Divide and rule

-- 16 December 2009 --
TEXT: E. Istomina
PHOTO: NatalyArt - Fotolia.com


In modern Russia the change in the rates of tax has usually meant tax cuts. The rationale is not the so-called supply-side principle, the idea that high rates discourage people from working or investing.

Nor is taxation perceived as inherently evil: ‘When a man has accumulated a sum of money within the law,’ John D. Rockefeller said, ‘the people no longer have any right to share in the earnings.’ The reason is the ineptitude of taxmen and, hence, the grudging agreement that tax is tolerable if it is kept at a low rate.

In 2010 payroll duties will go up. It will, for many companies, double the burden of taxation. To secure the loyalty of corporations, who must withhold the levy and pay it to the treasury, the tax service intends to put more pressure - and use the threat of criminal prosecution too - on employees.

The Councillor of the Federal Tax Service Kirill Kotov in an interview to RIA Novosti said that in 2010 “payroll committees” - whose main objective is to identify employers who fail to report the salaries of their workers - would become more active. He also said that ‘employees who receive their salary ‘in envelopes’ risk more than the company itself’ and that they, not the company, must be responsible for fraud.


Easy cash

Raising levies on salary is tempting. The payroll taxes, it is often argued, have ‘probably done more to increase the tax collecting power of central governments than any other tax measure of any time in history.’ With the pension fund confronting a deficit of $39 billion, the tax hike is not surprising.

What is striking is that the extra burden will be borne by the poor: in 2010 the below-the-average wages will be taxed two and a half times harder than in 2009, while high-earners remain untouched until 2011. In a world dominated by the adepts of progressive taxation, this is demonstratively unfair.

It is provocative too. The system, which imposes a duty on the employer to deduct tax when making a payment to an employee, is strong in theory, yet in reality is only as good as the information received by the tax collectors. It hiccups when companies and their workers do not tell tales about one another. And Russians don’t. It is surprising how many Russian people consider turning someone in to the authorities repulsive.

Russia has one of the lowest levels of taxation among industrial countries not because of the generosity of the government, but because of its weakness. Bigger tax would probably be uncollectible. Cut tax rates, they say, and fewer people will conceal their income, so more tax will eventually be paid. Whatever the merits of the argument – and some data speak in its favour - it carried the day in 2000 when the top rate was cut from a reasonable 30% to an incredible 13%.

With the economy in the doldrums business feels weak, yet the state is strong. Today it is eager to raise rates and collect more tax, something it could not do nine years ago.


Company as a criminal organisation

Moralists would say that the timing is wrong. The unemployment rate has surged to over 10 per cent. Businesses are being wound up. People tend to associate their own good more closely with the benefit of their employer and more are predisposed to receive their salaries ‘in envelopes’, unaccounted and untaxed.

Here, the taxmen say, a company becomes a criminal group. What Mr Kotov is saying, essentially, is that the authorities will treat companies they suspect of evading payroll tax as a bunch of culprits. And that includes the so-called ‘prisoner’s dilemma’: if others confess and you don’t, you will be punished severely; if you confess too, you will get off lightly. Not knowing what others are going to say is agonising and, when the gap between alternative outcomes is big enough, most people are likely to give up.

The law on plea bargains that came into force this summer has proved to be effective. It has shown that businessmen, let alone staff, are not fighters. And so has the practice of the “payroll committees”, a controversial institution that does not, strictly speaking, have jurisdiction over taxpayers. Yet, when called to its meetings, few dare not to come and fewer risk not raising the payroll to the suggested level.

The righteous disdain for taxation is clearly a part of a broader backlash against the government’s unwillingness to support business in the times of troubles. What people see is just a greedy hand stretching out for something it is not entitled to. Will business sabotage the tax collection as it did nine years ago? If not, then the time of low taxation is coming to an end.




TEXT: Sergei Zhestkov, partner, Baker & McKenzie

I do not think it is fully correct to say that ‘employees who receive their salary ‘in envelopes’ risk more than the company itself’. They both take serious risks, but in different ways.

By paying salaries in envelopes a company commits a series of violations: evasion of social taxes and duties, failure to act as a tax agent and etc which can lead to fines on the company (up to 40% of the amount of income in an envelope) and criminal charges against the management (imprisonment of up to 6 years).

Employees must pay tax from all sources, and money in an envelope is not an exception. In other words, it is their obligation to report the income. If they don’t do so, they risk being penalised and face criminal prosecution (imprisonment of up to 3 years). Where an employee fails to submit a tax return, the fine imposed is even more severe than that imposed on companies. The penalty can exceed the amount of tax: i.e. 5% of the tax due per month during the first six months and 10% per month thereafter. It is easy to see, then, that failure to file a tax return for just a first year would lead to a penalty of 90% of the tax. If, however, the taxpayer submitted the return but understated his income, the penalty would be capped by 40%, which is still a lot.

Note that company management or employees can be prosecuted even if they subsequently pay the outstanding tax and penalties. By the end of 2003 the Criminal Code of Russia contained an ‘active repentance’ clause and those who paid taxes and fines and cooperated with investigators - repented of their crime - could avoid criminal prosecution. Although there is some demand to reinstate this provision, it is not yet reinstated.

In practical terms, in order to collect taxes from individuals effectively, tax authorities should change the way they work. At the moment their main target is companies, and this consumes nearly all their resources. Companies are easier to deal with: taxmen do not need the court’s decision to collect taxes and late payment interest. It is different with individuals. If, however, there was both political will and resources, the threat to individuals would become absolutely real.



Tax collectors get more inventive and aggressive.


Illuminating. Thank you very much.