MSE taxation – Polish experiences

MSE taxation – Polish experiences Tbilisi, May 6, 2011 Maciej Grabowski, Ph.D. Undersecretary of State Ministry of Finance, Poland

Rationale for special tax treatment of small businesses • High tax compliance costs (in relation to f.i. turnover) • Limited access to capital • Income volatility • Difficulties with defining business and private consumption • Transaction evidence and enforcement

Business income taxation – general regime • CIT for incorporated businesses – rate: 19% • PIT for unincorporated businesses (sole proprietors and partnerships): • progressive tax scale with rates 18% and 32% (since 2009) • flat rate taxation (since 2004) – 19%

Business taxation – small taxpayers regime • Small taxpayer definition: taxpayer with annual gross income up to1.2 m € (1.6 m USD) • Income taxation: • special tax measures in general regime: • lower accounting requirements (only PIT) • option for cash based accounting • quarterly advance tax payments • accelerated deprecation • possibility of tax deferral • presumptive taxation – optional for unincorporated businesses • VAT: • optional tax exemption (with 50k USD threshold) • cash accounting for small taxpayers

Presumptive taxation • Simplified and optional form of taxation of individual entrepreneurs • Designed to reduce tax compliance costs (by many perceived as a tax preference) • Present in tax system since 1954 (abolished and reintroduced in 90s) • Three forms of presumptive taxation: • indicator-based (patent like) tax – „tax card” • turnover-based tax – „tax on registered revenue” • indicator-based tax - „tax on special farming activities”

Turnover based tax • Optional form of taxation – requires notification to tax authority • Annual turnover ceiling: 200k USD • Tax rates depending on activity type: • 3% - trade • 5,5% - production and construction • 8,5% - services • 17% - highly profitable services (e.g. consulting, real estate, hotel, car renting) • 20% - liberal professions • Certain activities excluded (eg. pharmacies, production of excisable goods, advertising, tax advisors, solicitors, architects) • Cash register required – if non or unreliable 5 times rate applies • Limited filing requirements – only annual tax return • Advance tax payments – monthly or quarterly

Lump-sum patent (tax card) • Applied to activities explicitly indicated in tax law (over 100) – basically hand made, laborious and recessing activities and basic retail • Application limited by number of employees • Fixed lump sum tax - depending on (proxy of profitability): • business type (ca. 100), • place of activity (small, medium, large cities) • number of employees (0-5) • Tax rates provided in tax law, still may be adjusted by tax authority • Monthly payments, no filing and cash register required

Tax card rates • Tax rates expressed in amounts • Indexed annually • Aimed to reflect profitability of businesses • In some cases tax based on specific criteria, eg.: • [parking lots] number of car posts • [leisure services] type of device used, no. of devices • [liberal professions] type of profession, no. of work hours

Tax on special farming activities (SFA) • Applied only to specific farming activities explicitly indicated in tax law, eg.: • cultivation of plants in greenhouses • breeding of poultry, fur animals (foxes, rabbits, chinchillas, nutrias), laboratory animals (mice, rats, guinea pigs, etc) • Indicator based tax – income assessment based on acreage or number of animals and annual income norm (estimation) from a given activity • Notification required – tax authority sets monthly tax payment • Limited filing requirements – only annual tax return • No accounting requirements (regardless of the scope of activity) • Problem: NO LIMIT OF SUCH BUSINESS ACTIVITY

SFA: examples of annual income norms

Small taxpayer regime performance • Presumptive taxation chosen by over 890,000 taxpayers (in 2009) - ca. 37% of all individual entrepreneurs (share slightly falling from 2005): • turnover tax: 30.5% (31% in 2005) • tax card: 5% (7% in 2005) • SFA Tax: 1.5% (2% in 2005) • Number of taxpayers: • [turnover tax] steadily growing, even after lowering in 2008 the turnover treshlod from 330 k USD to 200k USD • [tax card and SFA tax] decreasing • Total tax revenue generated by presumptive taxes in 2009 amounted to 500 mil. USD (8.5% of individual business tax revenue), slightly decreasing since 2007

Why do we operate simplified forms of taxation? • Advantages for taxpayers: • lower tax compliance costs • limited interaction with tax authority • in many cases lower tax liability • taxpayers’ customs • Political and economic reasons: • restrictive taxation of business before 1989 and taxpayers aversion to fulfillment of tax requirements • high political and economic costs of reform (experiences with abolishing and reintroducing turnover tax in early 90s, attempts to abolish presumptive taxation in 2006) • incentive for business formalization

Weaknesses of small taxpayers regime • No possibility to enjoy certain tax reliefs (esp. in case of tax card) • Separate filing and payment of social contributions and health contributions • Limitations in self-employment possibilities • Difficulties in access to capital (no proof of real income) • Fluctuations of business income (seasonal, cyclical) • Disincentive for business growth (eligibility ceilings: turnover, employment) • No possibility to resign from presumptive taxation during the tax year

Operational challenges • Risk of tax fraud: • hiding below threshold, usually by: • keeping turnover or employment off the record • splitting or setting up new business activity • issuing false receipts/invoices (in case of tax card, SFA tax) and lack of interest in receiving cost invoice • Family businesses – difficulties with determining private and business consumption, non-registered employment of family members • Self-employment and providing services / sales to former employer • Limited possibilities of tax audit • Disputes over application of proper tax rate (turnover tax) or eligibility of a given activity • Pressure for increasing turnover threshold and lowering tax rates in turnover tax (esp. after lowering tax rates in general PIT regime)

How do we address them?[Turnover tax] • Proper turnover record keeping: • requirement to keep register and produce a daily summary of sales • incidental and cross-check tax audits, • penalty tax rates if records are not reliable, • raising awareness of consumer rights and interest in receiving receipts, • popularization of electronic payments and banking, • Splitting of business activity – exclusion of spouses • Setting up new business activity – change of business activity or a partner deemed not to be a new business activity • Self-employment – prohibition of providing services/sales to former employer • Invoices – requirement to posses proof of purchase of goods • Exclusion of certain activities

What activities are excluded?[Turnover tax] • Business with high profit margins (eg. financial services, services related to intellectual property) • Liberal professions • Production of excisable goods • Businesses prone to operation (even partially) in the black market (eg. sales of spare parts, scrap-metal) • Businesses of great scale (eg. whole traders, telecommunication)

Lump-sum patent regime – target group • Applied to simple activities undertaken usually in micro scale: • usually run an entrepreneur personally, based on his skills or trained profession • requiring no additional staff (employment) • using private premises and based on home-made goods, • labor demanding and yielding low profits • usually with turnover below VAT threshold • prone to operation in informal sector • … as it main purpose to keep these businesses in tax net (formal sector) by easing tax compliance burden, not to maximize tax revenue…

Lump-sum patent regime – indicators • …still, it should not be generous in terms of tax burden – otherwise may be an incentive to hide below the threshold (employment level) • Critical issue: design of indicators reflecting profitability • Advantages of employment indicator: • reliable proxy of business profitability • stable indicator with no requirement for periodical reporting • easy to check • Weaknesses of employment indicator: • possibility of substitution with contractors • engaging family members • Why number of inhabitants matters? – it reflects margins differentiation between small towns and big cities, being objective factor with no need to verify

Thank you Ministry of Finance 12 Swietokrzyska Street 00-916 Warsaw

MSE taxation – Polish experiences