Tightening regulation and ambitious aspirations Can Estonia continue to attract investors?

Can Estonia Maintain its Attractiveness to Investors Amidst Growing Regulatory Standards and High Aspirations?

Author: TaxDAO

1 Introduction

Estonia is located in northeastern Europe, bordered to the north by the Gulf of Finland and Finland, to the east by Russia, and to the south by Latvia. Since its independence in 1991, the Estonian government has repeatedly promoted digital reforms, seeing the digital revolution as an important source for attracting foreign investment and building international relations. In 2008, the government announced the birth of “e-Estonia”, aiming to digitize all activities related to citizens and the government. In 2014, the government launched the e-Residency program, allowing anyone from anywhere in the world to establish a company in Estonia. Over the past decade, with the government’s high regard for information technology, Estonia has experienced rapid development in e-commerce and digital finance, transforming from one of the poorest countries in the euro area to one of the fastest-growing economies, earning the reputation of being the “most advanced business center in continental Europe.” Since 2017, over 2000 companies have obtained cryptocurrency licenses in Estonia. The accumulation of technological power, the government’s open attitude, and convenient and stable infrastructure have a strong appeal to the cryptocurrency industry. However, Estonia also faces challenges such as intense competition in the business environment and an imperfect legal framework. Therefore, it is necessary to further outline Estonia’s cryptocurrency taxation and regulatory policies, optimize investment strategies, ensure investment compliance, and mitigate investment risks.

2 Analysis of Estonia’s General Tax System

2.1 Estonia’s Main Direct Taxes

Direct taxes, namely income taxes, are levied on various income of taxpayers. In terms of personal taxes, taxpayers who have their permanent residence or main residence in Estonia, or who have resided in Estonia for 183 days or more continuously over 12 months, are subject to taxation. Resident natural persons are required to pay taxes on all income obtained from within and outside Estonia during the tax period, including employment income, business income, rent and royalties, interest, taxable scholarships and grants, and capital gains from the transfer of property. Non-resident natural persons have the tax obligation on income derived solely from Estonia, and the tax rate is influenced by the bilateral tax treaties between countries. Generally, the personal income tax rate in Estonia is 20%, with a maximum monthly exempt amount of up to 654 euros and a maximum annual exempt amount of up to 7,848 euros. If an individual receives a pension or reaches the pension age, the basic exempt amount is 704 euros per month and 8,448 euros per year. If annual income exceeds 25,200 euros, the individual is not entitled to the basic exempt amount. In terms of property tax, landowners are obliged to pay land tax, with a tax rate ranging from 0.1% to 2.5% of the assessed land value annually. The highest tax rate for arable land and natural grasslands is 2%. For taxpayers who own self-occupied housing in cities, if the land area occupied by the housing is less than 0.15 hectares, they are exempt from land tax. For any area beyond the limit, the excess is subject to taxation. In addition, Estonia does not impose gift tax or inheritance tax.

In terms of corporate taxation, Estonia has low tax rates. All undistributed company profits are tax-free, and this exemption covers both active (e.g., trading) and passive (e.g., dividends, interest, royalties) types of income, as well as capital gains from the sale of all types of assets (including stocks, securities, and real estate). In the case of taxing profits that are distributed as dividends or deemed as distributed, a 20% corporate income tax is generally paid on the net amount of profit distribution. From 2018 onwards, companies that regularly distribute profits can enjoy a lower corporate income tax rate of 14%. If the recipient of dividends is an individual, a withholding tax rate of 7% applies, unless a tax treaty provides for a lower withholding tax rate. According to tax law, profits distributed from Estonian companies’ global income are taxed, rather than just profits from Estonian sources, and other income received from Estonia may require an assessment to determine the amount of withholding tax or corporate income tax to be paid. In addition, both companies registered in Estonia and permanent establishments of foreign entities are required to pay 33% social tax on the total employee wages, where 20% is for pensions and 13% is for health insurance. Individuals operating as entrepreneurs are also required to pay social tax. There is no upper limit on the social tax paid by companies and it primarily applies to salaries, director fees, service fees, and additional benefits provided to individuals. If employees participate in a mandatory funded pension plan, the employer’s wage withholding tax includes a 2% contribution.

2.2 Main Indirect Taxes in Estonia

Estonia’s value-added tax rate is 20% and applies to most transactions of goods and services. According to EU regulations, certain specific goods and services, such as financial services, telecommunication services, electronic services, cultural and entertainment services, may be subject to a lower value-added tax rate. A reduced rate of 9% is levied on books, periodicals, hotel accommodation services, and listed drugs. Real estate transactions, healthcare, insurance, and financial and securities transactions can be exempt from value-added tax. If the taxable amount for an Estonian or non-Estonian company’s permanent establishment exceeds 40,000 euros, value-added tax registration is required.

