In light of the March ruling by the Supreme Administrative Court (case no. II FSK 1412/24), the approach to the tax qualification of companies formed from the transformation of sole proprietorships is changing. The judgment confirmed that such entities may benefit from the privileges granted to “newly established taxpayers” under the Estonian CIT regime.
This position, which contradicts the previous interpretative line of the tax authorities, allows entrepreneurs to enter the lump-sum tax on company income more easily, without the need to employ three individuals in the first tax year. The courts acknowledged the difference between continuing business activity in an economic sense and commencing a new form of taxation, which opens up an alternative path for business owners.
The disputed issue in the case was whether a limited liability company formed from the transformation of a sole proprietorship qualifies as a taxpayer commencing business activity within the meaning of Article 28j(2)(2) of the CIT Act. The company argued that “commencement of activity” should be understood as the beginning of an activity subject to CIT. Therefore, in its view, the prior operation of a sole proprietorship was irrelevant, as only after the transformation did the company become subject to corporate income tax.
The Director of the National Tax Information disagreed, pointing to the lack of a definition of “newly established taxpayer” in the lump-sum tax regulations. Referring to the Commercial Companies Code and the Tax Ordinance, the authority concluded that the transformation did not terminate the legal existence of the entity, but merely changed its legal form. As a result, the company was considered a continuation of the same business, and thus not a newly established taxpayer for CIT purposes.
However, the Provincial Administrative Court in Wrocław, in its judgment of 4 July 2024 (case no. I SA/Wr 105/24), held that under the CIT Act, the legislator treats entities formed through the transformation of sole proprietorships as newly established taxpayers. The court emphasized that in other regulations, the legislator explicitly denies such entities access to tax preferences, which is not the case under Article 28j(2)(2) of the CIT Act. The court agreed with the company’s position that the commencement of activity should be linked to the start of CIT taxation, which did not occur during the operation of the sole proprietorship.
This reasoning was upheld by the Supreme Administrative Court in its ruling of 11 March 2025 (case no. II FSK 1412/24), which confirmed that the terms “taxpayer commencing activity” and “taxpayer commencing business activity” are used interchangeably in the CIT Act. Therefore, the Court concluded that the legislator did not intend to differentiate between these terms.
The position adopted by the Supreme Administrative Court opens new possibilities for taxpayers who wish to switch to the Estonian CIT regime by transforming their sole proprietorships into limited liability companies. As a result, they may benefit from the exemption from the obligation to employ three people in the first year after transformation, since the company will not be classified as a “transformed entity.” However, it is important to remember that the obligation to gradually increase employment still applies from the second tax year onward.