Upon commencement of the business activity in Latvia the foreign companies, depending on intended business activity, should select the most appropriate legal form of business in Latvia. This article addresses basic tax and legal considerations for selecting the most appropriate form of business in Latvia.
The foreign entity may select to establish in Latvia either a representative office, register a permanent establishment with the State Revenue Service or a branch with the Enterprise Registry (filiāle); or to establish a legal entity – limited liability company (sabiedrība ar ierobežotu atbildību).
A representative office is the minimum presence that a foreign entity can legally have in Latvia. A representative office is not allowed to engage in any business activity and, as long as this restriction is observed, it is not taxed in Latvia.
Usually the following list of activities that a representative office can undertake would not be considered business activity for tax purposes: creating business opportunities; improving the exchange of commercial, scientific or technical information; developing trade and economic links with Latvian businesses.
Tax and accounting status
A representative office is not treated as a trading entity for Latvian accounting and tax purposes. It is therefore not required to maintain separate accounting records and/or systems, file regular tax returns or prepare annual accounts.
The only exception is requirements relating to the representative office’s capacity as an employer. If it employs local staff, the representative office must comply with the Personal Income Tax Act and the Social Security Act, including provisions relating to tax accounting procedures.
If the foreign entity’s activity extends the scope of allowable activities, which are not subject to tax, the foreign entity should register its presence in Latvia. The activities should be tested according the double tax treaty Latvia has entered with respective country of the foreign entity (Article 5 of the treaty) and Article 14 of the Taxes and Duties Act, in case if there is no treaty in place.
Overall, the foreign entity has to register its presence, if it has a place of business in Latvia with a certain degree of permanence where the foreign entity carries business activities.
In addition, the foreign entity will be deemed to have a permanent establishment, if it carries construction and/or installation works or provides supervisory and management activities connected with the construction site. The time threshold for creating a permanent establishment is usually 6 months.
The permanent establishment may arise also, if the foreign entity has a dependent agent in Latvia, who is authorized to sign or negotiate the agreements (usually – sales agreements) with the customers on behalf of the foreign entity.
Should a foreign entity makes the above activities in Latvia, it is required to register a permanent establishment with the State Revenue Service. As an alternative the business activities could be registered as a branch with the Enterprise Register.
For corporate tax purposes a permanent establishment is treated almost in the same manner as a legal entity, with exceptions as outlined below. Both types of entities operating in Latvia are subject to corporate income tax at a rate of 15% on their income.
The considerations when choosing the business entity in Latvia between the subsidiary and a permanent establishment are as follows:
- The dividend payments to the foreign entity might be subject to withholding tax. However, after-tax profits derived by a permanent establishment can be freely transferred to head office without withholding any tax.
- As a permanent establishment is treated as a part of the foreign enterprise, the following payments that the permanent establishment makes to its head office could not be treated as the costs of the permanent establishment and therefore will be non-deductible expenses for tax purposes – rental payments, royalties, management fees and interest. However, under the treaty in determining the profits of a permanent establishment it is allowed to deduct expenses that are incurred for the purpose of the permanent establishment, including royalty, interest and executive and general administration expenses so incurred.
Simplified method for assessment of taxable income of a permanent establishment
If operation period of a permanent establishment does not exceed 12 months it may choose to use simplified method for determining taxable income.To apply for this method a permanent establishment should notify the State Revenue Service within 10 days after registeration. Under simplified method the taxable income would be deemed to be 20% of permanent establishment’s total revenues and corporate income tax would be calculated as follows:
Corporate income tax = Permanent establishment’s revenues * 20% * 15%
Under simplified method a permanent establishment may also avoid preparing corporate income tax return, Profit and loss calculation, Balance sheet, if it derives income from no more than 3 Latvian companies with which agreements for tax deduction at source are in place and which have been notified to the State Revenue Service.
A subsidiary is a legal entity which could be established either as a private limited liability company (sabiedrība ar ierobežotu atbildību – SIA) or public limited company (akciju sabiedrība – AS).
The usual form of business is SIA. Its minimum share capital is LVL 2,000, at least half of the capital should be contributed in cash.
A subsidiary is managed by at least one board member appointed by the general meeting of the shareholders. The board members could be both residents and non-residents.
A subsidiary pays 15% corporate income tax on its world-wide income.
The annual capital allowances are calculated using the reducing balance method as follows: for buildings – 10%; railways, marine and power equipment – 20%, electronic devices and software – 70%; passenger vehicles – 35%; other fixed assets – 40% and oil research and extraction equipment – 5%.
Certain expenses not related to business activity are non-deductible and should be multiplied by coeficient 1.5 before adding back to taxable income.
Only 40% of representation expenses are deductible.
There is a number of other tax adjustments should be made to the profit before tax, to assess the taxable amount.
Permanent establishment compared to subsidiary
Permanent establishment –advantages
Under Latvian laws a permanent establishment may use simplified method for assessment of taxable income for the first 12 months period. This method considerably reduces administrative requirements in Latvia.
Profit derived by a permanent establishment might be exempt in the head office country or the tax paid in Latvia could be credited in respective country.
After tax profit of a permanent establishment can be transferred to the head office without payment of a withholding tax.
There are no legal requirements for management structure and the time period the management can remain effective.
The management would report directly to its head office, the head office would have direct control over the permanent establishment.
There is no need to prepare financial statements for a permanent establishment, except for profit/loss calculation and balance sheet for tax calculation purposes.
Subsidiary – advantages
Legal liability is limited to the Latvian entity and does not extend to the shareholders.
The shareholders could be one or more foreign entities.
Latvian laws and practice are more developed for the taxation of the subsidiary’s than permanent establishment’s profits, which mitigates corporate income tax risk.