On December 11 2024, the Parliament of Estonia passed the Defence Tax Act, which will apply to individuals, companies, and non-residents earning taxable income in Estonia.
The defense tax is expected to be in effect until the end of 2028 and consists of three components:
Compared to the initial draft, some amendments were made to the law, including a general anti-abuse provision and a provision to avoid double taxation of profits using the equity method for associates and subsidiaries.
From July 1, 2025, to December 31, 2028, the standard VAT rate will be increased from 22% to 24%.
To ensure uniform application of the tax to all transactions subject to the standard rate, the period for applying the 20% VAT rate to long-term contracts will be shortened to June 30, 2025, instead of December 31, 2025, as previously stipulated by the VAT Act.
Individuals will pay defense tax on income that is also subject to income tax under the Income Tax Act. However, for broader coverage, some types of income exempt from income tax under the Income Tax Act, such as wages earned by an Estonian resident working abroad and dividends received from abroad, will also be subject to defense tax. Additionally, defense tax will be levied on income from the first euro without considering deductions allowed for income tax purposes, such as tax-free income, withheld unemployment insurance and second pillar pension contributions, training expenses, gifts and donations, contributions to the third pension pillar, etc.
Since defense tax is generally withheld from payments made to individuals, most of the defense tax data will be pre-filled on the declaration. Therefore, an individual must submit a declaration if defense tax has not been withheld from their income.
The taxation period is the calendar year, and the first defense tax declaration must be submitted by April 30, 2027, with the payable defense tax due by October 1.
In Estonia, non-residents' income from Estonian sources (e.g., income from work performed in Estonia, income related to real estate located in Estonia, etc.) will be subject to defense tax. Non-residents must also submit a declaration by April 30 of the year following the taxation period, unless defense tax has been withheld.
Since the defense tax is similar to income tax, tax treaties also apply to the defense tax. Therefore, if a tax treaty stipulates that only the country of residence may tax a non-resident's income earned in Estonia, such income will not be subject to defense tax in Estonia. If a tax treaty limits the source country's right to tax by setting a lower withholding tax rate, the rate specified in the tax treaty must be applied.
Non-resident companies with a permanent establishment in Estonia will pay defense tax similarly to resident companies (see below).
Resident companies and non-resident companies with a permanent establishment in Estonia will pay defense tax on profits. The taxation period is the company's financial year, but advance payments of defense tax will be made quarterly from September 10, 2026, based on the previous financial year's profit.
The taxable profit is the company's pre-tax profit for the financial year, with a few adjustments allowed to avoid double taxation.
For example, dividends received from another company, whose underlying profit has been taxed with defense tax or foreign income tax, and where the recipient holds at least 10% of the shares in the dividend-paying company, can be deducted from the profit.
The provision to avoid double taxation has been supplemented regarding the adjustment of profits recorded using the equity method for subsidiaries or associates. Specifically, if the pre-tax profit for the financial year includes profit or loss recorded using the equity method for a subsidiary or associate, or profit or loss from the revaluation of an investment, which has been taxed with defense tax or foreign income tax at the subsidiary or associate level, such profit will be deducted from or such loss will be added to the pre-tax profit. A subsidiary or associate is considered a company in which the taxpayer directly or through a subsidiary holds at least 20% of the shares, units, or votes at the time of receiving the profit.
In contrast, a provision was added to the Defense Tax Act that does not allow companies to reduce the tax base by making expenses and payments unrelated to business. Specifically, non-business-related expenses and the amount taxed under transfer pricing rules must be added to the pre-tax profit.
Additionally, the pre-tax profit will be increased by the amount the company would have received as income or the amount the company would not have incurred as an expense if there had been no transaction, chain of transactions, or accounting entry meeting the criteria of abuse. This is a general anti-abuse provision that allows the Tax and Customs Board to determine the defense tax liability in situations where the tax authority identifies a transaction, chain of transactions, or accounting entry made to obtain a tax advantage.
For more detailed information on the taxation and declaration of defense tax on corporate profits, you can read the previously written article here.
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