Remuneration of a proxy in Estonian CIT under scrutiny by the tax authorities

The Director of the National Tax Information Service (KIS) has once again emphasised that remuneration paid to a company’s proxy, who is also a related entity, is taxable as income from hidden profits.

For instance, on 17 April 2025, the authority issued an individual interpretation (ref. no. 0111-KDIB1-2.4010.135.2025.1.MK), in which it was stated that the economic content of the benefit is important, as well as its legal classification.

The case concerned a limited liability company subject to flat-rate taxation on company income, which had entrusted the function of proxy to one of its partners. The partner had many years of experience in managing entities with a similar business profile. The scope of the duties entrusted to him included representing the company, negotiating with contractors and conducting day-to-day business. The remuneration was determined on the basis of market conditions, taking into account the candidate’s qualifications, experience and the scope of the duties entrusted. Despite the transparent and rational approach, the tax authority questioned this solution, considering it a form of hidden profit.

The company’s argument – marketability and the principle of equivalence

In the applicant’s opinion, the payment of remuneration to the proxy did not constitute a hidden profit within the meaning of Article 28m(3) of the CIT Act.

The company emphasised that the power of attorney was established for purely business reasons and that the remuneration was determined by a resolution of the management board at a level corresponding to market values. The company emphasised that remuneration is not linked to the right to share in profits, and that the benefit is equivalent to the duties actually performed.

In the opinion of the Director of the National Tax Information Service, the market remuneration of a proxy is also a hidden profit

The interpreting authority did not share the company’s position. In its justification, it pointed out that according to the literal interpretation of the provisions, only benefits classified as remuneration for the reasons specified in Article 12(1) and Article 13(7)-(9) of the PIT Act, e.g. employment contracts, contracts of mandate, management contracts – will not constitute hidden profit if they do not exceed 5 times the average remuneration for these items in the company or 5 times the average remuneration in the enterprise sector. Remuneration for performing the function of a proxy appointed by way of a resolution does not meet this condition and is therefore subject to automatic taxation as hidden profit.

The Director of the National Tax Information Service has stated that the benefit’s market nature, economic justification and actual performance are all irrelevant. The key issue is that the benefit paid to the partner was not included in the list of benefits specified in Article 28m(4) of the CIT Act. This is sufficient for it to be classified as income from hidden profits.

Practical consequences – limits on permissible benefits

The above interpretation indicates a narrow approach of the authorities to benefits paid to shareholders of companies subject to Estonian CIT. Despite actual involvement, business need and compliance with market conditions, key importance is attached solely to the legal form of the benefit and its compliance with the list of exemptions set out in the Act.

In practice, this means that the economic justification and equivalence of the remuneration of a proxy appointed by resolution does not preclude lump-sum taxation. Consequently, it may be advisable to consider concluding an employment contract with a proxy, for instance, one that stipulates a remuneration limit of no more than five times the average compensation within the company or five times the average enterprise sector remuneration.

MDDP comment

The tax authorities clearly indicate that when assessing the existence of hidden profit, it is not the economic circumstances that are most important, but the legal type of payment and the status of its beneficiary.

The approach to the remuneration of a proxy is consistent with the case law of administrative courts. The Supreme Administrative Court, in its judgment of 11 July 2023, ref. no. II FSK 93/23, had already indicated that the remuneration of a proxy is not included in the list of income excluded from hidden profits on the basis of the five-fold limit, because the remuneration of a proxy ‘by appointment’ constitutes income from other sources under the PIT Act.

Companies applying a lump sum tax on company income must therefore exercise caution when engaging partners to perform management or advisory functions, especially if the remuneration is not covered by the closed list of ‘safe’ PIT titles. Otherwise, the risk of taxation as hidden profit becomes real.