Forward contracts do not always deprive Estonian CIT

A fundamental requirement for Estonian CIT is that the majority of revenue must be derived from operating activities. In practice, this means that less than half of the company’s total gross revenue may come from so-called passive sources. In the list compiled by the legislator, the following items are included: income from the disposal and exercise of rights arising from financial instruments (Article 28j(1)(2)(f) of the CIT Act).

Practice shows that it is often challenging to distinguish between operating and passive activities. This was discovered by a company which, despite conducting actual operating activities, faced the risk of losing its right to a lump sum payment due to hedging the risk of exchange rate fluctuations in its operating activities with forward contracts.

Dispute over the nature of the activity

The company is engaged in the trade of gaseous fuels. A key part of this activity is to mitigate currency risk in order to support the company’s core business operations. There may be situations where revenues related to the execution of forward contracts will constitute more than half of the company’s revenues. The Director of the National Tax Information Office has determined that in this instance, the company will be unable to apply the lump sum tax, as income from the realisation or disposal of financial instruments is classified as passive income under Article 28j(1)(2)(f) of the CIT Act.

(Non-)passivity of revenue

The Provincial Administrative Court in Warsaw delivered its judgment on 9 July 2025 (ref. no. III SA/Wa 1037/25 adopted a different perspective on the matter.

A purposive interpretation was applied, and it was determined that income from financial instruments that are functionally related to the company’s operating activities, i.e. secure its primary source of income, cannot be treated as passive income within the meaning of the Estonian CIT provisions. The court therefore took a more flexible approach to the provisions, emphasising the overriding role of purposive interpretation.

The exclusion of companies conducting passive (e.g. financial) activities from the group of companies eligible for lump-sum taxation of income is in line with the objectives adopted at the stage of drafting the Estonian CIT provisions. The purpose of introducing this condition was to limit the possibility of flat-rate taxation by entities not engaged in active economic activity but focused on deriving income mainly from passive sources.

Purposive interpretation versus literal interpretation

The recent ruling of the Provincial Administrative Court in Warsaw aligns with the favourable trend in case law, indicating the need for an economic analysis of the nature of the income of a company applying Estonian CIT.

As previously outlined by administrative courts in Gliwice, Krakow and Warsaw, and as per cases concerning income from financial instruments and related to the use of factoring, a broader analysis of the nature of income is required. In justified cases, there is also a need to consider departing from a literal interpretation of the provisions.

MDDP comment

The judgment of 9 July 2025 is a significant step towards establishing a rational interpretation of the Estonian CIT rules on restrictions on passive income.

The Provincial Administrative Court in Warsaw has clarified that not all financial transactions can be considered passive. The fundamental question is whether the transaction serves an operating or investment purpose. Therefore, the economic context of the revenue in question must be examined on a case-by-case basis.