When it comes to problems regarding taxation and competitiveness, Romania is one of the ‘champions’, but there are problems everywhere – larger or smaller.
Europe has concerns with regards to the ‘common taxation base’ for multinationals, but also with respect to the implementation of anti-BEPS (‘Base Erosion and Profit Shifting’) regulations. VAT is another big issue that may be considered, without hesitation, an invitation to fraud.
VAT – in need of reform
The value added tax – VAT is, in the end, a tax on consumption borne by the end consumer, either households or companies or public institutions with no deduction right. VAT is charged only to the end consumer, as tax on consumption in USA. This European invention, afterwards exported across all continents, is based on the split payment of the VAT by companies concurring in the manufacture of such good or the provision of such service. Each company pays VAT for the purchased goods and services and charges VAT for the sold goods and services. The paid VAT is deductible, so the taxpayer pays to the state budget only the difference for the value added by such company. If the paid VAT is bigger than the output VAT, the taxpayer may request a repayment, so – at least in theory – the VAT should be neutral for the business.
If the taxpayer exports such good or product, things get more complicated: the VAT rate for exportation is zero. The taxpayer should request the VAT repayment – repayment which in certain countries is not easy to make. The chain of split payments does not break however, being rebuilt by the purchaser through the VAT customs payment, in its own country. Nevertheless, this is not the case in the European Union, where there are no customs. Here is where issues begin, but here is also where the solutions are.
The problem is very simple: without customs, the chain of split payments breaks. Europe had two options: (i) to allow the chain to break and to implement a reverse taxation system in which the purchaser owes the VAT in the country where the purchase is made or (ii) not to allow the VAT chain to break, with the seller to collect the VAT from the purchaser, as if it were in the same country.
The second option was quickly abandoned because it could not have been implemented: the VAT rates are different in EU countries and the latter should have relied upon each other for collecting their own income, as well as for setting up VAT clearing houses between the European countries.
The first option was the winner, but it creates two different VAT regimes: (i) intra-community acquisitions for which reverse taxation is usually applicable (the VAT is not paid to the supplier, but directly to the state). If the buyer has a deduction right, the VAT is no longer actually paid, but set off with the deductible VAT) and (ii) intra-country acquisitions, for which the system of split payments subsists (the effective VAT payment to the supplier).
The solution would have been very good if another issue had not occurred: the fraud. Shortly, two huge gaps were discovered in the system: (i) the possibility to benefit from illegal VAT repayments by purchasing goods for overrated prices, followed by exportation and (ii) the possibility to steal the entire VAT from the chain at a given time, by simply interposing a company between the purchaser and the seller, in an intra- community acquisition.
If the first gap has always been possible, but was harder to use because it involved the existence of corrupt or slightly skilled tax inspectors, the second one was a true blessing for the offenders: they could steal without depending on corrupt inspectors. This way, approximately EUR 110.8bn were stolen each year, i.e. more than half of approximately EUR 193bn missing each year from the treasuries of the budgets of EU countries, only from VAT. If another thousand illegal repayments adds up, it results that most VAT fraud comes simply from a faulty design of this tax, which is extremely important for all budgets of the European countries.
Europe took action for fraud reduction: new reporting, declarations, controls, restrictions upon giving the VAT code, but they all involved additional management costs, both for the European companies and for the European countries.
The obligation of the European companies to cross-check providers was also introduced, because, this way, there is the (real) risk that the tax authorities will refuse the deduction right for the VAT paid to providers which turn out to have committed fraud. This measure also resulted in other additional costs for European companies, but also in inevitably undertaking the risk of not being able to deduct a part of the paid VAT, because someone stole it.
Therefore, the management costs for European companies increase, the risks for correct taxpayer grow bigger, but fraud still does not decrease.
Is it possible for the VAT to be the best example of self-impairment of its own competition? In the current form, the VAT became an issue threatening to erase many substantial benefits of the European common market.
What is the source of the problem?
Fraud appears because of the different treatment in intra-community acquisitions versus national acquisitions. There have been administrative and legislative attempts to reduce the effects of the problem, but they gave rise to other issues requiring solutions and which, in the end, involve costs. All such costs are borne by the European taxpayers.
How can the source of the problem be removed efficiently?
The different treatment of the intra-community transactions compared to that of the national transactions may be eliminated by adopting the same regime currently applicable in case of intra-community acquisitions.
In other words, the solution is reverse taxation. If reverse taxation became general in all B2B (business to business) transactions, some of the VAT issues would disappear automatically:
? the main problem, the merry-go-round fraud, would disappear completely for the mere reason that the VAT would no longer circulate between companies, so there would be no money to steal;
? the fraud associated to VAT repayments would also disappear entirely for the simple reason that there would be no VAT repayments (only occasionally and for small amounts);
? the cost of VAT pre-financing, in particular for investing and exporting companies, would be eliminated.
Which are the impediments in applying the solution?
VAT Directive: Reverse taxation is allowed for member states only for certain goods, and for any other goods its application is conditional upon obtaining of an approval on the part of the Commission. Recently, starting with July 2013, the states are allowed to apply the reverse taxation measures without prior approval, but with a subsequent one (QRM – Quick Reaction Mechanism), in the cases in which a ‘sudden and massive increase’ of the fraud is ascertained.
The opponents of this type of taxation argue that the application of the reverse taxation erga-omnes would result in the outburst of retail fraud. But the retail may be much easier to control than B2B transactions. The answer is related again to record keeping. It is not possible to retail with phantom companies, because they have to sell, are visible and controllable. There are efficient IT solutions such as fiscal cash registers which may communicate directly with the server of the tax authority, electronic payments, etc.
