Passive income and Estonian CIT – an important ruling by the Provincial Administrative Court in Warsaw

The Provincial Administrative Court in Warsaw, in its judgment of 9 July 2025, ref. no. III SA/Wa 1037/25, made an important decision for companies using Estonian CIT. The court ruled that income from derivative instruments used to hedge operating activities should not be treated as passive income, which allows companies to avoid losing their right to flat-rate taxation of corporate income.

Background

In its request for an individual interpretation, the taxpayer, a company trading in gas fuels, asked whether income from hedging derivatives concluded outside an organised trading facility (OTF) constitutes passive income within the meaning of Article 28j(1)(2)(f) of the CIT Act.

The correct classification of income is crucial for the application of Estonian CIT, as entities whose passive income exceeds 50% are excluded from this form of taxation. In the company’s opinion, income from hedging derivatives should not be treated as passive (because they directly serve to hedge the core business activity). The Director of the National Tax Information Service (KIS) disagreed with this position, finding that the literal wording of the provisions does not provide for exceptions, even if the instrument in question serves an operational hedging purpose.

The court’s position

In the opinion of the Provincial Administrative Court in Warsaw, the key issue was the classification of income from the realisation of derivative instruments, namely whether they are automatically considered passive income, which could exclude the taxpayer from the Estonian CIT preference, or whether they can be interpreted in the context of their function in the company’s business.

The court did not agree with the tax authority’s approach, which was based solely on a linguistic interpretation of the provisions. In the court’s opinion, such an interpretation, although predominant in tax law, cannot be taken as absolute, especially when the legislator creates provisions that are pro-development and stimulating for entrepreneurs.

The Provincial Administrative Court ruled that Estonian CIT is a legislative tool designed to support operational activities, create a so-called ‘tax incubator’ for entrepreneurship and avoid rewarding income that is not the result of actual economic activity. In this context, income from derivative instruments that directly hedge basic transactions related to the supply and purchase of goods does not fulfil the objective pursued by the legislator in defining the catalogue of passive income. Furthermore, the court pointed out that the literal omission of the exception for hedging instruments may be considered a legislative oversight, which should be corrected through a purposive and systemic interpretation. Such an interpretation not only protects the essence of the regulation, but also ensures the consistency of the entire corporate income tax system. In this context, the separation of operating activities and strictly capital activities is crucial.

As a result, the court held that since the derivatives in this case serve solely to hedge operating activities and are not used for passive or speculative activities, the income from their settlement should not be taken into account when assessing the 50% passive income limit specified in Article 28j(1)(2) of the CIT Act. In the court’s opinion, this position not only better achieves the objective of the provisions, but is also consistent with the line of case law.

Conclusions for the future

The judgment of the Provincial Administrative Court in Warsaw is of significant importance for the practice of applying Estonian CIT. It confirms that not all income from financial instruments must be classified as passive, especially if its source and purpose is to secure business activity, rather than speculation or capital investment.

It is advisable for companies applying lump-sum CIT to conduct an in-depth economic analysis of the function of their financial transactions and, on this basis, assess their tax classification. It is also worth monitoring further case law and legislative changes in this area that may clarify the list of passive income in the context of lump-sum corporate income tax.