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Emerging Financial Centers, The Baltic Tiger

By John Dietz - Email Editor

Date : September 22, 2009

Dear Valued Reader,

Estonia, with its 1.34 million people and market-based economy ranking 13th in 2009 on the Heritages Foundation’s Index for Economic Freedom, is positioned to become a global leader and a true financial center. This rare gem, bordering Latvia to the south and the Bay of Finland to the north, makes it a perfect trading partner to Scandinavia, Latvia, Russia, and all of Europe.

I am writing today from the crown jewel and capital city, Tallinn. The city and the country have a long fascinating history dating back to a 1st century Roman reference where the Estonian name first appears. Through much of Estonian history they have endured war, occupation, and subsequent freedom. To their credit, they have been able to preserve their identity, language, culture, heritage, and are now fast becoming an economic leader. For more history on Estonia, click here.

The bright and shining new office towers in the financial center are a perfect complement to Tallinn’s Old Town, which surely represents one of the most beautiful seaside villages in Europe. When walking along Old Town’s charming coble stone streets, it is difficult to imagine Estonians’ 1991 struggle for independence and democracy. To get a visual of Tallinn now, mix Prague and Saltsburg together and add a harbor for a perfect combination of beauty and charm.

Although the concept of an income tax was first introduced in Great Britain in 1842, and the Isle of Jersey was the first European country to adopt a flat tax in 1940, Estonia is the first European continental country to adopt a flat-rate tax system on personal income in 1994 and no tax on reinvested corporate profits (tax is not levied unless a distribution is made) is well on its way to being a role model for all countries. According to the CIA, Estonia’s market-based economy currently enjoys one of the highest per capita income levels in Central Europe. Its currency, the Estonian Kroon (EEK), is pegged to the Euro, which has led to a competitive commercial banking sector and an environment ripe for foreign investment. The net end result is a unique economic advantage over its higher tax neighbors.

The early adoption of a flat-rate tax of 26 percent without any deductions and subsequent lowering of that rate each year from 2005 to the now 21 percent rate, regardless of personal income, has been a significant factor causing Estonia’s foreign investment to double. Until the crisis of 2008, Estonia was averaging a GDP growth of 8 percent per year.

By mandate and written into the Estonian constitution is a small but vital detail: The budget can have no shortfalls, meaning no deficits. Currently, Estonia's public debt is 3.8 percent of GDP and government reserves are close to 10 percent of GDP.

Estonia has be aptly nicknamed, E – stonia, for its strong electronic and telecommunications sectors. The people who connected the world through a unique program called "Skype" were in fact Estonians.

The local Estonian language is challenging, but not to worry as you will find English widely spoken. Stand on any street corner and you will hear conversations in English, Russian, Finnish, German as well as a host of other languages.

The Estonians believe their growth rate will continue and point directly to their flat-tax regime as a main reason. It should be of interest to our U.S. readers to take a gander at the Estonian Tax Authorities web site. You can view the complete site in a few short minutes. As mentioned above, the personal tax rate in Estonia today is 21 percent of your net income allowing for a 27000.00EEK.

Notice the chart below shows an income tax decrease and a fiscal increase.

Decreasing Income Tax from 2000, *2004 Income Tax Rate was 26 percent.

In Estonia, annual basic exemption (non-taxable amount) per year is income of the year 2009 - 27 000 EEK.

Corporate Income Tax

The moment of corporate income taxation is shifted to coincide with the distribution of profits in Estonia.

Taxation of profits in Estonia

The system of corporate earnings taxation currently in force in Estonia is a unique system, which shifts the moment of corporate taxation from the moment of earning profits to the moment of their distribution. There are two types of profit distribution possible – an implicit and an explicit way. The explicit way stands for dividends and other profit distributions. The implicit way to distribute profits is through fringe benefits, gifts and donations, as well as expenditures and payments unrelated to business activities.

All of these profit distributions are taxed at a rate of 21/79 (or slightly over 26.6 percent) in 2009. This tax rate should not be deceiving. It is still the same rate of 21 percent as in the provisions for the taxation of salaried work payments. The difference is that 21 percent is applied to gross payments and 21/79 is applied to net payments.

The resident legal person and the non-resident legal person acting through its permanent establishment registered in Estonia carrying out profit distribution must pay 21/79 (in 2009) of the amount of profits distributed.

A point worth noting is that non-residents (natural and legal persons) have a non-worldwide taxation system in Estonia; only the Estonian-source income is taxed in Estonia.

Estonia is fast becoming an international financial center with its current U.S. tax treaty along with 40 other tax treaties in place. Corporations may be able to lower their effective tax rates while gaining access to world markets.

On the business note, Estonians are talking about and thinking about global markets. With the current U.S. dollar weakness, America is once again on sale to the rest of world. I had a chance to speak with an American lawyer living in Estonia who is taking full advantage of cheap goods and services in the U.S. Weak dollars mean cheap U.S. exports. His latest venture was sending high quality furniture out of the U.S. to the Estonian market. He said there is more opportunity than anyone could imagine.

If you should venture to Estonia, you are bound to find warm inviting people ready to conduct business.

If you have questions, please email us at info@trustmakers.com.

Until next time,

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