Estonia’s e-Residency Is Awesome And Sucks, Too

If you’ve read my recent rant about how painful it is to found a company in Germany, you probably realized that I was quite annoyed about bureaucracy in Germany at the time. What you didn’t know, however, was that I was also looking at founding a company in Estonia, or moving my current one there.

Estonia? What? Yeah.. okay, let’s take one step back.

Estonia has a program called “e-Residency”. While other people on the internet go into huge detail into what it is and what you can do with it, I’ll just condense it down for you and say the TLDR is that it’s a chip card with a card reader for your USB port, coupled to your identity, and it allows you to authenticate yourself online (via a browser extension) to use Estonian government services. The most common use case is to found a company in Estonia. This probably goes without saying, but one huge benefit is that you can do everything online, very much in contrast to the German process, where you e.g. have to show up in person so that a Notary Public reads out your incorporation documents to you.

Now – why would any human want to found a company in Estonia, you ask? Simple: It’s very digital, and it’s very founder-friendly. If you think those things don’t sound like much, let me tell you, it easily makes up the 99% of pain you experience as a founder, especially in Germany. So, if the “founder’s UX” is good, like Estonia offers it to be, that’s a really good proposition.

Except that’s it’s not.

Why?

I’ll leave you with this cliffhanger for a second and tell you what’s actually good:

  • Everything is online. You just need your fancy e-Residency chip card and a card reader. You can run your business entirely from your browser. Wow.
  • 0% profit tax. Your company only gets taxed when you pay out dividends – those get taxed at 20%. If you “leave” money in the company however, it doesn’t get taxed. This is huge for startups which want to grow (which covers, like, 100% of startups at the beginning).
  • Pretty cool ecosystem. There’s a small bunch of companies which have specialized on serving e-Residents for e.g. bookkeeping and tax advice, everything at reasonable prices, fairly automated and, of course, digital.
    If you’ve ever tried to find a tax advisor and bookkeeper in Germany, you know that this is worth a lot.

So all of this is great. But.. now about the drawbacks. You see, it’s essentially in the fine print which people tend to not be aware of. The main problem is that of permanent establishment. What the hell?

Let’s look at an example: You are me. This is easy to illustrate because I know myself pretty well, at least that’s what I tell myself under the shower:

You’re a founder who lives mostly in Germany and is therefore taxed in Germany. You found an Estonian company via your e-Residency. Your company does digital stuff, like consulting and selling software.

The Permanent Establishment Situation, And Hell

Now here’s the problem: Because you, as the CEO, are mostly in Germany, your company actually “operates” in Germany, and is therefore taxed like a German company, too (the fancy term is “permanent establishment” in the double taxation agreement).

To say this is hell is probably an understatement. Because now your taxation likely looks like this:

  1. Do your Estonian taxes. Probably quite easy, because it’s digital and only dividends are taxed anyway. Still, you need to do your bookkeeping etc.
  2. Do your German taxes in addition to that. This is likely hell, because you have to probably do stuff like estimate how much of your business activity was in Germany (all? some?), possibly do your bookkeeping again based on German requirements, and then pay German tax on top.

One of the biggest problems on top is probably that you need to hire a tax advisor who knows international tax law and has experience in Estonian and German tax. The main problem with that is that finding pragmatic tax advisors is already a huge challenge, and you’re now narrowing it down to a tiny subset of tax advisors on the planet, so the challenge just became even huger. Also, for whatever reason, doing “international tax stuff” always seems to be a blanket reason for tax advisors to charge huge hourly rates, which makes no rational sense to me.

So.. hell.

Solving The Permanent Establishment Problem

What are possible solutions? I’ve done a fair bit of research, and I’ve found three viable solutions. Let me preface that with my opinion that all of them probably work, but none of them are great.

Solution 1: Don’t Live In Any Country, Tax-Wise

This is the “digital nomad scenario”: You’re never spending e.g. more than 180 days in any country, and therefore you aren’t taxed in any country any more (greatly simplified, do your own research, too!).

By the way, this doesn’t work for US citizens. More on that below.

Assuming you’re not a US citizen and a digital nomad: You’re free to found your company in any country, and Estonia is a pretty good choice because you can do everything digitally and the taxation is pretty good.

You avoid the permanent establishment problem because you don’t live in any country.

Technically, you could choose countries with even better taxation, but at the (potentially huge) cost of shadiness. Dubai and Singapore come to mind: In Dubai, laws might change and you still need middlemen to set up stuff for you, and in Singapore you have to hire a Singaporean managing director, because companies always need a Singaporean managing director. So you need to pay a company which provides a managing director on paper who also “manages” like 500 other companies.. shady.

Estonia is cool because it’s not shady: You own 100% of your company, and you’re the only managing director.

Solution 2: Move To a Country With Tax.. Flexibility

If you think that moving countries every <180 days sounds stressful, I agree. Another solution could be a country with tax “flexibility” which simply doesn’t care much about your permanent establishment situation.

