Corporate Tax 2021

Last Updated March 15, 2021

Lithuania

Trends and Developments


Authors



WALLESS is a modern full-service business law firm with a wall-less attitude. Launched as a spin-off from one of the biggest law firms in Lithuania and the Baltics at the end of 2018, with its third year on the market WALLESS now unites more than 50 professionals in Lithuania. Following the merger of WALLESS, of Lithuania, Derling Primus, of Estonia, and Primus Derling, of Latvia, in October 2020, WALLESS now serves clients in all three Baltic states. WALLESS has a vision of a modern Baltic law firm that is built on earned client trust, openness, innovation and kept promises. The WALLESS tax team in Lithuania consists of six professionals. The team is highly experienced in working with international and domestic clients in multiple fields of tax and customs law, including sophisticated tax litigation nationally and internationally, tax advice and structuring (tax risk mitigation) in complex transactions, dealing with tax authorities on innovative tax and legal issues, tax compliance and tax controversy.

General Trends in Tax Regulation and Administration, and the Role of the Tax Authorities under COVID-19 in Lithuania

The challenges to the Lithuanian economy brought about by COVID-19 have also inevitably affected the focus and operations of the tax authorities. Besides taking up a significant role in assisting the government and other public authorities in identifying businesses and sectors suffering the most from the pandemic lockdown and restrictions (by invoking an enormous amount of tax data gathered via various mandatory reports and returns), granting tax deferrals and implementing other state support policy measures, the Lithuanian tax authorities still carried on with business as usual – tax collection and control, making sure everyone continues to pay their fair share.

With entire sectors (hotels, tourism, bars and restaurants, wellness and beauty services, etc) being practically frozen or highly restricted from March until late May of 2020, and being the least concerned about possible underpayment of taxes from non-existing revenues, others swiftly moved online or (a surprisingly significant part), after some initial uncertainty and hesitation, continued their business as usual. Taxmen, in that light, had to adapt to the changes, modify their methods of operation and priorities of control, and engage new means of monitoring the activities of taxpayers, especially those benefiting from the tax payment moratorium but continuing their (limited) operations, generating revenues and VAT, and continuing to accumulate indebtedness to the national and social security budgets. 

One of the notable trends in the practice of the tax authorities is increased interest of the tax inspectors in the current and past tax compliance of high net worth individuals (HNWI) and business owners, including an assessment on where their wealth is coming from, what is the structure of their income, and whether there are cases of obvious private consumption or luxury hidden in the financial statements of their companies. Corporate restructurings and changes in the ownership chains also attract additional attention in terms of sufficiency of economic substantiation and reasoning of such restructurings, and scrutiny on if and what due or undue tax benefits such corporate conversions might create for the companies and their stakeholders.   

On the other hand, the tax authorities are still actively working with controversial pre-COVID topics in the area of tax compliance: transfer pricing, amortisation of goodwill and thin capitalisation, among others.

As for the tax regulatory changes, most of those seen during 2020 were related to and caused by the pandemic: adjustments facilitating more flexible and targeted responses to the situations faced by the taxpayers in terms of liquidity, their ability to settle outstanding tax bills, ease of the procedures for tax loans, deferrals, transfers of tax arrears from one taxpayer to another (cashless settlements), and the introduction of other EU-approved state aid measures in the field of taxation. As 2020 was Parliament election year in Lithuania, significant changes both in corporate income tax (CIT) and the tax system in general were not seen (although a changing tax environment has become typical for Lithuania in recent years). However, even in the light of COVID-related challenges, the tax authorities still had to deal with certain novelties in the Lithuanian CIT system, recently introducing a pan-European EBITDA-related interest deduction limitation, explaining exit tax, new tax anti-avoidance rules and national policy measures such as a "patent box" or the large-scale investment incentive.     

Lithuanian Large-Scale Investment Incentive – What Should Be Considered before You Plan to Accept This Challenge

Lithuanian CIT incentives were historically modelled either to attract investment, such as hi-tech or innovations, develop the economy in certain areas (eg, free economic zones, or FEZ), or support certain activities (such as cinema production). After a last huge step, the introduction of a special CIT regime at the end of 2018 (a patent box regime), in 2020 Lithuania introduced another very competitive regime for large investors applicable as of 2021: the large-scale investment incentive, which includes not only tax benefits, but also simplifications for zone planning, administrative decision-making processes, migration permits and others. The main requirements and tax benefits for such large-scale investments are highlighted below.

Why?

