New and old taxes in Azerbaijan: How it all works?

Azerbaijani tax system has had to ‘digest’ as many as 201 tax code amendment just within 2 weeks – from December 16 till January 1. It turned out to be hard not only for the taxpayers, but also for the Tax Ministry itself.

In have an insight into what actually happened, it’s necessary first to explain what the tax system is and how it works.

Theory: what taxes are and how they work

The basic taxation principles, applied nowadays by nearly each and every state worldwide, were formed back in 1776 by Adam Smith. And throughout that period, there have been debates as to whether taxes are necessary or not, how important they are and whether it’s worth paying them.

[toggle title=”What are taxes”]Under the theory, tax is an individual, compulsory, non-refundable regular payments, levied by the authorized public institutions with the aim to meet the state’s financial resource needs. The latter doesn’t imply satisfaction of certain officials and employees’ needs, but rather those of the public.[/toggle]

The development of history made it clear that not all citizens can secure their own safety, pay for education and medical treatment, but the country’s condition largely depends on the well-being of all of its citizens, rather than on individual characters. Roughly speaking, tax is what we pay to the state for our protection against outer enemies and crime, for provision of access to healthcare and education.

Although, under a classical market theory, the state shouldn’t intervene in the sphere where the marker exists, but then a kind of ‘law of the jungle’ would have been in effect in the community and those, unable to earn enough money, would have roughly died from hunger and diseases.

Tax levy terms and procedure and defined in the Tax Code. The procedure is based on certain principles stipulated exactly in the Tax Code. In his book- ‘Wealth of Nations’, Adam Smith laid down the following 4 basic principles (canons) of taxation:

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• Principle (canon) of equality, which implies general levying and equal distribution of tax between the citizens in proportion to their incomes;List item 2
• Principle (canon) of certainty implies that a taxpayer should be certain of and know in advance the amount of tax and its time of payment;
• Principle (canon) of convenience implies that tax should be levied at a time and in a manner which is most convenient for the contributor to pay it;
• Principle (canon) of economy, that provides for reduction of tax collection expenses. In other words, expenses for collection of tax itself shouldn’t exceed certain rate of the income therefrom. According to some studies, 7% rate is regarded as normal.

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In the Azerbaijani Tax Code, the aforesaid principles are complemented with a couple of other ones:

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• [toggle title=”Principle of economic justification”]A tax can’t be imposed without substantiating why it is necessary: for example, excise duty on leather import has been introduced to facilitate domestic leather production in Azerbaijan.[/toggle]
• [toggle title=”Principle of non-obstruction of implementation of the rights and freedoms set forth in the Constitution.”]It implies that a tax shall, in no way, violate the citizens’ right to entrepreneurship, free movement etc. This is the very point that raises controversies. For example, 1% encashment tax for legal persons and self-employed persons actually obstructs free entrepreneurial activity, making one to keep all funds on the accounts, and it’s not the only tax of this kind. The government justifies it by the need to prevent profiteering and control over cash flows. However, this eventually results in weakening of the banking system and emergency of numerous legal but dubious ways for capital disinvestment. [/toggle]
• [toggle title=”Principle of one-time levy of the same tax.”]Principle of one-time levy of the same tax. КАТ It implies that an economic entity shouldn’t pay one and the same tax from the same source more than once. In this case, it’s the aforesaid 1% encashment tax that raises controversy, since if it’s simplified tax, then what about those entitied that already pay simplified tax at different rate, should they pay again?In other words, the Tax Ministry is entitled to demand property tax, income tax and VAT, but it’s not entitled to demand paying any of them twice, irrespective of its rate etc.[/toggle]
•  [toggle title=”Principle of non-discrimination on any grounds.”]It implies prohibition of discrimination in terms of religion, ethnicity, etc., as well as ownership and field of activity: taxes should be the same for everyone. Preferences may be given only in case of the need for economic stimulation.[/toggle]
• [toggle title=”Principle of preference of a taxpayer.”]It implies that any controversial matters should be resolved in favor of a taxpayer.[/toggle]

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Tax reforms and common sense

Now let’s get back to the new taxes. Roughly speaking, they are all intended to boost budget revenue in order to help the country overcome the crisis. Those are such new taxes, as a regular tax for wedding party singers and cleaners; excise duties on imports of cars and jewelry, and further comes a lengthy list of other novelties.

