corporate income tax: the ultimate guide

What is Corporate Income Tax? What is Double Taxation? What factors should you consider when choosing a tax jurisdiction for your business?

Around the world, different countries impose taxes on businesses in the form of corporate income tax (CIT). Also known as company tax, CIT is a type of tax that is applied to company profits.

It’s vital for companies to know which tax laws apply to their operations, as this affects their profits and is critical to any multinational strategy. Understanding corporate income tax can be complex – particularly for businesses that operate across various countries and may be liable for taxes in multiple jurisdictions. 

Knowing about the tax laws that apply to your business, and the concepts of double taxation and permanent establishment are vital to ensuring your company is both tax compliant, and not paying too much tax. 

For Estonian e-⁠residents - who may operate their business in Estonia as well as in various other EU countries, and internationally - knowledge of Estonia tax laws is invaluable. And for any startups considering where to incorporate their businesses, awareness of tax laws can help you make the most strategic choice.

What is Corporate Income Tax?

Corporate income tax, also known as company tax or corporation tax, is a type of tax that applies to company profits. Tax laws around the world vary greatly, with corporate income tax (CIT) or company tax being calculated in different ways. Depending on the jurisdiction in which you establish your company, or where your company owes taxes, different corporate income tax rules may apply. 

Types of Corporate Income Tax

In many countries, the way that corporate income tax works is that companies need to calculate their gross profits that they’ve earned over a year and then subtract any allowable expenses to determine their net profits and total taxable income. The tax rate is then applied to the companies’ net profits to determine how much tax a company owes. Different countries have varying rules regarding deductions, credits and exceptions, and most have different tax rates that apply –with some even having different rates for different types or sizes of companies.

Some countries - like Estonia and Latvia - have a deferred system of corporate tax. This means that corporate taxes are only applied on profits that have been distributed, for example as shareholder dividends (but also in other forms -  on fringe benefits, gifts, donations, reception costs, as well as from business-unrelated expenses).

There are also several jurisdictions that do not impose any corporate taxes at all, such as the Bahamas, Bermuda, Cayman Islands, and Guernsey which are often referred to as ‘tax havens’.

Most countries that impose corporate income tax also require companies to file corporate tax returns and to pay any taxes owing by set dates. The process and cadence of filing tax returns will vary depending on the  jurisdiction in which you owe corporate taxes.

Double Taxation

Double taxation is when you get taxed twice on the same income. This can happen to companies where a company’s income is taxed in both the country where the company is registered, and the country where it operates and sells goods and services, for example. 

In the latter example, the country claiming rights to tax the company bases that claim on the concept of permanent establishment — which is usually established when a company maintains a fixed place of business in a country, and/or if they have a dependent agent operating in that country. 

For companies that operate across borders, it’s also important to be aware of controlled foreign companies (CFCs) rules that may apply. Each country may have their own CFC rules, which generally aim to penalise companies (especially so-called ‘shell companies’) that get established in tax havens and thereby help shareholders (who are residents of countries outside of where the company is registered) and companies to avoid paying taxes (i.e. tax avoidance or tax evasion).

To avoid being taxed twice (which is an unenviable situation), double taxation agreements have been concluded between many countries. Estonia for example, has established double taxation agreements in place with over 60 jurisdictions.

Why is Corporate Income Tax collected?

Corporate income tax is collected by governments to help fund public services and infrastructure like building roads, funding schools, and operating hospitals. It also plays a role in the economic growth of countries and local economies, not to mention national security.

Understanding corporate income tax is important for any company, as it has significant financial implications. It’s also crucial to stay updated about tax law reforms and changes, so that you can maintain compliance and create business strategies to optimise tax efficiency and profits.

Why Should a Business Consider Different Tax Jurisdictions

Whether you’re planning to launch a startup company, or you’ve already established a business, taking time to consider the pros and cons of different tax jurisdictions can help you make strategic decisions about the future of your business.

Below are several factors to consider when choosing where to establish your company from a tax perspective. Keep in mind that you may be liable to pay corporate income tax in more than one jurisdiction, making it imperative to seek professional tax and legal advice before making any decision.

1. Tax Optimisation

Corporate taxes can cut into profits significantly, which makes choosing a tax jurisdiction a strategic priority for many businesses. Choosing a country with a lower corporate tax rate can help to reduce total taxes and thereby ensure tax optimisation.

When considering tax optimisation options, look for jurisdictions that offer lower tax rates as well as jurisdictions like Estonia that allow to defer tax burden by reinvesting its profits, while helping companies to grow.

2. Access to Tax Incentives

Some countries offer tax incentives as a way of attracting foreign investment. These tax incentives can help to reduce overall corporate tax liabilities, while at the same time helping companies to scale and innovate. 

For example, some jurisdictions offer reduced tax rates for specific types of industries, or tax deductions for expenses like research and development. 

In Estonia, for example, one of the biggest tax incentives of running your company there is that there’s no corporate income tax on undistributed profits. This enables companies to reinvest their profits, which they can use to scale and grow their businesses.

3. Spread Your Risks

When companies operate in various tax jurisdictions, this can help diversity financial risks. That’s because if one country becomes politically unstable, or its economy is negatively affected, then your operations in other jurisdictions are not affected. 

However, managing your business operations in different countries adds complexity and costs, so you may want to consider the pros and cons of too much diversification. 

