Corporate Tax - Estonia

In a recent decision the Supreme Court declared part of the Value Added Tax (VAT) Act unconstitutional and invalid.(1) The decision reflects how the court interprets the Constitution and attempts to harmonize basic indirect taxation rights with EU standards.

The decision concerns the VAT rates applicable to institutions that organize cultural activities. The dispute arose in connection with the right of a theatre which did not receive state funding to apply a reduced VAT rate of 5%.

VAT Act

According to Article 15(2) of the VAT Act, a 5% VAT rate applies to the organization of performances or concerts by a state, municipal or private institution or the national opera, on the condition that the funds received from the state, rural municipality or city budget or the Cultural Endowment of Estonia amount to at least 10% of its budget revenue for the calendar year.

The VAT Act is based on the Sixth Council Directive of May 17 1977, which aims to harmonize member states’ laws relating to turnover taxes. The directive promotes a common system of VAT with a uniform basis of assessment.

Article 12(3c) of the Sixth Directive allows member states to apply a reduced VAT rate of no less than 5% to supplies listed in Annex H to the directive. Concerts, exhibitions and other cultural acitivities form one group in Annex H.

Article 13A(1n) of the Sixth Directive exempts “certain cultural services and goods closely linked thereto supplied by bodies governed by public law or by other cultural bodies recognized by the member state concerned”.

Supreme Court Decision

The court noted that an interpretation of the VAT Act should be based on the Constitution, general principles of EU law and the Sixth Directive. Since the dispute arose in connection with the application of the principle of non-discrimination, the court focused on the discriminatory nature of the VAT Act.

According to the court, the principle of non-discrimination is applicable under both the Constitution and general principles of EU law. The Supreme Court found that the principle of non-discrimination obliges the legislature to follow the principle when adopting laws. According to the principle of non-discrimination, equal parties must be treated similarly, except when there is relevant reason not to do so.

The court decided that the relevant parties to compare were cultural institutions which receive more than 10% of their budgetary revenues from state funding and cultural institutions which receive less or even no state funding.

Parliament claimed that the different tax treatment was due to the need to promote high-quality cultural events. The cultural commissions of local governments, the Ministry of Culture and the expert groups of the Cultural Endowment of Estonia are deemed to have the necessary expertise for such purposes.

The Supreme Court disagreed. Although the VAT Act’s aim to promote high-quality cultural events is reasonable, such an aim is not achievable since the VAT Act allows the application of a 5% VAT rate regardless of the quality of the performance. In fact, the only criterion for applying the reduced tax rate is the amount of state funding received by the cultural institution. Furthermore, the court doubted that high-quality cultural events would be staged only by institutions that were supported through public funds.

In conclusion, the court found that making the application of the reduced tax rate dependent on the amount of public funding received was not an appropriate and justifiable measure. Since there were no relevant grounds to justify the limitations of the VAT Act, the VAT Act was in breach of the Constitution.

ILO