22/22 Tax Policy

So-called 22/22 tax policy has been recently one of the key topics related to the reformation of the Russian tax system discussed among business representatives. This scheme involves reducing insurance contributions from the current 30% down to 22% while increasing VAT from 18 % to 22%.

Ekaterina Kalinkina
Head of Branch Office Intercomp Ryazan
This idea was officially voiced for the first time by Finance Minister Anton Siluanov in November 2016 at the Financial University Third International Forum. He also presented the specifics of this 22/22 scheme at the annual Russian Business Week of the Russian Union of Industrialists and Entrepreneurs (RSPP) in March 2017. The main objective intended by the Ministry of Finance is to increase growth rates in the economy by reducing the share of shadow revenues and leveling-off competitive conditions for business.

Possible consequences for companies after introduction of 22/22 tax scheme

The VAT rate currently applied in the Russian Federation is the lowest one in the country’s entire history.

Period VAT Applied based on
1992 28 % RSFSR Law No. 1992-1 On Value Added Tax dated December 06, 1991
1993-2003 20 % Russian Federation Law No. 3317-1 Amending the Tax System of Russia dated July 16, 1992
From 2004 to present 18% Federal Law No. 117-ФЗ Amending Part II of the Russian Tax Code and Other Legislative Acts of the Russian Federation, and Annulling Certain Legislative Acts of the Russian Federation dated July 07, 2003

VAT is currently one of the best administered taxes. All VAT payers, tax agents, entities which are not VAT payers but issue detailed tax invoices have been required since 2014 to submit tax returns electronically through an e-document operator (Federal Law No. 134-FZ Amending Certain Legislative Acts of the Russian Federation against Unlawful Financial Transactions dated June 28, 2013).

To audit VAT, tax authorities use the risk management system VAT Automated Control System. This tool ensures automatic collection of all information as recorded in purchase ledgers, sales ledgers, and ledgers of received and issued invoices in a single repository and also determines whether there are any discrepancies between the transactions in VAT returns prepared by taxpayers and the transactions in VAT returns prepared by counterparties. This system thus allows tax authorities to identify taxpayers evading VAT, fly-by-night companies, as well as recipients of unjustified tax benefits.

In view of the aforementioned VAT increase, some companies might be tempted to evade indirect taxation, but they might not go through with it given the high level of automation of VAT control. Moreover, according to estimates from the Ministry of Finance, the tax burden resulting from a 4% VAT increase and simultaneous reduction in insurance contributions by 8% should not be greater as only the tax levy structure will change.

VAT is an indirect tax so the effect of its increase will also make itself known indirectly. Although VAT is paid by end consumers as manufacturers (sellers) add VAT onto the cost of goods, for most companies, the current tax mechanism provides for a temporary diversion of funds as there is always a time gap between the payment of goods (work, services) to suppliers and the payment of sold goods (work performed, services rendered) by buyers. So, raising the VAT rate will increase the tax burden on companies, especially on those with a long production or sale process and with a high share of material costs. These companies will compensate their losses for temporary diversion of funds by either increasing their prices or decreasing their profits.

Who will be at an advantage?

The increase in tax burden will affect those companies that are not VAT payers or taxpayers that carry out operations which are not subject to VAT, i.e. primarily small businesses. For them, the cost of manufactured products (work performed, services rendered) will increase due to the VAT charged by suppliers and the fact that they cannot deduct it as their operations are not subject to VAT so they will also compensate their losses by either increasing their prices or decreasing their profits.

The companies that will gain from an increase in the current VAT rate are exporters charging 0% on sale as the VAT refundable from the budget will increase, while they will keep the same 0% rate. On the other hand, the tax burden will increase for importers due to the increase in VAT upon import of goods.

The simultaneous reduction in insurance contribution rate from 30% to 22% should be economically profitable for employers as well as an incentive for businesses to reduce the share of shadow wages. This change will be particularly profitable for companies with high wage costs. Companies paying so-called “gray” wages often pay greater profit tax (20%) as they cannot deduct their “gray” wage costs from their profit tax base, but they still “save” on insurance contributions which are not paid from “gray” salaries. The planned reduction in insurance contribution rate down to 22% is likely to make them think about the possibility of “whitewashing” their wage payments so that they can include them in their cost of goods (work, services) and deduct them from their profit tax base.

Foreseeable future

Although the 22/22 tax scheme proposed by the Ministry of Finance has its pros and cons for business, the government needs to consider all possible consequences before introducing it. Once this is done, it should take about 2-3 years for this policy to be put in place. But before doing so, appropriate compensatory measures should be developed for those sectors of the economy and those categories of consumers that will be most affected by this new tax policy. Anton Siluanov announced on May 22, 2017 that the government is still working out the possible consequences of this proposed policy. Another ratio is not excluded (the Ministry of Economic Development proposed a 21/21 ratio) or even rejection of the policy altogether could be considered if it is possible to achieve economic growth without it.