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                        ORGANIZATION OF ADVOCATES SPECIALISING IN INTERNATIONAL SERVICES

ESTONIA 2010/2011

 

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ESTONIA DEVELOPMENTS 2010/2011

Martin Simovart, Lepik& Luhaäär LAWIN

 

The year 2010 has been quite challenging for lawmakers in Estonia, and mainly due to the preparations for an important and long-awaited milestone in the Euro-integration process of Estonia – adoption of the Euro.

Preparations for the adoption of the Euro lasted for the whole of 2010 and embraced not only technical amendments in the currency designations of Estonian legal acts, but also more substantive changes, e.g. in the field of companies’ capital conversion rules. However, regardless of the complexity of the Euro-adoption process, both from the legal and technical point of view, the transition to the new currency was carried out smoothly and without any substantial drawbacks, which has been positively marked also by the high-ranked European officials.

At the same time, adoption of the Euro was not the only significant event on the Estonia legislation landscape that took place during the observable period, as a number of other amendments to the existing acts as well as new acts were adopted in Estonia during 2010/2011.

Namely, Estonian lawmakers continued to carry out corporate law reforms aimed at freeing companies from unnecessary and burdensome formalities, making thus carrying out of business in Estonia easier and quicker. Most of the innovations introduced during 2010/2011 concerned the private limited company (osaühing), although a very significant reform – introduction of no par value shares – was carried out also with respect of the limited liability company (aktsiaselts).

An important amendment has been also passed by the legislator in the field of taxation of employee share options. If last year we had to write about an intricate situation in this area, then this year we can report on an amendment which has made rules of taxation of employee share options much clearer.

As during previous years, Estonia is continuing to take measures against the consequences of the global economic crisis. Quite recently, a new Debt Reorganization and Debt Protection Act was adopted by the Estonian parliament with the aim of providing protection for natural persons in distress situation. This and all the other previously mentioned changes will be discussed in more detail below.      

 

1.              Adoption of the Euro

 

Starting from 1 January 2011 Estonian official currency is the Euro and the Estonian kroon is not in circulation any more (although Estonian kroons can be freely exchanged for Euros in the commercial banks and the Bank of Estonia).

The Euro was adopted in Estonia with a so-called “big bang”, i.e. without any transitional periods (except for a two week period following 1 January 2011 during which both the Estonian kroon and the Euro were in circulation simultaneously), i.e. Euro became official currency of Estonia and entered into circulation overnight, on 1 January 2011.

The consequence thereof was that all the values which were previously reflected in Estonian kroons (e.g. prices, accounting records), had to be recalculated into Euros as at 1 January 2011. Recalculations were carried out on the basis of general conversion and rounding rules set forth in the Euro Adoption Act, which entered into force on 1 January 2011. According to the said act values reflected in Estonian kroons were subject to conversion into Euros under the official exchange rate of EUR 1 = EEK 15,6466 and the result had to be subsequently rounded with the precision of 1 Eurocent.

Special rules for converting share capitals of companies into Euros, were introduced by lawmakers already in July 2010, simultaneously with the enacting of the new minimum share capital requirements for private limited companies (minimum share capital – EUR 2,500; smallest nominal value of one share – EUR 1) and limited liability companies (minimum share capital – EUR 25,000; smallest nominal or accounting (in the case of no par value shares) value of one share – EUR 0.1). The said share capital requirements have to be observed when converting the share capital from Estonian kroons into Euros.

In order to make the process of conversion of share capital smoother for companies, the legislator has provided for a simplified procedure of capital conversion, where the share capital of a company is either reduced or increased to the nearest possible value in Euros, whereas upon registering of such conversion in the Commercial Register no stamp duty has to be paid and in the case of capital reduction the company is released from following certain formalities which are normally required in such situations (e.g. informing of creditors).

An important reform has been carried out with respect of limited liability companies by introducing no par value shares. Adoption of no par value shares enables limited liability companies, which usually have large share capitals, conversion of which could require significant changes in the size of the share capital, to convert their share capitals into Euros without changing the size of the share capital. This is possible due to the fact that in the case of no par value shares the shares have merely an accounting value and the nominal value is not reflected.

There are no strict terms set forth by law during which all companies would be obliged to convert their share capital into Euros. However, it is advisable that the share capital is converted into Euros during 2011, because starting from 1 January 2012 it will not be possible to make changes in the articles of association of the company or to increase/reduce the share capital without having previously converted the share capital into Euros. Also, benefits connected with the simplified procedure of capital conversion will be available only during 2011.    

 

2.              Changes in the corporate law

 Amendments introduced by the legislator in the Estonian Commercial Code which entered into force on 1 January 2011 are mainly aimed at making the regulation applicable with respect of private limited companies more competitive. The main purpose of such regulation is fostering of entrepreneurship by making starting and running of business even quicker and cheaper than previously.      

 Probably the most important innovation introduced in the Commercial Code is the possibility to establish a private limited company without paying in the minimum share capital (currently EUR 2,500), if the proposed share capital of the company does not exceed EUR 25,000. However, in order to avoid abuse of the said possibility, a number of restrictions have been set forth for the protection of the interests of the creditors. Namely, upon founding of a company without any contributions into the share capital, all founders have to be natural persons, whereas such founders are personally liable for the obligations of the company to the extent of their contributions, until the whole statutory capital is paid in. Also, the amount of share capital cannot be changed and the company may not make any payments to the shareholders until the capital is paid in.

