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: / Analytics / The Tax System of the Kyrgyz Republic (2003)




Kyrgyzstan Review, 10 years ago




6. POSSIBLE DIRECTION OF TAX SYSTEM REFORMS IN KYRGYZSTAN

Analysis performed in respect of the tax system of Kyrgyzstan and its influence on the economy of the country, survey of opinions of businessmen, survey of experience of other countries, analysis of the budget losses connected with the shortcomings of the tax law and administration make it possible to formulate a number of recommendations on improvement of the tax system of Kyrgyzstan. They are aimed simultaneously at increase of tax receipts to the government budget of the country and at creation of favorable conditions for development of enterprises and the economy as a whole. Authors of the report believe that recommendations given below are in full conformity with objectives and tasks set forth in the strategic government documents of CDF and NSPR, and with the contents of the Fiscal Reform Strategy in the Kyrgyz Republic to 2005, approved by the President of the Kyrgyz Republic. Proposals, on which principal decisions have already been taken by the government bodies and mutual understanding achieved with the IMF, are not included into the composition of our recommendations14.
 
The following amendments to the legislation and the procedure of administration connected with public revenues have been proposed.
 
Legislation, budget and administrative system
 
¨ To make the Tax Code the only legislative act regulating taxation in Kyrgyzstan. To achieve this purpose, taxes regulated by other laws (deductions for prevention and liquidation of emergency situations, road tax, deductions for development and reproduction of the mineral and raw materials base), as well as a special tax treatment for business subjects registered in the FEZ, must be either revoked (as it has long been being planned in respect of the first two mentioned taxes) or introduced into the Tax Code. 
 
¨ To regulate the procedure of interpreting the Tax Law and establishing the practice of compulsory application of laws. First and foremost, it is expedient that the Jogorku Kenesh should adopt the Commentary to the Tax Code, which would contain detailed interpretation of the rules for application of the Tax Law. Courts must take decisions on specific disputes between economic subjects and the tax bodies connected with the issues of taxation. The Ministry of Finance must be the only government body entitled to and responsible for developing instruction materials and performing the work related to interpretation of taxation problems. This must remove the existing practice, when different organizations (the Ministry of Finance, STI, SCI, the National Bank) may give contradictory interpretations of the Law provisions and the rules of tax administration. 
 
¨ To establish direct dependence of the amount of grants from the Republican budget to the local budgets on the amount of collected taxes, which can be significantly influenced by the local authorities. This, first of all, refers to excise tax on domestic goods, payment of income tax on a patent basis, etc. This dependence must be established by Law as a special formula, which apart from other factors (the number of the population in the region, the level of the social infrastructure development, etc.) would take into account effectiveness of work on tax collection performed by the local government bodies. Availability of such formula would have increased transparency of inter-budget relations and created direct incentives for the local government for increase of tax collection and encouragement of economic activity bringing tax receipts.
 
¨ To increase official wages of the tax officers and introduce the appropriate incentives and sanctions for the purpose of encouraging high effectiveness of tax collection to the budget with simultaneous decrease of the number of employees. This will permit to attract qualified employees interested in performing their direct functions (i.e., increase of the tax revenues of the government by legal ways) to the tax service and get rid of the corrupted part of the tax bodies employees. Though this reform is necessary with regard to employees of all government bodies, a special role of the tax bodies in providing facilities needed for implementation of the administrative reform makes it necessary that the tax bodies were the first to be reformed.
 
¨ To develop the strategy of interrelations with taxpayers aimed at forming a positive attitude towards the tax system. There is a need in a considered, long-term informational campaign capable of persuading taxpayers of the necessity of effective functioning of the tax system, which facilitates effective functioning of economy and increase of social justice. To achieve this, the advancement to this tax system must be transparent.
 
Value added tax
 
¨ To insure timely and full credit of input VAT/excise taxes, as well as direct VAT refund from the budget for exporters and enterprises making investments. It should be recognized that such a credit/refund is not a special preference granted to enterprises, but normal rule in administration of VAT and excise taxes providing for their functioning as taxes on consumption. For this purpose the wording of Article 125 of the Tax Code must be changed in a manner stipulating that the government bodies should be obliged to refund VAT paid in excess within the periods (sufficiently short) established by the Law.
 
¨ To impose VAT on supplies of agricultural produce. This will: a) make it possible to decrease the tax burden on enterprises engaged in processing of agricultural products; b) make investments to the main funds of agricultural enterprises more profitable (due to the possibility to get credit of VAT included in the value of these funds); c) create greater incentives for exports of agricultural production (due to zero rate of VAT on export supplies); d) impel peasants to acquire material resources from producers/sellers capable of issuing them a VAT invoice, thus decreasing the demand for production of the shadow sector and smuggling. In view of the difficulties connected with administration of VAT with regard to numerous small taxpayers-agricultural producers, to oblige processing enterprises or trade organizations acquiring production from peasants to transfer VAT to the budget, which will allow increase of budget revenues (see Table 5). It goes without saying that agricultural producers will remain responsible for filing VAT tax declarations. Under some circumstances, this will improve their economic and financial situation, as they will be able to get a refund for the acquired material resources in cash15. 
 
