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THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
MSME Tax Simplification –
Can it Tackle Informality?
Rajul Awasthi
Global Tax Simplification Team
Investment Climate Department
World Bank Group
Bogota, Colombia
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
2
Table of contents
1. Taxing MSMEs: Objectives and challenges
2. Policy options and administrative solutions
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Why focus on Small Business Taxation (SBT)?
Informality/ enterprise formalization and MSME growth
Diagnostic studies on formalization decisions → SBT as an
“entry point”
„A World View of Informality― (Schneider/Buehn/Montenegro 2010, p. 35)
3
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
But it is not just about registering informal businesses…
4
All countries
OECD
South Asia
Middle East & North Africa
Sub-Saharan Africa
East Asia & Pacific
Latin America & Caribbean
54.39
36.24
36.26
40.78
62.17
63.78
73.63
% of Firms expressing that a Typical Firm Reports less than 100% of Sales for Tax Purposes
Source: WB Enterprise Surveys 2007-2012
11.3
10.4
12.3
17.2
9.2
2.1
9.5
3 3 3
1
4
12
3
0
5
10
15
20
All countries East Asia &
Pacific
Eastern Europe
& Central Asia
Latin America &
Caribbean
Middle East &
North Africa
South Asia Sub-Saharan
Africa
Perc
enta
ge o
f bus
ines
ses
cons
ider
ing
the
issu
e to
be
the
grea
test
obs
tacl
e fo
r the
ir bu
sine
ss o
pera
tion
and
grow
th
0
2
4
6
8
10
12
14
Rank among 15 offered obstacles
Practices Informal Sector as the biggest obstacle Rank among obstacles
% of Firms expressing that Practices of the Informal Sector are the Biggest Obstacle
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Tax compliance costs are particularly significant for MSEs
Source: Tax Compliance Cost Surveys, WBG Investment Climate Dept, Selected Countries 2007-1011
0
2
4
6
8
10
12
14
16
18
20
0 - 5 5 - 13 13 - 24 24 - 41 41 - 66 66 - 104 104 - 161 161 - 246 246 - 374 374 - 567 567 - 855 855 - 1287
1287 - 1936
1936 - 2909
2909 - 4369
4369 - 6558
6558 - 9843
Ta
x c
om
pli
an
ce
co
sts
as
% o
f Tu
rno
ve
r
Turnover (USD '000)
South Africa
Ukraine
Uzbekistan
Armenia
India (Bihar)
Kenya
Georgia
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
When the “cost” of formalization is too high…
6
Businesses stay out of the
formal economy and can
get a ―free-ride‖
However: more risks, fewer
opportunities (esp. access
to finance)
Serious limitations to
business growth…
Spurs vicious cycle of
―squeezing‖ the few compliers => ticket price↗
Government is not reaching
revenue potential
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
7
The burden of administering small business?! Number of businesses in the small taxpayer category continues to grow,
highly dynamic segment
With increasing importance of service sector number of high income MSEs
on the rise
How to maximize efficiency in allocation of (scarce) resources?
Cost of administering small taxpayers might outweigh (short term)
revenues raised
But is MSME taxation just about revenue? – The Tax and Development
Agenda:
Creating a ―culture of taxation‖ and regularizing of the rule of law and
legitimacy of the state
Encourage taxpayers to hold government accountable
To promote MSME growth
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
8
There are actual benefits of MSME tax compliance
8
The risk of tax inspections, both formal and informal, is significantly
reduced: less likelihood of having to pay bribes to stay out of tax net
Gets rid of limitations to business growth…need to split firms and business
to stay below a threshold turnover, for example…
Greater opportunities to access formal (i.e., bank) finance
Opportunities to get government contracts – usually restricted to tax-
registered entities
In a VAT regime, small un-VAT-registered firms lose business opportunities
MSME taxation a good instrument to strengthen local government and
foster links between the local small business community and the local
government
In the medium/long run, higher tax revenues for the government
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
2. Policy options and administrative solutions:
What does this mean for Small Business Taxation?
9
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
2. What does this mean for Small Business Taxation?
The overall objective
is a SBT regime:
With minimal compliance
and administrative costs
Closely aligned to the
general tax regime
Ideally based on taxpayer
self-assessment and risk
based verification by the
tax-authority
But, it’s a balancing
act…
Simplicity of a blunt
turnover instrument vs.
fairness of simplifying
the general regime
Simplified instruments
are a second best
solution and come with
many trade-offs
10
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
A quick summary of pros and cons of taxing MSMEs differently
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Why not?
Can be a disincentive to
growth
Better to address
distortions directly
Threshold effects:
Inverted U shape of
effective rates
Distortions can become
a source of corruption
Why?