It is possible to conceive guarantee systems for retailers, VAT weekly payments, even more sophisticated protection systems, such as ‘do not pay unless you receive the tax receipt’. Reverse taxation may be eliminated in retail and kept only in cash & carry stores, where minimum thresholds for purchasers, the obligation of wrapping up in big packs, etc. may be introduced.
Until then, the taxpayers have problems with administrative costs, but also with unfair competition on the part of tax dodgers, and lately with tax authorities attempting to recover still from the correct persons the damage caused by tax dodgers.
Conclusion: the European VAT system has nothing in common with competition. It is expensive and inefficient. It creates moral hazard, it offers thieves the possibility to steal easy the VAT paid by citizens and it gives rise to risks for honest taxpayers. The system must be reformed, and the reform will be extremely difficult for at least two reasons: (i) the reduction of administrative costs is not to the benefit of bureaucrats (who most often draft the regulations) and (ii) amending the VAT Directive requires unanimity.
Direct taxes are national regulations which are not unitary at all. There are countries in which the income tax is computed by applied progressive rates, with maximum rates which amount to even 50%, but there are also countries (in particular among those which recently joined the European Union) in which the income tax is computed by applying a single rate of income tax, which may decrease to even 10% (Bulgaria). The same situation is also met in case of social contributions, the differences being considerable from one country to another, both in terms of rates and the taxable base.
The case of Romania is top-ranked as a bad example. The income tax has a reasonable level, but social contributions are completely unreasonable, which leads to a low degree of compliance and substantial losses of income to the consolidated budget.
Main characteristics of the current system:
? Very big contributions for employment agreements. The employee pays on the whole 16.5% of the gross salary (without any deductions whatsoever), and the employer at least 28% more from the fund of gross salaries. The calculation base is capped, practically only in case of the employee contribution to health insurance (10.5%), but at a level which is much too high in order to be efficient, i.e. 5 average salaries, namely RON 11,000. The remaining contributions are not capped. Moreover, the principle of contribution is seriously breached by the fact that the employer may pay contributions for which the employees do not receive pension points;
? Much lower or even zero social contributions for other types of income. Practically, for each type of income we have different tax obligations, and the fiscal burden depends mainly on HOW we earn, not HOW MUCH we earn.
Such approach, typical to political mentalities, is unfortunately widely met in other European countries, as well. The logical scheme of operation of the current system of mandatory social contributions in Romania reflects the fact that the system is too complicated (Figure 1). Such scheme is difficult to understand even by experts. In addition, it poses great morality issues, since it creates different categories of taxpayers: some have to bear the full burden, others have the privilege of paying less for the same income.
Among the consequences of this system we may list: small number of employment agreements, huge percentage of employment agreements with salaries below the national minimum salary (13% in June 2012) or equal to it (another 11% in June 2012). Therefore, 24% of the total salaries are below or equal to the national minimum salary) and an extremely low number of employment agreements exceed Ron 9,000 (1.5%).
The administrative costs of the system are extremely high, both for the state and for the taxpayers. The complexity of the regulations gives rise to risks of re-treatment for the taxpayers. In other words, with such a system, we cannot talk about the reduction of social contributions, because this would only increase a deficit that is even now, being this way, harder and harder to finance.
Any discussion regarding a reduction of the tax burden in the labor area, as a factor to increase competition, must begin from the underlying principles, which today are either missing or not complied with.
If the fiscal burden would be based on ‘how much’ we earn and not on ‘how’ we earn, and the calculation base of the social contributions would be capped at a reasonable level (as the benefits of the insured should be capped), we would have to win in two directions: (i) a wide base would allow the substantial decrease of social contributions for income tax also, and (ii) through the systematic simplification of the system, the administrative costs would be reduced both for the state and for companies. In addition, there would no longer be any risk of re-treatment from the tax viewpoint of the income, which also contributes to increasing competition by removing certain uncertainty in the implemented business models.
In the European Union, the tax on companies’ profit represents, in the budget of the countries, less than a third of the income obtained from the income tax or VAT and less than a fifth from the income from mandatory social contributions. Nevertheless, there are attempts to harmonize the taxation base. There is even a project of directives called CCCTB (‘Common Consolidated Corporate Tax Base’) which, in the improbable case of being adopted, would allow multinationals operating in Europe to calculate the taxable profit for all operations, and the allocation of the rates by countries would be computed according to algorithms, which are certainly questionable. There are also rules regarding the transfer pricing generally conceived based on the OECD model, there are disputes between the taxpayers and the authorities in relation to the adjustment of the income or expenses registered in the commercial relationships with affiliated parties, there are of course arbitration procedures between countries in order to avoid the situations in which the adjustments made by one of the authorities lead to double taxation.
Nevertheless, there would be even more rules. ‘Keep calm and wait for BEPS’ is the latest joke heard among the tax officials. In the near future, ‘Base Erosion and Profit Shifting’ will represent the main ‘toy’ in the hands of authorities and consultants, but also an additional administrative burden for multinationals. Of course, this will not contribute either to the increase of the economic competition of Europe.
The matters mentioned in this study are only a part of the taxa- tion and competition issues that should concern us. Romania will not become more competitive if things remain complicated. The principle ‘less is more’ could work better in taxation too. The relationship between the state and the taxpayer should be based on rules as simple as possible, clearer and so, easier to be under- stood and complied with.
The amount of taxes and duties is another issue to be discussed. Lower taxes are more attractive is a country for investors, but low taxes are not a guarantee that investors would knock at the door. The available infrastructure, the skilled workforce, the size of the internal market or the proximity one may be factors at least as important. Romania, as well as Europe, have to find the balance between all such factors.