It should be noted, that by type of influence of VAT on agricultural producers the latter may be divided into three groups: 1) small and poor farms mainly producing products for their own consumption and selling surplus products in the market; the interests of this group will be scarcely influenced by imposition of VAT, as this group will be under the registration threshold (see also the previous paragraph); 2) actively developing farms making investments and exporting their products; this group is sure to benefit from imposition of VAT; 3) farms producing commodities for domestic market; these farms will probably not be considerably effected in respect of products sold by them to final consumers (it will be rather difficult to administer collection of VAT from these sales, though possible, provided proper administrative efforts are made); their tax burden will increase to some extent with regard to products sold to the persons engaged in processing/wholesale trade. Thus, the poorest part of peasantry and prospective farms, which must insure economic growth in the country, will benefit or at least will lose nothing from imposition of VAT. The rest farms will make greater contribution to financing of the state expenditure programs, which now is too small compared to the contribution of enterprises in other sectors of economy.
 
 
 
The current law (agriculture is VAT-exempt)
The regular scheme of VAT (tax is transferred to the budget by a seller of agricultural production)
The proposed scheme of VAT (tax is transferred to the budget by a purchaser of agricultural production)
Agricultural producer
Material expenses - total
11.00
11.00
11.00
Factor prices
10.00
10.00
10.00
VAT
1.00
1.00
1.00
Value added
10.00
10.00
10.00
Cost of production in factor prices
21.00
20.00
20.00
VAT
 
4.00
4.00
Selling price
21.00
24.00
24.00
Proceeds (the amount received directly by an agricultural producer)
21.00
24.00
20.00
VAT liability
 
3.00
-1.00
Administration coefficient
 
0.10
0.90
Actual tax payment
0.00
0.30
-0.90
Processing enterprise
Material expenses - total
45.00
48.00
44.00
Agricultural raw materials -total
21.00
24.00
20.00
Factor prices
20.37
20.00
20.00
VAT
0.6317
4.00
 
Other material expenses - total
24.00
24.00
24.00
Factor prices
20.00
20.00
20.00
VAT
4.00
4.00
4.00
Value added
20.00
20.00
20.00
Cost of products in factor prices
60.37
60.00
60.00
VAT
12.07
12.00
12.00
Selling price
72.44
72.00
72.00
VAT liability
7.44
4.00
8.00
Administration coefficient
0.40
0.50
0.50
Actual tax payment
2.98
2.00
4.00
Summary VAT receipts from agricultural and processing enterprises
2.98
2.30
3.10
 
¨ To impose VAT on public utility supplies to the population. These services do not differ in principle from other services, which are VAT-taxed. This step is especially appropriate, as actually full privatization of this sector of economy is supposed to take place in the medium-term perspective. It should be noted that this step would not affect the poorest part of the population, living in rural areas. For urban poor the imposition of VAT must be compensated for from the budget expenditures. 
 
¨ To set a zero rate of VAT on export supplies of gold (with regard to production of new natural deposits). This will help to attract investors for development of new natural deposits of gold. 
 
 
¨ To insure implementation of international agreements when taxing services with VAT. This will improve the possibilities of the services sector development (telecommunications in particular) and increase the export potential of the country.  
 
Taxes on incomes
 
¨ To set the rate of profits tax at the level of 10 %. For many enterprises this will create incentives for coming out of the shadow and stopping to keep double accounting caused by the current rates, which are too high. To avoid the loss of tax receipts from large enterprises, which are the state enterprises or operating on monopoly markets, it is proposed to compensate for the payments of this tax, which are decreasing, by increase of the dividends paid to the government budget or license payments for monopolists.
 
¨ To set the flat personal income tax rate at the level of 10 %. This will be helpful in removing one of the most important sources of ineffectiveness of the tax system, which is considered to be so, because a law-abiding taxpayer declaring a sufficiently big taxable income, is actually penalized in connection with this income through the system of progressive tax rates. The effort must facilitate coming of many economic agents out of the shadow. The analysis shows that even an initial relatively weak reaction of taxpayers to introduction of a flat rate of personal income tax will make it possible to avoid budget losses, and jointly with the changes in the rates of deductions to the Social Fund one may expect a marked growth of income tax receipts.
 
