The idea of saving on taxes has been alive for long time, but especially recently as everybody tries to tighten their belts as much as possible.
Given the poor economic situation, business leaders should forget about quick profits and resort to budget planning.
The process of tax payments has two sides; on the one hand is the taxpayer who seeks all possible ways of preventing it, and on the other is the needy state or municipality whose tax revenues are its main source of income.
"Anyone may arrange his affairs so that his taxes are as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes," said Janis Zelmenis, Partner of BDO Zelmenis & Liberte, quoting US Federal Judge Hand in the case "Helvering v. Gregory" which dates back to 1935.
He continued by saying that when many of us hear the term tax optimization we still find difficulties in comprehending it as a completely legal term, not understanding that tax planning has nothing to do with national trickery.
Tax optimization or evasion?
"Unfortunately, a few years ago, society got the wrong impression about what tax optimization is, as there were a lot of companies that cheated the country in criminal ways. I would name money laundering, for example. Stealing from the country has nothing in common with legal tax planning," Zelmenis said.
He named cases of tax evasion according to the Law On Taxes and Fees – giving deliberately false statements in tax declarations, avoidance in submitting the required declarations or requested information to the State Revenue Service (SRS), illegal appliance of tax incentives, benefits and discounts or any deliberate act or omission which results in taxes or fees not being paid in the full amount or partly.
However, the law also contains provisions to which the taxpayer may avail in various combinations, which are not prohibited. Zane Štālberga-Markvarte, Managing Partner at the Markvarte Lexchange Law Office, stressed that legal tax optimization involves the structuring of property relations in a way that property and assets are used to gain maximum benefit as well as finding the best structure to hire labor – to select the most favorable terms for agreement and payment while maintaining employee loyalty and enthusiasm for good results.
Zelmenis said that the most common way to optimize taxes is the restructuring of entrepreneurship, for example in deploying existing companies of the international network in countries with a favorable tax system, taking into consideration the sphere of business.
Given that there are plenty of ways to plan your taxes, he gave an example of legal tax optimization: "If I am considering opening a business in Azerbaijan but want to receive the profits in Latvia, then I should analyze which solution would be the best. Do I have to establish a foreign branch of the Latvian company in Azerbaijan directly, or should I establish a subsidiary in Cyprus at first?"
Drawing the line between legal (but undesirable) tax avoidance and illegal tax evasion is sometimes difficult. Asked what the border is between legal avoidance and evasion, Elizabete Krivcova, Lawyer at bnt Klauberg Krauklis said: "The border is violated at the moment when economic substance no longer meets the legal form."
Her colleague Artūrs Krauklis, Attorney and Partner at bnt, added: "Though this border is quite large, there is quite a good opportunity within the law to optimize taxes. However, this is always associated with experimentation, in which the outcome unfortunately is not always 100 percent predictable." The nature of tax avoidance is such that an adviser may come up with a complex scheme, but you cannot be certain that it is fireproof until it has been approved at the State Revenue Service or in the courts.
What to start with?
Tax planning involves conceiving and implementing various strategies in order to minimize the amount of taxes paid for a given period. For a business, minimizing the tax liability can provide more money for expenses, investment, or growth. In this way, tax planning can be a source of working capital. As you move up the scale of complexity, avoidance schemes take advantage of the issues of territoriality and legal personality.
"The first step in tax planning, for business owners and investors, is to select the right form of organization and country for your enterprise," said Štālberga-Markvarte. Although there are bilateral tax agreements between many countries, taxation is essentially limited to activities in a particular territory and subject to national statutes. "It is always important from which country the investors come here and does Latvian government has concluded effective tax treaties for the avoidance of double taxation," Krivcova said. Viktors Koposovs, President of the law office Inlat Plus, suggested that the next step would be to find a reliable accountant and tax consultant. "As there are always two sides in the tax calculation process – the legal and the mathematic – this is an economist and lawyer in cross-border discipline." All our experts stressed that tax-planning schemes are tailored according to the needs of the client as well as the size and structure of the company, the industry they operate in and other details. Common schemes can lead to fatal errors. However, the plan also depends on whether to reduce the tax burden, thus paying less, or attempts to defer taxes when and wherever possible. Deferring taxes enables the business to use that money interest-free, and sometimes even earn interest on it.
