The target for Kazakhstan is 30th place among the 190 economies analyzed by the World Bank. The ranking depends on multiple indicators, starting from the “ease of starting business” to “paying taxes” and “enforcing contracts”. In 2017, the Doing Business Guide ranked Kazakhstan 35th. While Kazakhstan is high on some indicators (e.g. 3rd for “enforcing contracts”), others are much lower.
The “Paying Taxes” indicator (just one of the indicators) is monitored by the Ministries of Finance and National Economy. In 2016, Kazakhstan was in 18th place, but dropped to 60th in 2017 following the introduction of a new measure in the study. On a like for like basis in 2016 and 2017, Kazakhstan’s ranking for paying taxes in 2016 was restated as 57th (not 18th).
What was the reason for the sharp drop and how can it be improved?
Unavailability of a VAT refund for the case-study company (not previously taken into account by the study) was the main cause. The State Revenues Committee of the Ministry of Finance (the SRC) proposes that the introduction of special VAT accounts would simplify the VAT refund procedure and improve Kazakhstan’s rating.
How the Paying Taxes ranking is determined
Paying Taxes measures all mandatory taxes and contributions paid by a company in a given year. It also measures the administrative burden of filing and paying taxes and complying with post-filing processes. Taxes and contributions include corporate income tax, social contributions and labor taxes, property taxes, other minor taxes and obligatory payments.
The World Bank analyzes a medium-sized case study company applying a number of assumptions:
· It operates in the largest city in the country (i.e. Almaty for Kazakhstan);
· It produces ceramic flowerpots and sells them at retail outlet;
· All transactions are domestic (neither imports nor exports);
· The company does not qualify for any special tax benefits or investment incentives;
· The company is 100% domestically and privately owned.
Effectively the study considers the general taxation regime. It ignores any benefits for taxpayers engaged in international transactions.
In addition, the sub-indicators are calculated by reference to a particular calendar year, i.e., data in Paying Taxes 2017 relates to the year ended 31 December 2015. Effectively any tax reform has impact only two years after its implementation.
Nonetheless, this should not discourage legislative improvement but foster quicker actions. The World Bank website also provides a tool to assess the effect of any amendments to a country’s indicators in advance.
A crucial change was introduced in 2016. Previously Paying Taxes measured the total tax rate, the number of tax payments and the time to comply with major taxes. In 2016, Paying Taxes was extended to include processes after a tax return has been filed.
The new post-filing index measures two processes (after tax filing): claiming a VAT refund and correcting an error in a corporate income tax (CIT) return. The new post-filing index is equally weighted with the three other sub-indicators.
The World Bank intends the post-filing data to help governments understand the impact that such processes have on businesses. It encourages reform of such procedures to make it easier for companies to do business. More efficient tax systems are good for businesses, which in turn helps to promote economic growth and investment.
In Paying Taxes 2017, Kazakhstan performed well on all sub-indicators, except the “post-filing index”. The country’s total tax rate was lower than the world average and the average for OECD and Central Asia countries. Excluding the “post-filing” sub-indicator, Kazakhstan was 18th among 190 economies.
The sharp drop in the country’s ranking is largely caused by unavailability of a VAT refund for the case-study company. Correction of an error in CIT returns is neither overly problematic nor time-consuming, and it does not necessarily trigger a full-scale tax audit.
Although there is a system of VAT refunds in Kazakhstan, it is not available for all categories of taxpayers engaged only in domestic transactions. The case-study company is not a subsoil user, an exporter or an importer.
There is talk about ‘universal’ VAT refunds, but to be introduced only in 2022. Thus, the post-filing index would not improve until 2024.
Special VAT accounts & their impact
According to a recent Ministry of Finance press release, introduction of special VAT accounts is a tool to automate the monitoring of transactions and allow VAT refunds for all taxpayers.
The key aspect of the proposed mechanism for VAT collection is that VAT payments between businesses are made only through special VAT accounts. On paying a supplier, a purchaser transfers the VAT to the supplier’s special VAT account administrated by the state. The purchaser may then claim the VAT for offset.
