OASIS

                        ORGANIZATION OF ADVOCATES SPECIALISING IN INTERNATIONAL SERVICES

ESTONIA DEVELOPMENTS 2009/2010

Martin Simovart, Lepik& Luhaäär LAWIN

A number of amendments to the existing acts as well as new acts have been adopted in Estonia during 2009/2010. The amendments passed during the period from 2009 till the beginning of 2010 can be characterized as domestic-oriented, including large scale legislative events such as passing of fundamental reforms in the existing regulations and introduction of new acts, as well as moderate improvements in the regulations, where such necessity has arisen.  

Similarly to 2008, reforms passed by the Estonian legislator in 2009 have been significantly influenced by the harsh economic reality, forcing lawgivers to search for more flexible and cost-effective solutions in various fields of law. The embodiment of this policy is the much debated new Employment Contract Act, which finally came into force on 1 July 2009, turning a new page in the Estonian employment law. The new act replaced the employment laws that had been in place since 1992 and resembled in many ways the employment laws of the Soviet era. It is a fresh and modern take on regulation of employment relations based on “flexicurity” principles and takes into account the needs of today’s labour market and economic environment.  

Legislator has also been guided by the principles of flexibility and cost-effectiveness when passing another important piece of legislation – Conciliation Act, which provides for a brand new concept of conciliation procedure as an alternative dispute resolution method previously unknown to Estonian legislature. 

As during previous years, Estonian legislator has continued to seek for higher efficiency also in the fields of register keeping and communication with courts and other state authorities by making use of the advanced IT solutions. Progress in this field has expressed itself in a number of innovations introduced in 2009/2010.     

1.     Employment Contract Act 

The new Employment Contract Act unifies various employment law rules that were previously scattered across different legal acts and integrates employment law with the general contract law system. Several strict formal requirements have been abolished and more room has been left for freedom of contract and flexibility in employment relations. However, considering the social and economic inequality of an employer and an employee, the law still includes many mandatory provisions securing employees against unlawful employment termination and protecting their health by limiting the working hours and setting a right for vacation.  

1.1   Redundancy – relief for companies in difficult economic situation 

One of the most important changes in light of the current economic situation was decreasing of the financial burden of companies in redundancy situations. The new law divides the obligation to pay severance between the employer and the national unemployment insurance fund. Previously, the burden of paying severance pay in cases of redundancy lied solely on the employer. Under the old law the severance pay ranged from the employee’s two to four months average salary and this was on top of the two to four months notice period during which the employer also had to continue payment of salary. This often induced employers to find other reasons for dismissing employees, as the financial burden was heavy, especially when terminating contracts of long-time employees. Under the new law the employer, as a rule, is obliged to pay severance pay only in the amount of the employee’s one month average salary, and any additional compensation, which depends on the employee’s length of employment,  is paid out of the unemployment insurance funds by the state. In order to make use of this change, a lot of companies that experienced financial difficulties and planned redundancies had postponed the actual termination of contracts until the stepping into force of the new law. 

Another welcomed change in redundancy rules is related to the abolishment of some of the former restrictions. Previously the employer was not allowed under any conditions to lay off an employee who was raising a child under three years of age (regardless of whether the employee was working or being on his/her parental leave). This strict prohibition has been replaced by a ban on making an employee redundant only during her pregnancy or maternity leave or his/her parental leave (but not if the employee is working), except where the redundancy occurs because the company is wound up or becomes bankrupt in which case termination via redundancy is justified. The new law, however, gives an employee who is raising a child under three years of age a preferential right to maintain his or her job if the choice is being made between several employees with similar job specifications. Although there is still a public debate as to whether parents of small children are treated unfairly under the new law, it can still be said that the new law sets a better balance between the employee’s need for protection and the employer’s interest to organise its work. 

The new law also removed several burdensome formal requirements, as a result of which, the obligation to apply for the approval of the local labour inspectorate for collective redundancies or for terminating contracts with protected categories of employees, such as employees with small children or employee representatives, became history. 

1.2   Employee’s liability for damage 

Substantial changes were also made to the regulation of employee’s liability. Before the new law came into force, the proprietary liability of employees was regulated by an odd chapter of the Labour Code which was for some reason kept in force even after the other parts of the Labour Code were declared invalid. These rules were out of date and did not correspond to today’s practical needs (e.g. employees’ liability was in most cases limited to only one month average salary). Limitations of employee’s liability have now become much more flexible. This allows for the determination of the extent of the employee’s liability to be based on the actual circumstances, and to impose on an employee higher liability as compared to the former regulation. This change will probably lead to a rise in the number of disputes regarding the extent of employee’s liability.  

1.3   Limited working hours to protect employee’s health 

Although the new law has removed most of the former strict formal requirements and attempts to create more flexibility, the law still includes a number of mandatory provisions related to the employee’s right to daily and weekly rest time as well as annual leave. To some extent the new law is even stricter than before. After the stepping into force of the new act, many employers have faced problems in interpreting and applying new working hours and rest time requirements. Limitations on working hours for night workers became stricter and this has forced companies using night shifts to weigh possibilities and reorganise the shifts so as to avoid shifts longer than eight hours.

