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




Kyrgyzstan Review, 10 years ago




2. PROBLEMS OF THE TAX SYSTEM OF KYRGYZSTAN

The system of taxation in the Kyrgyz Republic was put into action since the beginning of 1992. The Constitution of the KR, the Tax Code of the KR, laws and resolutions of the JK of the KR and its Chambers, decrees of the President of the KR, resolutions of the Government of the KR and acts of the Ministry of Finance of the KR, decisions of the local government administrations and local self-government bodies, all being universally compulsory, refer to law-making acts establishing the norms, which regulate the tax legal relations. The Tax Code of the KR (KR TC) is the main law in the system of law-making acts, which regulate taxation in the Kyrgyz Republic.
 

1.1. The government budget revenues structure

Table 1 contains the structure of the government budget revenues and shares of the main taxes existing in the KR at the time of the research.
 
 
 
2000
2001
11 months of 2002
thousand soms
%
thousand soms
%
thousand soms
%
Total revenues
9 283 283
 
11 921 554
 
11 827 421
 
Total tax collections
7 675 772
100.0
9 187 901
100.0
9 170 939
100.0
VAT total
2 931 167
38.2
4 122 501
44.9
4 094 230
44.6
VAT on domestic production
1 174 481
15.3
1 252 666
13.6
1 184 191
12.9
VAT on imported goods
1 756 686
22.9
2 869 835
31.2
2 910 038
31.7
Profits tax
565 965
7.4
965 669
10.5
822 933
9.0
Personal income tax
734 246
9.6
947 291
10.3
921 178
10.0
Personal income tax on a patent basis
107 182
1.4
165 556
1.8
171 152
1.9
Excise tax collections - total
1 273 422
16.6
1 099 360
12.0
954 941
10.4
Excise taxes on domestic goods
791 551
10.3
610 485
6.6
480 188
5.2
Excise taxes on imported goods
481 871
6.3
488 875
5.3
474 753
5.2
Customs payments
241 623
3.1
301 428
3.3
378 072
4.1
Land tax
189 682
2.5
234 209
2.5
222 877
2.4
Deductions for prevention and liquidation of emergency situations
553 804
7.2
557 394
6.1
570 923
6.2
Road tax
378 935
4.9
360 191
3.9
296 250
3.2
Deductions for development and reproduction of mineral and raw materials base
22 279
0.3
24 237
0.3
144 016
1.6
Local taxes, simplified scheme taxation
301 114
3.9
380 022
4.1
472 378
5.2
Other taxes
483 534
6.3
195 603
2.1
293 142
3.2
Extra-budgetary funds
 
 
 
 
 
 
Social Fund
2 871 770
 
3 256 200
 
3 534 612[4]
 
 
The data in the Table show that the most important sources of the government budget revenue are VAT, excise taxes, personal income tax and profits tax. Of other compulsory payments, deductions to the Social Fund account for a large share of the government revenues. The growing role of VAT and decreasing importance of excise taxes are of special interest. A number of taxes bring insignificant revenues (first and foremost, local taxes and taxes from small businesses collected according to the simplified scheme).
 
Some taxation problems connected with certain taxes, which are supposed to create an excessive tax burden for taxpayers and hamper collection of taxes in the amount necessary for effective functioning of the government, have been considered and listed below. A detailed survey of each type of budget revenues given below (taxpayers, rates, preferences, peculiarities of administration) is provided in Appendix 1.
 

1.2. Value added tax

VAT is the main tax in Kyrgyzstan both for the budget (it brings a little less than half of all tax receipts) and the taxpayers, who consider it to be the most burdensome tax. The rate of VAT equal to 20%, which is currently valid in Kyrgyzstan, is high according to the international standards, however VAT receipts do not exceed 5% of GDP, while in the other countries VAT receipts amount to 8-9% of GDP with the same rates (see Table 3). This means, that the system of VAT collections faces problems, which impede its effective functioning.
 
In its essence VAT is a tax on domestic consumption; products produced for exports and investment expenses must be free of this tax. That is why its key elements are zero rate for export supplies and full credit of VAT paid by taxpayers for the used material resources. The existence of such credit may lead to the situation, when tax liabilities of certain taxpayers (exporters and/or enterprises, making large-scale investments in the fixed capital) appear to be negative in certain periods of time or regularly, i.e., a refund of input VAT paid in excess is payable to these taxpayers from the budget. An important feature, which might enhance collection ability of this tax, is a multi-staged mechanism of its payment. A payment is made by each enterprise in a technological chain of production of finished goods.
 