However, a small business should never incur additional expenses only to gain a tax deduction. Nevertheless, purchasing necessary fixed assets prior to the end of the tax year can be a valuable tax planning strategy. Štālberga - Markvarte suggests using all legitimate tax incentives and always finding the economically favorable solutions for hiring labor. As an illustration, she said: "If the income of the entity is highly dependent on customer orders – one week they are more, the other much less – then I would recommend using a system of piece wages instead of a time-rate payment system. In this case the employee will be paid for work done, not for the time spent." However, tax planning is interesting not only for entrepreneurs but also for self-employed professionals such as architects, notaries and musicians.
"Do you know what the most famous sport in Sweden is? Avoiding taxes! Those who earn above the average level often move to other countries with a friendlier tax system. In the Latvian case they would pay 15 percent personal income tax and mandatory state social insurance contributions from a freely chosen amount of income, except it can't be lower than minimum wage," Zelmenis said.
A positive outcome
As mentioned above, lawyers and tax consultants cannot guarantee the success of a chosen scheme. "Legal and tax advisory services are distinctive in that the client won’t be given a guarantee for a positive outcome," Zelmenis warned. He recommends that entrepreneurs choose reliable tax advisers with an excellent reputation and extensive experience. His colleague Arturs Krauklis recommends, in cases where the outcome is arguable, at first paying the taxes and then claiming back. He suggests not being afraid of the courts.
“Latvia is a relatively small country where the law has not defined all possible cases, compared for example to Germany where all taxes are defined to the tiniest details,” he said. “The positive aspect is that lawyers and tax consultants can be quite free in their interpretation of the law. And if the court approves the given scheme within the law, the SRS will have to pay the money back."
Koposovs also recommends not giving up, as the State Revenue Service sometimes makes mistakes too. "Once we had an interesting case where the director of a company came to us and told us that his company had received the results of a tax audit and they had imposed a penalty of EUR 89,000. What we did was to make our own audit, checking the results of the SRS and the company's own documentation. The result was that we found that in this case the fine should only have been EUR 30,000. The SRS's mistake was that while calculating fines they applied rules that were in force at the time of the audit and not rules that were in effect at the time of the conclusion of the transactions and processing the relevant documents. This was an illegal action as in previous years the terms and the amount of the penalties were different."
Founding a company in Latvia
The lawyers mentioned that the efficiency and transparency of the tax system should be improved in future. Krauklis said that sometimes he gets the impression that the SRS is working too slowly and too hypocritically.
However, the issue of taxes should be explored not only at the local but also the international level. Andrejs Svikss, Lawyer at Inlat Plus, mentioned that the system of taxes in Latvia is more “humane” than in other European countries. For foreigners the most alluring tax is the 15 percent corporate income tax. Until January next year, the income received from dividends is also untaxed revenue, though after the New Year it will be set at 10 percent.
Additionally, as a positive aspect for eastern investors if they open a company here, they are automatically given permission to live here for period of between one and five years. As Latvia is a member of the Schengen zone, that allows them to travel without limitations around most of Europe, which is a great way to find new business contacts.
Also Svikss pointed out that Latvia’s free economic zones carry even more tax incentives. Plus the registration of a company can be made in a really short time – as soon as two days. The core capital needed to start a company is just LVL 2,000. Additionally, Latvia has a highly developed, western-style economy and extensive modern transport infrastructure. The country has a well-educated, technologically sophisticated workforce among whom Russian and English is widely spoken. As a full member of the European Union, it enjoys full access to EU markets, while the location next to Russia opens great markets there as well. So – what are you waiting for?