Why Lithuania's Dividends Paid to EU Companies Could Cost You 15% Tax: Key Lessons from a Court Case!

Let's say that Lithuanian company X is directly controlled by a Lithuanian natural person shareholder. This company has been accumulating dividends for several years but has not paid them out. The shares of this company are then sold to UK company A and later to Estonian company B, and the Lithuanian company pays the accumulated dividends to the Estonian company.

The case established that Estonian company B has no employees (the shareholder and manager is a permanent resident of Lithuania); this company also has no long-term assets; it has no premises (an office where activities would be carried out) and/or has not incurred any costs for renting premises (an office); it does not carry out any active real economic commercial activities, including providing management or any other services, does not invest funds in securities, etc. ; representatives of the group of companies do not disclose the circumstances of the acquisition of shares in Lithuanian company X (how, from whom, and for what purpose Estonian company B acquired shares in Lithuanian company X). In this case, Estonian company B would be considered an intermediary company that has no economic logic. Therefore, dividends paid by the Lithuanian company to the Estonian company B would be subject to a 15% income tax, despite the fact that these dividends are eligible for tax exemption. This can be stated based on the current practice of the Supreme Administrative Court of Lithuania.

It should also be noted that the fact that the company established in Estonia manages (controls) Lithuanian company X, the shareholders of Estonian company B (who were also shareholders of Lithuanian company X prior to the transfer of shares) and the representative (manager) of Estonian company B are permanent residents of Lithuania (no other Estonian or foreign entity is involved in this management), also gives rise to doubts that the structure of the group of companies in question was established for any significant commercial reasons. The fact that such a structure of the group of companies was not aimed, for example, at more effective management organization, especially considering that the shareholders of Estonian company B were permanent residents of Lithuania, is confirmed by the fact that Estonian company B did not have any material or human resources.

In such a dispute, even the Supreme Administrative Court of Lithuania has indicated that, for example, in this situation, the investments of Estonian company B in the currency market, when it invested the dividends it received in the currency market, do not constitute grounds for establishing objective reasons for the establishment of the entity. In other words, the court did not take into account the fact that Estonian company B invested the dividends it received in currency trading. The court also failed to take into account the fact that the dividends were not paid to natural persons – the emphasis here is that the situation is assessed specifically for income tax purposes. In other words, the specific stage at which dividends are paid between legal entities is assessed, as such dividends could be subject to income tax, while personal income tax obligations are irrelevant, as it is the transaction that is assessed from the perspective of the income tax of legal entities. Consequently, whether or not personal income tax will be paid by the final beneficiaries has no bearing on how Estonian company B is assessed. The latter is analyzed precisely in terms of whether its establishment and operation have economic logic or whether it was essentially inserted only as an intermediary company in order to obtain income tax benefits – to avoid income tax on dividends transferred to it.

Thus, the dividends received by company B, established in Estonia, were not paid out to natural persons in any form. However, Lithuanian company X did not pay dividends earlier, but accumulated them, and finally, when its shares were already owned by Estonian company B and the conditions for dividend tax exemption between these companies were met, the dividends were paid out immediately. It should be noted that dividends between companies are not taxed when at least 10 percent of the voting shares (parts, units) are held for at least 12 months without interruption, including the moment of dividend distribution.

Let us consider what argument could help to find the economic logic of Estonian company B. For example, simpler accounting or other similar business environment advantages may be an important commercial reason mentioned in EU legislation. For example, representatives of the company structures under analysis could argue and claim that in some EU Member States, including Estonia, the procedure for paying interim dividends is simpler than in Lithuania, e.g. there is no need to audit interim financial statements, the controlling holding company can borrow from creditors itself and invest in the projects of its subsidiaries, but in the case at hand, the applicant does not provide evidence to support such claims. If this were justified and undoubtedly proven immediately by real documents and facts, and not just verbal objections at the very beginning of a possible dispute (for example, by submitting comments when the tax administrator initiated a tax audit), then it would be possible to consider the possible economic logic. However, let us assume that the circumstances established in this situation do not essentially justify (inter alia, taking into account the period when the shares were held by UK company A and their subsequent transfer to Estonian company B) that, during the relevant period, as far as dividends are concerned, the arrangement in question (the establishment of Estonian company B and the transfer of the block of shares in Lithuanian company X to it) was made for any commercial reasons. In the practical situation under consideration, there is no objective data to substantiate the existence of any abstractly indicated possible reasons for establishing a holding company (e.g., consolidation of the management of several companies into a single parent company with a view to selling the entire business). If such statements are only theoretical and not supported by calculations or documents, they should be considered questionable and not based on any economic logic.

Therefore, according to the court ruling, it can be concluded that in the case under consideration, it has not been established that at the time of the establishment of Estonian company B or at the time of the payment of the aforementioned dividends, the establishment and existence of this entity was determined by any other important economic reasons reflecting economic reality or economic logic. economic logic. Therefore, it could be said that Estonian company B is only an intermediate company that was established for the purpose of obtaining income tax benefits – to take advantage of the aforementioned dividend tax exemption (dividends between companies are not taxed when at least 10 percent of the voting shares (parts, units) are held for at least 12 months without interruption, including the moment of dividend distribution.

So, we have another situation where Lithuanian company X is directly controlled by a Lithuanian natural person shareholder, with no Latvian companies in between. When the Lithuanian company pays dividends to the natural person shareholder who is a Lithuanian resident, they will be considered Class A income and the Lithuanian company X must deduct 15% income tax and pay it to the budget by the 15th day of the following month.

In other words, the Supreme Administrative Court of Lithuania has once again clarified that in both situations there is no difference in terms of the income tax liability, regardless of whether Latvian company Y is established as an intermediary or not; in both cases, as described in the situation, 15% income tax must be paid to the budget. However, the emphasis is placed on the fact that the Supreme Administrative Court of Lithuania explained in a case examining such situations involving intermediary companies that the specific stage at which dividends are paid between legal entities is assessed, as such dividends could be subject to income tax, while PIT obligations are irrelevant, as it is the transaction that is assessed from the perspective of corporate income tax. This means that whether or not PIT will be paid by the final beneficiaries has no bearing on how the Latvian company Y is assessed. The latter is analyzed in terms of whether its establishment and operation make economic sense or whether it was essentially inserted only as an intermediary company in order to obtain income tax benefits – to avoid income tax on dividends transferred to it. It should be noted that dividends between companies are not taxed when at least 10 percent of the voting shares (parts, units) are held for at least 12 months without interruption, including at the time of dividend distribution.

Thus, the practical situation presented essentially focuses on the content of the activities of the Estonian holding company B and finds that the content is insufficient.

It was precisely the tax benefit that led the Lithuanian company X to unjustifiably apply the income tax relief to the payment of dividends.