4. Enhanced Competitiveness

If your company can save costs by operating in a country with lower corporate tax rates, then this may help your business to price its products and services more competitively. 

This in turn may provide a competitive edge over other similar products or services that are more costly – allowing you to attract more customers and increase your brand’s reputation and market share. 

Estonia ranks 1st in the Tax Competitiveness Index, which measures and ranks 38 OECD countries’ tax systems using 5 main categories including corporate taxes, individual taxes, consumption taxes, property taxes, and international tax rules. Estonia has been awarded this coveted title by the Tax Foundation for 11 consecutive years.

5. Market Access

Your choice of which jurisdiction to operate in, affects which markets you are able to operate in. Depending on which country your business operates in, you may be able to take advantage of beneficial trade agreements and trade tariffs, or easier tax reporting requirements. 

For example, by choosing to establish your business in Estonia, you can then access the EU marketplace and take advantage of the EU’s unified foreign trade policy and trade agreements, as well as the Baltic Free Trade Agreement (BFTA) between Estonia, Latvia, and Lithuania.

6 Factors to Consider when Choosing a Tax Jurisdiction for Your Business

Below are 6 important things to consider when choosing where to register your company, based on tax competitiveness and tax optimisation. These include company tax rates, tax incentives available, the existence of double taxation agreements, the regulatory environment, political and economic factors, the reputation of the country from a tax and ethics perspective, market access, and operational costs.

1. Corporate Tax Rates

Each country has its own corporate tax systems with set tax rates that change from time to time. Some jurisdictions are known for having no corporate tax, others for having low tax rates (e.g. Ireland which has 12.5% on trading income), and countries like Japan are known for their high corporate tax rates (at around 30%).

Estonia is a popular destination for startups for many reasons; one of which is that corporate income tax is deferred until profits are distributed. This incentivises startups to reinvest their profits – helping them to scale and grow at an early stage. When dividends are distributed, Estonia’s corporate tax rate is 22%. 

When considering countries to incorporate your company based on their corporate tax rates, consider that low tax rates can help your company save money. But, it’s important to also consider other factors too such as political stability, ease of doing business, and market access.

2. Tax Incentives

Some countries offer tax incentives as a way of attracting foreign investment. This includes reduced tax rates or tax deductions for certain types of expenses. Choosing to incorporate your business in a jurisdiction that offers tax incentives can help your business save costs and reinvest in business growth.

3. Double Taxation Treaties

Oftentimes your company will owe taxes in more than one jurisdiction. If there’s no double taxation agreement in place between these countries, your company could end up paying taxes twice which is highly undesirable.

For that reason, it’s preferable to ensure that the jurisdictions in which you will pay taxes, have double taxation treaties in place which help to minimise your tax burdens.

Estonia has many double taxation agreements in place with other jurisdictions. Here’s a full list of 60+ countries that Estonia has double taxation agreements with.

4. Regulatory Environment

When choosing where to establish your company, consider the regulatory environment and how onerous it is to run a business in different countries in terms of tax compliance and financial reporting. Related to this, consider how easy it is to conduct business in the country and how stable and reputable their legal and regulatory framework is.

Many foreigners opt to establish their companies in Estonia because it's simple, fast, affordable and easy to register a company online, and to manage a company as an e-resident. In addition, Estonia is known for its thriving startup ecosystem, its tax competitiveness and advanced e-services.

5. Political and Economic Stability

Have you considered the effect of geo-political issues and local economies on your business? Depending where you choose to establish and operate your business, these issues could have a significant bearing on your business profitability, continuation, and success.

There are many risks associated with starting a business in a country that is politically or economically unstable, including sudden changes to tax laws, and conflicts. According to Fitch Ratings, Estonia has an ‘A+’ rating, which reflects its “strong governance standards and institutions underpinned by EU and eurozone membership, low (albeit rising) public debt and debt service metrics, and a strong (albeit declining) net external creditor position.“

6. Reputation and Ethics

There may be reputational risks associated with operating your business in certain jurisdictions which should also be considered. While it’s prudent to look for opportunities for tax optimisation, it’s equally important to consider the reputation and ethical implications of your choice of jurisdiction.

As mentioned above, Estonia ranks first in terms of the Tax Competitiveness Index, and has an A+ Fitch Rating. Furthermore, Estonia has a reputation for its business transparency.

Comparing Corporate Tax in Different Countries

Final Thoughts on Choosing a Tax Jurisdiction for Your Company

Choosing a tax jurisdiction for your company or startup requires strategic considerations regarding different countries’ corporate income tax rates, tax incentives and deductions, tax competitiveness, country reputation and tax transparency and ethics, and administrative burdens.

By considering all the factors mentioned above, you should be able to make a more informed decision on where to register your business based on your long-term goals. As the global economy and political situations transform and change over time, it’s important to remain agile and adaptable – and aware of changes in geopolitical situations and economics that may impact your business operating costs, continuity and reputation.

Navigating tax considerations and comparing tax in different jurisdictions can be complicated. It’s advisable to seek advice from qualified professionals that takes account of your particular circumstances and goals to help you make the best choice on jurisdiction from a tax and general business perspective.

Disclaimer

This article was written by guest contributor Andy Stofferis (www.andysto.com). Andy is not a tax or VAT expert and the article is not intended to give any legal or tax advice. Tax laws and regulations vary greatly from country to country, and this information is a general guide only. You are advised to contact a professional tax advisor for any legal or tax advice, and not to rely on this article as gospel.