Spring often brings a familiar discussion in many companies: should profits be retained to support growth or distributed to owners as dividends? If the choice falls on dividends, practical questions quickly arise – from when dividends can legally be declared to how distribution and taxation work for different types of investors.
The key principle is that dividends are not paid from future profits, but from retained earnings of previous periods. For a dividend payment to be valid, the annual report must be approved and the shareholders must adopt a decision on profit distribution.
If a company has received dividends and wishes to distribute them onward to its own shareholders, it must have sufficient retained earnings from prior periods. If not, the distribution must be postponed to future financial years.
As an exception, a public limited company may provide in its articles of association that the management board, with the supervisory board’s consent, can make advance payments to shareholders after the end of the financial year but before approval of the annual report. These advance payments may not exceed half of the amount that could be distributed.
In practice, there is often a desire to distribute profits from the current financial year or, in companies not covered by the public limited company exception, from a financial year that has not yet been approved. However, such payments do not qualify as dividends under income tax law and are instead treated as other profit distributions.
Payments of other profit distributions (from available equity) are taxed similarly to dividends, but they do not automatically grant a corporate shareholder the right to redistribute the received amount tax-exempt. Therefore, it is generally more reasonable to wait for the approval of the annual report and then make a proper dividend distribution decision or consider alternative solutions.
As of 1 January 2025, dividends in Estonia are subject to a 22% corporate income tax on the gross amount (i.e. 28.2% of the net distribution).
The previously applicable reduced tax rate for regularly distributed dividends no longer applies.
If a company has previously received dividends from another company in which it held at least a 10% shareholding at the time of receipt, and those dividends were paid from taxed profits, the company may redistribute those amounts to its shareholders tax-exempt.
Dividends received before 31 December 2024 that were taxed at a reduced rate can also be redistributed under the same principles as dividends taxed at the standard rate. In other words, if such dividends are redistributed to a corporate shareholder holding at least 10%, this can be done tax-exempt. The same principle applies further along the distribution chain.
However, if at any stage such dividends are distributed, in whole or in part, to an individual shareholder, an additional 7% withholding income tax applies. For residents of certain countries, double taxation avoidance treaties may allow for a lower withholding rate (5% or 0%).
In addition, if a company has earned income abroad through a permanent establishment and that income has been taxed abroad, it may also be distributed tax-exempt.
If an Estonian company’s shareholding in the dividend-paying entity was below 10%, tax-free redistribution is not available. However, the Estonian company may credit foreign income tax paid and reduce its Estonian tax liability accordingly when redistributing dividends.
To redistribute dividends or foreign taxed profits tax-free, it is essential that the relevant tax-exempt rights are properly declared in Annex 7 of the corporate income tax return (TSD). Otherwise, the tax authority will not have visibility of these rights.
The company must also be prepared to substantiate both the origin of the dividends (e.g. annual reports, dividend distribution resolutions) and the income tax paid abroad (if necessary, with a certificate from the foreign tax authority). In recent years, the tax authority has been paiying close attention to the use of tax-exempt rights, so careful documentation is important.
Estonia’s corporate income tax system is cash-based: a decision to distribute dividends does not in itself trigger a tax liability. The tax obligation arises only upon actual payment, although the decision and liability must be properly recorded in accounting.
While the general logic of dividend distribution and taxation is relatively straightforward, details can become important in more complex situations, such as international ownership structures or non-cash dividend distributions (e.g. set-off of claims), and may affect the tax treatment.
If you have questions or need to assess a specific situation, Grant Thornton Baltic tax advisors can help you find the right solutions and mitigate risks.
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