Companies engaged in large-scale investment projects that meet the requirements set out in the Lithuanian Law on Corporate Income Tax could pay 0% CIT on the taxable income generated by the large-scale investment project for 20 years or until the maximum state aid intensity is reached. The incentive will not be limited to specific geographic areas of the country and will apply to companies located in any part of Lithuania; however, if a company benefits from the FEZ incentive, the large-scale incentive is not available.

Requirements

In order to make use of the incentive, a company has to conclude a Large Investment Agreement (an "Agreement") with the Ministry of Economics and Innovation (MEI).

An investment in Lithuania should reach at least EUR20 million, or EUR30 million if the company is investing in the Vilnius (the capital) region. This investment threshold has to be reached within five years after concluding the Agreement; ie, it is not required to make an initial investment of EUR20 million or EUR30 million – it could be accumulated over a few years (though the application of CIT relief would be postponed until this minimum investment amount would be reached). Investments should be made into capital expenditure (assets and know-how). To confirm the level of investments, the company has to obtain auditors’ confirmation.

Another important criterion is that the average number of new employees in a company during a tax year should be at least 150 (or 200, if the company is investing in the Vilnius region). "New employees" is determined by counting the average number of employees before and after the investment is made. 

Investment made as of 1 January 2021 until the Agreement is signed as well as new employment places created during this period could be acknowledged as part of large-scale investment project, if the application is submitted within two months after implementing legal acts come into force.

It is also important that at least 75% of the company’s income is received from either data processing or internet server services and related activities or manufacturing activities. Although the remaining part of the income (apart from the large-scale investment project) is taxed regularly (the standard CIT rate in Lithuania is 15%), it should not exceed 25%.

It is important to comply with those criteria, because if the investment amount or new employees number falls below the mentioned thresholds, the CIT relief application would be suspended until the requirements would be rebuilt; however, the term (20 years) would continue.

When?

The incentive was introduced in the middle of 2020 and entered into force from 1 January 2021. Applications to sign an Agreement couldbe filed from 1 January 2021 and the deadline for signing an Agreement is 31 December 2025.

Implementing legal acts (including those setting up requirements for the applicants, procedure and evaluation criteria) are still published as drafts at the time of writing (23 February 2021); thus, those regulations could be amended. However, significant amendments should not be expected.

Applicants

The investor could be a company registered in Lithuania or the shareholders of such company. In the latter case, both the company and its shareholders are jointly liable for the implementation of the project. Shareholders of a future company, registered in Lithuania, could also act as investors for the purposes of an application, however, the company should be registered in Lithuania until signing the Agreement. Natural persons, who could be engaged in the mentioned activities, could also be investors.

The total annual operating income of the investor (including the income of the investor’s group companies or companies controlled by the investor) for at least one financial year in the previous three financial years has to be at least EUR10 million and the applicant should be engaged in manufacturing activities for at least five years or service activities for at least three years. The investor must be able to demonstrate that it is economically capable to ensure execution of the Agreement.

Process

The investor should prepare an investment project and submit an application to the MEI. The application could be submitted in either Lithuanian or English (a translation could be required) and could be signed electronically. The whole project is to be presented in the application in detail and should receive at least 50 points (lower-valued projects are rejected) during an evaluation process performed by a governmental investment agency, Invest Lithuania.

The aspects most relevant in the evaluation process are:

  • the number of new jobs created due to the project;
  • the percentage of highly qualified workers in the total number of new jobs;
  • the average wage compared to the average wage in the municipality where the major project is being implemented;
  • the location of the project;
  • the percentage of exported goods (in the case of manufacturing activities); and
  • the impact on the economic development and competitiveness, and increase of public welfare in Lithuania.

To sum up, expectations of the country due to the large-scale investment project incentive are high. Business (both national and international) is also interested in such possibilities and, with the joint efforts of the MEI and Invest Lithuania, it will most likely attract investment from large businesses. Moreover, other CIT incentives are also applied to those intending to use the large-scale investment incentive, such as an investment project incentive (a double deduction of the costs of certain new assets) and an R&D incentive (a triple deduction of costs). However, it is important to observe the requirements and state aid intensity (as the maximum 20 years of CIT relief could be much shorter in reality).

Tax Amortisation of Goodwill – New Controversy in Lithuania

Historically, a number of foreign investments in Lithuania ended up with a similar corporate/financing structure: acquisition of a target via a local special-purpose vehicle (SPV), having internal and/or external debt financing, followed by a merger of the target and SPV. Depending on the situation and circumstances, the merger could be downstream (the SPV is merged into the target, which is the most suitable and effective choice in most cases) or upstream (the target is merged into an SPV – more of a unicorn, because the merger of an operating business does not matter if manufacturing, retail, services or even developed real estate, trigger much more hassle and legal risks). The usual consequence of a downstream merger is new debt, used to finance the acquisition, "landing" on the target with its inherent interest expenses. 