Deviation from the said main characteristic features of the classical VAT scheme violates its functioning as tax on consumption. Namely, where negative tax liabilities arise, a partial credit of VAT and refusal to refund it from the budget mean that this tax has already been applied to the export/investment activity. The existence of non-payers of VAT in the technological chain (exempt under the Law or evading from payment of tax) results in inability of enterprises situated further in this chain to get input VAT refund and pay VAT for the value added by them and by those, who were ahead of them in the chain. This causes a cascade effect (payment of tax on the value added and on the amount of the same tax paid by technological predecessors). That is why the problems with credit and the existence of enterprises, which do not pay VAT in the middle of a technological chain, make this tax similar to turnover tax, which is characterized by economic and fiscal ineffectiveness, as all taxes of this type.
 
In real life some deviations from the classical scheme are inevitable; however, if these deviations are large, this tax significantly loses its potential advantages. Unfortunately, sufficiently big deviations from the classical scheme have been made in Kyrgyzstan[5]. They include the following peculiarities of the current tax regime:
 
¨ Exemption of agricultural enterprises from VAT. This decreased attractiveness of export/investment activity in agriculture and placed the persons engaged in processing of agricultural products in hard conditions (as one can see from practice, the existing fixed credit does not solve the problem).
¨ Exemption of gold-mining from VAT. This amendment to the Law was introduced in connection with the activity of only one (though very big) enterprise. The possibilities of attracting investors for development of other natural deposits decreased, as they may not count on a zero rate in gold exports.
¨ Lack of full clarity in VAT taxation of export/import of services (see examples in Chapter 4). This creates an excessive tax burden for enterprises working in this sphere.
¨ Exemption from VAT of public utilities services supplied to the population. This deprives enterprises of this sphere of the possibility to get full credit for input VAT. At the same time social effect from this effort is insignificant, as curbing the prices for public utilities at the expense of VAT exemption is one of the least targeted forms of social protection.
¨ The practice of administration, which hampers getting VAT credit (see, for example, Chapter 4 of this report), and direct refusal of the government to refund VAT, when negative tax liabilities arise (Article 125 of the TC).
 
It is important, that all these characteristic features of VAT, which increase the tax burden for enterprises and, accordingly, create incentives for evasion from payment of taxes, produce effect on those sectors of economy and types of economic activity, which are recognized in the national strategic documents of CDF and NSPR as the most important: agriculture, mining industry, the services sphere and investment activity.
 

1.3. Profits tax

Before 2002 the rate of this tax was 30 %, i. e., it was high enough and stimulated evasion from payment of this tax. Actually it is paid by only large enterprises and in those branches of economy, where the possibilities of concealing profits from taxation are limited. Small and medium-size business enterprises very often find legal and illegal ways of evasion. In view of the fact that possibilities of enforced payment in the existing tax system appear to be limited in practice, one can count only upon voluntary payment of this tax by a significant number of enterprises, which is possible under condition that the profits tax rates correspond to the reasonable size of these rates[6] as it is understood by businessmen. These considerations led to decrease of this tax rate in 2002 to 20% (except for natural monopolies). However, the problem lies in the fact, that reduction of the rates (which must be universal, otherwise serious problems can arise in administration of this tax and a distorting influence can be produced on economic activity) covers its main current payers, thus threatening with significant losses in tax receipts.
 
Among other problems connected with this tax are unclear definitions of the aggregate annual income and the main income for agricultural producers. Conditions, in which activity of a foreign legal person leads to establishing a resident institution in the KR, have not been defined. Another problem is a possibility of the taxable base understatement as a result of agreements made with natural persons carrying on their activity on a patent basis and not keeping accounting of incomes and expenditures.
 

1.4. Personal income tax

Personal income tax, which is currently acting in Kyrgyzstan, is based on a progressive scale of rates. In different years the maximum rate amounted to 40%, then 33%; besides it was to be applied beginning with the level of incomes (a little more than $200 a month) typical for the middle class, but not for the rich people. It is evident that very few people paid personal income tax at the maximum rate. In 2002 the maximum personal income tax rate was decreased to 20%; the receipts of this tax even have grown, though insignificantly.
 
