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- realization of goods (works, services) 1 156 591 214 28,6% 1 346 569 069 28,1% 1 774 797 996 29,4% - transfer for own needs 3 055 965 0,1% 2 945 509 0,1% 7 641 050 0,1% - building and assembly works (BAW) for own consumption 3 140 605 0,1% 4 948 719 0,1% 8 418 548 0,1% - amounts relating to payments for taxable goods works, services) 20 912 217 0,5% 221 614 608 4,6% 330 822 688 5,5% - amount earlier accepted for deduction after the receipt of exemption 1 882 707 0,0% 6 033 310 0,1% 0,0% - realization of goods (works, services) by tax agents 0,0% 6 405 429 0,1% 8 451 791 0,1% - advance and other payments 169 617 753 4,2% 5 718 933 0,1% 1 007 076 0,0% - unconfirmed right to apply the 0 % rate 0,0% 28 412 924 0,6% 36 040 053 0,6% Tax deductions 1 066 057 989 26,4% 1 250 517 971 26,1% 1 738 877 598 28,8% including:

I. Purchase of goods (works, services)) 861 350 708 21,3% 999 835 955 20,9% 1 376 448 710 22,8% - purchased fixed assets and intangible assets 0,0% 64 785 237 1,4% 58 322 137 1,0% - purchased materials for performing BAW for own consumption 0,0% 4 268 755 0,1% 8 600 769 0,1% - purchased materials transferred for performance of BAW on tolling terms 0,0% 1 883 976 0,0% 1 980 910 0,0% - VAT amounts presented for deduction by contractor organizations performing capital construction 0,0% 8 266 051 0,2% 27 497 364 0,5% - purchased noncommissioned capital construction objects 0,0% 6 156 249 0,1% 1 882 017 0,0% - performance of BAW for own consumption 2 787 067 0,1% 4 191 082 0,1% 8 530 024 0,1% - other 858 563 641 21,2% 910 284 605 19,0% 1 269 635 489 21,1% II. Import of goods to the RF customs territory 32 088 898 0,8% 45 856 228 1,0% 58 932 889 1,0% - from countries outside NIS 0,0% 39 529 424 0,8% 51 343 964 0,9% - from CIS member countries 0,0% 6 326 804 0,1% 7 588 925 0,1% III. Other deductions 165 691 447 4,1% 204 825 788 4,3% 303 495 999 5,0% - VAT accruals relating to advance payments and prepayments (as concerns the return of advances) 164 365 284 4,1% 195 735 636 4,1% 298 046 913 4,9% As on 1 July, 2001 As on 1 July, 2002 As on 1 July, Rub. thous. % GDP Rub. thous. % GDP Rub. thous. % GDP - VAT amounts paid by tax agents 3 411 381 0,1% 4 530 230 0,1% 7 583 428 0,1% - tax on goods (works, services) in the case of return (rejection) thereof 472 042 0,0% 1 414 202 0,0% 3 027 761 0,1% - VAT amounts previously included in deductions but subject to restoration 2 557 260 0,1% 5 505 696 0,1% 10 339 516 0,2% - VAT amounts acceptable for deduction pertaining to operations not confirmed to be taxable at the 0 % rate 0,0% 8 651 416 0,2% 5 177 413 0,1% VAT accruals payable as per declarations 289 142 472 7,2% 372 130 530 7,8% 428 301 604 7,1% VAT amounts pertaining to the operations confirmed to be taxable at the 0 % rate 90 755 056 2,2% 127 554 886 2,7% 175 207 738 2,9% VAT accruals minus confirmed refunds 198 387 416 4,9% 244 575 644 5,1% 253 093 866 4,2% Transferred to the RF Revenue Ministry budget* 204 068 680 5,0% 235 256 830 4,9% 297 868 605 4,9% including current accruals 259 471 429 4,3% VAT generated revenues of the federal budget 268625732 6,6% 336 246 288 7,0% 419 552 069 7,0% GDP 4041900000 4790500000 * as on July 1, 2001, and July 1, 2002, the presented data on accrued VAT pertain to domestic realization only due to the unavailability of the respective information in the RF Revenue Ministry reporting Source: RF Revenue Ministry (Form 5nbn, Section 2), RF Goskomstat, authors calculations The presented data reveals that in the first six months of 2003 there was observed a growth in the amounts of both accrued tax and tax deductions. Thus, the amount of accrued VAT increased from 39.9 per cent of GDP in the first six months of 2002 to 36 per cent of GDP in January through July of 2003. At the same time, the amounts of VAT presented for deduction over the respective period increased form 26.1 per cent of GDP to 28.8 per cent of GDP, while the amount of VAT on operations confirmed to be taxable at the 0 rate increased from 2.7 per cent of GDP to 2.9 per cent of GDP. As a result, the amount of VAT accruals payable to the budget as per declarations minus confirmed refund at the zero rate declined from 5.1 per cent of GDP registered in the first six months of 2002 to 4.2 per cent of GDP in January through June of 2003. In spite of this decrease, the VAT generated revenues of the federal budget in the first six months of 2003 were at the level observed in the respective period of 20025.

