of the €9 000 maximum amount). Out of €5 000, €1 000 is paid out in April 2018, €1 500 in October 2018, and the final €2 500 is not paid out at all, which means in 3 years €2 500 will be reclassified as retained earnings of the company (subject to dividend payments in future).
The corporate income tax on the distributed profit is paid in Estonia based on the actual dividend payments (point 3), not the “decided” payments (1b). For example, if the shareholders decide to distribute €5 000 in March, but pay out only €1 000 in April, only €1 000 is reported to the Estonian Tax authorities, and the corporate income tax of 20/80 (€250 in this case) has to be paid to the Estonian Tax authorities in May (the next month).
By default the shareholders’ decision about the distribution of dividends (see 1b) is declared in the annual report, once per year. And by default the decision is “not to pay any dividends this time”. Now, there are 2 options:
If the shareholders can, and plan to, pay dividends within the current year (based on the previous year’s results), they usually declare the sum in the same decision which is attached to the annual report (instead of “not to pay in dividends”, they declare “plan to pay x EUR as dividends”). In that case the formal part is done, and they can choose if and when they actually make the payments (see 3) without any formal procedures (except the tax reporting). It makes sense to go this way if the plan to pay out dividends is reasonably certain, and the shareholders have a decent understanding of how much they’d like to pay in total. If the sum declared is more then the actual payments, nothing serious happens (see 3). If the sum declared is less than the actual amount needed for payments, see the next option.
The shareholder can make the relevant decision (see 1b) later in the year as well. In the annual report they can declare the decision “not to pay any dividends”, but in July they make a new decision to “pay out x EUR as dividends”. The latter decision has to be formalized, but doesn’t have to be reported to any authorities unless asked for specifically (e.g. by Estonian Tax authorities). It makes sense to take this approach if, during the time of submitting the annual report, there’s no intention to pay any dividends or there’s some uncertainty about how much would actually be needed by the shareholders.
If the company decides to pay dividends, it’s strongly recommended to also pay a reasonable board member fee, if it hasn’t been done before. Otherwise the tax authorities might argue that the underlying profit has been earned by using the contribution by the board member (vs. the company earning it somehow magically), and as the contribution by the board member has to be compensated by the board member salary, the tax authorities would have an incentive to reclassify the dividends as the board member salary instead, and tax the payments in a different manner. To avoid this, it makes sense to pay the board member salary proactively.
For everything to remain in order, the board member salary payments have to be recorded as company costs in the same period when the company earned the profit which is distributed as dividends. So if the company decides to pay out dividends in 2018, the company can do it only based on the profit earned up to the end of year 2017 (see 1a), and this means that any relevant board member salary has to be recorded in the company’s financial figures of 2017, not 2018 (the board member salary would reflect the contribution the board member made in 2017 to earn the profit in 2017, which would be paid out as dividends in 2018). And that’s why, if the shareholders make a decision to pay dividends in 2018 and declare it together with the annual report, it makes sense to record the board member salary costs in the annual report as the costs of 2017 (lowering the profit accordingly), even if the board member salary and the relevant taxes would be paid out in 2018.