ESTONIAN CIT AND THE RIGHT TO DEPRECIATE RESIDENTIAL PROPERTY

As of the beginning of 2023, the provision of Article 16c(2a) of the Corporate Income Tax Act, which prohibits the depreciation of residential property, came into force under the Polish Deal. This change negatively affects returns on investments in residential units and buildings. However, it turns out that there is a way to circumvent this prohibition. The solution to this problem is presented in this article.

The introduction of the Polish Deal resulted in taxpayers losing the right to include depreciation deductions on buildings and dwellings as tax expenses from 1 January 2023. As a consequence of this change, any costs that increase the initial value of a fixed asset cannot be deducted either through depreciation or on a one-off basis. Expenses such as tax on civil law transactions, notary fees and stamp duties incurred in the acquisition of real estate can only be deducted upon eventual sale.

The elimination of the possibility of depreciating residential real estate has raised major constitutional questions, especially with regard to the principle of protection of vested rights and pending interests, which stems from Article 2 of the Polish Constitution. These reservations were shared by the Provincial Administrative Court in Łódź in its judgment of June 27, 2023, ref. I SA/ Łd 258/23, in which it referred the situation to the conclusions reached by the Constitutional Tribunal in its judgment of February 10, 2015, ref. P 10/11, regarding similar provisions of the CIT Act. However, the Supreme Administrative Court, in a judgment of July 13, 2023, ref. II FSK 119/23, taking a position on a similar factual situation, ruled that the one-year vacation legis was sufficient for taxpayers to prepare for the upcoming change and there was no violation of the principle of protection of vested rights.

However, it turns out that entities that pay income tax in the form of Estonian CIT (flat-rate taxation on company income), who own and rent apartments, will not be adversely affected by the change in depreciation regulations for tax purposes. Under this tax regime, settlements are based solely on accounting principles, eliminating the need to calculate tax expenses or depreciation.

Companies taxed under Estonian CIT can depreciate premises and residential buildings without any restrictions, thus affecting their tax base. This possibility is confirmed by the individual interpretation of the Director of National Tax Information dated January 19, 2024, with the number 0111-KDIB1- 2.4010.646.2023.3.MC.

In the aforementioned interpretation, the tax authority pointed out that, pursuant to 28h (1) of the CIT Act, the choice of flat-rate taxation on company income implies a departure from the classic corporate income tax accounting rules under Articles 19, 24b, 24ca and 24d of the Act. The authority stressed that based on the provisions of Chapter 6b of the CIT Law, the company should determine the depreciation rules for fixed assets at the time of Estonian CIT taxation, following the provisions of the Accounting Law, while the tax rules for depreciation do not apply here.

In conclusion, the changes introduced under the Polish Deal do not necessarily mean that the possibility of depreciating residential real estate is eliminated for the entrepreneur. For the maintenance of this option in the case of companies, it is worth considering the transition to Estonian CIT. On the other hand, in the case of a sole proprietorship, it is worth considering changing the legal form of the business to a limited liability company in order to benefit from flat- rate taxation on company income.