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We regularly promote Estonia as the best hub for investors who wish to set up a company for holding investments. This is especially the case for long-term investors focusing on reinvesting their income. In this article, we’re focusing on the taxation of foreign dividend income.
Reducing your company’s tax liability
When investing in foreign stocks, income tax is often already withheld from dividend payments abroad before they hit your bank account. This means that foreign dividends may be taxed at source.
By investing through your Estonian company (OÜ), it’s possible to declare such tax withheld abroad to the tax authorities. By doing so, you’ll reduce your company’s future tax liability by the same amount so long as you distribute dividends to shareholders in the future.
This can be a great way to save you money!
How Does Taxation of Foreign Dividends Work in Estonia?
Imagine your Estonian company has invested in the US stock market, e.g. buying shares in the Coca-Cola Company. As an investor, you’re entitled to a dividend payment. Currently, Coca-Cola’s annual dividend amount is US$1.84 per share (please note that in the US dividends are paid quarterly, but for simplicity, in our example, we use the annual dividend figure).
When a foreign dividend is paid, a tax is automatically withheld under the laws of the country in which the company is located. This is known as a dividend withholding tax.
In the case of US stocks, the standard withholding tax rate is 30%. However, international tax treaties between the US and other countries may reduce that rate. As Estonia has a tax treaty with the US, the tax rate is reduced to 15% if you have completed the W-8BEN tax form as an investor.
W-8BEN is a certificate of foreign status of the beneficial owner for US tax withholding and reporting. You can fill out the W-8BEN tax form through your bank or broker. However, not all banks offer this option so the standard 30% tax rate would apply.
When investing in foreign dividend stocks, make sure you choose a bank or broker that allows you to fill out this very important tax form!
In our imaginary case, the amount of the gross dividend payment, or the figure that the company declares as a dividend payment, is $1.84 per share annually.
If you’ve completed the W-8BEN tax form, 15% income tax, or $0.276 per share, is withheld from the dividend payments annually, so your account would receive $1.564 per share.
If the tax form is not completed or your bank/broker does not offer this service (currently, for example, Swedbank in Estonia), then 30% income tax, or $0.552 per share, is withheld. As an investor, you will receive $1.288 per share in net dividend income.
Declaring a foreign withholding tax and reducing future tax liability
According to the Estonian Income Tax Act, Estonian companies whose participation in a foreign company is less than 10% can apply the foreign tax credit method. This means you reduce the income tax liability on dividends you distribute yourself as a shareholder of an Estonian company by the amount of tax withheld abroad.
This means more money in your pocket!
So, it’s possible to reduce the potential income tax liability of dividends distributed to you as a shareholder by declaring a foreign withholding tax on dividends received by your Estonian company.
If your company has Coca-Cola stocks in a portfolio with a total gross dividend income of $1,000, then $850 will end up in the company’s bank account. In the US, $150 is withheld as taxes. This means that you can take out $150 tax-free from your company by distributing yourself a cash dividend in this amount.
If you’ve chosen an Estonian company as your investment vehicle, make sure your accountant always declares foreign dividend income and taxes withheld properly. This can save you from losing your hard-earned money!
We’re here to help!
If you need any support with your tax declarations and international tax advice, team is ready to help. Accounting requires knowledge of local and international laws and regulations. This is a competence that we’ve curated over many years in business.
Our expert team are well-versed in understanding the specifics of local and international laws, and regulations. Estonia has a wonderful and unique corporate tax system, and we know how to make it work best for you, ensuring you an efficient corporate structure that benefits your back pocket.
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