In terms of customs duties, as an EU member, Estonia applies the Community Customs Code and related implementing regulations: trade between Estonia and other EU member states is duty-free, while products imported from non-EU member states are subject to EU customs duties, and numerous free trade agreements concluded between the EU and non-EU member states apply to Estonia.

In terms of excise taxes, excise taxes are levied on tobacco, alcohol, electricity, certain packaging materials, and motor vehicle fuel. In 2023, the parliament passed a bill announcing annual increases of 5% in the consumption tax on alcoholic beverages, cigarettes, and tobacco from 2024 to 2026, and at the same time, the consumption tax on special diesel fuel was abolished. Property values are exempt from property tax, but property transfers are subject to local taxes and notary fees.

3 Analysis of Estonia’s Cryptocurrency Regulation

Estonia has been one of the early adopters of cryptocurrency and blockchain technology. In December 2009, Estonia passed the Payment Institutions and E-money Institutions Act, aiming to establish a clear regulatory framework to govern the actions of payment service and e-money service providers. The act defines e-money institutions as organizations that issue and provide services related to electronic currencies such as electronic wallets and prepaid cards. Electronic money refers to currency value stored on electronic media, representing a monetary claim against the issuer and issued with a face value as a payment instrument accepted by at least one non-same e-money issuer. According to the act, companies providing payment and e-money services need to register with and obtain a license from the Estonian Financial Supervision Authority (EFSA).

With the development of the cryptocurrency industry, the issue of cryptocurrency taxation has become increasingly prominent. In 2014, the Estonian government declared cryptocurrency as property, subject to property taxes, and further categorized it for tax purposes. Profits from cryptocurrency trading are subject to income tax, which is calculated based on the difference between the selling price and the buying price or the difference between the price received for the transfer of property and the purchase price of the cryptocurrency in cases of exchange. Each transfer transaction is considered a separate taxable object and needs to be reported. Only transfer transactions causing losses can be included in the tax consideration under the conditions specified in Article 39 of the Income Tax Act. In the same year, the Estonian Tax and Customs Board issued guidelines on cryptocurrencies, clearly stating that cryptocurrencies like Bitcoin are not legal tender.

In 2015, based on a ruling by the European Court of Justice, Estonia announced that transactions involving non-traditional currencies should still be considered financial transactions, as long as all parties involved accept the cryptocurrency as an alternative to legal tender. It was further announced that the exchange between non-traditional currencies and traditional currencies would be exempt from value-added tax. However, the provision of paid wallet services is subject to value-added tax. If paid wallet services involve transactions with the mentioned cryptocurrency, besides storing the cryptocurrency as a means of payment, and generate rights and obligations related to that means of payment, they can enjoy the exemption from value-added tax. Mining cryptocurrency as a service provided to others is also exempt from value-added tax. Taxable income obtained from cryptocurrency, such as rent, interest, business income, etc., is subject to income tax. Mining income is also considered business income.

In 2016, the Estonian government amended the Payment Institutions and E-money Institutions Act to require service providers to comply with anti-money laundering and combating the financing of terrorism regulations and enhance international tax cooperation with other countries to combat tax evasion. The act stipulates that payment institutions and e-money institutions need to conduct customer identification and take measures to protect customer funds and privacy. In addition, institutions are required to establish a customer compensation system to address potential payment risks. Both payment institutions and e-money institutions are obliged to report their business activities to the EFSA and maintain customer identity information, transaction records, and other relevant information for at least 5 years to prevent money laundering and terrorist financing.

In 2017, Estonia perfected its regulatory framework and became the first country to issue licenses for cryptocurrency assets. Hundreds of companies obtained licenses from Estonia and started conducting related businesses. Estonia defines virtual assets as digital values that can be traded, stored, and transmitted, accepted by individuals and legal entities as a means of payment, but not as a legal tender of any country. Cryptocurrency assets and their derivatives fall under this definition. The licenses distinguish between two types of services: the first type includes crypto wallets and custody services that involve generating and storing cryptographic client keys, and the second type includes cryptocurrency exchanges that provide services for the exchange of cryptocurrency assets with fiat currency. After the implementation of the license system, Estonia issued over 4000 licenses, but there were also cases of shell companies operating and using the e-residency program to apply for licenses. In 2018, the Danske Bank money laundering scandal and the accusation of suspicious funds amounting to $200 billion urged the government to reevaluate cryptocurrency asset regulation.

