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13.2. Thin-capitalization and other Restrictions to Interest Deduction

An earnings stripping based interest deduction barrier has been implemented in Estonia effective 1 January 2019, in line with the EU Anti-Tax Avoidance Directive (ATAD1). Prior to that, Estonia did not have a specific thin-capitalization rule.

Under the new rules, the deductibility of interest charges is restricted to 30% of EBITDA with a EUR 3 million safe harbour. Excess borrowing costs exceeding the interest deduction limits in a tax period are subject to corporate tax on an annual basis.

In case the excess borrowing costs do not exceed the limit, a credit may be claimed for the tax paid on excess borrowing costs in the preceding periods up to the limit provided.

The interest deduction restriction rules do not apply to:

  • Financial undertakings;
  • Standalone undertakings (companies that are not part of a group and have no related companies or permanent establishments);
  • Loans used to finance public infrastructure projects in the EU; and
  • Members of a consolidated group where the equity to total assets ratio is equal to or greater than that of the group, except financial corporations belonging to the group.

Companies which are part of a consolidated group may apply a higher limit on excess borrowing costs, which is determined by multiplying the EBITDA of the member by a group ratio (excess group interest expense with third parties over group EBITDA).

Effective 1 January 2018, Estonian companies (including permanent establishments of non-residents), are required to demonstrate to the tax authority, within 30 days on request, that their intragroup loans are not hidden profit distributions. On failure to do so, such loan will be subject to the 20% corporate tax rate (20/80 on the net amount of the profit distribution – see Sec. 8.1.1.). This requirement applies with respect to loans with a term exceeding 48 months, granted on or after 1 July 2017 to a parent company or a subsidiary of the parent that is not a subsidiary of the taxpayer.

Companies are also required to file quarterly reports with the tax authority disclosing all intragroup loans meeting the above criteria.