The flat-rate taxation of corporate income (the so-called Estonian CIT) is becoming more and more popular. More and more entrepreneurs, including software companies, are interested in choosing this form of taxation.
Passive income from copyrights, including their sale
The conditions for the application of the Estonian CIT are numerous and of different nature – positive and negative. For the software industry, the negative condition (excluding the right to apply the Estonian CIT) of the taxpayer’s receipt of passive income from, inter alia, copyrights or industrial property rights, including the sale of such rights is important (Article 28j, paragraph 1, point 2 of the CIT Act). At the same time, the tax legislator has not introduced any exceptions to the said exclusion, e.g. income related to the taxpayer’s core business (e.g. in the IT industry) or rights created by the taxpayer himself (e.g. in the case of capital gains, which do not include copyrights created by the taxpayer and the taxpayer’s remuneration for their sale).
However, the exclusion of the applicability of the Estonian CIT does not apply to all situations of obtaining the above-mentioned categories of passive income. This form of taxation may be used by CIT taxpayers who earned less than 50% of their income from such activities in the previous tax year, calculated taking into account the amount of goods and services tax due (introduction to Article 28j(1)(2) of the CIT Act). At the same time, the above condition must be met not only in the year preceding the first year of taxation with Estonian CIT, but also in the whole period of taxation under this regime. Exceeding the above threshold results in the loss of the right to apply Estonian CIT at the end of the tax year in which the passive income threshold was exceeded (Article 28l(1)(3) of the CIT Act).
Verification procedure
In view of the above, a taxpayer interested in applying the Estonian CIT should, in addition to verifying the other conditions for the application of this flat-rate tax on business income, take the following steps:
- identify the passive income received, inter alia, from copyright or industrial property rights, including from the sale of such rights;
- add up the passive income received (including VAT);
- check the portion of passive income in the total tax revenue (as long as this share does not exceed 50%, the Estonian CIT may be applied).
First of all, it is important to classify the income received into the category of income from copyright or industrial property rights, including income from the sale of such rights. Such classification does not result from the provisions of the CIT Act, but from the Copyright and Related Rights Act. According to its wording, the author’s economic rights include only the author’s right to use and dispose of the work in all areas of exploitation and to receive remuneration for the use of the work (Article 17 of the Copyright and Related Rights Act). In contrast, the transfer of ownership of a copy of a work does not result in the transfer of the author’s economic rights in the work, and the transfer of the author’s economic rights does not result in the transfer of ownership of a copy of the work to the acquirer (Article 52 of the Law on Copyright and Related Rights).
Typically, IT companies generate revenues from the transfer of economic copyrights that meet the criteria of passive revenues mentioned above. However, this is not the case in all situations. For example, companies providing services in the SaaS model generate income that is qualified as income from the provision of services (cf. tax ruling of 16 February 2024, no. 0111-KDIB1-2.4010.685.2023.2.EJ).
In confirming the existence of, inter alia, the above-mentioned passive income, it is important to determine its value (including VAT) and then compare it with the value of any tax revenue received. This may be difficult, if the value of such remuneration is not clearly defined by the parties. For example, if income from copyright or industrial property rights, including from the sale of such rights, is an element of a composite service, then not the entire remuneration, but only the remuneration attributable to the above-mentioned passive income should be taken into account for the purpose of assessing the existence of a negative condition for the application of the Estonian CIT (cf. the judgment of the WSA of 7 February 2014, ref. III SA/Wa 2399/23, non-binding). At the same time, there are no clear rules that explicitly indicate how the value of passive income should be determined (e.g. as in the case of the so-called IP box rules). The tax legislator has only indicated that passive income should be increased by VAT. It is therefore necessary to adopt an appropriate approach to the valuation of passive income.
Summary
Taxpayers whose passive income in the form of income from copyright or industrial property rights, including the sale of such rights, exceeds 50% of the total tax revenue are excluded from the right to apply the flat-rate corporate income tax. However, the mere existence of the above-mentioned passive income does not exclude the right to apply the Estonian CIT. Consequently, not every software company is automatically deprived of the right to tax its income in this way. However, this requires proper verification, calculation and documentation.