In 2020, the regulatory authority for cryptocurrency assets shifted from the Ministry of Internal Affairs to the Ministry of Finance, with the Financial Intelligence Unit responsible for developing cryptocurrency asset regulatory rules. After an in-depth investigation into cryptocurrency companies holding Estonian licenses, the Financial Intelligence Unit revealed that large amounts of illicit funds were being transferred through blockchain and the shell companies behind it. Despite being registered in Estonia, these companies did not have a physical presence in the country. As a result, Estonia revoked the majority of the licenses, leaving only around 300 remaining. On June 14, 2021, Mátis Mäeker was appointed as the head of the Financial Intelligence Unit and stated that the unit’s main task in the coming years would be to establish strategic analysis functions for money laundering and terrorism financing, as well as promote reduced anonymity in cryptocurrency asset transactions to ensure transparency and more effective monitoring of the business environment. Subsequent regulatory policies have been strengthened: identity verification is required for providing cryptocurrency exchange services, and personal data must be communicated with transactions in the same manner as bank transfers; real-time transaction monitoring and risk analysis must be ensured for each transaction if the recipient’s wallet does not have a service provider or is unable to receive data; if a company holding a cryptocurrency license is found to have no connection to Estonia, measures may be taken to refuse to issue or revoke the license.

In 2022, Estonia introduced the Money Laundering and Terrorist Financing Prevention Act, which sets stricter requirements for companies applying for Estonian cryptocurrency licenses, including the following:

Changes

Old Regulation

New Regulation

Definition of “Virtual Currency Service”

Includes only virtual currency exchange and wallet services

Definition of “Virtual Currency Service” expanded to include:

Virtual currency transfer services;

Services related to the issuance of virtual currency, namely organizing its public or targeted issuance, sale, or provision of related financial services

License Fees and Operating Costs

License fee of 3,300 euros, minimum share capital of 12,000 euros

Higher license fees are required, as well as additional costs for providers:

Management fee for new licenses increased to 10,000 euros;

Management fee for changes in cryptocurrency activities is 4,000 euros;

Minimum share capital for providing cryptocurrency exchange services is 100,000 euros;

Minimum share capital for providing cryptocurrency trading services is 250,000 euros;

License Application Requirements

Companies submit information regarding their services, internal rules, and procedures, etc.

Companies must provide additional information and documents to obtain a license:

Financial information such as asset and share capital size, income overview, cash flow, etc.;

A two-year business plan, including a description of the nature of the applicant’s business activities, organizational and management structure, etc.;

Records of risk preferences and risk assessments;

Information about the technical systems used to provide planned services, including descriptions of security measures, business continuity measures, and the level of technical organization;

Information about the information technology system used to identify and monitor transactions, customers, beneficial owners, and fulfill travel rule obligations;

Information about the auditing firm that checks the applicant’s funds. Companies must also appoint an internal auditor and provide relevant information for the auditor to examine the anti-money laundering systems and procedures, good practices, and the decisions of management bodies;

Information about the quantity of shares and voting rights held or to be obtained by each shareholder.

Board Member Requirements

The board provides proof of education level, work experience, and previous positions held, etc.

Board members must have tertiary education and at least two years of work experience in industries like finance, law, accounting, auditing, public administration, financial regulation, information technology, and may not simultaneously serve as board members for more than two cryptocurrency service providers;

Reasons for Refusing to Issue a License

Companies may be refused licenses due to a lack of anti-money laundering procedures, Estonian payment accounts, etc.

Additional reasons have been introduced:

Questionable legality of share capital;

The company has no intention of operating in Estonia or has no significant connection to Estonia;

Insufficient internal rules considering the nature and complexity of the business activities;

Inadequate technological means, such as information technology systems, to provide services;

Prior licenses granted to entities or qualifying shareholders have been revoked.

 

In addition, the Financial Intelligence Unit is required to decide whether to grant a license within 60 working days after receiving all required documents and information. Within two years from the date of revocation of an existing license or refusal of a license by the Financial Intelligence Unit, the company, its management members, or qualifying shareholders may not apply for a new license.

Reasons for Revoking a License

Licenses may be revoked due to repeated failure to comply with the requirements of the Financial Intelligence Unit or failure to resolve compliance issues within a

Despite the Estonian government’s continuous refinement and strict regulation of cryptocurrency assets, Estonia is attracting numerous investors in the cryptocurrency industry due to favorable conditions such as tax exemption on undistributed company profits, no annual license fees, economic stability, a business-friendly environment, the availability of cryptocurrency asset accounting declaration, and a large number of issuances. In the future, Estonia’s regulatory policies for the cryptocurrency industry may become even stricter, but it maintains an open and inclusive attitude towards the development of legitimate and compliant cryptocurrency enterprises. It strives to achieve the regularization and sustainability of the cryptocurrency industry, solidifying Estonia’s leading position in the global cryptocurrency industry.