In this article, we will examine a situation where one natural person has established a limited liability company (LLC) to conduct business activities, is the sole shareholder and board member of this LLC, and wants to pay the funds obtained from the LLC’s commercial activities to himself/herself personally as regular income.
Mandatory taxes for the sole board member
First of all, it is necessary to take into account the regulatory enactments that if a board member is the only employee of an LLC, and the monthly turnover of the LLC reaches the amount of five minimum monthly salaries, which is currently EUR 3,900 (5 x 780), the LLC is obliged to pay personal income tax (PIT) and social security contributions (SSC) for this board member, calculating it from the minimum monthly salary set by the state. It is not mandatory for a board member to make a cash payment to his account, just to pay the taxes mentioned. Moreover, this obligation does not depend on whether or not the LLC has any other business expenses for which the funds obtained are used.
Taxation of dividends
It is also important to note that in Latvia taxation of LLC profits is deferred until such profits are distributed as dividends or are deemed to be distributed as dividends.* Distributed profits are subject to 20% corporate income tax (CIT). However, before applying the rate, the tax base is divided by a coefficient of 0.8. Thus, the effective CIT rate is 25%. If 20% CIT has been paid on the LLC profits, dividends paid to a member – a resident of Latvia – are exempt from CIT.
Extraordinary dividends
The Commercial Law also provides for the possibility of paying extraordinary dividends. Such a possibility must be stipulated in the articles of association of the LLC – that dividends can also be determined and calculated from the profit earned in the period after the end of the previous reporting year. The minimum term for which extraordinary dividends can be paid is three months. One of the prerequisites for the payment of extraordinary dividends is that the LLC draws up and the shareholder approves a report on the economic activities of the LLC for the period for which extraordinary dividends are determined (for example, for a quarter or half a year), and a proposal for the payment of a share of profit in dividends. The aforementioned report on the economic activities of the LLC must comply with the requirements for drawing up an annual report. This means that in practice it is possible to pay dividends also three times a year. However, in the case of extraordinary dividends, additional costs for the work of accountants to prepare the economic activities report must be taken into account.
The cost of paying only in dividends
The above means that if the LLC generates a turnover of at least EUR 3,900 per month, but the sole board member and sole owner of the LLC intends to pay the income from the LLC to himself only in the form of dividends, additional costs will be incurred here by the obligation to pay PIT and SSC from the minimum monthly salary, which in annual terms creates expenses in the amount of over EUR 5,300 (or ~ EUR 444 per month). This obligation does not apply if the LLC has at least one employee who receives at least the minimum monthly salary set by the state.
However, it should be taken into account that paying out income only in dividends and making social security contributions only from the minimum monthly salary or not making them at all can negatively affect a person’s social security in the long term.
Example: paying yourself a salary
In the event that the LLC has earned income and there is an opportunity, for example, to pay 3,000 EUR to the owner, then if all of it is paid out as remuneration to the board member for performing the duties of a board member (salary), the board member (owner) will actually receive only 1,618 EUR in the account, everything else must be credited to the state budget:
| Gross salary | EUR 2426.60 | |
| Social security contributions | 10.5% | EUR 254.79 |
| Personal income tax | 25.5% | EUR 553.81 |
| Social security contributions, employer’s part | 23.59% | EUR 572.43 |
| Commercial risk state fee | EUR 0.36 | |
| Total employer’s cost | EUR 2999.39 | |
Described above are the two basic ways in which a board member and sole owner of an LLC can pay themselves income earned by the LLC.
Other ways to pay income to the owner
It is important to note that a board member and sole owner of an LLC is not obliged to place themselves in the most disadvantageous situation from a tax perspective, that is, a board member and sole owner of an LLC is not obliged to pay themselves all the profits made by the LLC as remuneration for performing the duties of a board member (salary).
If you are considering the possibility of paying money to the owner in other ways than the two mentioned above, you should take into account the provision of Section 23, Part 14 of the Law “On Taxes and Duties”: “The tax administration determines the amount of tax payment, taking into account the economic content and essence of a separate transaction or set of transactions of the taxpayer, and not only their legal form.” This means that, for example, fictitious contracts between an LLC and an owner for the lease of some movable property, which the LLC does not actually use in its business activities, may be qualified as a hidden dividend payment or even as income taxable with PIT and SSC.
If, for example, equipment or vehicles are required for the economic activity of an LLC, their purchase can also be financed by issuing a loan to LLC by the owner, rather than, for example, investing the necessary funds in the LLC’s share capital. The income from the LLC can then be paid to the owner as a loan repayment, plus interest on the loan, which should not exceed 10% per year in order not to cause CIT consequences. Another alternative here would be to lease the movable property necessary for the economic activity of the LLC from the owner of the LLC, paying a monthly rental fee, but in this case, these lease relationships must be economically and commercially justified and this movable property lease agreement must be registered with the State Revenue Service (SRS), and the lessor (owner) must pay 10% PIT on such income. Here, it must also be taken into account that paying out the majority of income in this way in the long term may negatively affect the person’s social security in the future. In addition, there is a possibility that paying income to the owner in this way may negatively affect the LLC’s rating as a taxpayer.
Finally, it should also be noted that any amount of money paid by an LLC to an owner/board member without an appropriate legal basis may be subject to PIT and SSC, as well as may have CIT consequences for the LLC. Similarly, the payment of income by way of a loan from an LLC to an owner may have CIT consequences for the LLC if interest is not paid on the loan or the loan is not repaid within the specified period.
* The deemed dividend distributions are: 1) Non-business expenses; 2) Accruals for doubtful/bad debts; 3) Excess interest expense; 4) Long-term loans to related parties; 5) Transfer pricing adjustments; 6) Liquidation quota; 7) Employee benefit