Like Thailand before 2024 (it changed now): Any “foreign” income would not be subject to Thai tax, as long as you don’t move the funds to Thailand within one year. If you think this sounds very vague, probably every digital nomad and their Thai dog will agree with you. So the procedure was to just leave your money in an overseas bank account and set yourself a reminder to move it to your Thai bank account in one year’s time. Or, you know, just don’t move it at all and spend it with your overseas credit card in Thailand every day.

Vague.

So here, you technically have a permanent establishment in the country you live in, but it’s just that that country doesn’t tax your company.

To be clear: I’m not ranting about Thailand here (Thailand is actually pretty cool) – I’m just pointing out that countries exist with weird tax schemes which don’t cover foreign income. If you now think this is only limited to developing countries, then.. take a look at the non-dom status in Great Britain.

Then again, people say that, since Brexit, Great Britain might be reverting back to a developing country. Anyway! Onwards to solution 3.

Solution 3: Permanent Establishment In Estonia

The last solution would be to actually set up a permanent establishment in Estonia. Depending on how you do it, the implementation of this ranges from “shady and risky” to “extremely easy”.

Let’s look at the extremely easy solution first:

Move to Estonia.

That’s it. Onwards to the shady and risky solution:

Set up what I call a “weird permanent establishment” in Estonia while you continue to live in your own country. Depending on what you read online, it boils down to 1) rending an office which consists of more than a letterbox, 2) actually hiring an Estonian person to sit in said office (hence the requirement for more than a letterbox, as you can’t sit in a letterbox) and 3) some proof that you also often sit in said office and make serious business decisions as its managing director.

This is also vague, because it leaves many questions unanswered: Hire an Estonian managing director or a normal employee? How big must the office be?

The three biggest problems for me are:

  • What if your company grows, and it doesn’t grow in Estonia? Say, you hire five more people in Germany, while only one person continues to sit in your non-letterbox office in Estonia? Will this “tilt the scales” towards you suddenly having permanent establishment in Germany?
  • If you hire other people in other countries, you’ll likely have to hire them through a so-called “Employer of Record” (EoR) which easily charges 500€ / month / employee for that service (crazy). This adds up and cuts into your “tax savings” you were expecting due to Estonia’s better taxation system.
    Or.. if you hire, say, >10 people in Germany, you might be better off founding an additional local German company for that, too, and now you’re stuck with a German company again!
  • There’s always the risk that your local financial authority will disagree with your Estonian non-letterbox company resembling a permanent establishment. You might win this argument, but you might also not. It’ll cost you time and legal fees for, yep, you guessed it, the international tax advisors.

The Real Solution To The Permanent Establishment Situation

Here’s a very simple flowchart (in text) which boils it down for you:

  1. You want to permanently live in one country and that country cares about permanent establishment / foreign income, e.g. Germany: Bite the bullet and found your company in your own country.
  2. You live in a country which doesn’t care about permanent establishment / foreign income or are a digital nomad: Consider an Estonian company.

That’s it.

And maybe one more point: If you’re as deep into this sort of research as I am right now, both of us should probably actually get back to work and actually work on our companies and products and not research highly hypothetical scenarios of how to optimize this sort of stuff.

Now, back to topic: Does the Estonian e-Residency suck? Yes and no. Let’s look at it again:

It’s awesome because its execution is near-perfect: Getting e-Residency is straightforward, and all the online services I’ve seen so far are amazing and simple. The actual process of founding a company in Estonia is digital and very impressive.

It sucks because Estonia can’t change the international tax system. Founding a company in Estonia is essentially non-viable for people who reside in countries which care about permanent establishment and/or foreign income.

This actually prohibits a huge number of e-Residents from founding an Estonian company. Further, I think that most e-Residents are not even aware of this.

It’s not Estonia’s fault though, because, well, they can’t change the way the international tax system works – like, they can’t change the way e.g. Germany taxes German tax residents running an Estonian company. Or, worse yet, US citizens anywhere in the world, because the US taxes people based on citizenship, not residency (so solutions 1-3 literally don’t work for US citizens.. yeah). Oh wait, there’s another country which does that.. Eritrea. Yes, seriously.

What would be a better solution? Maybe something like a “EU-wide system of choosing a company”: Nowadays, a German business (like ours) can choose a bank in Lithuania or Belgium for its corporate bank account, and thanks to SEPA and IBANs, none of this is a problem. This is really cool!

What if, in the future, a German business could choose any country for its corporate “founding”, like Estonia, regardless of where its employees live? That would really be awesome.

If you think this is outlandish, I disagree. Look at the US, where Delaware is now the de facto place to found a company.

It would line up well with the whole idea of the EU which was.. hm, I don’t know, but enabling this sort of stuff. And there’d suddenly be competition among EU countries on who provides the best business services.

I’d look forward to that competition and Estonia becoming the Delaware of the EU. I’d move my business there in a heartbeat.

Anyway. Hope this was useful! If I missed anything, write a comment below.

And as always, the usual disclaimer applies: I’m a doctor, not a tax advisor. So.. unfortunately you’ll still have to do your own research and/or hire one of those rare and expensive international tax advisors if you’re considering moving forward with your Estonian company.


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