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Delayed Revolution
Alexei Mikhailov, Mikhail Zadornov
Vyedomosti,
July 19, 2000

One of the principle changes in the tax system, which will be discussed by the Duma today, concerns the transition in VAT payments with CIS countries to the principle "country of destination". What does this mean for Russia?

First, this implies a preservation and expansion of CIS markets. Russian goods which are often taxed in both Russia and a CIS country (i.e. are taxed twice) lose in the competition. Our exports accounted for 19.5% of the total volume of exports in 1997. This figure fell to 14.9% in 1999 (cf., 192.% in 1998). At the share of imports from CIS countries in the total volume of imports grew from 26.8% to 27.6% (cf. 25.9% in 1998). Thus Russia paid dearly for its adherence to dubious principles. How can this problem can be resolved? There are two solutions.

The government proposes the signing of bilateral treaties with each CIS country on indirect taxation issues and the transition to the principle "country of destination" individually with each state as soon as these treaties are ratified, rather than a simultaneous transition with all the CIS countries.

This approach has serious drawbacks.

Firstly, the negotiation process on this issue has been protracted for many years already and it is highly unlikely that it will finish soon (especially with some of the countries).

Secondly, it is absolutely pointless to set different regimes for different CIS countries.

For example, we transfer to the "country of destination" principle with one of the countries, but retain the previous procedure with another country. This has a predictable result: Russia's exports to the second country will be re-routed through the first country; however, Russia will not tax the imports from the second country.

The position of the government on the "country of destination" issue is not consistent. For example, the draft of the Tax Code submitted by the government and adopted by the State Duma at its first reading in 1998 envisaged an unconditional transition to the principle "country of destination" with all CIS countries.

The motivation of opponents to the principle "country of destination" is clear.

In addition to certain efforts required to consolidate tax control and thereby prevent false exports, the spheres of influence of some federal departments will be reduced. For example, the Ministry of Taxes and Duties will lose a part of the financial flows that it currently controls, as the new procedure stipulates that the State Customs Committee with be responsible for this control.

An alternative and, we should add, more radical solution of the problem, was offered by the Budget Committee of the State Duma.

This approach envisages the establishment of the "country of destination" principle in the law "On VAT" and its simultaneous introduction for all the CIS countries. To protect budget revenues, it proposed excluding oil and natural gas from this regime (i.e. they should be taxed in line with the present procedure).

Excluding oil and gas, Russia's trade balance with the CIS countries for the past few years has been negative. Consequently, the transition to an

internationally accepted principle of accepting VAT will yield additional revenues to the Russian budget, amounting to about $400 mln.

Moreover, here we did not consider the impact of the increase in the export potential of the domestic industry. For example, finance also reveals the advantages of the radical option.

To provide normal conditions for the transition to a new procedure of VAT collection, the terms for introducing this norm are set, beginning form July 1, 2001. In other words, the government will have a year to prepare for the new conditions of work and conduct, if necessary, negotiations with the governments of the CIS countries.

If this proposal is not accepted, what will be the essential changes in the law "On VAT"?

Now it is difficult to say anything about any reduction in the tax burden with regards the VAT, as no calculations have been provided here.

This also applies to a reduction in the list of tax concessions. Here decisions were as a rule taken with eyes closed. We can only note here that the volume of the article on tax concessions has increased considerably.

Also it remains unclear whether such concessions (especially on VAT) are necessary for tax reform and why the wording of the present concessions was changed substantially. For example, today medical goods are exempted from VAT: the new law devotes almost a page to this concession and devotes a separate line to lens and glasses frames.

It will become significantly harder to apply the law, as it is written in an unusual form for Russian laws. Here too state goals are not met.

If we adhere to the aforementioned criteria, we will see that the reform of VAT already occurred at the end of 1999, when the Duma made changes to the present law "On VAT".

Those changes were more radical and obvious; however, the present version of the chapter "VAT" contains only one "revolutionary" norm - transition to the "country of destination" principle in trade with the CIS countries.

And another "revolutionary" change concerns the inclusion of individual entrepreneurs in the group of VAT payers. Now they will all have to keep

accounts books to obtain their annual exemption from the tax payment. This new provision is dubious, as an additional burden on all entrepreneurs has been introduced to prevent tax evasion on large turnover by some entrepreneurs.

If the government insists on suspending the transition to the "country of destination" principle in trade with the CIS countries for the future, then the rationality of the adoption of this chapter will be cast in doubt.

ei Stepashin on Grigory Yavlinsky's proposals