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PT TP See Item 10, Article 2 of the Federal Law No. 119_FZ as of 22 July 2005, On making amendments to Chapter 21 of Part Two of the Tax Code of the Russian Federation and recognizing as null and void some provisions in the legislative acts (or provisions of legislative acts) of the Russian Federation on taxes and levies PT TP See Items. 2, 7, 8 9 of Article 2 of the Federal Law No. 119_FZ as of 22 July 2005, On making amendments to Chapter 21 of Part Two of the Tax Code of the Russian Federation and recognizing as null and void some provisions in the legislative acts (or provisions of legislative acts) of the Russian Federation on taxes and levies.

Like in the first case, the new measure will not affect budget revenues in the long-term perspective (regardless the inflation of tax refunds), whereas in the short-term outlook (in the year of 2006) a decrease in budget revenues is observed as compared with the situation of 2005 due to two reasons: first immediate acceptance of applications for VAT refunds on unfinished objects of capital construction (which in 2005 were accepted only upon completion of the objects of capital construction, and second due to the new transitional provisions, according to which the refunds of the amounts of VAT, paid by contractors of construction objects, should be made by equal installments within the year of 2006TF F.

P TP The RF FTS estimates the reduction of budget tax proceeds in the first half-year of 2006 as compared with 2005 in the amount of RUR 61 billion, i.e. 0.5 per cent of GDP.

Therefore, the total temporary shortage of tax proceeds in the budgetary system, caused by tax reform measures implemented in 2005, was estimated by the RF FTS as 1.5 percent share of GDP (about RUR 177 billion). It should be pointed out again, that such reduction of tax proceeds is temporary and should not affect the budget tax revenues in future.

4) Reviewing the VAT budgetary proceeds in the first half-year of 2006, many analytics pay attention to the growth of VAT refund amount for the sales of goods under zero tax rate. It is true, according to the RF FTS data, the amount of refunds in the first half-year of 2005 made about RUR 190 billion (about 2 per cent in GDP) as opposed to the results of the year of 2005, when the amount of actual VAT refund made nearly RUR 460 billion (2.13 per cent in GDP, whereas by the end of the first half-year of 2006 the actual amount of VAT refund, received by the taxpayers, has already exceeded RUR 367 billion, i.e., over 3 per cent of GDP). Therefore, in the first half year of 2006 the amount of VAT refund to the taxpayers was 1.5-fold higher, i.e., 1 per cent point share in GDP more than in the first half year of 2006 (in terms of shares in GDP).

Making an analysis of actual VAT refund dynamics, one should note that it cannot be separated from a review of dynamics of the tax chargeable for the sales of goods (works, services) on the territory of the Russian Federation, because the taxpayers, who apply a zero tax rate, get reimbursed from the amount of tax, paid earlier by other taxpayers. In other words, in conformity with tax legislation provisions, there can be no refund of input VAT to one taxpayer without a relevant output VAT paid by another taxpayer. Moreover, the dynamics of VAT refund under zero tax rate procedure, for instance, for exporters, depends on the amount of their input VAT, i.e. on VAT paid by other taxpayers on for the sold goods (works, services) in the domestic market, rather than on actual export dynamics.

Meanwhile, as mentioned above, in the first half year of 2006, growth of both, the amount of VAT liabilities and VAT refunds was observed in the amount of approximately 6 per cent points, as compared to the first half year of 2005, caused by the above-mentioned reasons. In these conditions the growth of the amount of VAT refund for the operations, taxable under zero rate, by only 1 per cent point in the period under review is not a disaster at all, it only demonstrates that about 16 per cent of growth of taxable operations on realization of goods (works, services) on the territory of the Russian Federation were used for production of the good (works, services), chargeable under the zero tax rate.

Naturally, there might be some abuses in VAT refunding, but in the background of the reviewed situation with VAT one cant say that the growth of deductions looks threatening.

Therefore, basing on an analysis of dynamics and basic factors of in VAT proceeds to the budget system, one can make the following conclusions:

1) Making an analysis of the federal budget revenue from VAT in the first half year of 2006, one should take into account all factors, which make an impact on the tax proceeds of the previous and current years. Thus, in case the single inflow of VAT proceeds in the first half year of 2005 (NK YUKOS extra tax payments) is excluded from the estimates of the tax base, a conclusion can be made that the VAT budget revenues have even raised as compared with the relevant period of preceding PT TP The balance of tax liabilities, charged on the taxpayer for operations in capital construction (on materials, construction and assembly works, contractors operations) within the period before January 1, 2006, are refundable in the previously effective order, i.e., upon registration of the relevant objects of capital construction or the sale of unfinished construction objects (See Article 3 of the of the Federal Law No. 119_FZ as of 22 July 2005, On making amendments to Chapter 21 of Part Two of the Tax Code of the Russian Federation and recognizing as null and void some provisions in the legislative acts (or provisions of legislative acts) of the Russian Federation on taxes and levies).

year (by 1 per cent point share in GDP), and basing on the year-end results they have been reduced insignificantly (only by 03 per cent point share in GDP).

2) The Russian tax reform in regard to VAT, implemented in the year of 2005 (transfer to accrual method and new procedure of refund of the VAT, paid in the course of capital construction), which, in our opinion, makes a positive effect on VAT efficiency in Russia, has resulted in considerable temporary budget losses in the first half-year of 2006 (about 1.5 per cent points in the GDP as opposed to the situation of 2005). However, even with regard to those losses (see Item 1 above), one can state that there no vast-scale decrease of the budget revenues. Moreover, we can say that in view of favorable situation with the budget revenues in the current year, the most suitable period of time for implementing of such reforms was selected in terms of stabilization of the Russian budget.

