Estonian entrepreneurs will develop an opportunity to grow significantly only if they are able to expand to foreign markets, says Kuldar Väärsi, the CEO of defence contractor Milrem Robotics. Väärsi knows what he is talking about, as Milrem has subsidiaries in the US and Sweden and has its sights set on a number of countries in Southeast Asia and the Middle East.
“The Estonian market is not sufficient in the defence industry and thus we defined our market as global right from the outset. But all of the bureaucracy involved in expanding across borders is something that Estonian companies are not used to – be it legal procedures or tax accounting. The fines for flouting the rules or misinterpreting them can be pretty high,” says Väärsi.
A given company usually does not employ legal and tax specialists who know the tax systems of different countries and know exactly what the first steps are when founding a subsidiary in the US or another European country. Milrem lacked such competence as well. “As I believe it is less costly to make the necessary preparations properly and thoroughly at the start rather than discovering later that something important was missed, we turned to our advisers at Grant Thornton Baltic straight away,” Väärsi says about his first steps taken toward entering markets abroad.
Milrem’s goals were different in the US and Sweden. In the US, the focus was placed on establishing sales potential on that market while in Sweden the objective was to draw on skill sets that could not be found in Estonia. “We have seen very rapid growth in Estonia over the last year, we have over 90 people working for us, 50 of whom are engineers. But for certain larger projects we found that we had deficits when it came to certain skill sets - there just were not engineers with those experience. Sweden had them, though, and so it was a good idea in the sense of clarity of the corporate structure and recruitment to establish a subsidiary,” says Väärsi about his goals in entering the respective markets.
A local agent or a subsidiary?
The company’s business model and goals largely determined the way in which it starts operating on the new market: does it pay to find an agent who sells the products and services of the Estonian company locally or is it a better idea to establish a subsidiary.
The head of tax advisory at Grant Thornton Baltic, Kristjan Järve, talks about the options in more detail. “One option is to find a partner or agent in the foreign market who represents the Estonian company and sells its products. But if they want to secure a solid foothold in that country and the destination market is very important for Estonian companies, it is wise to establish a subsidiary. Taxation and the complexity thereof depends on which option to choose.”
Järve explains. “The local agent/partner model is the simplest option when entering a new market abroad. This way minimises the red tape associated with tax accounting and founding a company abroad. In the sense of business strategy as well, this is a safe bet. After all, we do not know how things will go on the new market, and thus it is easier to establish a foothold using a cooperation partner,” he says.
But the agent/partner model involves one important nuance. If the partner becomes very dependent on the Estonian company – perhaps it intermediates only the Estonian company’s goods and services or is closely tied to marketing and marketing conditions and negotiations, the Estonian company may be viewed in the eyes of international taxation rules as having a permanent place of business in that foreign country. In short, the Estonian company is considered to have a separate business in that company, which means accounting and income tax obligations and in certain cases, VAT obligations as well. “The conventional tax bureaucracy arises,” Järve says in summing up the consequences of a permanent place of business.
Friendly and not so friendly tax officials
If the plan is to set up a subsidiary, one should analyse right at the outset what the reasonable and conservative method for transfer pricing - distributing profits between related persons – is so that it would be acceptable to the local country and Estonian tax authority. Järve notes that it should also be remembered that tax authorities in different countries have different practices in dealing with customers. “For example, southern European tax authorities are more aggressive in regard to permanent place of business and use different interpretations than other European countries’ tax authorities. I praise the Dutch and Finnish tax boards, for example, they are very keen on providing good service and happy to answer questions. The most complicated situation is in countries where the taxman has taken the position that they are not a service organisation and it is hard to get practical information out of them. In that case one has to rely on local advisors,” says Järve.
Väärsi emphasises that when choosing a consultant in Estonia, it is important to look at whether the advisor has a local partner in given foreign country or is represented in some other manner, as knowing the conditions “on the ground” is important. Järve also says that international network is an important keyword, to allow Estonian clients to be supported when expanding across international borders. “Even the broadest-minded Estonian tax advisor who has good knowledge of tax law and specific knowledge of the destination country is not able to provide consultation on an expansion to a foreign country. One should turn to local consultants to double-check the local rules,” he emphasises.
Once the Estonian company has made the selection and is establishing a foothold in a new country through an agent or subsidiary, administrative support functions should be considered. “How will administration take place, how will IT solutions be provided, how will HR management work. One should not expect it all to be done from Estonia. For example, labour law regulations vary widely and thus a decision has to be made whether to hire a local personnel manager or contract for that skill set from a local advisory partner. The expense on consultation will work out cheaper than finding out later that something has not been done or done improperly,” says Väärsi.
Summing up the topic, Estonian companies should remember two proverbs when plotting a move to new markets abroad. One of them says: measure nine times, cut once. The other is: the bold wolf eats well at the end of the day!
Tax Mergers and acquisitions Legal due diligence Transaction advisory