Basing on the presented data, it can be concluded that in spite of the outpacing rate of growth in tax deductions and the amount of tax presented for refund at present there no sufficient grounds to state that there is observed a growth in tax evasion endangering the stability of the federal budget and requiring urgent measures to be taken in the sphere of tax administration. At the same time, it may be assumed that the 2 per cent increase in tax deductions observed as concerns purchased goods (works, services) not relating to capital construction, is in part caused not only by economic growth, but also tax evasion via the use of shortlived enterprises. This type of evasion requires a thorough analysis of the situation in Russian and international experience aimed at working out measures effectively preventing such tax evasion.

5. Impact of the introduction of VAT accounts on budget revenues As it has been mentioned above, the major argument in favor of the introduction of VAT accounts in Russia is decreasing tax evasion and growing budget revenues generated by the value added tax. At the same time, the major objective of the reform is the removal of possibilities to evade taxation resulting in a more neutral tax system and lesser competitive advantages of unscrupulous taxpayers.

The reform of the VAT collection mechanism is aimed at the attainment of effectiveness of taxation (greater neutrality, fairness, predictability of the tax system, lower costs borne by taxpayers and The situation where tax revenues of the federal budget remain at the previous level may be caused by such factors as an increase in VAT revenues collected by customs authorities in the course of import of goods, delays in refund of VAT to exporters, work on recovery of debts and exaction penalties and fines from taxpayers.

administrative costs). In the case an increase in budget revenues is a result of the reform, it will be, apparently, a positive development, however, it shall not be counted on in the course of planning of the reform6. In any case, introduction of accounts should not be accompanied by a reduction in the rates of the value added tax.

In the case the scale of VAT evasion via short-lived enterprises is high, and at the same time there are no other similar methods of tax evasion (both assumptions need additional testing), the present draft system of VAT accounts (envisaging introduction of a number of extremely strict measures, including the impossibility to withdraw funds from VAT accounts, refusal to reckon paid VAT amounts in certain cases, etc.) shall result in an increase in budget revenues generated by domestic VAT in the case it is approved.

However, even in the case the introduction of the VAT accounts system results in lesser tax evasion, there are factors limiting the capacity of this system to increase tax revenues:

(a) Simplification of procedures and faster VAT refunds in the case of taxation at the zero rate (mostly to exporters) are named among the advantages of the VAT accounts system. On the one hand, this decision should result in higher effectiveness of the value added tax. On the other hand, it will result in a decline in VAT budget revenues both in the transitional period and in the future.

(b) The assumed increase in VAT accruals per unit of value of realized goods (works, services) means that the effective tax burden on the economy will increase (on assumption that short-lived enterprises conduct their activities in collusion with end sellers). The increase in the tax burden will result in a growth in prices.

The price rise may result in shrinking demand and a decline in VAT revenues. It is difficult to evaluate this effect in quantitative terms, however, its probability is extremely high.

(c) Beside price effects, a more heavy effective tax burden on the economy may result in an increased tax evasion on the part of firms, which at the moment do not evade taxes, but whose full compliance costs are comparable to their evasion costs. It means that in the case expenditures for tax administration grow, or the amount of tax liabilities increase, many taxpayers will find it more feasible to evade taxation, i.e. there will be observed the effect opposite to the legalization of revenues in 2001 resulting from the introduction of the flat tax rate on personal incomes and the regressive scale of the single social tax.

