A new sales tax to deteriorate the business environment

On November 21, 2014, the State Duma adopted in the third reading amendments to the Tax Code, which allow a sales tax to be introduced in the cities of federal importance. The size of the sales tax will be pegged to the value of the sales business patent. Moscow entrepreneurs will have an opportunity to test in practice the new amendments effective fr om July 1, 2015.

According to the authors of the amendments, the introduction of the new sales tax entails no fiscal burden and tax burden upon entrepreneurs. It can be explained by the fact that in case of individual entrepreneurs most of which pay taxes under a simplified tax system (STS), tax contributions are reduced by the value of sales tax. In case of large retailers who are subject to the general taxation system, the amount of profit tax will be reduced by the value of the same sales tax.

In theory, neither small-sized traders, nor large retailers will see any changes.

Let's start from individual entrepreneurs and entrepreneurship patents to which the new sales tax is supposed to be pegged. The truth is that the foregoing patents are not favored by entrepreneurs in Moscow – only 8% of individual entrepreneurs are holding such patents. It is well known that the patent replaces a series of taxes, namely personal income tax, personal property tax, VAT. The patent system provides for a unified tax at a rate of 6% of the potential income which is regulated by a regional legislation. However, individual entrepreneurs who are subject to the patent system of taxation continue paying tax contributions whereby the former is so unfavorable among businessmen.

A different story is the simplified tax system whereby individual entrepreneurs pay to the budget a tax of either 6% of their income, or 15% of the difference between income and expenditure, while insurance contributions may be deducted from the tax amount or the tax base. This is beneficial for entrepreneurs rather than local budgets, because of shortfall of some taxes.

Theoretically, the new sales tax must not exceed the patent value and the tax paid under the simplified tax system. This is why the initiators of the amendment to the Tax Code wouldn't recognize the fiscal nature of the sale tax. However, there is a small detail which is missing here. The sale tax is pegged to the sales floor space rather than entrepreneur's profit. It appears that if the sales floor space is way beyond 50 square meters, the sales tax may be far bigger than taxes paid under the simplified system. Take for example a sales floor space of 150 square meters with a monthly profit of Rb 100,000. Entrepreneurs would pay Rb 15,000 monthly under the simplified tax system, whereas they would have to pay Rb 30,000 upon the introduction of the sales tax .

Entrepreneurs having far less than 50 square meters of sales floor space will encounter problems. For example, having a sales floor space of 20 square meters, businessmen will have to pay Rb 150,000 (the cost of the patent to which the sales tax is pegged) annually irrespective of the income amount. At the same time, entrepreneurs having, say, 52 square meters of sales floor space would pay Rb 123,000 rather than Rb 150,000, because the law stipulates that if a sales floor space is more than 50 square meters, payments must be calculated by multiplying the sales floor space by the sales tax rate (Rb 2400 annually).

The authors of the amendments expect the introduction of the sales tax to generate extra Rb 3bn revenues to the Moscow budget. However, entrepreneurs believe that the figure is underestimated. For instance, according to the estimates of the Pillar of Russia, all-Russia SME non-government organization, Moscow budget revenues may total near Rb 8,5bn. The figure is presumably underestimated because during the feasibility study of the introduction of the sales tax the authors failed to consider the difference in sales floor spaces.

There will be no problems if the profit tax paid by retailers to the budget of a constituent territory of Russia is far beyond the amount of sales tax. However, sales revenue can be unstable, especially amid slumping sales due to weakening purchasing power in Russia in times of economic downturn. If one year the profit is higher than the sales tax, it doesn't mean that next year it will be sufficient to cover the given tax. Furthermore, the sales tax fails to consider investment activity which is subject to profit tax allowance.

The other side of the coin is that constituent territories of Russia may change the patent terms, namely tax rates as per 1 square meter. On the 19th of November the Moscow City Council made amendments to the Patent System of Taxation law, under which the cost of the patent depends on wh ere a store is located. In this case, entrepreneurs' concerns about growth in tax rates are reasonable and justified.

The introduction of the sales tax will make both individual entrepreneurs and large retailers opt between closing their sales areas or cutting investment or increasing retail prices, or going into a shadow economy. In any case, business activity will deteriorate as well as the tax base.

Yekaterina Pospelova, senior researcher

The comments are based on Yekaterina Pospelova's article published on Forbes.ru