The use of funds from VAT accounts is limited. The funds can be transferred only to VAT accounts of other taxpayers and to the state.
The SRC believes introduction of VAT accounts will quicken the process of VAT refunds under a simplified procedure for all taxpayers and be advantageous for the state and overall economy by virtue of:
· increased tax collection due to reduction of the shadow economy;
· increased transparency in the VAT collection due to the tax authorities’ capability to control VAT movements in real time.
The aims of the Ministry of Finance are clear and understandable. However, the necessity for VAT accounts needs more discussion.
Certain aspects of the introduction of VAT accounts may impede Kazakhstan business and development of the economy:
· Conflict between cash and accrual method
Output VAT is assessed based on the accrual method while the cash method applies for offset of input VAT. Consequently, VAT payable is the difference between output VAT accrued on invoices to purchasers (regardless of whether cash was collected) and input VAT allowed for offset based on payments to the special VAT account of a supplier.
As a result of the impossibility of input VAT being available for offset without prior payment to VAT accounts, VAT payable may be assessed on the full value of goods or services (as opposed to ‘added value’). While this is a temporary difference, where the state is collecting VAT in advance, the cash flow impact is likely to be significant.
In Azerbaijan, advance payments (received prior to supply of goods or services) are VAT-able events. If this practice is adopted in Kazakhstan, other adverse effects would be compounded, especially for long-term (infrastructure) projects.
· Restriction on the use of VAT received from purchasers within a tax period
Since purchasers pay VAT directly to suppliers’ VAT accounts, the suppliers are restricted in use of such funds. This reduces taxpayers’ liquidity.
· Time and cost for the administration of VAT accounts
Taxpayers need to open an additional account within the state treasury, control it and adapt accounting information systems. The tax authorities may also have to bear an additional administrative burden.
These issues may result in higher prices of goods and services, as well as persistence of the shadow economy, as fraudulent taxpayers could resort to ‘double accounting’ and cash settlements.
International practice in this regard is relevant. In Bulgaria, VAT accounts were abolished prior to its accession to the European Union (EU), as they did not meet the VAT norms of EU. In Russia, special VAT accounts were considered but not introduced for reasons including those mentioned above. Currently, special VAT accounts are used only in Azerbaijan. Poland, however, will introduce them imminently on a voluntary basis for the buyers, which could result in challenges for the suppliers similar to the described above.
Overall, in our view, introduction of special VAT accounts does not necessarily ensure automatic VAT refunds for all taxpayers in practice. In Azerbaijan, refunds are rare.
Ultimately, the Paying Taxes ranking is based on actual (not theoretical) availability of and time required for VAT refunds. Taxpayers may in fact face a higher administration burden.
Paying Taxes 2017 shows that economies in Europe and Central Asia perform well in regard to VAT refunds with an average refund processing time of 16 weeks. Serbia, Moldova and the Russian Federation have the best results on the “post-filing index” among the 19 economies in the Europe and Central Asia regional ranking. Kazakhstan is one of seven economies in the regional assessment that do not provide VAT refund for the case-study entity.
VAT refunds are simplest in OECD economies: a VAT refund is made within 14.4 weeks on average. This is attributable to their commitment to apply the OECD International VAT Guidelines and the mandatory 2010 EU Directives on VAT implementation. The study also indicates that electronic services support an efficient VAT refund process. Electronic services minimises administrative costs and ‘trapped cash’.
The Paying Taxes study plays a key role in highlighting which processes and practices are effective and those which are not. It encourages governments to change and develop their processes accordingly. Kazakhstan’s post-filing index when benchmarked against other countries is low and makes clear the necessity to introduce effective VAT refund procedures for all categories of taxpayers. We believe the universal VAT refund should be introduced earlier than planned. After all, availability of VAT refunds for only limited categories of taxpayers discourages development of the domestic economy and its diversification.
Aliya Utegaliyeva, PwC Kazakhstan, Tax Director
Marzhan Surabaldinova, PwC Kazakhstan, Senior Tax Consultant