In order to protect employee’s health, the new law encourages employers to compensate overtime work above all by giving time off. The former law preferred compensating the overtime work through monetary compensation. The current law still allows making extra payments for overtime work but the first and most preferred option in the light of the new law is the provision of additional time off. This also clearly reduces the interest of employees to work overtime.

2.     Conciliation Act 

The Conciliation Act entered into force on 1 January 2010, implementing mediation and conciliation principles of the Directive 2008/52/EC of the European Parliament and of the Council of 21 May 2008 on certain aspects of mediation in civil and commercial matters. The Conciliation Act introduces a new concept of out of court dispute resolution in civil law matters, which is based on the voluntariness of the parties and creates a new authority – a conciliator.  

The aim of the reform is to promote besides the formalistic court proceedings, flexible and cost-efficient alternative dispute resolution methods which are optional for the parties. Thus, under the Conciliation Act, conciliation is defined as an activity based on voluntariness of parties, in which a neutral person (conciliator) supports communication between parties in order to help them achieve a solution to the dispute. Such activity does not only include mediation between parties (supporting of communication), but also material conciliation, as on the basis of the circumstances of the dispute and the course of the conciliation procedure the conciliator is allowed to present his own proposal for solving the dispute.     

2.1   Who can qualify as a conciliator? 

Conciliation Act enables quite a wide range of persons to qualify as conciliators: attorneys at law, notaries, but also any other persons whom parties choose to elect as conciliator. The act provides also for a possibility to establish special state or local municipality conciliation bodies to help parties find solutions to disputes in specific fields of law. Estonia already has a number of special out of court commissions, established e.g. for the purposes of resolution of insurance, employment and consumer disputes, however, the purpose of such commissions is the resolution of disputes, not provision of conciliation to the parties. Therefore, to date, functioning of the conciliation commissions and enforcement of their decisions has practically not been regulated in Estonia, making provision of an effective base for the formation of such conciliation commissions also one of the important aims of the act.  

2.2   Enforceability of agreements reached within conciliation procedure 

The most important aspect of the conciliation procedure is the enforceability of the agreements reached in the course of the conciliation procedure, which would guarantee performance of the agreed compromise. The Conciliation Act acknowledges the importance of a possibility to enforce agreements between parties and sets forth different regimes for recognizing the enforceability of such agreements. The said regimes depend on the status of the conciliator who has helped the parties to reach a compromise within the conciliation proceedings, where agreements reached with the help of state or local municipality bodies, attorneys at law and notaries are deemed to be more reliable and thus upon recognizing as enforceable are subject to milder requirements. Agreements reached with the help of all other conciliators are subject to stricter requirements as far as their recognition as enforceable is concerned.  

Thus, an agreement which is reached in the conciliation body is deemed automatically enforceable (although parties may choose not to apply for the enforceability of such agreement) without any additional formalities. The agreements reached within the conciliation proceedings with the help of a notary public or an attorney at law can be recognized as enforceable under a bit stricter conditions, i.e. on the ground of a notarially authorised agreement, which includes a consent of the debtor to be subject to compulsory execution, or upon the ground of a court ruling within the simplified proceedings on petition. The most demanding requirements of recognition of enforceability apply with respect to agreements reached in the conciliation proceedings with the help of conciliators who do not qualify as attorneys at law, notaries or conciliation committees. In this case the enforceability of the agreement has to be certified by the court at a court meeting, where the judge is obliged to undertake a check of the impartiality and fairness of the conciliation procedure.   

Protection of confidentiality of the conciliation proceedings is protected by the requirements that the conciliation proceeding shall not be public and by the conciliator’s a duty of confidentiality.  

3.     Authorized Public Accountants Act 

The new Authorized Public Accountants Act entered into force on 8 March 2010, implementing Directive 2006/43/EC of the European Parliament and of the Council of 17 May 2006 on statutory audits of annual accounts and consolidated accounts, amending Council Directives 78/660/EC and 83/349/EEC and repealing Council Directive 84/253/EEC.  

The need for a new act, which would more thoroughly regulate the requirements applicable to auditors, auditing companies and audits being carried out by them, has been brought about by the recent financial scandals related to such well-known international companies as Enron and Parmalat, which caused regulators around the world to seek for better protection of public interests through more strict regulation of the financial reporting and auditing requirements. Therefore, the main aims of the new act include securing of the objectivity and impartiality of the auditors, eliminating possible conflicts of interests, providing of demanding professional and ethical requirements with respect to the authorised auditors.  

