The Ministry of Finance has confirmed that it plans to increase the VAT rate from 18% to 22% on January 1 2019 to reduce the amount of social security contributions paid by businesses for their employees and to curb tax evasion. The tax increase will also allow the government to lessen its dependence on oil revenues and control the widening Russian government deficit. The finance ministry has said the tax change will be revenue neutral.
Employers in Russia pay some of the highest social contributions across Europe. In 2016, for example, businesses paid social security contributions at an average rate of 32.6% – much higher than the 22.21% average for the continent, according to KPMG’s rates table.
Finance Minister Anton Siluanov said that the expenses which businesses incur for social contributions means that Russia imposes a high burden on the payroll and it needs to be reduced to increase the competitiveness of the economy. He also believes that the “quite large” direct tax burden is motivating entrepreneurs to stay in the grey economy and evade taxes.
Russia’s plans highlight a growing trend across EU and OECD countries to increase VAT rates with a simultaneous reduction in corporate tax rates or to facilitate other tax incentives. “Most of the EU and OECD [nations] increased the VAT rate from 1 to 6 percentage points during recent years and most of them reduced corporate income tax,” said Nadezhda Orlova, partner at FBK Legal. “Taxes on employee income remain the most controversial issue, one can note the opposite trends in different countries to reduce or increase them, depending on the policy pursued by the country's steering party.”
A VAT rate increase in Russia, however, would be good news for manufacturers, suppliers and exporters of goods who will see their overall tax burden fall as they will benefit from the cut in employee taxes and be able to pass the higher VAT rate onto the end consumer, ultimately increasing the cost of products. However, for suppliers of services, the change is unwelcome as their tax burden could rise as they cannot recover input VAT.
The winners of the VAT hike
Russian exporters have the most to gain from the VAT increase, as they may see their taxes and overall costs fall.
Exporters benefit from a 0% VAT rate on export sales with the right to recover input VAT. Although, they will not be hit by the VAT hike, the government’s plans to reduce the employer social security contributions will reduce their overheads. The combination of zero-rated exports and a reduction on the cost of the workforce will make these companies more profitable.
Orlova told International Tax Review that “if the goods are produced for sale for export, foreign buyers will not suffer because of the manoeuvre, since the export of goods from Russia is carried out at a rate of 0%. In this case, it would be possible to predict even a decrease in the cost of the goods or an increase in the seller's margin, if together with the increase in VAT, the costs of the work force will be reduced.”
Losers to be hit with higher costs
The higher VAT rate will adversely affect businesses that supply services because they cannot recover input VAT as a tax credit.
Vladimir Konstantinov, partner at PwC who specialises in indirect services and customs, said increasing the VAT rate will negatively affect those business which have non-vatable revenues. "Such businesses usually cannot recover input VAT on their expenses. Increasing the VAT rate will increase input VAT costs for such entities. The examples of non-vatable activities include provision of marketing, advertising or consulting services from Russia to non-Russian clients," he said.
VAT hike threatened by elections
Although the VAT plans have raised some fears for businesses, there is a possibility that the change may not happen.
Oleg Berezin, tax partner at Deloitte CIS, said that there is a moratorium on changing the tax environment until 2019. "Although this moratorium may be interpreted differently but it is unlikely that any serious changes like increase of a standard VAT rate to 22% will be effective before 2019, and especially before 2018 elections. As such, the government may continue proposing changes to the tax system in 2017-18 but until there is a draft law for an amendment of the Tax Code, statements given by government’s officials should be treated as only suggestions," Berezin said.
There is no draft law at present for an amendment for the VAT legislation and it is still under discussion. The Russian finance ministry confirmed to International Tax Review that President
Vladimir Putin instructed the government to carry out in 2017 a detailed and comprehensive review of proposals to fine-tune the taxation system, involving business associations in this effort, and, in 2018, to draft and adopt all relevant amendments to laws and the Tax Code so that they can come into force on January 1 2019, setting new, stable long-term rules. "We are working on the fulfilment of Presidential instructions. No decisions have been made yet."
"To the best of my knowledge, there are no detailed calculations on potential economic effect that are behind this suggestion, some experts show criticism of this measure. Also, alternative suggestions were given by the government before (e.g. increasing the VAT rate to 20%), so there is no consensus at this stage and the latest suggestion may not necessarily be the final one and agreed by everyone," Berezin said.
The prospects of the VAT increase and simultaneous cuts to employer social security contributions will depend on whether Russia follows the tax trends across Europe and OECD member nations, but the upcoming elections in the country could also change the direction on tax policy.