3) In the analysis of dynamics of the VAT refund to the taxpayers, operating under zero tax rate, one should note, that due to specifics of Vat as a tax, chargeable in various production-and-sales cycles, this indicator shall be estimated in correlation with other indicators of the dynamics of VAT liabilities versus the refunds. At that, with due regard to the reviewed reasons of growth of the indicators in the year of 2006, caused by the impact of tax reform, there was an increase of the amount of VAT refund by 1 per cent point in the first half-year of 2006 against the relevant period of preceding year, which gives no grounds for serious concern.

In spite of the above considerations, one shouldnt say that the Russian VAT system is absolutely perfect and does not need enhancement. On the contrary, there are many drawbacks in Chapter 21 of the Tax Code, which need to be eliminated, as well as the approaches to the tax under review and other taxes.

It should be noted that popular judgments, based on considerable decrease of VAT proceeds observed in the year of 2006, bring to conclusions on the low efficiency of this tax and on its abolishment in Russia. However, it is evident that the issue of VAT abolishment and replacement with the sales tax (on retail trade operations) should not be regard as an acute problem of the day. There are other arguments in favor of further VAT system enhancement, rather than its abolishment and replacement with the sales tax.

Firstly, in spite of all inconveniencies, related to complicated administration of VAT, both, taxpayers and tax authorities have acquired some of skills of proper assessment and settlement of VAT, as well as methods of control over application of relevant tax law provisions. Introduction of a relatively new tax (especially with regard to expectations that the tax proceeds will be equal or comparable to the current level of VAT proceeds) will involve a necessity to develop completely new approaches to both, the execution of tax legislation provisions and tax administration.

Secondly, at present, though tax authorities cover a wide range of taxpayers in the framework of VAT administration, the number of tax offices, which ensure the highest tax proceeds, is relatively small. In the conditions of a transition to the sales tax, the tax authorities will have to reorganize their work to supervise a great number of retail trade businesses, where tax evasion risks are quite high. At the same time, there arises a necessity to remodel tax regimes for small businesses, to develop new regulations on differentiation of realization of goods services for the purpose of final consumption from those ones for production purpose, etc.

Besides, an overall advantage of VAT as opposed to the sales tax (on retail trade operations) is that the budget tax liabilities on each type of goods are distributed between the taxpayers through different stages of production and sales cycles. Even if tax evasion happens on a certain stage of this cycle, the budget will receive a portion of the tax payable on other stages. If a taxpayer avoids taxation in regard to sales tax, the budget will lose the tax in complete amount. As a result, the demand for tax administration resources will be much higher.

Thirdly, it will be hardly feasible, especially at the beginning of transition, to raise budget revenues, comparable with VAT proceeds. In the period the sales implementation in Russia, the share of its proceeds in the GDP did not exceed 0.5 per cent. Therefore, to reach the level of VAT proceeds, the sales tax collection level should be ten-fold higher. In such circumstances there are high chances to seek for the sources of compensation of lowered budget revenues, new tax administration measures, strengthening of tax authorities supervision capacities, which could result in unjustified pressure on businesses. Moreover, there is an opinion under dispute to transfer the sales tax proceeds to the regional budgets, which would result in considerable relocation of assets between both, interregional budgets and between the territories, which, it its turn, is hardly expedient for the mid-term perspective development of Russia.

In view of the above, the following measures can be proposed for VAT enhancement administration:

1) Further amendments of approaches to refund procedure and justification of zero rate. One should realize, that in terms of economy, there is no difference between tax refund and tax deduction. Moreover, the scale of misuse of provisions related to unjustified tax deductions might noticeably overcome the level of refunds from the budget. Therefore, there is a demand to amend the requirements for special confirmation of the right to apply to the zero tax rate with further mandatory verification of documentation on the part of every single taxpayer. In line with international practices, submission of tax returns results in tax liabilities either on the part of the taxpayer to the to the budget, or vice versa. The selection of taxpayers for audit should be developed on the basis of a special package of regulations and instructions.

2) Countermeasures are necessary to reduce the scale of total-coverage audits in the system of tax administration, which are far less effective than random selection methods. A typical total-coverage audit is aimed at confirmation of the right of a taxpayer to imply VAT at zero rate, which covers all taxpayers. However, incompliance cases are observed in this area in any case, but the compliant taxpayers incur explicit losses due to delayed VAT refund. However, there is no provision for total coverage in taxpayers audit in legislations of many countries. Audits are not executed on every taxpayers application for a refund, the resources of tax authorities are rather addressed to the cases, where, by their estimates, there is a higher risk of tax evasion.

In the discussion of an analytical system of taxpayers selection for audits, one should point out that regulations on this issue should be exclusively internal documents of the tax services and be treated as strictly confidential information. Junior staff members should not, as a rule, have an access to those documents or have a restricted access to the results of their application and data entry.

According to the international practice, those regulations are neither published, nor disclosed as arguments in court proceedings in case a taxpayer lays a claim against the results of the tax audit. It is justified in legal terms by an exclusive right of the government to select a taxpayer for audit. The way of selection lies exclusively in the competence of the government. Such approach is in line also with our constitutional provisions and tax legislation. It is evident from practice, that in case of taxpayers awareness of the criteria of audit selection, incentives might arise for the taxpayers to avoid those indications of selection criteria (for instance, an incompliant taxpayer can present the reporting, an analysis of which against selection criteria will not disclose any indications of a high fraud risk).

Moreover, a decision on implementing of an analytical system of selection criteria should not be taken, unless there is a guaranteed way to ensure its safety, as the drawbacks may overcome all the advantages of such a system.

3) A system of targeted registration of taxpayers for VAT purposes should be developed (VAT registration), which, like in many countries with an advanced VAT system will allow to streamline the efforts of the tax services to the audit of a restricted number of taxpayers.

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