Starting in 2026, the new coalition plans to introduce a new 2 percent tax on corporate profits.

Erki Usin told ERR that the only positive aspect of the defense tax, essentially an additional income tax, is its transparency – it's clear what the money is intended for.

"Unfortunately, that seems to be the only good aspect, as everything else about this topic is very, very bad. The paradox in these circumstances is that Estonia's defense capability will not receive the expected additional funding. Since the whole idea of the additional income tax is fundamentally flawed, regardless of its detailed implementation, it cannot change the overall picture," he said.

According to Usin, the additional tax will not generate the desired additional revenue. There are several reasons for this, the first being the associated administrative costs, the extent of which the Tax and Customs Board does not yet know.

"Considering both IT development costs and the creation of additional jobs, it's good if this remains a seven-figure number annually. Additionally, I don't believe anyone can fully calculate the impact of the increased administrative burden on companies," he noted.

Usin highlighted the temporary nature of the tax as another negative aspect.

"Today, 24 years after the implementation of Estonia's innovative tax system, various resulting tax gaps are still being patched. What can be expected from a three-year tax experiment? It's likely to be full of holes like Swiss cheese. The result is a real risk that only a fraction of the estimated €40-50 million in annual tax revenue will be collected," predicted the Ernst & Young Baltic representative.

Estonia to become unique in the world

Problems may also arise from tax exemptions, as recalling the income tax law in effect before 2000, investments significantly reduced the tax base. However, if no tax exemptions are provided for investments, companies' investments in their sustainability will decrease even further, negatively impacting the competitiveness of Estonian companies in the global market, according to Usin.

Furthermore, if such tax exemptions are not made, it is worth remembering that corporate profits depend on various estimative factors.

"For example, if a 10 percent depreciation rate is applied instead of a 5 percent rate, the company's depreciation expense will be twice as high, and the profit correspondingly lower. This is a simple example, but there are many areas in financial accounting that are based on estimates," he noted.

According to Usin, other taxes also have an indirect impact. Corporate profits have been declining for several years, and rising VAT and income tax rates reduce the money available for consumption, while inflationary pressure on inputs remains.

"Considering the ongoing economic downturn that has lasted for several years, it is very difficult to predict anything other than the continued decline in corporate profits, which in turn significantly reduces the base for the 2 percent tax," said Usin.

He added that with the planned dual tax system, where corporate profits are taxed both on a cash basis – through dividend income tax – and on an accrual basis with a 2 percent temporary additional tax, Estonia will once again be unique in the world.

"I don't know of any other country that has imposed such a diverse administrative burden on businesses regarding income tax," Usin concluded.

Details of the tax plan completely unclear

Kristjan Järve, partner and head of tax at Grant Thornton Baltic, stated that as far as they know, the Ministry of Finance does not yet have a concrete plan detailing the new tax accounting specifics. He pointed out that in other countries with accrual-based, or traditional, corporate income tax, advance payments are determined based on the confirmed profit of the previous financial year.

"For example, in Sweden, advance payments are made monthly, while in Lithuania, they are made quarterly. However, the frequency of advance payments depends on various factors, including the estimated amount of tax. For instance, below a certain threshold, advance payments are made less frequently," Järve explained.

Järve added that in most countries with traditional corporate income tax, a company can also apply for a reduction in advance payments if the forecast for the current financial year's profitability is significantly lower.

"In Estonia, credit institutions already have an accrual-based corporate income tax with quarterly advance payments, and the size of the advance payments is calculated based on the profit earned in the previous quarter. What principles for the calculation period, tax base and frequency of advance payments the Ministry of Finance will develop are completely unclear today," Järve noted.

According to Järve, it is also difficult to assess how the settlement will look if the actual profit turns out to be lower or higher than forecasted.

"If the actual profit for the calculation period is lower than forecasted, then presumably the tax base can be reduced accordingly, but it is unknown whether any preconditions or restrictions will apply. If the actual profit is higher than forecasted, then additional income tax must certainly be paid, but it is unclear what else might be involved. For example, elsewhere, if actual economic results exceed the forecast submitted to the tax authority, the final income tax must be paid along with interest," Järve highlighted.

Expenses may outweigh revenue

Erki Usin from Ernst & Young Baltic considered the advance tax calculation and the subsequent adjustment less significant in the context of the new tax, as it is essentially a straightforward technical calculation.

Since the tax authority generally does not pay interest on advance payments, the key issue, according to Usin, is how to set the advance base as fairly and cost-effectively as possible: whether to trust companies' own forecasts, rely on past years' profits or use some other method.

Usin believes that the tax change will increase the administrative burden on companies, but this is not the only problem.

"Regarding the expected revenue from this 2 percent tax, the government will likely have to swallow a very bitter pill: the revenues will be much lower than forecasted, and the administration of this tax will be much more expensive than anticipated, at least if it is planned to be done efficiently. Personally, it seems to me that this is a loss-making decision – the costs associated with the change will exceed the potential revenue," he said.

Whether the change might affect corporate accounting practices and lead to more optimization depends largely on how the accrual-based income tax base is planned to be calculated, according to the head of tax at Grant Thornton Baltic.

"In other traditional tax systems, the tax base calculation generally excludes revaluations of financial investments and real estate, meaning unrealized gains/losses, and the tax amount is also influenced by specific depreciation rates or rules for assets that may differ from accounting rules," Järve said.

If the Estonian government plans to base it entirely on accounting profit for simplicity, it could lead to a wave of optimization of asset classification principles and depreciation rates for different asset classes, Järve noted.

Both auditors believe the change will create additional work for auditors, but Järve said it will create even more work for accountants, entrepreneurs and software developers.

Usin pointed out that unlike many other factors, this is not a significant harm associated with the decision, but income taxation will become an important audit issue for many companies, requiring additional verification.

"For a so-called average company, we are talking about an estimated up to a couple of additional audit days, but since these are hours requiring specific expertise, this often means a few thousand euros of additional annual costs for companies," Usin noted.

The government plans to start collecting the 2 percent corporate income tax as an advance payment from 2026. The Ministry of Finance aims to finalize a more detailed plan by the end of this month.

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