Russia cuts taxes on income but leaves VAT untouched

-- December 15, 2008 --

Federal law N 224-FZ cuts taxes on incomes of companies and individuals. The amendments would have been met with a great enthusiasm by the business community just a few months ago, but today the measures introduced by the law are hardly sufficient.

The Russian Parliament (the Duma) adopted Federal law 'On Amendments to Part One, Part Two of the Tax Code of the Russian Federation and other Legislative Acts of the Russian Federation' in three hearings in one day. The law is presented as the major element of the 'anti-crisis package' meant to support business in difficult days.

The law cuts the rate of income tax on legal entities. From January 2009 the tax rate will be 20% instead of 24% in 2008, 2.5% will be paid to the Treasury with the remaining 17.5% contributing to the relevant regional budgets. The regions may at their discretion reduce their regional tax rates to 13.5 per cent. Therefore, in 2009 the effective tax rate will be 16% - 20% depending on the region.

The state should have done what it could to stimulate the activity of consumers

The regions may now reduce the rate of tax on companies and sole traders which selected the simplified system of taxation to 5% (as compared with the maximum of 15%). It is interesting that in the past the regions were allowed to reduce regional fraction of the tax. This brought into being so-called 'internal tax havens' where companies from all over the country registered affiliated structures in order to shift tax burden to the region with lower taxation. Today a regional company with tax on income of only 5% can be tempting enough to bring old tricks back to life.

The law sets accelerated depreciation of acquired assets. From January 1, 2009 assets with lifetime between 3 to 20 years can be depreciated for up to 30% of the total value in the tax period when the asset was acquired (in 2008 companies were allowed to deduct only 10% of the asset value).

Amount of interest that can be deducted from taxable income will be increased to 19% for the rouble loans (the Central Bank's rate multiplied by 1.5) as against 13.2% now and to 22% for loans nominated in the foreign currency (in 2008 - 15%). Raising the bar on the deductibility restriction, though, is seen as a temporary measure for the year 2009.

Some other restrictions on deductibility of expenses have been lifted. For instance, payments to educational institutions deductible for tax purposes will no longer be limited to programmes aimed at improving professional skills but will include fees to colleges and universities. The payments will not be taxed in the hands of respective individuals either. In other words they will be exempt from taxation both at the corporate and personal level. Restriction on out-of-pocket expenses has been raised for both domestic and international trips. Moreover, research and development expenditures will be deductible at 150 per cent of the actual cost (with certain restrictions established by the Government) regardless of whether the result has been utilised by the company or not. Such generosity is quite unusual.

Individuals will now be allowed to reduce their taxable income on costs and expenses entailed in constructing or buying new buildings or apartments for up to 2 million roubles (approximately $62,000). This is twice what was allowed for deduction from personal income before the new law came into force. This allowance can be applied to the income for the year 2008.

Alas, the law can miss the target. The state should have done what it could to stimulate the activity of consumers i.e. reducing taxation on consumption. However, indirect taxes (with the exception of export duty on oil and gas) were left untouched or even raised.

Long expected reduction of VAT has been postponed to better times. Indirect taxes compose the major part of the Federal Budget and the Parliament did not dare to part with a fraction of the most stable source of state revenues. Instead it adopted impressive income tax reductions as if it felt a hidden guilt for its own greediness clumsily masked as generosity.

For many Russian companies 2009 will be a way down the long and difficult road of dramatic reduction in revenues. Some may never come as far as calculating income tax to feel any gratitude.