¨ To allow natural persons a deduction of expenses for services in the field of education and health care from the aggregate annual income. This, on the one hand, will create better conditions for reproduction of the human capital and, on the other hand, will stimulate increase of transparency and significant improvement of accounting of paid services in these branches. Certain losses of income tax, which can take place, will be entirely compensated for by increase of the government revenue, which must take place due to the fact that a significantly greater part of payments for services will be officially registered. Introduction of this measure is sure to require strengthening of administration with regard to organization of income declaring by the population. 
 
¨ To perform a significant increase of the duties/fees payable by natural persons during registration of large purchases made by them (real estate, cars), and to allow deducting of a part of these payments from the aggregate annual income at submission of personal income tax declaration. Such measure will not affect the persons, who officially declare their income and regularly pay income tax; it will also help to some extent in re-distributing the tax burden to the persons gaining incomes in the shadow economy. To stimulate filing of declarations, the total amount of a duty may be stipulated to be less than the current one, including deduction. For example, if the current duty is equal to 5%, it is possible to introduce a duty equal to 7%, with the subsequent deduction of 3% allowed from the aggregate annual income.  
 
¨ To apply income tax to the salaries and other incomes of military and other servicemen. The rights and duties (including the duty to pay taxes) of the officers of law-enforcement bodies do not differ from the rights and duties of all other citizens. For the purposes of preventing decrease of their net salary, it should be increased with regard to all the mentioned categories of officers. 
 
Patent payments
 
¨ To revise the cost of patents upwards. According to our estimates, the level of the tax burden of the persons paying income tax in the form of a patent purchase is markedly lower, than that of those, who pay income tax according to the usual scheme. 
 
¨ To collect contributions to the Social Fund simultaneously with the payment of the cost of a patent form the persons working on patents. At the same time a patent payment (a form of income tax payment) and deductions to the Social Fund will remain as two different payments. This will make it possible to sharply improve administration of deductions to the Social Fund and extend the taxable base. Unification of all government services involved in collection of the government revenues, into the Committee on Revenues would facilitate this objective from organizational point of view. 
 
Deductions to the Social Fund
 
¨ To set a zero rate for deductions to the Social Fund for all incomes exceeding 4000 soms a month per worker. This will help to avoid significant reduction of receipts to the Social Fund and create significant impetus for legalization of the real level of wages. It is universally recognized that deductions to the Social Fund are one of those taxes, which prevent lots of enterprises from coming out of the shadow economy. One may expect in this respect that a decisive reduction of rates will lead to gradual extension of the taxable base. Temporary losses of collections connected with adaptation of taxpayers to the new rates and the possibilities of entering official economy arising in this connection must be compensated for at the expense of transfers form the government budget (at the expense of income tax receipts growing as a consequence of this measure, in particular). Of course, this is far from being in compliance with the intention to move towards the cumulative principles of the pension system functioning. But, this transfer in any case will not be possible without a drastic reform of the pension system, connected with significant increase of the pension age and revocation of numerous preferences; this will not be possible either without significant improvement in functioning of the financial system of the country. 
 
¨ To strengthen connection between contributions to the Social Fund and payment of personal income tax, the amount of pensions and provision of medical services. This will raise interest of citizens in payment of contributions to the Social find in a timely manner (and in the appropriate amount). Special measures making targeted protection of the vulnerable layers of the population possible will be required. 
 
Land tax
 
¨ To provide a clear description of criteria in the Law, according to which it will be recognized, that a taxpayer must pay land tax and not other taxes (personal income tax, profits tax, etc.). According to the practice, many persons, who are not peasants and gain income mainly in the sphere other than agriculture, are registered as payers of land tax, which leads to the budget losses.  
 
¨ To increase the amount of land tax. This will facilitate an increase in financing of the public services at the level of aiyl okmotu, i.e., in the place, where many of these services can be provided in the most effective manner. The amount of the land tax rates must be based on the actual data of incomes received from agricultural activity for each region and type of agricultural land. Proceeding from the data of Table 2 one can state that the amount of rates may be increased by more than 50% as an average over the Republic. 
 
Local taxes
 
¨ To revoke those local taxes, which do not bring revenues to the budget. It is expedient to leave only sales tax (which should also be revoked in the perspective as duplicating VAT), tax payable by vehicle owners and, probably, a couple of other taxes. All the rest taxes bring revenues, which may be compared with the expenses connected with their administration. 


14 Establishing the unified system of taxpayer registration, introduction of VAT invoices as blank forms, for which strict records are kept, imposition of real estate tax, revocation of deductions for prevention and liquidation of emergency situations and road tax in the medium-term perspective, etc.
15 It should be noted that the scope of activity of official suppliers of material resources for agriculture issuing invoices is not big so far. This effort will contribute to increase in demand for production of those suppliers, who act on an official basis, and will promote an increase in transparency in this sphere of economic activity.
16 The value added and the values of expenses for raw materials and other resources in the table are conventional, though brought into accord with the input-output table data.
17 The amount of 3% fixed VAT credit.