From 1 January 2020, the Estonian income tax legislation includes the new chapter 102, with which Estonia introduces tax measures to tackle with hybrid mismatches as required in the EU Directive 2017/952. Hybrid mismatches are generally deemed to be various crossborder situations, where the same payment or expense is deductible in more than one country (i.e. double deduction) or where the same payment or expense is deductible in one country without the corresponding inclusion for tax purposes in the other country (i.e. deduction without inclusion).
An example of double deduction is the case, where the foreign branch of the Estonian company takes a loan and commences to pay loan interest in that foreign country, which can be for corporate tax purposes deducted both in the country where the company is resident, a well as in the country where the branch is located. However, the profits attributable to the branch are taxed with corporate tax only in the country where the branch is located, as Estonia (i.e. the residence country of the company) applies an exemption to such branch profits.
Under the new primary rule, in such a case the Estonian company must pay corporate tax on interest so deducted. If the primary rule is not applied by the company, then under the secondary rule the branch as a payer of interest must pay corporate tax on such interest.
The example on deduction without inclusion for tax purposes is the case, where the company of the first country pays interest to the hybrid entity of the second country (which is treated as transparent and thus not subject to tax), but the third country, where the shareholder of the hybrid entity is tax resident, treats the respective hybrid entity as a taxpayer. This will result with the scenario, where the first country allows the deduction of interest from taxable income, but neither the second nor the third country will tax the interest received under their domestic tax rules.
The hybrid mismatch will often arise between the resident company and its associated entity, but also between the company and its permanent establishment or branch office or between permanent establishments or branches located in different countries. In addition, that mismatch may also arise as a result of the payment made to or by the hybrid entity, which is deemed to be an entity or company (e.g. general or limited partnership), which is treated for tax purposes by one country as a taxpayer, but by the other country as as transparent entity the income of which is taxable at the level of its shareholders.
The amount resulting from the hybrid mismatch during the financial year must be declared and corporate tax paid to the Estonian Tax and Customs Board by the 10th day of the ninth month of the following financial year, at the latest.
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