Of the more concrete changes, the new act has made amendments also to the criteria, establishing, when a company must arrange auditing of its annual account. The said criteria have been raised as compared to the old criteria, due to a sharp rise in the financial results of Estonian companies over the past few years. According to the new Authorised Public Accountants Act accounting entities must audit their annual accounts if at least two of the following criteria are fulfilled: 1) turnover of EUR 2,000,000; 2) book value of assets EUR 1,000,000 and 3) average number of employees 30, or if at least one of the following criteria is fulfilled: 1) turnover of EUR 6,000,000; 2) book value of assets EUR 3,000,000 or 3) average number of employees 90.  

However, all public limited companies (AS - aktsiaselts) are obliged to audit their annual accounts regardless of the above criteria. Private limited companies (OÜ - osaühing) are obliged to audit their annual accounts if they qualify under the criteria and regardless of the amount of their statutory capital (previously all private limited companies whose capital exceeded EEK 400,000, i.e. approx. EUR 25 565, were subject to auditing obligation).  

4.     Taxation of share options to employees 

The amendments to the Estonian Income Tax Act which are currently being prepared propose also amending of the current rules of taxation of share options granted to employees, especially regulation of the taxable event of such options. The proposed changes to the Income Tax Act and recent court practice and interpretations of the Estonian Tax and Customs Board have brought about a lively discussion related to the taxation of the employee share options. Therefore, we would like to give a short overview of the regulation of the taxable event of employee share options in Estonia in the light of recent developments.     

Under Estonian tax law share options provided to employees are considered to be and are taxed with income tax at 21/79 and with social tax at the rate of 33% as fringe benefits, whereas the taxable person upon offering of option programs is always the employer and from the perspective of employees granting of share option rights is not taxable in Estonia.  

Although share option rights can be generally taxed upon granting, vesting, execution or sale of shares (acquired under the share option program), Estonian legislator has not specified the exact event upon which share options must be taxed. According to the generally accepted principle in Estonia share options must be taxed at the moment when employees receive a monetarily appraisable benefit.

Estonian Supreme Court has specified the above general rule by defining granting and execution of the share options as moments triggering the tax obligation under Estonian law. Which of the two moments is to be used depends on the particular circumstances, but primarily on the type of the share option granted.      

According to the interpretation of the Supreme Court taxable event is considered to occur at the moment of granting of a share option right, where it is possible to determine the market value of the share option premium already at the moment when the share option is granted. This can be done in the case of simple transferable options, which are not restricted with various conditions (e.g. continuation of the employment relationship for a certain period, non-solicitation, non-transferability of the option right, etc). The taxable amount upon taxing at the moment of granting is the margin between the fair market price of the option premium and the price paid for the share option (if any) by the employee.   

The taxable event is considered to occur at the moment of execution of a share option, where the market value of the share option cannot be determined upon granting because due to various conditions pertaining to the share option the employee cannot be considered to have received a monetarily appraisable benefit already at the moment of granting. Determining the tax amount upon execution of the share option is characteristic of share options granted to employees because such options usually contain a number of conditions that need to be fulfilled before the employee is vested a right to execute the option (e.g. continuation of the employment relationship for a certain period, non-solicitation obligation, non-transferability of the option, tying of the right of execution with certain financial results, etc). The taxable amount upon taxing at the moment of execution is the margin between the fair market price of the share and the price paid for the share by the employee.             

Important interpretations have been given also by the Tax and Customs Board and by the Estonian Supreme Court to the situations, where share options are granted by third persons who do not have a direct employment relationship with the beneficiaries (employees to whom options are granted), for instance where share option rights are granted by a parent company to the employees of its subsidiary. According to the binding preliminary ruling issued by the Estonian Tax and Customs Board in this case options will be taxed as gifts only with income tax at 21/79.  

However, Estonian court practice has introduced an exception to this simple rule. Namely, if the subsidiary carries the costs related to the granting of share option rights to its employees, even though formally they are being granted by the parent company, the option rights may be deemed as actually granted by the subsidiary and taxed as fringe benefits.    

5.     Filing of annual reports 

Estonia has continued improving its register keeping also this year as starting from 1 January 2010 all annual reports of companies covering periods from 1 January 2009 and later must be submitted with the register in a special electronic environment. This means that it will not be possible to submit annual reports on paper or upload them in pdf format any more, instead annual reports will have to be filled in special standard forms and submitted with the register electronically. The electronic environment can be accessed with an ID-card or through the internet-bank.  

The right to submit an annual report have only members of the management board, who hold an Estonian personal code, however, management board members of a company may authorise any other person (e.g. an accountant) holding Estonian personal code to fill in the report and submit it with the register on behalf of the management board member, by adding the said persons to the list of users of the company’s profile. In the same way management board members of companies, subject to auditing obligation, have to add an auditor to the system. The auditor files his report also via electronic environment. All signatures given in the environment are electronic i.e. given with the ID-card.  

The new rules allow, though, certain exceptions during the transitional period of 1 year as well as exceptions for persons, who cannot sign documents electronically with an Estonian ID-card (e.g. foreigners). Also, alternatively, the annual report can be uploaded to the environment by a notary public.        

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