Do they meet the principles set forth in the Tax Code?

Not quite. For instance, one of the main problems of the implemented tax reform has been VAT deduction from services rendered by foreign companies that are not the tax agents (i.e. they don’t pay taxes in our country). The amendments have been in effect since January, and the banks and the Tax Ministry are still discussing the tax deduction mechanism: it has turned out that it’s impossible to distinguish goods from services by billing documents, because the Tax Ministry didn’t bother itself to introduce relevant amendments to the records maintenance procedure.

There have been certain problem with regard to internal services (that is, when a local branch of a foreign company is operating in Azerbaijan) and procurement of goods abroad. The latter should be actually exempt from VAT, but the banks started deciding it their own way: as a result, many determined payment for services, even those of the local UberTaxi, as a foreign resident’s services and deducted the taxes.

The Tax Ministry is now facing 2 tasks: urgent development of a mechanism and settlement of problems emerging due to the lack of clear mechanism.

The point is that for some reason the disputable issues are rarely resolved in the taxpayers’ favor, though this principle is laid down in the Tax Code.

Thus, some novelties and mechanism of their implementation violate the basic principles of taxation. To justify that, many refer to the fact that the priority is given to the tax functions, rather than to those very principles.

Azerbaijan-almost UK?

Taxes have two major functions: fiscal and economic. The fiscal one implies that very collection of funds for the budget to ensure any kind of protection of the population, that we’ve already mentioned above. Whereas the economic function of taxes means that through raising or lowering tax rates, we can make for the development of economy. For example, to complicate imports of certain goods, so that the local producers have more chances to succeed at the market. Or cut taxes for businessmen for a while, so that small business can ‘regain its feet’ and start bringing in profits. The theory, under which economic development can be stimulated through taxes, isn’t a new one and is widely adopted.

It is usually said that the lower is the tax burden, calculated as a ratio between total taxes paid and the average income across the country, the better the economy is developing. There is nothing Azerbaijan can boast of in this regard. Our tax burden makes 39% (in Georgia -16% and in Armenia – 20%). Though, we are a little bit ahead of the UK, with its 37%.

But there is one more important point. Tax burden in Kuwait makes 11%, but the investors don’t rush there anyway.

In Russia, the income tax is lower than in UK, but the capital so far has been flowing in the opposite direction.

Legal framework plays an important role here. The UK’s Tax Code comprises almost 15 thousand pages. Our tax officials can’t even imagine how incredible it’s system of ‘differentiation’ of various activities and rates is. Alhough the major part of this tome has been preserved since 18-19th centuries, but much has been introduced to it in the recent decades. And that’s because a lot of new fields of activity have emerged, which required new laws. So, the code has been reformed and all the details were thoroughly worked out.

As a result, the UK is nowadays one of the centers of global capital.

What has changed for enterprises?

Generally speaking, any tax reform is implemented to accomplish 2 major goals: to put the real processes into the legal framework and to promote investments and entrepreneurship.

Thus, some of the Azerbaijani Tax Ministry’s reforms transferred the real processes into the legal framework.

For example, the article on e-services, electronic consignment notes, has been introduced to the Tax Code. A provision on the need for inclusion of photograph has been added to Article 89.10 on property inventory, while earlier only the protocol and inventory were required.

Similar changes can be observed in respect of Article 90.3.4 on organization of bids. A paragraph on possibility to place Internet or social media ads has been introduced to it. Earlier, ads could be placed only with the registered media. Thus, the Ministry of Taxes has taken into account the development of technologies and modern realities.

Now, let’s touch upon the reforms. The Tax Code contained a list of enterprises that were not required to work with cash registers, for example, small hair salons. 29 types of activity have been removed from the list and only 5 are left there now. But even before that, due to the excessive ‘zeal’ of the Ministry officials, the entrepreneurs still used cash registers for accounting, being unaware of the allowances they were entitled for. So, nothing has changed for them.

