Entrepreneurship no longer in favor

Photo: SCANPIX

When Minister of Economic Affairs and Infrastructure Kadri Simson and Port of Tallinn CEO Valdo Kalm presented the port’s stock market plans the week before last, both said the company would become a dividend stock, while the minister also said she first and foremost perceives pension funds and retail investors as future shareholders.

“Estonia has a lot of potential retail investors, but also pensioners who say they cannot find a safe enough investment opportunity. As dividend shares, those of Port of Tallinn will surely qualify,” Simson told Aktuaalne kaamera at the time. What the minister failed to tell the port’s potential shareholders is that Estonia’s new tax system will mean double taxation of dividends for many, probably most investors come next year.

Shareholders’ dividends are subject to income tax from the paying company. Currently, when a person is paid dividends on shares or holdings, they do not have to pay income tax as that part is taken care of by the company.

Things will become more complicated from next year, and some shareholders and partners of limited companies will also have to pay tax themselves as the recent basic exemption proportional income tax will be replaced with a reverse-ratio minimum income exempt from tax system.

Dividend income as punishment

The new system prescribes a minimum income exempt from tax of €500 to people whose average monthly income falls below €1,200. The minimum will start to shrink by 56 cents on the euro for people making between €1,200 and €2,100 a month and will no longer apply for people making more than €2,100 a month. Income tax will be applied, in addition to salary, to other types of income, including dividends that are already taxed on the company level.

Nothing will change for people whose income, including dividends, falls below €1,200. Dividends will basically be subject to double taxation for people who make more than €1,200 a month. People whose salary is below €1,200 a month but whose total income is greater on account of dividends will also have to pay income tax on dividends.

“This effectively results in double taxation of dividends,” member of the Riigikogu Finance Committee Aivar Sõerd (Reform Party) told Postimees.

Sõerd gives an example where a taxpayer earns €1,000 and uses €500 of income exempt from tax a month, which means they make €12,000 a year, with income exempt from tax coming to €6,000. Income tax is calculated on €6,000 and comes to €1,200. If that person is paid a dividend of €20,000 at the end of the year, his annual income comes to €32,000. This exceeds maximum annual income that qualifies for the exemption of €25,200.

“Therefore, the person must pay additional income tax of €1,200 because of dividend income,” Sõerd explains.

Tax expert, head of consultations firm EY Eesti (former Ernst & Young Eesti) Rando Tingas does not refer to the new system as double taxation but admits that it could lead to people losing their exemption.

“We can basically say that additional dividend income is punished by lower income exempt from tax,” Tingas said. “This policy does not motivate people with low and middle income to earn more or demonstrate entrepreneurship,” he added.

The change in dividend taxation first and foremost concerns people who make average salary or slightly more but who have decided their income does not have to depend solely on employers and who invest in shares of listed companies to boost their income or prepare for retirement.

Estonia’s largest listed company is Tallink that has 10,000 small shareholders. Estonian retail shareholders own 6 percent of Tallink, or 43 million shares. These are mostly ordinary investors who do not do business themselves, as major shareholders largely invest through companies.

Tallink paid a dividend of three cents per share this year, which means that local private shareholders got a total of €1.3 million. Looking at the shipping company’s financials for 2017, it is probable its dividend payment will be the same or even greater next year. It is to be speculated that the state will collect double income tax on at least half of that.

Growth of dividends might not persist

Tallinna Kaubamaja has a total of 5,000 shareholders and Estonian individuals own 4.6 million shares. The company paid out a dividend of 63 cents per share last year. Dividends have grown by on average 20 percent annually. Growth might not be as substantial next year.

Physical person taxpayers would get a total dividend of €3 million were the payment to remain unchanged. Income tax would be paid twice on the lion’s share of dividends – by both the company and private shareholders.

“I believe that this kind of redistribution is based on politicians’ view that if dividends and other type of income is sufficient, people do not need state support in the form of a tax exemption. That is the choice of our government and people,” Tingas said.

“Once the peculiarities of the new tax system hit home for hundreds of thousands of people through income tax returns in the spring of 2019, it will be exciting to see what the 2019 Riigikogu election will bring,” he added.