SMEs role in fostering
innovation and growth
Compensating for Market
failures/ financing constraint
Fixed cost component of tax
compliance + Cost of
administering small
contributors
Simplicity can help close
avenues for corruption
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
There are important regional differences
Region # Countries analyzed Countries operating
presumptive regimes
European Union 21 8
ECA region 19 16
The Americas 19 16
Africa 25 23
12
Transition countries: presumptive systems, primarily based on
turnover, in almost all countries
Latin America: primarily turnover / gross income based regimes for
micro and small businesses (in some countries limited to micro
businesses)
Africa: primarily turnover based presumptive systems for MSEs
below the VAT threshold
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
A wide range of tax treatment of MSMEs
From very simple patent taxes to full application of standard regime
From high VAT registration threshold to no threshold at all
From exemption of micro businesses from taxation to uniform treatment
of all MSEs.
From substituting income taxes only to covering social security
contributions (Brazil, Argentina, Uruguay)
Inclusion (Peru, Brazil) or exclusion (Argentina, Colombia) of small legal
entities from presumptive tax regimes?
But also on the administrative side:
From practically exempting most MSEs from tax audit (Korea,
Germany) to comprehensive audit coverage (some FSU countries)
13
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
The basic building blocks of MSME tax reform
14
MSME tax
reform
Taxpayer
outreach and
communications
Tax
administration
training
Segmentation
of taxpayers
Designing
simplified tax
regimes
Implementing
rules and
regulations
Monitoring
implementation
MSME
compliance
management
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
15
The devil is in the detail: SBT regime design options and challenges
What is “small”? No universal definition
How should the system be designed to avoid both over- and under-taxation of MSMEs?
What kind of safeguards are required to avoid abuse of system by larger businesses?
How to align the MSME regime with the standard tax regime?
System must be perceived as fair and transparent
How to provide incentives for keeping proper books and records?
What assistance to MSMEs is required to facilitate voluntary compliance with the regime?
How to reduce the administrative burden for the tax administration?
b. Single
(presumptive) tax
replacing all other
taxes
a. Presumptive tax
to replace income
tax (+VAT)
- Simplification of tax forms, filing and
payment process, alignment of payments
- Reduced direct tax rates
- VAT simplification for SMEs
2. Special regimes 1. Simplification of gen. regime
3. Combined
turnover and
indicator
based tax
2. Indicator
based
1. Turnover
based
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
A whole range of issues/approaches: Examples
Georgia
Bold reforms but high compliance burden and little compliance among micro and small businesses
Kyrgyz Republic, Kazakhstan:
Misaligned thresholds; downward migration, widespread abuse
Yemen
Record keeping based on taxpayer capacity. Tax payments for almost all taxpayers outside the LTO negotiated
Sierra Leone
One size fits all? ► inappropriate tax treatment + accounting requirements; Administration squeezing the wrong end
Lao PDR
No official records, skewed audit focus; win-win for
admin and tp
Vietnam
A hugely complex “simplified” system
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Strengthening MSME regimes: Our work to support reforms
Evaluating/strengthening policy options - Learning from (regional)
success stories and mistakes
Disaggregation SMEs and setting adequate thresholds between micro, small, medium, VAT
Determining profit margins and setting appropriate rates
Building-in linkages between taxation, licensing and business registration fees; Linking costs and benefits of formalization —offering carrots
Integrating small businesses into the reform process!
―Smart‖ enforcement and outreach - Supporting the establishment of
dedicated administrative approaches/structures for MSME taxation
Specialized MSME service and information program supporting self-
assessment of SME tax
Risk based MSME audit programs (designing fallback indicators, focus
on outliers)
Technology – potential and limitations 17
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Main Lessons Learned
Ministries of Finance generally are pushing MSME tax reforms much
more than tax administrations. But tax administration management
needs to be involved early in the reform process.
System abuse by larger businesses is major problem in many client
countries. Need policy and administrative countermeasures.
Lack of reliable data considerably complicates fallback indicator design.
More research and analysis early in the system design process
necessary.
Refining good practice examples is required: not only how have other
countries done it, but also why have they done it in a particular way.