It’s unclear, how the receipts for sewerage services are going to be produced (these enterprises are also removed from the list and they should have cash registers).

Another group of amendments has been introduced to the Tax Code to ease the large retail chains’ life. Retailers account for 80% of all tax payments. As early as since 2016, they have been seeking an opportunity to pay VAT only in respect of trade margin, rather than the total sum of value of the agricultural products (the latter and its production isn’t subject to VAT in Azerbaijan). This will allow to reduce the retail prices.

For this purpose, the Tax Ministry has eventually introduced to the Tax Code such concepts as agriculture, retail and wholesale trade, trade margin and transfer price. In other words, what actually existed has been now reflected in the Tax Code, because Azerbaijani tax system was too literally following a principle of universality of the tax system: a barber and a bank paying the same tax.

Strange amnesty

Being under the influence of some kind of ‘euphoria’ from tax reform, the government also announced a ‘tax amnesty’. But even here there was a misconception.

The so-called ‘amnesty’ didn’t even apply to the amount of tax itself, but rather to the interest accrued for non-payment and financial penalties, and that’s not in full. In reality, this is commonly referred to as debt relief. The Tax Ministry just ‘settled its matters’ with various state agencies (utility service providers, that owed substantial sums to the budget) and came to the initial reference point-writing off penalties and interest, leaving only the very sum.

Plenty of enterprises that are to be privatized this year have been put on the list. Apparently, this measure also aims to improve their condition, since idle plants that require considerable investments and, in addition, have huge tax arrears, are far from being an attractive object for privatization.

What will change for ordinary people?

With the aim to increase the volume of bank deposits and securities investments, the citizens have been exempt from dividends tax for the period of 7 years.

For implementation of the health insurance reform, the relevant agencies and state-run medical institutions have been exempt from income tax.

Earlier, the betting fans paid 10% of the winning amounts, whereas now they will pay 10% of winning with the deduction of the amount spent on it.

Import and sales of wheat, flour, as well as manufacturing and sales of bread, sales of poultry meat and bank toxic assets, have been also exempt from taxes. And all that is for the period of 3 years.

As for the singers and housemaids, whom many were so much concerned about, their lives should become easier to some extent: the Tax Ministry will no longer be ‘hunting’ them, but will just require them to make monthly payments to the budget. Depending on their activity (be it a shoemaker, a private driver, a photographer or a wedding party host) he/she will pay a corresponding monthly tax (from AZN5 to AZN60 depending on location and the type of activity). Though, they have been laid under the obligation to issue checks and receipts. I wonder, how a singer is supposed to issue a check for performance at a wedding party.
A non-existing market

As far as facilitation of the economy is concerned, the Tax Ministry proposed a number of rather peculiar measures. The Ministry started thinking of developing the local analogue of the ‘e-Wallet’ (digital wallet), which hasn’t been introduced in Azerbaijan so far, and imposed 10% tax on money translations from Azerbaijan to the foreign ‘e-wallets’. This measure apparently was supposed to stimulating an explosive development of ‘e-wallets’ in Azerbaijan, but it hasn’t been the case so far, as there isn’t anything that can develop due to the lack of market.

The Tax Ministry remembered about the car manufacturer too. As far as I remember, last year, even the Labor Ministry facilitated the expansion of output at the Azerbaijani NAZ Lifan car factory through the state orders. And the President also focused on them. However, it turned out that there wasn’t enough government support. For example, in 2016, the enterprise produced 270 cars as compared with 725 in 2015. Moreover, 140 out of the total 270 produced vehicles remained in stock.

But the Tax Ministry keeps its head up: it has raised excise duties on imported vehicles, though the excise duties on the import of key competitors to Naz Lifan products, the vehicles with engine capacity up to 2 liters, haven’t changed. Whereas the excise duties on the rest of products have been raised on average 2,25 times.

Interestingly, the excise duties on yachts, gold and diamonds, have doubled. However, in view of the population’s standard of living, there’s hardly anyone concerned about it.