INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru A considerable limitation is that the “taxpayer shall have no right to change the object of taxation over the whole period when the simplified system of taxation is used”31 (Article 346.14, item 2). However, the possibility of simultaneous coexistence of several simplified regimes per se creates opportunities to evade taxation, especially taking into account the fact that taxation at lower rates makes it more effective to use simplified regimes for these purposes. It may be expected that in 2003 and 2004 payment of wages and salaries via such small enterprises will acquire massive character. It seems that this regime will be hardly abolished before 2005, when it is to be abolished in accordance with the Tax Code; however, it is important to prevent its prolongation.
It seems dangerous that there are no limitations on the use of simplified regimes for participants of external economic activities. Although the complete prohibition seems to be an excessive measure, at the same time the complete absence of constraints does not seem feasible. First, it may result in evasion practices relating in considerable losses of the budget (what may be facilitated by vague definitions of the Tax Code as concerns VAT imposed on imports; however, it shall be noted that federal law No. 191 FZ of December 31, 2002, amends this provision stipulating that VAT exemptions shall not concern VAT payable on goods imported to the customs territory of the Russian Federation in accordance with the Tax Code (see Article 346.11, item 3). Second, as a rule participants of external economic activities have forex accounts, what requires regular professional accounting, i.e. such enterprises would less benefit from simplified accounting, moreover, professional accountants would be more comfortable with double-entry accounting.
The incomes as defined for the purposes of the simplified system include proceeds from sales and proceeds other than those from sales as defined in Articles 249 and 250 of the RF Tax Code. The consistent use of cash flow tax of type R32 requires taxation of only real cash flows, i.e. proceeds relating to goods, works, and services shall be included in the tax base, while borrowings and interest shall be excluded. Payments for purchased factors of production shall be also excluded from the tax base, while payments relating to interest and principal debt shall be taken into account. In order to correctly define such a base it would be feasible either make a separate list of incomes and expenditures for small businesses, or refer to respective articles of Chapter 25. In the latter case, it would be necessary to take into account the specifics of the structure of the RF Tax Code, which includes a part of proceeds from sale of foreign currency, proceeds from leased property, payments for the right to use the results of intellectual activities, property acquired free of charge, and some other types of incomes in a It concerns rather the possibility to choose between objects of taxation in the framework of the simplified regime as set forth in the Code, i.e. income and income reduced by the amount of expenditures taxable, respectively, at 15 per cent and 6 per cent, rather than the possibility to choose the simplified or general regime. The right to choose income as the object of taxation shall be valid until January 1, 2005.
Economists have worked out several types of cash flow taxes, all of which are investment-neutral in the sense that such taxes do not distort marginal investment decisions. Each tax has its merits and shortcomings. From our point of view, the tax on Real (R-based) cash-flows is best suited for taxation of small businesses. Other cashflow taxes include the tax of RF type (real plus financial) imposed on all real and financial flows, i.e. the base of which includes all cash inflows (proceeds, borrowings, and interest) minus all expenditures (payments related to purchase of goods, works, services, repayment of borrowings and interest) and the S type tax imposed on net cash flows to shareholders, i.e. dividends plus purchase of shares minus cost of newly issued shares. The two latter taxes are practically similar (in the first case the tax base includes the tax itself, while in the second case the tax is excluded since in legal terms the tax shall be paid by an enterprise from the amounts paid to shareholders) (See: Tax Policy Handbook, IMF, 1995. Р. 169).
RUSSIAN ECONOMY in trends and outlooks separate article “proceeds other than those from sales” (Article 250). The same article concerns received interest. Therefore, it would be feasible to specifically refer to this rule in order to exclude received interest from the tax base. A symmetrical procedure should be introduced in relation to payable interest, i.e. such interest payments shall not be excluded from the tax base.
However, the State Duma took the decision to include received interest in incomes and deduct paid interest from the expenditure component of the tax base. This decision ensures neutrality, however, only on condition that incoming cash flows are included in the tax base alongside with interest, while all cash outflows are excluded, i.e. in the case the RF tax from the cash-flow group is imposed. In this case the principal debt should be included in the tax base, and be deducted from the tax base after repayment. Therefore, the tax as defined in Article 26.2 of the Tax Code is not a cash-flow tax. However, definitions are irrelevant. The point is that the main advantage of cash-flow taxes, investment neutrality, is not ensured under the new Russian simplified regime. Besides, this regime ensures the advantage of the enterprises receiving credits over those having to rely on own resources, while small businesses are most interested in deduction of costs relating to financing of investment at the expense of own funds, since real small businesses seldom have an opportunity to use borrowed funds.
Apparently, all reflections on the neutrality of cash flow taxes make sense only in the case there are no limitations on transfer of losses (this issue is analyzed below).
