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. Last Updated: 07/27/2016

Duma Dilutes Cabinet's Tax Plans

The State Duma on Wednesday approved a watered-down version of government-sponsored proposals for dramatic new taxes on gasoline, alcohol and cigarettes, and the government responded by saying it was not enough and might now back away from its plans to cut other taxes.

Prime Minister Mikhail Kasyanov's government had been seeking a quintupling of the gasoline tax, a doubling of tobacco excises and hefty new taxes on alcohol.

The government says the gasoline, alcohol and cigarette taxes are needed to make up for revenue that would be lost to plans to slash other taxes. These include introducing a 13 percent flat income tax, reducing other payroll taxes, getting rid of "turnover taxes" that are assessed against a company's turnover as opposed to its profits and allowing businesses to write off expenses for advertising, staff training and entertaining.

The Duma did vote, 306 to 30, to raise some alcohol, tobacco and gas taxes. It approved a new 50 percent tax on tobacco, a 10 percent tax on beer, a 5 percent tax on wines and liquors and a threefold hike in the gasoline tax.

But Finance Minister Alexei Kudrin announced that this was not enough and added that in response "the government will most likely preserve the turnover taxes," even though it disapproves of them. The turnover taxes are particularly notorious because they now take 4 percent of revenues and so can easily take all of a company's profits.

The Duma also voted to cut taxes, including by lowering the 4 percent turnover taxes to 1 percent, and to abolish even the 1 percent tax by 2003. It also approved a government proposal to reduce natural gas export rates to 15 percent from 30 percent f handing the natural gas monopoly Gazprom a windfall at a time of record-high oil and gas prices. It did not discuss the proposed flat tax or the payroll tax cuts.

The tax changes would have to be approved in a third and final vote and then sent to the upper house of parliament, the Federation Council, and from there to President Vladimir Putin for final approval or veto. If passed, the new taxes would go into effect next year.

If they are struck down, then of course the government can start again, reintroducing its plan to the Duma.

Reform or Reshuffle?

The government argues that its tax plan would be good for business and the economy because it would lead to an end to the double bookkeeping and creative tax evasion so common in business.

Business leaders and analysts alike, however, are sharply divided on what would happen if the proposals were adopted.

To avoid the crushing national tax burden, almost all companies here use a "gray" payment system, whereby an employee is officially paid a fictionally low salary f based upon which the employer calculates and withholds income taxes and other payroll taxes. Since a worker's actual remuneration package is usually far higher, the scheme allows both parties to dodge taxes.

As a countermeasure, President Putin suggested introducing a flat 13 percent income tax to replace the three existing brackets f which now run between 12 percent and 30 percent f and reducing the payroll taxes to 30 percent from about 40 percent.

The government argues that such changes would give workers incentives to openly declare their income, businesses greater motivation to become more transparent, and tax authorities greater access to real cash flows.

But it remains far from clear if the road from gray to white will be so rosy.

As to the 13 percent flat tax, it is for the vast majority of the population a tax hike: Ninety percent of the population already falls into the lowest tax bracket of 12 percent.

As to cuts in other payroll taxes, it will still almost always be much cheaper for businesses to pay 40 percent on a fictionally low "gray" salary then to pay 30 percent of a true "white" salary.

"I'm afraid that chang ing to 30 percent will not be enough to interest employers in legalizing their payments - it's not enough to change the system," said Sergei Kouksa, a partner at PLB Personnel Law Bureau.

Kouksa said companies are also wary that if taxes are lowered and they show their real books, they will then be vulnerable if taxes are hiked back up again.

The proprietor of a small chain of laundromats in and around downtown Moscow agreed.

"Of course, I use two [books] and I'm not planning to stop f no matter what the Duma does. Today it's a flat tax and a lower payroll tax. Who knows what it will be tomorrow?" said Sergei, who employs a staff of about 60.

Gray Workers, Gray Rights

On the surface, the gray schemes are appealing to workers: They allow them to avoid income taxes and thus take home more pay.

But in fact, gray payment schemes also provide companies with an easy means to control their employees. If a company has a gray payment system, the employer can simply start paying a troublesome employee his or her "official" salary f the fictional one. The employee suddenly has no legal recourse.

Pavel Teplukhin, vice president of the Troika Dialog investment bank, said that under the flat tax employees would also have another incentive to declare their true incomes: "It will immediately give them access to personal loans that had previously been beyond their reach."

Peter Arnett, chairman of the European Business Tax Club's tax committee, co-chairman of the American Chamber of Commerce's tax committee and a tax partner at Ernst & Young, said that if the changes become law, it will clearly be a positive development for employees who fall into the highest, 30 percent tax bracket f those who make more than the ruble equivalent of $440 a month. Their personal tax burden will be significantly reduced.

The tax burden on employers would also be reduced, he said. "With employment costs down, employers will be more inclined to take on new employees and less inclined to use payroll tax evasion schemes."

"The major impact of the proposals," said Teplukhin, "is that companies that declare their real incomes will be able to go to banks with more working capital. Banks need to know a company's profits before disbursing loans, which is a real incentive for full disclosure.

"It certainly will generate higher income tax revenues for the government f that's for sure f as well as having a positive impact on the overall economy."

Arnett was slightly less optimistic on that point, saying simply that employers would have less incentive to mislead authorities.

"White" Companies Win

Of course, not every company uses gray payment schemes. The local Marriot hotel chain, which has three hotels with about 900 employees, says it does not.

"We operate under a white system, so, of course, we view the [government's tax] proposals as generally positive," said John Kellites, the chain's director of finance and administration. "No [payroll] reduction is going to bring us into the open f we're already in the open f so for us it's a non-issue.

"As far as the income tax cut is concerned, it doesn't help us f but it doesn't hurt us either," Kellites added. If the proposals do pass, he said Marriot would be more inclined to reinvest the money into benefits for existing employees, rather than taking on new staff.

Kellites and American Chamber of Commerce president Scott Blacklin agreed that it would take some time for the tax changes to take hold.

"People have to be sure that it's not just another ploy to lure them f and their real salaries f out into the open before reintroducing higher rates," Kellites said. "They're going in the right direction, but right now it's just a lot of conversation."

Blacklin concurred. "We've been disappointed too many times in the past," he said. "As far as investment is concerned, more work needs to be done."

Waiting for Windfalls

Both businessmen and tax analysts agreed on two key points:

?Should the government's proposals become law, they must remain in effect for at least a couple of business cycles before the government begins to lure both employers and employees out of the shadows and reap any sort of windfall.

?Corporate tax improvements f the new writeoffs for advertising, training and entertainment and the end of the turnover taxes f will have a more direct, positive impact on companies' bottom lines than either the flat income tax or the payroll tax cut.

"Corporate tax changes will have a greater impact, although many remain unresolved issues. For example, just what exactly is considered a deductible business expense is still under debate," Troika Dialog's Teplukhin said.

Blacklin said, "We're hoping for the corporate tax [changes] to go through, particularly the full deductibility of business expenses."

Companies want to see the corporate tax statutes, which should be considered by the Duma by the end of this year, brought in line with international standards. This would include the full deductibility of advertising expenses, training costs and travel expenses.

Experts do not view the current 35 percent profit tax as excessive. The problem, as Teplukhin sees it, is that with so many expenses not deductible, companies are taxed on artificially high profits f i.e. on "profits" that assume money spent on travel, training and advertising is actually still in the company's hands.