In this situation, VAT generated revenues may decline, and the probability of such an effect is high in the case the costs borne by taxpayers in relation to compliance with the tax legislation increase as a result of the reform.

It is also necessary to take into account the fact that such costs borne by the taxpayer are to a certain degree constant expenditures and, therefore, they will disproportionately grow at the small and medium sized enterprises. At the same time, tax evasion costs (for instance those relating to the transition to settlements in cash unaccounted for) are relatively low for small and medium sized businesses, therefore tax revenues generated by this sector may significantly decline.

(d) The proposed scheme blocks only one mechanism of tax evasion, at the same time failing to prevent evasion from other taxes. The possible growth in the VAT evasion costs borne by the taxpayers using shortlived enterprises due to the introduction of VAT accounts may result in the use of other methods of evasion from both VAT and, to a greater degree, other taxes (settlements in cash unaccounted for, false exports, overstatement of expenditures acceptable for deduction from the profit tax, etc.), what may prevent a growth in the tax revenues of the consolidated budget7.

6. Elimination of distortions created by the tax legislation currently in force On the one hand, the improvement of efficiency of the tax system is an objective of the reform and according to the intentions of its authors the taxpayers presently evading the taxation should loose their advantages over scrupulous taxpayers. On the other hand, the uneven distribution of taxpayers compliance costs will result in advantages of large enterprises over small and medium sized businesses.

It should be noted that the objectives of increase or decrease in tax revenues should be primarily attained by changes in the tax rate.

In this connection it should be noted that taxpayers take decisions concerning tax evasion or compliance basing on the ratio between marginal business costs borne in relation to tax compliance and evasion (in this case costs are broadly defined and include not only costs borne in relation to payment of taxes or economy resulting from tax evasion, but also benefits relating to transparency of business or costs of sanctions imposed in the case authorities detect tax evasion). In the case the costs of VAT payment and the use of the existing VAT evasion methods simultaneously grow while other characteristics of the tax system remain constant, taxpayers may shift their efforts towards evasion from other taxes or the search for other VAT evasion methods.

It also should be mentioned that in order to make the argument about elimination of distortions in taxation with the use of VAT accounts true, it is necessary to assume that there are a sufficiently large number of taxpayers not using short-lived enterprises for tax evasion purposes. However, in the case this assumption is true (i.e. that in Russia there exists a sufficiently large share of taxpayers not evading taxation), the necessity to struggle with this phenomenon using the proposed cost-intensive methods is not quite apparent.

As an example of distortions created by the presently proposed system of VAT accounts there may be named the stipulation envisaging that in the case an organization is liquidated, the balance of funds on the VAT account after the liquidated organization pays the value added tax due to the budget and its suppliers should be transferred to the budget. At the same time, as it will be indicated below, there are sufficient number of cases where the taxpayer will have to credit the VAT account from the current account before expected VAT amounts are transferred by buyers. In fact, the recommended procedure will result in a situation where amounts entered to the VAT account from the taxpayers current account not subject to return to the current account, will, eventually, be transferred to the budget.

7. Taxpayers costs of compliance with the tax legislation Lower costs borne by taxpayers in relation to compliance with the tax legislation may be named among priorities of any tax reform. At the same time, according to estimates of both supporters and opponents of VAT accounts, the envisaged measures will result in an increase in such costs. Evaluations differ both as concerns the scale of losses borne by taxpayers, and distribution of these losses across different groups of taxpayers (large, medium, small) and sectors of the economy.

Taxpayers costs, as a rule, are defined as withdrawal of working capital, costs of administration of additional bank accounts, issue and processing of additional payment orders, training of personnel, etc. It may be noted that taxpayers will bear the following costs not related to the withdrawal of working capital:

- All persons engaged in entrepreneurial activities, including organizations and individual entrepreneurs exempted from taxpayers obligations, without any exception should open VAT accounts. At the same time, one of the advantages of the regime relieving the taxpayer of tax obligations is a decline in compliance costs borne by small businesses. However, it may be assumed that such expenditures will increase in the result of the imposition of the responsibility to administer additional bank accounts.

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