Under Latvian legislation, a company’s CEO is responsible for keeping and organising its books. When applicable provisions of law or the company’s internal processes change, it is important to revise its internal accounting procedures. Due to the corporate income tax (CIT) reform, the approach to calculating CIT is changing fundamentally in 2018. This article takes a look at common taxable items that deserve a revision of their accounting principles this year.
Representation expenses and staff sustainability expenses
Representation expenses by definition are expenses a taxpayer incurs to build his prestige, entertain his customers and suppliers, and provide meals, as well as amounts spent on low-value items intended to make the taxpayer popular.
A new concept of “staff sustainability” events is introduced from 2018. These are expenses a taxpayer incurs to motivate his staff, build teams, or maintain social infrastructure.
Representation expenses and staff sustainability expenses are capped at 5% of gross wages for the past year. There is no taxable item until the cap is reached, but afterwards CIT is payable monthly.
To apply the exempt 5% limit, the company should keep a separate record and accurately describe representation expenses and staff sustainability expenses in its accounting guidelines, and provide supporting documents.
Non-business expenses
CIT will be payable on these expenses monthly. Accountants often recognise expenses without supporting documents as non-business expenses, e.g. representation expenses or fuel costs not accompanied by appropriate documentation. It is therefore important that the company’s accounting policy should accurately describe its documentation requirements for business expenses and define principles for recognising non-business expenses.
Donations
Donation relief is available on donations to Latvian public benefit organisations or their equivalents in an EU/EEA member state or a country that has an effective double tax treaty with Latvia. The donor can take relief on his total donations by using one of the following three methods:
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Exclude donations from the tax base up to 5% of profit after taxes for the past year;
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Exclude donations from the tax base up to 2% of total gross wages on which NSI contributions were paid in the past year;
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Reduce the CIT charge on dividends by 75% of the donated amount, capped at 20% of the CIT charge on dividends.
Donations to public benefit organisations are not considered non-business expenses if the company has chosen method 1 or 2 and does not exceed its limits. Since the law lays down additional requirements and restrictions for donors, it is important to incorporate those into the company’s agreements with public benefit organisations and keep appropriate records.
Bad debts
Under the new CIT Act, a bad debt that remains unrecovered within 36 months after a provision was made for it, should be added to the tax base, unless the exemption criteria are met. An internal checklist can be drawn up for claiming an exemption. It is also important to ensure that accounting records are transparent, including a separate record of bad debts incurred before 2018 and an accurate record of new bad debts arising after 2017. This will allow the company to select information about the age of a provision from its accounting records and to consider claiming an exemption in the case of writing off that provision.
Other provisions
As to provisions made before 2018, their reduced amount multiplied by a coefficient of 0.75 can be deducted from the tax base if they are recorded separately from other provisions on 1 January 2018. As to any excess of provisions made in 2017 over 2016, a reduction is available only if CIT is being paid on dividends. Companies should therefore keep appropriate records in their accounting system in order to monitor tax deductions in subsequent years.
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Loans treated as profit distributions
Loans to a related party are treated as profit distributions. The law lays down criteria for determining when a loan is not treated as a profit distribution, such as a short-term loan maturing in up to 12 months or a loan that does not exceed the amount borrowed from an unrelated party. It is therefore necessary to revise the conditions for cash movements between related companies and to define internal criteria for recording related-party loans by keeping a separate record of loans that are deemed distributions and on which CIT has been paid. If those loans are repaid, the company can reduce the tax base.
Retained earnings brought forward and dividends
Tax-free dividends can be declared out of retained earnings arising before 2018 for an indefinite period. Within those retained earnings, the company can also lend to related parties or write off bad debts meeting the exemption criteria without CIT implications (paragraphs 10 and 31 of the transition rules of the CIT Act). Since retained earnings attract a favourable CIT treatment and can be reduced for a number of reasons, the company should keep a separate record in order to monitor any differences arising from such retained earnings being distributed in dividends and used for CIT purposes.
Under the Personal Income Tax (PIT) Act, dividends to be distributed to the owner – an individual – in 2018 and 2019 out of profits earned before 2018 will be taxed at a rate of 10%. As from 1 January 2020, the rate of PIT (unless CIT or PIT has already been withheld) will be 20% on payment to an individual. In order to keep correct accounting records, it is important to separate retained earnings arising before 2018 and those arising after 2017. This separation will help the company identify the rate of tax payable on a deemed distribution. Finally, when approving a profit distribution, it is important to determine whether the amount of profit to be distributed is stated net or gross.
Utilising tax losses brought forward
Utilising tax losses is subject to a five-year restriction. The company can utilise 15% of its loss, capped at 50% of the CIT charge on dividends. This means that losses brought forward can be utilised only if the company distributes profits arising after 2017. Given this restriction, the company should assess whether it will be able to distribute new profits over the next five years and make necessary adjustments to its shareholders’ equity.
Share capital
Deemed dividends are a part of retained earnings for the current or past financial years that is added to the company’s share capital if the profits used for such a share capital increase arise after 2017. It is therefore important to keep a separate record of share capital set up before 2018 and after 2017.
Under the CIT Act, the draft CIT return provides that taxpayers will be required to file information as at 31 December 2017 with the State Revenue Service about the balance of retained earnings and the amount of loss that reduces retained earnings, as well as about bad debts and provisions, and any other adjustments capable of affecting the tax base under the new CIT Act.