At the same time, it is necessary to note that in reality not all taxpayers are eligible for the immediate deduction of expenditures for fixed assets in accordance with Article 26.2. As concerns fixed assets purchased by an enterprise prior to the introduction of the simplified regime, in fact there is applied depreciation, although according to other rules than those determined by the general regime. As concerns fixed assets operable under 3 years, the deduction shall be made in one year, while assets operable from 3 to 15 years, depreciation shall make 50 per cent, 30 per cent, and 20 per cent in the first, second, and third years under the simplified regime respectively (Article 346.16, item 3). Assets operable for longer periods shall be written off “within 10 years of operation under the simplified system of taxation, in equal shares of the value of fixed assets.” It turns out that no immediate deduction is carried out, depreciation is charged, and, in the case the term of an asset operation makes 16 years, and it has been operated for 15 years prior to the introduction of the simplified regime, its residual cost would be written off over the next 10 years. Although in this case the amounts are probably rather small, accounting becomes more complex nevertheless. This procedure in fact renders the “simplified” system rather complicated for those earlier operating under another regime. The purpose of this is rather vague, since the deliberate acceptance of the general regime at the moment of investment followed by the transition to the simplified regime does not benefit the enterprise as concerns taxes. In the case depreciation is carried out, double-entry accounting is easier and more free of errors than proceeding directly from the income and expenditure ledger. Apparently, enterprises employing professional accountants would prefer the double-entry accounting while reporting in accordance with the “simplified forms.” In these circumstances the abolishment of the requirement to submit balance sheets to tax agencies seems to be unfeasible.
As concerns the enterprises where owners who are not accountants keep books independently, this system is too complicated and does not decrease costs relating to the tax payments, i.e. this regime does not allow to achieve its announced goals.
INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru Moreover, enterprises are required to recalculate depreciation for the time of operation under the simplified regime in accordance with the general procedure in the case the asset is sold. In fact, the budget benefit from the respective penalties. At the same time, the tax base resulting from the sale do not change. Income resulting from the recalculation shall be deducted from the tax base since the residual cost of fixed assets diminishes by the same amount. It seems that this measure was introduced to prevent the potential possibility to write assets off via small enterprises and their consecutive sale to individuals or other persons having no right to deduct expenditures for purchase of fixed assets from the tax base. In the case it is true, it would be more feasible to set forth a special respective clause.
Article 346.18 describes the procedure of collection of the minimal tax (1 per cent of proceeds) applicable to those who chose proceeds minus expenditures as the object of taxation. Generally speaking, this stipulation is justified, however, it may become too tight in combination with the limitations on transfer of losses. Moreover, although the consequent transfer of the paid minimal tax is a feasible measure, it becomes considerably less advantageous because it is subject to all tight limitations on all other losses.
The procedure governing the transfer of losses contains all limitations in force for enterprises operating under the general regime, where they also are unjustified. “A loss shall not diminish the tax base by more than 30 per cent. At the same time, the balance of the loss may be transferred to next tax periods, but not more than 10 tax periods” (Article 346.18, item 7).
The role played by the transfer of losses in creating incentives for investment and the destabilizing effect of limitations were repeatedly discussed in works by different authors. It shall be noted that limitations have the most serious destabilizing impact on small businesses. Alongside with the general limitation, those using the simplified system are subject to an additional limitation – losses accumulated over the term under the general regime are not set off in the course of transition to the simplified regime and vice versa. The first limitation does not make sense at all, since it is better to set off the losses accumulated under the general regime in the framework of the same regime, since the 24 % rate is higher than the 15 % rate applied under the simplified regime. There is no danger that budget revenues decline due to transition to the simplified regime (except the losses directly relating to the use of the simplified regime). As concerns the losses accumulated under the simplified system, the issue is more complex.
Nonetheless, the complete prohibition to transfer losses in the course of transition from one regime to another is a too tight measure destroying enterprises’ development incentives. The potential of tax planning – transition to the simplified system for the moment of investment aimed at the rapid depreciation - may be effectively prevented by capitalizing losses accumulated under the simplified regime in the process of transition to the general regime and write them off over a number of years. In this case it would be feasible to limit acceptance of losses in the case of mergers in order to prevent trade with losses.
The prohibition to transfer losses is not the only too tight limitation relating to the transition from one regime to another. Article 346.25, item 3, stipulates that the value of fixed assets purchased in the period of operation under the simplified system shall be recalculated in accordance with the regulations applicable to the general regime. This measure is too tight and will result in losses both for enterprises and society. The potential of tax planning may be effectively prevented by the simple method mentioned above, i.e. capitalize losses accumulated under the simplified regime in the process of transition to the general regime and write them off over a number of years. At the same time, the approved procedure of recalculation will artificially check development of enterprises and increase accounting costs in cases it be RUSSIAN ECONOMY in trends and outlooks comes profitable to expand the capacity of enterprises even exceeding threshold indicators, and increase costs borne by tax agencies in the process of verification of the tax base. At the same time, this measure fails to eliminate major possibilities to evade taxes. Enterprises subject to such limitations may expand by creating new organizations eligible for the general regime, or lease fixed assets from small enterprises owning these assets. These developments will result in even more considerable losses of the budget than in the case enterprises could expand and transit to the general regime without any limitations.
It shall be once more stressed that introduction of the 5 per cent tax on alternative objects of taxation, i.e. an income-related tax will result in massive tax evasion relating to wages and salaries. The most simple scheme of such evasion is to register employees as individual entrepreneurs and conclude respective civil law contracts in stead of paying wages and salaries. The paid amounts, similarly to wages and the single social tax, shall be deducted from the profit tax base, however, in this case in stead of paying the single social tax at the rate of 35.6 per cent (in the case the wage is over Rub. 100 thousand and the enterprise answers a number of requirements) the enterprise has to pay relatively small (in 2002 – Rub. 150 a month) payments to the Pension Fund. Besides, these payments are deductible from the single social tax (up to 50 per cent, however, it is difficult to exceed this limit taking into account the negligible payments to the Pension Fund).
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