Russia: Thinking the unthinkable about tax reform
This week's column expands our horizons eastward to Russia. Now, I've never been there and haven't really considered that an enormous loss, but I received an interesting update on Russian taxes from my colleague Tim Carty in our Moscow office. I make no apologies for borrowing large chunks from Tim's update, with his permission of course (so that he can fulfill his ambition of being quoted in the Business Journal.)
So far, Poland has been at the forefront of tax reform in this part of the world, but now it seems that Russia is catching up, and in some cases taking the lead in thinking the unthinkable. I would add that with vacations and publication schedules this week's column was written while the legislation was still in draft form, but it may have already passed by the time you read it or been rejected altogether. However, for the purposes of "Tax Watch," the fact that it was even considered makes it worthy of mention.
While at the time of writing a great deal of uncertainty remains regarding the detail of the changes to personal tax and social security legislation approved at a second reading by the Duma, and whether these changes will be successfully carried through to actual legislation, certain highly encouraging themes are emerging in this area.
The main struts of reform, effective Jan. 1, 2001, are as follows:
Reduction in the personal income tax regime from graduated rates of up to 30% to a flat rate of 13%.
Penalty rates of 30% on income delivered through traditional "sham" salary schemes using interest deposit and insurance-based delivery methods.
Revision of existing sourcing laws to bring them in line with internationally accepted principles. At present Russian source income is taken to be income paid in Russia; in the future, it will be income in relation to services physically performed or assets located in Russia.
Thirty percent taxation on income paid to tax non-residents.
Abolition of employee social security contributions, currently at 1%.
Reduction in employer social security contributions. Two possible suggestions are prevalent. One would be to shrink the contributions from 38.5% to 35.5% (plus the new and imaginatively named professional diseases surcharge, which is usually an additional 0.3%) and amalgamate three of the four funds, thus reducing administration. The other would be to introduce a unified social security charge with regressive employer contributions, starting at 35.5% and falling to 2% for income in excess of Rbl 600,000 ($23,000).
It is the stated aim of the government to have these reforms, in whatever form they will eventually appear, on the statute book before the Duma's July 7 summer recess, so that the revenue side of government finances is in place in time for the autumn debate on the 2001 budget. It is clear the general trend is to push both employee-tax costs and employer-payroll costs down.
One would anticipate that the main driver for this is a desire to flush more and more people's income out of the darkness of the black economy and into compliance, and to combat the excessive levels of tax avoidance and evasion that currently plague the country's finances.
There also seems to be a genuine desire to encourage the development of a more liberal regime in which simplicity of collection and transparency of administration will lead to a more effective operation of the state budget. Inevitably in Russia, there are a great number of political obstacles to such reform.
The communists who form the largest single bloc in the Duma appear opposed to the removal of progressive taxation on principle. In addition, the trimming of social security revenue, traditionally under the heavy control of the regional governors, is likely to be opposed by the Federation Council, the communist-dominated upper house of the legislature. On the bright side, President Vladimir Putin appears to be lending his considerable post-election and post-Chechnya political weight to the reforms, which gives some hope that they will be pushed through.
While one might think the effect of rates that would make Russia look almost like a tax haven would be obvious, there is deep cynicism within Russia as to whether the reductions are simply a temporary device designed to pull people into a tax net, with the tax burden set to increase as soon as the "catch" has gone up sufficiently. This shows a deep mistrust of authority that is endemic in Russia, but the probability of such a scenario should not be discounted. Some analysts believe that even if the government's agenda is aboveboard, a reverse in the premium price of oil (now standing at a 10-year high) could see excise revenue falling to such an extent that a return to higher personal tax rates would be inevitable.
Nonetheless, the usual verbiage about tax reform that has been touted for so long now appears to be accompanied by positive action. It is inevitable that the detail of the legislation will be unwieldy, and that poor drafting will mean some laws miss their intended targets or cause unexpected collateral damage, but it does seem that things are moving in the right direction. The idea of Russia being at the forefront of positive tax reform is a new concept, but this should I hope be enough encouragement for the Polish government to also keep up the momentum of tax reform and simplification. It would never do to have to admit to falling behind Russia in tax legislation!
Peter Ferrigno is a tax manager in the Warsaw office of Arthur Andersen. Tim Carty is head of the Human Capital practice in the Moscow office of Arthur Andersen.
