Estonia e-Residency: Should you set up your Company in Estonia?
A lot of clients have come to us with the idea of setting up a company in Estonia. Let's look at how the Estonia e-residency works, who should apply, whether it makes sense from a tax and compliance point of view.
Let's get started!
What is Estonia e-Residency?
Estonia e-residency allows foreigners to obtain digital residency in Estonia, without actually living there.
E-Residency enables digital entrepreneurs to start and manage an EU-based company online.
Estonia is the first country to offer e-Residency – a government-issued digital identity and status that provides access to Estonia’s transparent digital business environment.
E-Residency allows digital entrepreneurs to manage business from anywhere, entirely online.
As an e-Resident, you'll be able to:
Establish and run a company online
Conduct your banking online e.g. make electronic bank transfers
Have access to international payment service providers
Digitally sign documents (annual reports, contracts) within the company as well as with external partners
Verify the authenticity of signed documents
Encrypt and transmit documents securely
Declare taxes online
How to apply?
Estonia e-Residency's website has some excellent information on how to apply alongwith a series of explainer videos. Linking to the website here.
Why would anyone want to apply for Estonia e-Residency?
Having an Estonia based company can definitely have it's advantages including:
Ease of doing business
Being a EU company might appear to be more reliable than an Indian company
EU regulations might be easier for business's to operate than Indian regulations
The main reason is of course perception. Being an Europe (EU) incorporated company can definitely be a significant positive for a lot of startups and businesses.
Advantages for startups:
Easier fund raising
International investors may be more willing to invest in an EU incorporated company rather than Indian company
Easier access to US and Europe markets
Galactic Note: If you are a startup or an investor and need assistance with deal advisory, feel free to contact us. We're happy to help!
What about tax?
A LOT of people are under the impression that if they set up a Company in Estonia, India will not tax their income. Unfortunately, tax laws don't work this way.
Let's break this down into parts:
A. Tax in Estonia
This is why everyone is considering Estonia - There is no corporate income tax on retained and reinvested profits.
This means that Estonian resident companies and the permanent establishments of foreign entities (including branches) are subject to 0% income tax for all reinvested and retained profits.
If you do distribute dividends, a 14% tax applies. This also seems more reasonable to people than the ~25% plus tax at slab rates on dividend in India.
Note: Tax is 14% on dividend, only if distributed to a legal person. Otherwise, tax is 20%.
Dividend paid to Non-Residents is not even subject to withholding tax.
B. Tax in India
Unfortunately, this is where things start falling apart if you look at this from a tax point of view.
Bear with us, we're going to get slightly technical. Feel free to ignore the actual provisions and just read our Galactic summary if you don't want to understand the technicalities.
Residency in India and Place of Effective Management
Provision Section 6(3) of the Income-tax Act is reproduced below: A company is said to be a resident in India in any previous year, if— (i) it is an Indian company; or (ii) its place of effective management, in that year, is in India. Explanation.—For the purposes of this clause "place of effective management" means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.
Accordingly, the Estonian Company might be considered Resident in India, considering that a person is residing in India controls the entity and all key management and commercial decisions shall be made in India.
However, CBDT vide Circular No. 25 of 2017 has clarified that Place of Effective Management (“POEM”) provisions shall not apply to a Company having turnover of INR 50 crores or less in a Financial Year.
Now, if your turnover exceeds INR 50 crore, this doesn't affect you.
However, if your turnover is less than INR 50 crore, POEM rules might not apply to you and the Estonian company may not be considered Resident in India.
Note that the aforesaid circular may be repealed in the future. In case said circular is repealed, the Estonian Company shall be considered a resident for Indian tax purposes.
Before you start thinking that this is a great idea, let's come to the next problem:
Business Connection in India
Section 9(1) of the Act provides Income that shall be deemed to accrue or arise in India, irrespective of place of receipt of Income.
The following incomes shall be deemed to accrue or arise in India :—
(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.
Explanation 2 to Section 9(1)(i) inter-alia states the following
For the removal of doubts, it is hereby declared that "business connection" shall include any business activity carried out through a person who, acting on behalf of the non-resident,—
(a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident or habitually concludes contracts or habitually plays the principal role leading to conclusion of contracts by that non-resident and the contracts are—
(i) in the name of the non-resident; or
(ii) for the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that non-resident has the right to use; or
(iii) for the provision of services by the non-resident
The Estonian Company shall be deemed to have a Business Connection in India, considering that an Indian Resident may have the authority to conclude contracts on behalf of the Estonian Company.
Accordingly, the income of the Estonian Company shall be deemed to accrue or arise in India and shall be taxable in India.
This is probably the worst case scenario - tax rate for foreign companies in India is 40% (plus surcharge and cess).
Double Taxation Avoidance Agreement
Before you scream India and Estonia have a Double Taxation Avoidance Agreement (Tax Treaty), read our article on how a DTAA works.
Now, it is a settled position in law that the provisions of the DTAA override the provisions of the Act, to the extent more beneficial to the assessee.
Let's see if there's any shelter available under the India-Estonia DTAA:
Article 7 of the India-Estonia DTAA deals with taxability of Business Profits. Extract is reproduced hereunder
The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.
Article 5 of the India-Estonia DTAA provides that
The term "permanent establishment" includes especially:
(a) a place of management
The above provisions would indicate that the Estonian company has a permanent establishment in India. Accordingly, there is no relief available under the DTAA in this specific instance.
The whole of the income shall be attributable to the Permanent Establishment in India. Accordingly, the whole amount shall be taxable in India.
Note that the above implications are oversimplifications based on a direct reading of the law. In some cases, it might make sense to set up a company in Estonia. There's definitely ways of structuring this for tax efficiency. Feel free to contact us if you need assistance.
For a lot of people, there may be other ways of structuring their business in India itself. If you are one of these people, feel free to contact us. Our team of experts are always happy to help!
Tell us if you're interested in more articles relating to Estonia's e-residency. We might do a few caselets and examples to aid in understanding if there is enough interest.