Due to peculiarities of the countrys economy and the Tax Law, the smaller part of the population of the country must pay income tax according to a progressive scale (about one third of the economically active population). Besides peasants, who pay income tax in the form of land tax, numerous small traders and producers may also pay income tax in the other form as patent payments (see below). From this point of view, not even touching the issues of justice and problems of administration, a progressive scale of personal income tax cannot effectively perform the function of income re-distribution, for which it is intended.
 
The Law stipulates a number of types of incomes and categories of the population, which are exempt from taxation. Lack of allowed deductions for expenses incurred by households for education and health care attracts attention. Such deductions are a usual practice in many countries. Taking into account that paid provision of services in these sectors is extremely important for development of the country, is widely spread in Kyrgyzstan and is supposed to spread further, one may come to the conclusion, that, first, due to lack of such deductions these services appeared to be more expensive for citizens; second, lack of such deductions does not facilitate appropriate accounting and payment of taxes in these sufficiently large sectors of economy. On the other hand, wages and other money payments to the persons in the armed forces, militia and representatives of other law enforcement structures have been completely exempt from taxation.
 
There are significant differences in administration of personal income tax. It is much better to administer the tax withheld at the source of payment, than the one collected directly by the tax bodies during filing of declaration by taxpayers. It is partly connected with the circumstance, that many categories of taxpayers have the right not to file and have no incentives (for example, getting some deductions) to file a declaration of incomes on the results of the year. So, the persons, who declare their real incomes, have no advantages over those, who gain incomes from the shadow activity.
 

1.5. Excise taxes and customs payments

A serious problem of excise taxes is mass evasion from its payment in the form of illegal production of excisable goods on the territory of the Republic and especially smuggling from the neighboring countries. In these conditions economic measures, aimed at expansion of the taxable base through reduction of rates were ineffective so far. This was confirmed by excise tax reduction for alcohol in 2001, which resulted in significant fall down of tax receipts. Sharp improvement in administration of this tax is absolutely necessary.
 
Last years the customs duties are mainly considered as a means of imports regulation and protection of domestic producers of goods. The fiscal function of customs duties acquired a secondary importance.
 

1.6. Land tax

Land tax is the only tax, which is paid by agricultural producers. It is a common knowledge that its rates are very low. The receipts of this tax account for only 2% of the budget revenues, while the share of agriculture is 35% of GDP. According to the data of the survey of agricultural enterprises, which was carried out in 2002 by CASE-Kyrgyzstan jointly with the University of Wisconsin-Madison (USA) and the Center for Land and Agrarian Reform of the Ministry of Agriculture, Water Resources and Processing Industry of the KR[7], the average payments of land tax account for only 1.6% of the gross income of agricultural enterprises, this being significantly less than taxes paid by enterprises of other branches of economy. According to the data of this research, if income of peasants would have been taxed at the usual income tax scale, then, all allowed deductions and the amount and type of agricultural land per one worker as an average being taken into account, the amount of tax liability per one hectare would have appeared to be 52% more, than the rate of the current land tax. As land tax is almost entirely transferred to the budget of aiyl okmotu, such low rates of this tax sharply limit the volume of services provided at this level of government.
 
 
Indicator
Source
Measurement units
Value
Annual net income from the main agricultural activity[8]
BASIS/CASE-Kyrgyzstan Research Report (see footnote 8)
Soms per worker
18600
Allowed deductions - total
 
Soms a year
10200
Standard deduction (650 soms a month)
The Tax Code, Article 76
Soms a year
7800
Deductions for children, mothers with many children and other deductions
The Tax Code, Article 76;
Demographic statistics of the NSC
Soms a year
2400
Aggregate annual taxable income
Annual net income allowed deductions
Soms per worker
8400
Personal income tax liabilities (at 10 % rate)
The Tax Code, Article 76
Soms per worker
840
Land area per one worker
BASIS/CASE-Kyrgyzstan Research Report
Hectares
4.1
Equivalent land tax rate
Personal income tax liabilities/ Land area
Soms/hectares
205
Actual average land tax rate (taking into account the structure of agricultural land by type)
Law On the Base Rates of the Unified Agricultural Tax; BASIS/CASE-Kyrgyzstan Research Report
Soms/hectares
135
Difference in land tax and personal income tax rates
(Equivalent rate/actual rate - 1) * 100%
 
52%
 

1.7. Deductions of funds for prevention and liquidation of emergency situations, road tax, deductions for development and reproduction of mineral and raw materials base

All these taxes were brought into action prior to the Tax Code. They were supposed to be revoked with adoption of the Tax Code, but are still in force, because there is no possibility so far to substitute the revenues from these taxes by receipts from other sources. These taxes refer to cascade ones, which is the reason for the desired revocation. Unfortunately, the need of these types of receipts will hardly decrease. Evidently, real prerequisites of their revocation will arise, if the tax base is significantly expanded (at the expense of enterprises coming out of the shadow economy) and administration of the main taxes, VAT in particular, is improved.
 