At the end of the day, an upstream or a downstream merger gives a rather comparable outcome: an acquired business with a changed owner, potential additional debt, interest expense and goodwill – the positive difference (if any) between the market value of the target’s assets and the price paid for the shares of the target, to be potentially amortised for CIT purposes in the next 15 years.

The Lithuanian Law on Corporate Income Tax – allowing the amortisation of goodwill (if positive) and imposing immediate recognition of income (if negative) in share acquisition situations, followed by a merger – does not impose any additional requirements in relation to direction of the merger, timing (a possible gap between the share acquisition and merger), reasons for the merger or others. In an upstream merger, when an actual business "moves" into an SPV, that borrowed funds and spends them for the acquisition, the link between expenses (part of which form goodwill) and the acquired business (assets, contracts, reputation) and income it is supposed to generate is direct and easily seen. It is quite hard to argue that a taxpayer (an SPV) actually spends money on an "asset" that generates taxable income for the company it had not been generating before and that it does have a right to amortise/depreciate the acquisition price of that "asset" (although it might be the same business, generating the same level of revenue as before, but, as a consequence of the acquisition and merger, is encumbered with the loan, interest expenses and goodwill amortisation).   

However, in the case of an alternative merger – downstream, when an acquiring SPV (now parent company), usually having no significant prior business or much traditional substance (premises, employees or equipment) is merged into an operating business – the situation might be seen quite differently: successfully (not a fact) operating and profitable taxpayer is, upon such merger, encumbered with a loan, which was used to finance its acquisition, interest and goodwill depreciation, further reducing the tax bill of a previously successful (not a fact) business, bringing no material change to it.

Although the ultimate result in both cases is absolutely the same, and the choice of the method of the merger might have very practical and logical reasoning, having nothing to do with taxation (licences held by the acquired target, land lease agreement, distribution contracts or just saving time and funds because of a simpler process), a downstream merger is considered to be a highly tax-motivated transaction, the tax outcome of which is highly questioned by the tax authorities and the threshold of reasoning and substantiation for which are set very high: to demonstrate clear economic reasoning and benefits from the merger itself (not the acquisition), and show how this accumulated goodwill is actually used (like any other "common" asset) in the further business operations.

The first concern for the market in this Lithuanian goodwill controversy, on which courts are yet to have their say, is the fact that such downstream mergers upon acquisition have been a long-standing market practice, some of which was upheld by the binding rulings or non-binding written consultations issued by the tax authorities. Now, without any changes in the laws or judicial practice on this matter, the authorities are making a U-turn in their approach and reassessing transactions already completed and goodwill amortisation deductions made, applying tests and criteria that were never there (in the law or their public commentary).

Another aspect that is not easy to comprehend and accept is the logic of this new approach, targeted at and critically assessing downstream mergers only. It gives no clear answer if and how it could or would apply (if at all) on an upstream merger or a merger where two companies would merge into an entirely new corporate entity (taxpayer). And one might also ask if and how this same logic on tax recognition of the goodwill would apply in an opposite situation, when a target is acquired for less than the market value of its assets and, upon subsequent merger, negative goodwill is formed, which, under the Lithuanian Law on Corporate Income Tax as it stands, is to be booked as taxable income immediately. Would, in such case, any additional assessment criteria be applicable, or would the provisions of the law be applied directly and literally? 

All those questions above are currently being considered by the courts and there is much hope in the market that the courts, in their rulings, will shortly not only add more clarity on the concept of goodwill and content of the provisions of the law for the future, but also give guidance on how such situations of changing administrative practices are to be resolved for the past.

WALLESS

Upes str. 23
08128 Vilnius
Lithuania

+370 611 04864

info@walless.com www.walless.com
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Trends and Development

Authors



WALLESS is a modern full-service business law firm with a wall-less attitude. Launched as a spin-off from one of the biggest law firms in Lithuania and the Baltics at the end of 2018, with its third year on the market WALLESS now unites more than 50 professionals in Lithuania. Following the merger of WALLESS, of Lithuania, Derling Primus, of Estonia, and Primus Derling, of Latvia, in October 2020, WALLESS now serves clients in all three Baltic states. WALLESS has a vision of a modern Baltic law firm that is built on earned client trust, openness, innovation and kept promises. The WALLESS tax team in Lithuania consists of six professionals. The team is highly experienced in working with international and domestic clients in multiple fields of tax and customs law, including sophisticated tax litigation nationally and internationally, tax advice and structuring (tax risk mitigation) in complex transactions, dealing with tax authorities on innovative tax and legal issues, tax compliance and tax controversy.

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