Implementation of base erosion and profit shifting (BEPS) provisions
Following the OECD initiative, Council Directive (EU) 2016/881 amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation was introduced on 25 May 2016. Under the directive, Latvia is a part of the mandatory automatic exchange of information (AEOI) mechanism in the field of taxation and has implemented the CbC report by adopting the Cabinet of Ministers’ Regulation No. 397 of 4 July 2017.
Latvia has transposed the OECD Common Reporting Standard (CRS) as well as Council Directive 2014/107/EU amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation, into domestic law. Latvian financial institutions covered by the CRS must report certain income and asset information on certain non-resident account holders to the Latvian tax authorities.
While drafting the new CIT Act, Latvia already transposed some of the rules of the Anti Tax Avoidance Directives (ATAD 1 and 2) (limitations on the deductibility of interest, a general anti-abuse rule, rules to tackle hybrid mismatches). Some of them are already effective while the rest are expected to be introduced swiftly.
Limitations on the deductibility of interest
CIT Act fully transposes the interest limitation rule prescribed by ATAD. In other words, where a taxpayer’s interest expenses for the financial year exceed 3 million euros on borrowings or finance leases from parties that are not credit institutions (financial institutions) of Latvia, the EEA or a country that has an effective double treaty with Latvia, the CIT base should include any interest charges over and above 30% of the taxpayer’s EBITDA.
A general anti-abuse rule
Under Latvian CIT Act, flow-through dividends are not exempt from CIT where the taxpayer’s main intention, or the main reason a related party was set up or exists, or the main purpose of the transaction, was to claim a tax exemption on dividends available under the CIT Act or the PIT Act.
Draft legislation - Rules to tackle hybrid mismatches
Planned amendments in Latvian CIT act will oblige the taxpayer to neutralise the consequences of a hybrid mismatch by increasing the tax base. It is proposed to have a secondary adjustment as well as a primary one (a secondary adjustment will be made when the other party to the transaction, who is not an EU member state and has not adopted measures for neutralising hybrid mismatches, fails to make a primary adjustment).
In order to neutralise a double deduction, the proposals provide that if both countries involved in the transaction are EU member states, the payee will have to increase the tax base by an appropriate amount deducted under the law of the payor’s country. If the other party is in a non-EU country, the EU company will have to resolve the hybrid mismatch regardless of the payor’s/payee’s status.
To neutralise a deduction without inclusion, the onus of increasing the tax base will lie with the payor if the parties are EU-registered companies. If the payor is established in a non-EU country, the EU payee will have to ensure the payment is properly included in taxable income.
Special rules will govern a chain of transactions where the EU company technically does not create a hybrid mismatch, but assessing that chain leads to the conclusion that a hybrid mismatch arises in the non-EU country, i.e. the payment received and included in the tax base is offset by another payment for that transaction in the non-EU country, which creates a double deduction. The EU taxpayer should eliminate this by adding to the tax base the deduction taken in the non-EU country for offsetting the hybrid mismatch.
The amendments also place the taxpayer under an obligation to increase the tax base by the income of an unrecognised foreign PE, with separate rules for transparent (hybrid) units.
A hybrid mismatch itself will result in a deemed profit distribution to be included in the tax return for the last tax period of the financial year.
Draft legislation - Exit tax
To complete the adoption of the ATAD 1 provisions, the CIT Act is to include new rules on the tax treatment of assets a taxpayer moves abroad free of charge. The tax base is to exclude any assets a taxpayer moves to a foreign country free of charge and makes them available for a period of up to 12 months –
- for financing securities;
- as collateral;
- to meet capital adequacy (so-called prudential capital) requirements;
- for liquidity management.
EU state aid investigations
Latvian law provides the necessary references to EC Regulation No. 651/2014, which ensures that the EU funding intensity complies with EU rules for state aid. Currently, there are no investigations on the part of the European Commission with regard to Latvian tax law.
Double tax treaties (DTTs) and intergovernmental agreements (IGAs)
Latvia has effective DTTs with 61 countries and continues developing its tax treaty network. Latvia has signed the OECD's Multilateral Convention on Mutual Administrative Assistance in Tax Matters.
Latvia has also signed an IGA with the United States (US) government to implement the tax reporting and withholding procedures associated with the Foreign Account Tax Compliance Act (FATCA). On 2 April 2014, the US Treasury announced that the IGA was ‘in effect’ and, on 27 June 2014, the US Treasury and Latvia signed and released the IGA.