Why do I have to pay salary when I pay dividends (operating in Estonia)?

Last updated: December 20, 2018

If the company decides to pay dividends, it's strongly recommended to also pay an average salary to yourself, if you haven’t before. As Estonian tax authorities state, when providing services through a company it’s necessary to bear in mind - a sole shareholder and member of the management board who alone provides services or is engaged in the economic activity of the company and receives remuneration for this work, has to be paid for his/her active engagement, either the fee of management board member, wages or other compensation depending on the type of work. A sole shareholder also has the right for passive proprietary income, i.e. dividends, but his/her active economic activity has to be taxed by all labour taxes.

If you ignore the recommendation above, the tax authorities may have an incentive to reclassify the dividends as salary instead, and tax all the payments in a different manner. To avoid this, it makes sense to pay the salary proactively.

There is no exact formula to calculate an average salary, based on the expected dividends. It all depends on the nature of your company’s business activities and your active contribution.

For everything to remain in order, your salary payments have to be recorded as company costs in the same period when the company earned the profit which is distributed as dividends. So if the company decides to pay out dividends in 2019, the company can do it only based on the profit earned up to the end of 2018. This means that any relevant board member salary has to be recorded in the company's financial figures of 2018, not 2019 (the board member salary would reflect the contribution the board member made in 2018 to earn the profit in 2018, which would be paid out as dividends in 2018). And that's why, if the shareholders make a decision to pay dividends in 2019 and declare it together with the annual report, it makes sense to record the board member salary costs in the annual report as the costs of 2018 (lowering the profit accordingly), even if the relevant salary and taxes would be paid out in 2019 (along with dividends).

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