On Thursday, 23 August 2018, at a meeting of State secretaries, amendments were announced to the Corporate Income Tax (CIT Law). It is planned that the CIT Law will be augmented with provisions regarding controlled foreign companies (CFC), stipulating the obligation in Latvia to pay enterprise income tax from a share of profits in a foreign company, in which there is a significant shareholding and profits are obtained by creating hybrid entities, with the goal of securing tax breaks.
These amendments have been drawn pursuant to Council Directive (ES) 2016/1164, laying down rules against tax avoidance practices that directly affect the functioning of the internal market (anti-tax avoidance directive (ATAD)), which will be adopted 01.01.2019, as specified in the annotation of the amendments to the law.
At present, the CIT Law does not include provisions in relation to controlled foreign companies.
Accordingly, the CIT Law will be augmented with Section 6.1, which stipulates that the income of a subsidiary enterprise – foreign company, controlled as a result of the provisions of controlled foreign companies, from hybrid entities, which are not taxed or for the profits of which (or relevant form of profits) taxation has been waived, will be applicable to its subsidiary enterprise – taxpayer with a taxable base.
Under the draft law, regulation of controlled foreign companies applies only to income which has been artificially redirected to a subsidiary enterprise – foreign company, evidence of which is provided by the fact that the majority of decision-making actions, as a result of which channeled income has been generated at the level of the controlled subsidiary enterprise, are made at the taxpayer’s level.
The draft law stipulates that the provisions for controlled foreign companies are applicable to the profits of foreign companies, which have been obtained from hybrid entities, the objective reason for the founding of which was to gain tax breaks. One of the signs of the obtainment of tax breaks is that profits are not taxed (or the tax burden is significantly lower than in Latvia) or taxes are waived for profits, or a company is based, has been established or founded in low taxation and tax-free countries or territories referred to in laws and regulations. In assessing the objectives of the founding of the entities or range of entities, all facts and circumstances will be taken into account (including the economic substance and nature of transactions, not just their legal form), which testify to the artificial redirection of income, including actions involving the making of important decisions, which have resulted in the generation of redirected profits for the foreign company, i.e. the transfer of the tax burden to such a hybrid structure, as a result of which the tax burden will either be significantly reduced or no longer exist at all.
To avoid double taxation, the taxpayer will be able to reduce the amount of dividends included in the taxable base during the taxation period by the amount that the taxpayer has received in the form of dividends from the profits of foreign companies during the taxation period, regarding which tax has already been paid during one of the pre-taxation periods in accordance with the CIT Law.
It is planned that the amendments will come into force from 01.01.2019.