1.8. Local taxes and fees

16 local taxes and fees are valid in Kyrgyzstan. Of them only sales tax and, to a lesser degree, tax payable by vehicle owners generate revenues for local budgets; the share of the rest taxes in the budget is not actually noticeable. At the same time both the government and taxpayers incur expenses connected with their administration.
 

1.9. Taxation of small businesses and taxation on the basis of compulsory patenting

This tax was imposed recently, at the end of 2001. Revenues from the tax to the budget are small so far. This may mean that simplifications stipulated by this tax are not particularly attractive for small businesses. If the existing plans of the Tax Law amendment (revocation of deductions for prevention and liquidation of emergency situations, road tax, sales tax, reduction of profits tax rates) are implemented, attractiveness of the unified tax for small businesses imposed to replace the mentioned taxes will decrease. Besides, even if this tax were very profitable for taxpayers, the existing threshold of a 3 million soms a year (or any other threshold), above which taxation treatment markedly changes, would have created barriers for the natural growth of small enterprises and for their turning into medium-size and large enterprises.
 
Introduction of taxation on the basis of compulsory patenting reflects the fact that in a number of sectors of economy it is still impossible to insure accounting and administration necessary for collection of taxes according to the usual scheme. Unlike the unified tax for small business subjects, this form of tax payments is rather popular among taxpayers. This may be connected with considerable simplification of accounting and with the cost of patents, which is much smaller than the amounts payable in the form of the usual taxes. Low cost of patents provides for a more favorable situation of economic agents in those sectors, where patenting was introduced, compared to the normal sectors. The existence of legal entities and natural persons paying taxes on a patent basis can cause difficulties for collection of other taxes. For example, if an enterprise, which makes payments on a patent basis, is in the middle of the technological chain, its customers will be deprived of the possibility to require VAT for credit. Besides, there is the possibility of understatement of the taxable base on profits tax as a result of agreements made with natural persons, who carry on their activity on the patent basis, and who do not keep accounting of incomes and expenditures.
 

1.10. Deductions to the Social Fund

Though this type of compulsory payments is not a tax, it does not actually differ from other taxes, as taxpayers see it. Besides, the Social Fund regularly receives subsidies from the Republican Budget, so actually deductions to the Social Fund are closely integrated in the tax system of the country.
 
An expensive pension system of the country insures a sufficiently high level of deductions to the Social Fund. In 2000-2002 the rate of summary deductions of employers and employees decreased from 38% to 33% of the amount of assessed wages; nevertheless, 33% is a high rate. The existence of this compulsory payment is one of the most important reasons for double accounting at many enterprises and understatement of the official amount of wages.
 
We would like to note that, like in the case of personal income tax, deductions under a regular scheme are made by small number of taxpayers. Peasants pay deductions to the Social Fund in the amount equal to land tax, which is much smaller than 33% of the cost of their labor force. Persons working on a patent basis must pay amounts, which do not exceed 33% of the cost of a patent. In view of the above mentioned small cost of patents, it is extremely profitable. Nevertheless, due to shortcomings in administration and insufficient understanding by many payers of connection between payment of these deductions and possibilities of their medical servicing and pension security, even these small payments are collected in the amount, which is far from being full.
 

[4] Preliminary data for 12 months.
[5] It should be noted that VAT represented in the initial wording of the Tax Code in 1996 corresponded to the international practice to a greater extent, than the current VAT, which is the result of numerous amendments made to the Tax Code.
[6] According to the survey of businessmen, which was carried out in 2002 with support of the TACIS Kyrgyzstan SME Program, the majority of the respondents agreed to pay this tax at the rate of 10%.
[7] See M. Childress, R. Mogilevsky, A. Kalpakova, K. Kadyrov (2002) Resources and profitability of agricultural enterprises in Kyrgyzstan. BASIS/CASE-Kyrgyzstan Research Report No. 1/2002. Bishkek.
[8] As in the case of personal income tax payers, income from the plot adjoining the house is not considered to be taxed.