Gas Energy OÜ acquired two LPG tanks from Raisan OÜ, a related entity, and recorded them as a non-cash capital contribution at a significantly higher value than what the tax authorities determined to be the market price.
The tax authorities found that the value declared by Gas Energy OÜ was inflated, as previous transactions involving the same tanks had been conducted at €6,000. Based on this discrepancy, the tax authorities argued that the transaction resulted in an understatement of taxable income, triggering an income tax liability under Section 50(4) of the Tax Code, which governs transfer pricing rules for related-party transactions. The tax authorities rejected Gas Energy OÜ’s argument that improvements had been made to the tanks, concluding that the alleged enhancements did not justify the significant price increase.
Gas Energy OÜ contested the tax assessment, arguing that Section 50(4) was not applicable to a contribution in kind, as such a transaction does not generate income in the traditional sense but rather results in a capital increase for the receiving entity. The company maintained that the valuation was appropriate and that the improvements made to the tanks justified the recorded value.
The case proceeded through the lower courts, which upheld the tax authority’s decision, emphasizing that the company failed to provide sufficient evidence that the tanks’ value had increased to the extent claimed. The courts also ruled that the improvements described—such as cleaning, inspections, and minor repairs—did not substantiate a nearly eightfold increase in value.
Judgment of the Supreme Court
Upon appeal, the Supreme Court of Estonia ruled in favor of Gas Energy OÜ, finding that Section 50(4) of the Tax Code did not apply to a non-monetary capital contribution. The Court clarified that income tax can only be levied when profit is distributed, and since this transaction did not generate taxable income or deductible expenses for either party, it did not meet the criteria for disguised profit distribution. While the tax authority is entitled to verify the fair market value of a contribution in kind, any adjustments must be made under Section 50(2) of the Tax Code, which applies to capital contributions and share transactions rather than transfer pricing adjustments for taxable income.
As a result, the Supreme Court annulled the tax decision and lower court rulings, instructing the tax authority to reassess the transaction under the correct legal provision.
Excerpt
“17. It is clear from the foregoing that the disputed gas tanker was not transferred to the applicant on the basis of a sale contract but as a contribution in kind on the basis of a decision to increase the share capital. The transfer of a contribution in kind is by its nature a transaction to which Paragraph 50(4) of the Tax Code does not apply, since, irrespective of the value of the transaction, neither of the parties to the transaction receives any income or incurs any expense as a result of such a transaction. Gas Energy OÜ increased its share capital and OÜ Raisan acquired a stake in Gas Energy OÜ. There was no increase or decrease in the profits of either party to the transaction. OÜ Raisan would only be able to generate a profit if it disposed of the shares in Gas Energy OÜ that it owned. If the profit of the transaction party does not increase, there can be no risk of a disguised profit distribution and the presumption of the application of Section 50(4) of the IRS is not fulfilled.
18. The tax authority and the courts have failed to take into account that the taxation of contributions and distributions of share capital of a company is governed by a special provision in Section 50(2) of the Income Tax Act, according to which (2017. In the version in force in 2017), a resident company is liable to income tax on the reduction of share capital or contributions, on the repurchase or redemption of shares, participations or contributions, or otherwise on the part of the amount of distributions from equity and liquidation dividends paid in excess of the cash and non-cash contributions to the company’s equity.
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20. The College considers that the tax authorities are entitled to verify whether the value of the object of the contribution in kind transferred to the share capital of a company corresponds to its market value. The valuation report submitted to the Companies Registry is not binding evidence in tax proceedings. If, as a result of the verification, the tax administration establishes that the non-cash contribution item has been valued at more than the market value, the taxpayer has declared incorrect information in Annex 7 to the TSD and the tax administration is entitled to issue a tax ruling reducing the value declared in box 7030 of Annex 7 to the TSD. As a result, the amount to which the company will be able to make the future tax-free payments referred to in section 50(2) of the Tax Code will be reduced. In summary, such an adjustment will result in the company being liable to the same amount of income tax as would be payable if section 50(4) of the ITA were applied, but the timing of the tax liability is different – under section 50(2) of the ITA, the income tax liability arises only when the share capital of the limited liability company is reduced, the limited liability company acquires its own shares (share buy-back) or distributions are made to the shareholders on liquidation of the limited liability company.”
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