Interpretative discrepancies of the KIS Director regarding the lease agreement between related entities on the Estonian CIT

Recently issued individual interpretations indicate that tax authorities have inconsistent positions on the classification of lease or rental costs from related entities as so-called hidden profits.

While the regulations remain consistent, the authorities’ positions are subject to variation depending on the specifics of each case. The following three approaches demonstrate the various perspectives of the tax authorities.

Leasing from a related entity in the absence of own assets

Concluding a rental or lease agreement between related entities in a situation where the company does not have its own assets is subject to the risk of hidden profit. In one interpretation, the authority determined that a company engaging in short-term rental activities, in a scenario where it does not possess any real estate and utilizes facilities provided by a related entity under a lease agreement, will be liable for a lump-sum tax due to the generation of undisclosed profits.

The authority noted that the mere use of a shareholder or related entity’s property, even on market terms, may result in hidden profit distribution if the company lacks the necessary assets to conduct its business activities. The KIS Director has stated that it is imperative that the partners ensure that the company is adequately equipped, as this would indicate that the payment of rent is a method of transferring funds to the owners in a manner other than a formal dividend.

Notably, the authority did not raise concerns regarding the amount of the fee agreed upon by the related entities. This means that the market nature of the transaction is not a sufficient argument for concluding that the fee paid to the related entity does not constitute a hidden profit.

Lease agreement from related and unrelated entities

In another case, the authority adopted a different approach [2], specifically in a situation where a company was utilizing real estate assets owned by both related and unrelated entities. In this case, the KIS Director ruled that if a given lease transaction with a related entity was concluded on market terms and similar transactions are also concluded with other independent contractors, there are no grounds for considering such rent to be a hidden profit.

The interpretation cited is based on the reasonable assumption that if a company actually needs a given asset and concludes similar agreements with unrelated entities, there can be no question of hidden profit distribution. Furthermore, the authority took into account the fact that the business requires the use of specific locations and that the choice of real estate was not based on ownership relations but on business conditions.

In practice, this means that the use of a partner’s assets does not always pose a risk of hidden profits, provided that the company demonstrates that when deciding to conclude an agreement with a related entity, the offers from other economic operators were less favorable and that the conclusion of the transaction with the related entity was the only economically justified solution.

Justified lease on market terms

The third interpretation case [3] involved a scenario where a company leased real estate from a related entity. In the case under analysis, the company had a high level of equity and owned the assets necessary to conduct its business, including warehouse facilities and means of distribution and delivery of the goods sold. The transaction itself was thoroughly documented, based on market valuation and justified on business grounds. Consequently, the authority did not question the rationality of this solution and concluded that no hidden profit was generated.

The interpretation highlighted the pivotal role of economic factors, underscoring the transaction’s necessity due to the company’s operational requirements, the absence of viable alternatives, and the market nature of the agreement. The KIS Director has indicated that transactions involving related entities should be evaluated based on actual need and economic rationality, rather than solely on formal ownership relationships.

In this case, the argument that the company’s activities require specific locations and infrastructure that were only available from a particular related entity may prove crucial.

Same provision, different conclusions

As illustrated by the above examples, despite all three cases being based on the same legal basis, the interpreting authority reached inconsistent conclusions. The reason for these discrepancies is the different assessment of the business motivations and asset structure of the company. These elements are not directly derived from the provisions, but rather form part of the facts.

It is important to note that even if the ‘market transaction’ requirement is met, this does not guarantee that the transaction will not be considered a hidden profit. The tax authorities may determine that the business structure itself (e.g., absence of proprietary assets, substantial capital interconnections, absence of supplier diversification) results in an unwarranted transfer of funds to shareholders.

Conversely, if a company can demonstrate economic justification and the market nature of the transaction, it may obtain a positive individual interpretation.

MDDP comment

The interpretations presented demonstrate that the tax authorities have not yet established a consistent position on the recognition of lease or rental income from related entities as hidden profit. Criteria such as “sufficient equipment of the company” or “economic justification of the transaction” remain vague and open to interpretation. For taxpayers, this means exercising particular caution and maintaining accurate records of transactions with related entities. Conversely, even actions that are consistent with market standards may result in an unexpected tax liability.

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[1] Individual interpretation of 5 May 2025, ref. no. 0111-KDIB1-1.4010.98.2025.2.RH.

[2] Individual interpretation of 17 April 2025, ref. no. 0114-KDIP2-2.4010.32.2025.3.IN.

[3] Individual interpretation of 28 March 2025, ref. no. 0114-KDIP2-2.4010.45.2025.1.ASK.