Economic and Political Environment
Latvia is a small, open economy with exports contributing significantly to its GDP. Due to its geographical location, transit services are highly-developed, along with timber and wood-processing, agriculture and food products, and manufacturing of machinery and electronic devices. The bulk of the country's economic activity, however, is in the services sector. Corruption continues to be an impediment to attracting FDI flows and Latvia's low birth rate and decreasing population are major challenges to its long-term economic vitality.
Latvia's economy experienced GDP growth of more than 10% per year during 2006-07, but entered a severe recession in 2008 as a result of an unsustainable current account deficit and large debt exposure amid the softening world economy. GDP plunged 18% in 2009 - the three Baltic states had the world's worst declines that year. Thanks to strong export growth in 2009 and 2010, the economy experienced its first real quarterly GDP growth in over two years (2.9%) in the third quarter of 2010.
The IMF, EU, and other international donors provided substantial financial assistance to Latvia as part of an agreement to defend the currency's peg to the euro. This agreement calls for reduction of Latvia's fiscal deficit to below 3% of GDP by 2012, in order to meet the Maastricht Treaty criteria for euro adoption. DOMBROVSKIS' government enacted major spending cuts to reduce the fiscal deficit to a maximum of 8.5% of GDP in 2010, and Latvia has approved a 2011 budget with a projected deficit of 5.4% of GDP.
The majority of companies, banks, and real estate have been privatized, although the state still holds sizable stakes in a few large enterprises. Latvia officially joined the World Trade Organization in February, 1999. EU membership, a top foreign policy goal, came in May 2004. Latvia's current major financial policy goal, entrance into the euro zone, is targeted for 2014.
Key economic indicators:
Population: 2,204,708 (July 2011 est.)
GDP (purchasing power parity): $32.2 billion (2010 est.)
Per capita GDP: $14,300 (2010 est.)
Real GDP growth: -1.8% (2010 est.)
Unemployment: 14.3% (2010 est.)
Public debt: 46.2% of GDP (2010 est.)
The Banking Environment
Latvia has an independent central bank, the Bank of Latvia (Latvijas Bank).
There are about 60 credit institutions operating in Latvia. Of these, about 30 are credit unions and 21 bank and 8 branches of a foreign bank. There are five representative offices of foreign banks in Latvia.
A company is considered resident if it is established and registered (or is required to be) in Latvia. There is no management and control test in Latvia for establishing tax residency.
The tax year generally corresponds to the calendar year. However, a company may elect to have a tax year that does not correspond to the calendar year. An annual return must be fi led within four months of the end of the tax year.
The fl at rate of enterprise income tax is 15%. Resident companies are generally subject to taxation on all income. Nonresidents are subject to enterprise income tax on income and capital gains derived from a permanent establishment in Latvia. Non-residents without a permanent establishment in Latvia are subject to enterprise income tax on certain types of their Latvian-source income.
Advance tax ruling availability
Although there is not a special procedure for obtaining advance tax rulings, taxpayers may apply to the State Revenue Service for an opinion on the application of Tax Laws before a relevant transaction is undertaken.
There is an annual restriction on deducting interest, which is calculated by multiplying 1.2 by the average short-term interest rate for loan institutions for the last month of the tax year, as determined by the State Statistics Committee. Other provisions as provided by the Law impose restrictions if the debts of the company exceed the company’s equity by more than four times. Thus, even if the interest rate is ‘market based’, the interest deduction would be limited if the debt to equity ratio exceeds 4:1. The largest sum, which is calculated on the basis of both provisions, is taken into account in determining the total interest payments to be deductible in the respective tax year.
The restriction does not apply to interest payments to credit institutions established in Latvia or any other EU Member State, nor does it apply to interest payments to the State Treasury, or a member of the group of the Nordic Investment Bank or the World Bank. As from 1 January 2007, interest paid in respect of loans from resident companies is exempt from the application of thin capitalisation rules as well. However, the current provisions may be challenged before the court under EU non-discrimination rules.
Transactions between associated companies may be adjusted if the transactions are made at prices below fair market value (in the case of sales) or above fair market values (in the case of purchases).
