What should you consider?
1. The financial statement must be approved.
2. Paying dividends from the current year's profit is not allowed.
3. The share capital must be paid in full. (Since since 2011 it has been possible to establish a private limited company without making a share capital contribution, it is necessary to account for the shareholders making a contribution to the share capital before distributing dividends and to submit an amendment registration application to the Business Register.)
4. Dividends are paid out of retained earnings, which is the sum of the profit or loss for the reporting year and previous years' profits/losses. This means that if last year the company had a loss of 500 euros and this year a profit of 1,750 euros, the retained earnings amount to 1,750 - 500 = 1,250 euros.
5. Shareholders' decision is required to pay dividends. After the decision, there will be: dividend debt, income tax expense, and income tax payable (these are recorded immediately, not based on disbursement).
But what are the pitfalls of dividends?
You have earned a profit, but is paying dividends always justified? Usually, this concerns sole proprietorships or small companies where the owner develops the business personally. A dividend must not replace salary! The owner's contribution to business development must be compensated according to MARKET CONDITIONS, and social tax must be paid on this compensation. The tax authorities monitor this very carefully, and courts also hold that dividends can be considered salary income if no remuneration is paid to a board member or employee under an employment contract or if it is paid very little.
There are no pitfalls; paying dividends is justified.
How are dividends taxed?
Dividends are taxed at the company level. In Estonia, the current corporate income tax rate is 20%, i.e., 20/80. When calculating dividend tax, it is assumed that the disbursed amount is a net amount from which withholding tax has already been deducted. Therefore, for a dividend payout of 1,000 euros:
1000 * 20 / 80 = 250 euros in income tax.
Since January 1, 2019, a lower rate of 14% (14/86) applies to regularly paid dividends. A resident company can pay dividends taxed at this lower rate in the fourth year if it has received an average taxed dividend and made share capital distributions over the previous three years.
For example:
In 2018, 2019, and 2020, a total of €3,000 in dividends was paid out. In 2021, we want to pay out €2,000. The tax calculation proceeds as follows:
1. 3000 * 1/3 = €1000 (applying the lower rate)
2. 1000 * 14/86 ≈ €162.79 (tax at lower rate)
3. 1000 * 20/80 = €250 (tax at standard rate)
4. Total company cost (tax + dividend): €2000 + €162.79 + €250 = €2412.79
Now an important point! The lower rate exists but is practically beneficial only for legal entities (juridical persons). If the dividend recipient is an individual (natural person), withholding tax at this lower rate must be deducted from their dividend income, declared, and an additional 7% income tax transferred to MTA (Estonian Tax and Customs Board). In our example:
If the entire amount goes to an individual recipient: €2000 - (1000 * 7%) = €1930.
This knowledge must be used if you plan to receive dividends in the future (including investing in stocks). It’s more advantageous through a company.
Dividend payments must be declared using Form TSD Annex 7 and Form INF-1. If you need help with filing these declarations, we are happy to assist you.