 The procedure for making non-monetary contributions has been also simplified. If previously a non-monetary contribution had to be evaluated by the auditor if the value of the non-monetary contribution exceeded EUR 2,500 or constituted at least half of the company’s share capital, then starting from 1st January 2011, the threshold has been raised and companies, whose capital is less than EUR 25,000 can make non-monetary contributions without the need to attract an auditor, regardless of the value of the non-monetary contribution.  

 In addition to the above, a number of requirements which were previously obligatory for private limited companies, have been made optional, i.e. companies may choose whether to enact certain remedies in their articles of association or not. For instance, if previously, upon sale by one of the shareholders of its share to a third person, other shareholders had a statutory pre-emption right (which could be substituted by an approval of the general meeting), then starting from 1st January shareholders are free to exclude applicability of the pre-emption right at all or bind the right to sell the share to a third person with any condition by enacting respective rules in the articles of association.

 Also, a private limited company may choose not to form the reserve capital, which prior to 1st January 2011 was compulsory, constituting at least 1/10 of the company’s share capital.

 A number of amendments have been also made in order to simplify the work of the private limited company’s management bodies. For instance, if previously the term of office of the member of the management board constituted 3 years (but in any case not more than 5 years under the articles of association), then starting from 1st January members of the management are elected for an indefinite term (unless otherwise provided for in the articles of association of the company), which eliminates the need for periodic re-election of management board members. Also, the company is free to indicate in the articles of association whether the supervisory board shall be formed (previously the supervisory board was compulsory if the share capital exceeded EUR 25,000 and the management board consisted of less than 3 members).

 Numerous other less important amendments were introduced in the Commercial Code with the aim of simplifying corporate requirements applicable with respect of private limited companies.    

 

3.              Taxation of employee share options

Starting from 1 January 2011 a number of amendments have been introduced into the Estonian Income Tax Act, including amendments in the fringe benefits regulation, and especially in the rules applicable to the taxation of employee share options. We would like to give a short overview of the taxation of employee share options in Estonia in the light of recent changes.   

 The general rule of taxation of the sale/transfer of shares to the employees has remained unchanged, i.e. the selling/transfer of shares is considered to be a fringe benefit if the shares are sold/transferred to the recipient at a price lower than the market price. The taxable amount of the fringe benefit is the difference between the market price and the price paid by the employee for the share (if paid at all). When determined, the taxable amount is taxed with income tax at the rate of 21/79 from net amount. In addition to the income tax fringe benefits are also subject to social tax at the rate of 33% which is calculated from the total of the net amount of the benefit and of the income tax calculated from such benefit. Taxes from fringe benefits must be paid by the employer and not the employee, therefore, from the viewpoint of an employee, the acquisition of shares is not taxable in Estonia.

However, quite importantly, the definition of employer used for the purposes of fringe benefits regulation has been broadened significantly starting from 1 January. Namely, if prior to the reform, only direct employers of the employees to whom benefits are provided, were subject to the fringe benefits regulation, then starting from 1 January 2011 also any other company belonging to the direct employer’s group of company (e.g. mother company), is considered to be employer for the purposes of the fringe benefits regulation.  

Estonian Income Tax Act has been also supplemented with respect to the specific regulation applicable to share options granted to employees. Namely, it has been clarified by the legislator that the taxable event upon taxation of share options is the moment of execution of the share option right, whereas the amount of the fringe benefit in the case of the acquisition of a shareholding upon execution of the share option right corresponds to the difference between the market value of the shareholding and the cost of execution of the share option right.

And finally, according to the most important innovation introduced as of 1 January 2011, granting to an employee of a right to receive a shareholding in the employer or in any company belonging to employer's group of companies is not deemed to be fringe benefit if the shareholding is acquired by the employee by way of execution of the share option right not earlier than after 3 years since the granting of the share option. This means that following the reform share options with a vesting period of over 3 years can be granted to employees without being subject to any tax obligation.

 

4.              Debt Reorganization and Debt Protection Act

 With the entering into force as of 5 April 2011 of the Debt Reorganization and Debt Protection Act, a reorganization procedure similar to the procedure available for companies under the Reorganization Act, has become available also for natural persons. Such reorganization procedure enables natural persons to seek protection from court, reorganize their debts and avoid personal insolvency.

 

Similarly to the reorganization proceedings with respect to businesses, restructuring proceedings with respect to natural persons have the following important effects to the enforcement of financing and security documents:

 

(i)              Any and all pending enforcement procedures are suspended by the court until approval of the restructuring plan or termination of the restructuring proceeding;

(ii)            Calculation of delay interest and/or other contractual penalties is suspended until approval of the restructuring plan;

(iii)           If so decided by the court, certain pending court proceedings related to monetary claims against the debtor may be suspended;

(i)              If so decided by the court, creditors can be restricted from carrying out their rights arising from collaterals granted by the debtor, including selling of a pledged thing or demanding its sale;

(iv)          After approval of the restructuring plan, no claims may be enforced or submitted to the court (unless such claims are not covered by the restructuring plan) until the restructuring plan is in force.

 

The restructuring plan may involve restructuring of claims against the debtor (by prolonging the payment term, approval of payment schedule or reduction of debt).

        

 

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