RUSSIA'S SINGLE-RATE TAX

NEW YORK (March 1, 2002 8:37 a.m. EST) - Once again, American taxpayers are struggling to complete their tax returns. They will pay accountants and attorneys about $140 billion this year to generate paperwork to accompany their checks to the IRS. The 46,900-page U.S. Tax Code governs the whole process, with enough loopholes to lasso a light breeze.

Too bad this isn't Russia. Since Jan. 1, 2001, Russians have enjoyed a 13 percent flat tax.

That's right. The once-Communist superpower now stands to the right of publisher Steve Forbes on taxes. The former GOP presidential contender staunchly advocates a 17 percent flat tax.

Sometimes philosophical seeds fall on interesting ground, Forbes says. After Marxism, which was the philosophical equivalent of the IRS code, something understandable has obvious appeal.

The old Russian system featured three income tax rates: 12 percent, 20 percent and 30 percent. The top rate kicked in at the ruble equivalent of $5,000 in taxable income. In contrast, the U.S. has six tax rates: 10 percent, 15 percent, 27 percent, 30 percent, 35 percent and 38.6 percent, the last of which takes hold at $307,500 for married couples filing jointly.

Russia's single-rate tax is reasonable and comprehensible. Most important, the Russian government no longer uses graduated tax brackets to punish those whose incomes improve. Americans should be so lucky.

After just one year, the results of this law already look positive. As Hoover Institution scholar Alvin Rabushka observes in a Feb. 21 analysis for www.russiaeconomy.org, the 13 percent flat tax has exceeded the expectations of the government in terms of revenue. For the vast majority of taxpayers, its implementation is simple, and no forms need to be filed. Adjusting for currency fluctuations, Rabushka adds, real ruble revenues increased about 28 percent.

This initiative is establishing the custom of paying taxes in Russia, senior Duma member Dr. Konstantin Remchukov told me over lunch last fall. It's greatly simplified everything. He says that three years ago, tax revenue equaled 9 percent to 10 percent of Russian GDP. By last November, that number had grown to 16 percent. This follows the supply-side Laffer Curve: Lower marginal tax rates produce higher revenues as both new and previously-concealed economic activities enter the tax base. No wonder Russia's GDP grew 5 percent in 2001.

There was a huge, monstrous non-compliance problem with the old system, says Richard Vedder, an Ohio University economics professor and board member of the National Taxpayers Union. People essentially operated in the underground economy. There were a lot of payments in kind where people were not paid in cash but in goods to facilitate tax evasion. That problem, from what I understand, has not totally disappeared but has dramatically declined in the last year or two.

Beyond the flat tax, President Vladimir Putin has signed legislation to chop the corporate tax from 35 percent to 24 percent, effective last Jan. 1. Putin hurled the double taxation of corporate income onto the ash heap of history. The Kremlin also may offer Russians privately-invested social security accounts, much as President Bush wants for Americans. Thanks to actual and potential reforms, Putin expects the average Russian to be happy by 2010.

In two former Soviet socialist republics, meanwhile, flat-rate taxes fuel progress. Since 1994, Estonia has had a flat tax of 26 percent while Latvia has enjoyed a 25 percent flat tax since 1995. Both have stimulated growth and higher revenues.

While ex-Communist states confidently reject progressive taxation, America remains plagued by Marxian class-warfare rhetoric. A May 28, 2000, New York Times editorial praised the Russian flat tax's promise to reduce political corruption, removing layers of subsidies in the code that officials like to shower on favored constituents. However, the previous Oct. 30, Republicans for a U.S. flat tax were disingenuous, when the basic result would ease the tax burden on the super-rich, the Gray Old Lady screeched, her dainty fist clenched overhead.

Senate Majority Leader Tom Daschle, D-S.D., complained Jan. 4 that Republicans have one unchanging, unyielding solution that they offer for every problem: tax cuts that go disproportionately to the most affluent.

Analyzing all this from his dacha in Hell, V.I. Lenin must be stroking his beard in utter bewilderment.

Of course, the country that Lenin once misruled still must do plenty to unravel his legacy. Stronger private property rights, a rule of law and full respect for free speech are sorely needed. But with its 13 percent flat tax, Russia now has a far more impressive export than those interlocking, wooden matrioschka dolls.

New York commentator Deroy Murdock is a columnist with the Scripps Howard News Service and a Senior Fellow with the Atlas Economic Research Foundation in Fairfax, Va.

But with its 13 percent flat tax, Russia now has a far more impressive export than those interlocking, wooden matrioschka dolls.

Seems the Russians have been learning from the Europeans and our Congress Critters on how to out fox the electorate:

RUSSIA: PART TWO OF THE RUSSIAN FEDERATION TAX CODE

August 10, 2000

Alexander Chmelev and Evgeny Astakhov

Baker & McKenzie, Moscow Office

Sent by BISNIS, U.S. Department of Commerce, http://www.bisnis.doc.gov

Judith_Robinson@ita.doc.gov, Tel: 202-482-2293. BISNIS sends this report as a courtesy to the U.S. business community. This is not to be construed as endorsement or sponsorship of any information or group.