Methods used for transfer pricing adjustments include the comparable uncontrolled price method, the resale price method, the cost-plus method, net profi t method and profi t allocation method. Latvia follows the principles of the OECD guidelines in the application of these transfer pricing methods.
Capital gains tax
Capital gains are, in general, taxable as ordinary income (at the rate of 15%).
Gains derived from the sale of publicly traded securities are exempt from tax.
Capital losses on taxable securities (other than publicly traded securities) may only be set off against gains on other taxable securities. The net capital losses in a tax year may be carried forward for fi ve years to be set off against gains on the sale of other taxable securities. Capital losses on other assets are deductible from ordinary income.
At present, income from the use of any movable or immovable property located in Latvia is taxed at the rate of 5% for non-residents. The rate of withholding tax on proceeds received from the sale of Latvian real estate is 2%. Withholding tax is also applicable (if shares are alienated in the company,
trust or investment fund) if more than 50% of the assets are represented by the real estate situated in Latvia. Capital gains on the sale of securities in Latvia are not taxable on nonresidents.
Withholding tax (subject to tax treaties)
A withholding tax of 5% is levied on dividend payments to non-resident companies (unless a reduced rate under a tax treaty applies) except dividend payments to EU companies to which the EU parent/subsidiary exemption applies. A withholding tax of 5% is levied on interest paid to associated non-resident. All other interest payments are exempt from withholding tax. The exemption from withholding tax applies to interest payments to associated companies resident in other EU Member States from 1 July 2013. The tax rate is to be gradually reduced: withholding tax at 5% rate is applied from 1 July 2009 - 30 June 2013. Until 30 June 2009, the 10% rate will apply.
A withholding tax of 15% is levied on royalties paid to non-residents for the right to use a copyright on a work of literature or art, including fi lms, videos and other recordings. For other royalties the rate is 5%. The exemption from withholding tax for royalties paid between EU resident associated companies
will apply from 1 July 2013. Until that date the tax rate of 15% will be gradually reduced: from 1 July 2005 - 30 June 2009 the tax rate applicable shall be 10%, from 1 July 2009 till 30 June 2013 the applicable rate will be 5%.
A withholding tax of 10% is levied on all management and consultancy fees paid to non-residents. If the recipient can prove it is registered in a tax treaty country, an exemption from withholding tax could be given.
Payments to persons resident in listed low or nil-tax jurisdictions are subject to a 15% withholding tax, with certain exemptions. Taxpayers may also apply to the State Revenue Service for exemption from said withholding tax, provided they prove that the payments made to the listed low-tax or nil-tax jurisdiction are not made with the sole purpose of reducing their taxable income in Latvia.
Withholding tax at a rate of 15% applies to the income derived by nonresident companies from their participation in partnerships in Latvia. A 25% rate applies to the same income derived by natural persons from their participation in a partnership.
Withholding tax on other income is also applied in the following circumstances:
2% on the income received in respect of the alienation of immovable property, 5% on the use of immovable property situated in Latvia, 10% on management and consultancy services and 15% on income paid to participants in a partnership.
Special reliefs from withholding tax may be granted to payments made by resident companies established in the special economic zones (Liepaja and Rezekne) and free ports (Riga and Ventspils) subject to legal restrictions.
No stamp duty is levied on loan agreements.
Latvia has an extensive Tax Treaty network. It has entered into 42 effective treaties, of which 23 are concluded with EU countries. Different rates of withholding tax can apply to interest, dividends and royalties, depending on the terms of the agreement with the particular country.All tax information supplied by Deloitte & Touche (www.deloitte.com). Data as at 1 April 2008.
There are very few restrictions on residents holding foreign currency accounts both within and outside Latvia. Non-resident accounts are also permitted.
Central Bank Reporting
Transactions between residents and non-residents above LVL5,000 and all payments to and from accounts held abroad have to be reported to the Bank of Latvia. Banks submit the reports on behalf of their corporate clients. There are four reporting periods every month and reports must be submitted within three business days of the end of each period.