Hidden profits – renting real estate from a partner
June 18, 2024
Entering into transactions between a company taxed under Estonian CIT and its partner carries the risk of such transactions being considered hidden profits. However, in practical business situations, there are cases where a company, for rational business reasons, rents real estate from a partner to conduct business activities. Would income from such transactions also be considered hidden profits?
What is hidden profit?
Analysing the provisions of the CIT Act, it is worth noting that the legislator specifies that hidden profit is the surplus of the market value of the transaction determined following art. 11c over the established price of this transaction. Hence, it can be inferred that the payment to a related entity will not constitute hidden profit if the transaction price is set at a market level.
When does the rental fee constitute hidden profit?
However, in practice, tax authorities, in addition to the above premise, also analyse whether a given transaction is, among other things, economically rational and whether the partners have equipped the company with the necessary assets to conduct business activities. Based on this, tax authorities argue that the company would not have entered into a lease agreement with the partner if it had been adequately equipped with the necessary assets to conduct business. Therefore, without the relationship between the company and the partner, such transactions would not have occurred.
Therefore, the rent payment for real estate from a partner should – according to tax authorities – be considered hidden profit (cf. individual interpretation of the Director of the National Tax Information dated November 24, 2022, 0111-KDIB1-2.4010.642.2022.2.DP).
Hidden profit: the position of administrative courts
Administrative courts present a different position. As indicated, for example, by the Administrative Court in Gorzów Wielkopolski in the judgment of December 7, 2023, I SA/Go 276/23, providing the company with the private assets of a partner is not contrary to law, and there is no provision requiring the company to own real estate. It cannot be concluded that renting real estate from a partner will result in income from hidden profits. As explained by the Administrative Court, hidden profits under the CIT Act are benefits provided in connection with the right to share in profits.
Therefore, not every benefit to a partner will be considered hidden profit because not every benefit will be provided in connection with the right to share in profits. Payment of rent does not constitute a benefit provided in connection with the right to share in profits under the CIT Act.
Should you take the risk of renting real estate from a partner?
Renting real estate from a partner carries the risk of hidden profits being recognized on the side of the company taxed under Estonian CIT. Therefore, taxpayers wishing to take advantage of this form of taxation should carefully analyse transactions with related entities, and in doubtful situations, secure their settlements with individual interpretations.
Tags hidden profits, nieruchomość, real estate, ukryte zyski