On August 5, 2000, Russian Federation President Vladimir Putin signed into law four chapters of Part Two of the Russian Federation Tax Code and Federal Law No. 118-FZ ôOn the Implementation of Part Two of the Russian Federation Tax Code and Amendments to Certain Federal Laws on Taxationö (the ôImplementation Lawö). The chapters of the Tax Code signed into law by the President are Chapter 21 - VAT, Chapter 22 - Excise Taxes, Chapter 23 - Personal Income Tax, and Chapter 24 - Unified Social Tax. These four Chapters and the Implementation Law were officially published in Rossijskaya Gazeta on August 10, 2000, and, with few exceptions, will become effective on January 1, 2001.

The most sweeping changes introduced into the Russian tax system by this new legislation are as follows:

1. VAT (Chapter 21 of the Tax Code)

Although Chapter 21 of the Tax Code does not change VAT rates or the general VAT structure, it contains numerous provisions, which will significantly affect most businesses in Russia. Most notably, Chapter 21 substantially modifies the ôplace of serviceö rules, which generally determine whether for VAT purposes a particular transaction has occurred in Russia and is, therefore, subject to Russian VAT. Effective from July 1, 2001, Chapter 21 also will treat export sales to CIS countries in the same way as sales to all other foreign countries, and will exempt them from VAT. On the downside, Chapter 21 will repeal a number of long-standing and important VAT exemptions, including an exemption for license fees for the use of intellectual property (such as, patents, copyrights, and trademarks), and will significantly narrow the VAT exemption for pharmaceuticals.

2. Personal Income Tax (Chapter 23 of the Tax Code)

Chapter 23 of the Tax Code will replace the current progressive tax rates ranging from 12% to 30% with a flat tax rate of 13%. This 13% rate will apply to almost all categories of income earned by individuals who are Russian tax resident. A 30% rate will apply to dividends, and to any Russian source income received by individuals who are not Russian tax resident. A 35% rate will apply to income from gambling, lottery prizes, deemed income from low-interest or interest-free loans, certain insurance payments, and excessive bank interest.

3. Unified Social Tax (Chapter 24 of the Tax Code)

Chapter 24 of the Tax Code will replace the existing employersÆ contributions to four separate social benefit funds (which currently are imposed at an over-all rate of 38.5%) with one unified social tax. This unified social tax will have a regressive tax scale from 35.6% to 2% of an employeeÆs salary with the lowest rate applicable to the portion of an employeeÆs annual salary in excess of 600,000 Rubles (approximately US$22,000 at the current exchange rate). It should be noted that under the Implementation Law, as a transition rule, the lower rate of this tax will be 5% rather than 2% during 2001.

4. Excise Taxes (Chapter 22 of the Tax Code)

As a countermeasure to reducing rates of other federal taxes, Chapter 22 of the Tax Code provides for an increase in excise tax rates for gasoline and other oil products by almost 300%. It also provides for a less dramatic increase of excise tax rates for tobacco products and certain passenger cars.

5. The Implementation Law

a. Turnover Taxes

Effective from January 1, 2001, the Implementation Law repeals the Housing Fund Tax of 1.5% and reduces the Road Users Tax from 2.5% down to 1% and completely repeals the Road Users Tax effective January 1, 2003. These taxes are imposed on gross sales and have been among the most onerous taxes on business in Russia.

b. Regional Tax Concessions

The Implementation Law reconfirms the right of regional authorities to provide tax exemptions for the regional portion of federal taxes retroactive to April 1, 1999. This reconfirmation resolves an issue that arose in 1999 as to whether the regional portion of profits taxes could be reduced pursuant to regional incentive laws.

c. Profits Tax Rate

Apparently in compensation to local budgets for the cancellation of turnover taxes, the Implementation Law authorizes municipal governments to introduce an additional ômunicipalö profits tax of up to 5% of a taxpayerÆs taxable profits. Thus the maximum overall profits tax rate may be increased from 30% to 35%.

* * * * *

Needless to say that with the introduction of Part Two of the Tax Code, both Russian domestic businesses and foreign investors will experience the most sweeping and positive changes in the Russian tax system since the beginning of Russian economic reforms in the early 1990s. It remains to be seen, however, how efficiently this new legislation will be enforced and administered and to carefully plan against traps for the unwary that can be found in this new legislation. In addition, with such significant tax reform, and the expected movement on the Tax Code proposals on profits tax, tax planning by all companies in Russia will now need to be reassessed. We will continue to monitor this matter, and we will inform you with new Legal Alerts of any further developments.

Questions regarding the above matters can be addressed to either Alexander Chmelev, tax partner, or Evgeny Astakhov, senior tax associate, in the Moscow Office at +7 (095) 230-6036, or James Hitch, Managing Partner, or Yulia Smolina, tax specialist, in the St. Petersburg Office at +7 (812) 325-8308.

Baker & McKenzie issues this LEGAL ALERT to inform clients and other interested parties of time-sensitive legal developments that may affect or otherwise be of special interest to them. The comments above do not constitute legal advice or opinion, and should not be regarded as a substitute for detailed advice in individual cases.

This report is provided courtesy of the Business Information Service for the Newly Independent States (BISNIS)

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