Russia has enacted an important new tax reform programme, significantly reducing certain business and personal income taxes, and streamlining tax legislation in a variety of other respects. In August 2000, Russia adopted the first four chapters of the long-awaited and heavily-discussed second part of the tax code. These four chapters, which will be effective from January 1 2001, govern four federal taxes: value-added tax (VAT), personal income tax, payroll tax and excise tax. Turnover taxes are also modified substantially. The new chapters in the tax code will replace the complex existing legislation regarding these taxes. Key features include the following:
VAT. The new rules appear designed to resolve several past uncertainties in Russian VAT legislation that hindered standard financial and investment transactions. For example, it is now somewhat clearer that inter-company loans, derivatives transactions (including forward contracts and options), and purchases of interests in the charter capital of legal entities are not subject to VAT. In line with the government's stated policy of reducing special tax concessions, some existing exemptions from VAT are terminated. Notably, VAT may now apply to certain agreements for the transfer of patents, trademarks and copyrights. Similarly, VAT is now applicable to "in-kind" charter capital contributions in the form of imported assets, except for so-called technological equipment.
Personal income taxes. For Russian residents, the law introduces a flat 13% income tax rate applicable to most forms of income, including salary. The new rate contrasts with the existing progressive scale, which ranges from 12% to 30%. This dramatic change provides Russia with one of the world's lowest personal income tax rates.
Payroll taxes. Presently, employers are required to pay four separate "off-budget" social taxes tied to employee salaries. The recipients are the so-called pension fund, social insurance fund, medical insurance fund and employment fund. The combined tax burden is 38.5% of the monthly payroll, payable by employers. In addition, employees pay 1% of their salaries to the pension fund.
In a significant improvement, these separate taxes will now be replaced by a single new "unified social tax," payable by employers. The tax has a declining scale. Rates range from an initial rate of 35.6% of the first tranche of an employee's gross annual compensation, to as low as 2% (5% in 2001) on the maximum tranche.
Excise tax. These are an exception to the general trend of reducing taxes. Excise duties for certain alcoholic beverages and cigarettes have been increased. An accrual method now applies for assessing the tax, except for petrol and certain fuels, which remain on a cash method.
Turnover taxes. The much-criticized taxes on turnover have been reduced, although not abolished entirely. The "road user's tax," which is 2.5% of gross turnover at present, will initially be reduced to 1%, and then cancelled entirely from January 1 2003. The "municipal-housing tax" is being abolished. However, in an attempt to compensate local governments for the budgetary losses resulting from these tax reductions, an "auxiliary" corporate profits tax of up to 5% has been introduced, in addition to the existing corporate profits tax of 30%. The exact rate of the auxiliary corporate profits tax will be set by local governments, who are expected to be hungry for revenue.
Russia is to be commended for adopting these changes, which will help to simplify the tax system and somewhat reduce the substantial tax burdens imposed on the business sector. Nevertheless, it may be too early to declare victory. Much will depend on the implementation of the new rules by the Russian authorities. In addition, Russia still has much work ahead to complete its ambitious plans for reform of the tax system. It is encouraging to see that progress is finally being made, after many years of delay and confusion.
Vasilisa Strizh and Brian Zimbler
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