Refining approach to estimating turnover based on indicators and profit
margins based on turnover
Developing guidelines for MSME tax accounting design
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THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Some examples
South Africa
Bihar
Georgia
Kyrgyz Republic
19
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
VAT is a Main Element of High Compliance Costs in South Africa
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Compliance costs as % of turnover for small businesses in
South Africa
Source: FIAS, Tax Compliance Burden for Small Businesses: A Survey of Tax
Practitioners in South Africa, 2007
0
1
2
3
4
5
6
0.15 0.3 0.65 3.5 10
Mid-point of turnover band (in R million)
Not VAT registered
VAT registered
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21
Bihar, India: Compliance cost burden is much higher for MSMEs
VAT cost as a percentage of turnover; Base- 1003
3.5%
0.8%
0.2%
Small sized
businesses
Medium sized
businesses
Large sized
businesses(Base; 621) (Base; 250) (Base; 124)
Cost of compliance, as a percentage of turnover significantly higher
for small businesses
1%
2%
3%
4%
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
22
The small taxpayers contribute less than 1%
81% of the dealers have turnover below Rs. 50 lakh, and contribute just
0.87 per cent of VAT collected (2007-08 data)
22
TurnoverNo. of
dealers
% of total
dealers
Tax
deposited
(Rs.crore)
% of total
tax
below 50 lakh 35058 81 30 0.87
50 lakh- 1 crore 2932 7 21 0.61
1-2 crore 2161 5 34 1.00
2-5 crore 1412 3 60 1.78
5-10 crore 555 1 59 1.73
above 10 crore 1009 2 3191 94.01
Total 43127 100 3394 100
Note that VAT payment of Rs. 62,500 implies a turnover of Rs. 50 lakh (applicable rate
12.5%, gross margin 10%)
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Multilateral Investment
Guarantee Agency
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Simplified regime for small taxpayers
Recommended lump-sum, flat tax payment:
Single slab of small taxpayers, defined as those with turnovers below Rs. 4 million
Lump sum tax payment – Rs. 10,000 per annum
Payment in one or two installments at the option of the taxpayer
No input tax credit allowed
Optional scheme
Implemented April 2011 (start of fiscal year)
Result: As of March 2012, 4580 new taxpayers registered and paid the due tax
*Assumptions: Margin 8%; tax rate from 4% - 12.5%
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
MSMEs in Georgia: 1st Reforms missed 80% of Georgian entrepreneurs
Significant improvements in 2005, but not for small firms
11%
17%
26%
16%
20%
8%
4%
15%
0%
5%
10%
15%
20%
25%
30%
small medium large total
Share of Firms Who Rated Tax Administration as a Major Obstacle to Their Businesses
Georgia 2005
Georgia 2008
(Source: Enterprise Survey 2008)
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THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Smaller Firms Pay Larger Portion of Their Revenues in Compliance Costs
12.2%
4.5%
2.1% 2.6%
2.3%
8.2%
0%
2%
4%
6%
8%
10%
12%
14%
0-30K 30K-60K 60K-100K 100K-200K 200K-500K Overall Average
To
t C
om
pl C
ost
as %
of
Rev
en
ue
Annual Tax Compliance Costs as Percent of Gross Annual Revenue, Average by Revenue Group
25
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
New taxation regimes
Micro Business - Turnover below 30,000 GEL
- Physical persons only
- No hired labor
- Certain activities excluded
- separate income derived from
each activity
Tax exempt
Small Business - Turnover between 30,000
and 100,000 GEL
- Physical person only
- No VAT registration
- Certain activities excluded
Turnover based presumptive
tax
3% rate if documented
expenses (excluding salaries)
equal to at least 60% of gross
income
5% in other cases
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THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Challenges
Encourage micro businesses to voluntarily register
Ensure proper turnover reporting of small businesses
Develop proper risk analysis system to detect major
underreporting by small businesses
Introduce fallback system for small businesses not keeping
any books and records
Develop very simple system for identification of micro
businesses which should move to the small business
category.
27
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Risk based audit selection for MSMEs – Example from the Kyrgyz Republic
Audit selection in the Kyrgyz Republic:
Discretionary decision making at local offices as a source of rent-seeking
Low capacity within Tax authority (IT and audit departments)
Limited data available and few tax offices connected to central server
Project developed risk criteria (and weights/scores) based on available
information and software for administration of audit process.
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66%
59%
10%
0%
10%
20%
30%
40%
50%
60%
70%
IEs SMCs Farmers
Reported audit coverage in the Kyrgyz Republic
Share of enterprises that were inspected by the tax committee in 2008
36%
32%
26% 26%
18%
1% 0% 0%
5%
10%
15%
20%
25%
30%
35%
40%
% of firms reported that informal payments are requested during tax inspections
Source: Enterprise Surveys: 2007-2010
Source: IFC SME
Survey 2008
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
RBA software provides web-based access to local tax offices through the STS web site
Main functions
Segment and sector based analysis of taxpayer risks
Generation of audit plan based on risk assessment (HQ)
Internal administration of audits Audit notice
Monitoring of audits
Depository of audit materials
Quality control and monitoring of staff
Fewer, more targeted and transparent audits
THE WORLD BANK World Bank Group
Multilateral Investment
Guarantee Agency
Thank you for your attention!
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