Russia's Simplified Taxation
Part II: Advantages and Disadvantages
Galina Karagodina, Internal Auditor, Methodologist,
Alinga Consulting Group
Before we begin to list the advantages and disadvantages of Russia's Simplified Taxation System (STS), it will be valuable to review briefly the basics of the system in contrast to the basics of the Regular Tax system (previously examined in Part I: The Basics of the System
). The chart below will help us do this:
|| Simplified Tax System (STS)
|| Regular Tax System|
|| It is recommended, but not required, that limited liability companies and joint stock companies maintain complete accounting records. Other forms of legal entities should keep accounting records of their fixed and intangible assets. (Note, however, that in practice this "advantage" is rarely used as it is very difficult to run a successful business without full accounting.)
|| Maintaining complete accounting records is mandatory. |
| Financial Reports
|| Are not turned over to the Federal Tax Inspectorate.
|| Financial reports are submitted to the Federal Tax Service (FNS) quarterly.|
| Income and Expenses
|| Declaring Income
|| Cash basis.
The taxpayer chooses between:
- accrual basis;
- cash basis (possible if the average sales proceeds without VAT was less than 1 million rubles during each of the last four quarters)
| Determining Expenses
|| Only the expenses listed in Article 346.16 of the Tax Code can be used to lower the tax base.
|| All justified and documented expenses are eligible, there are no limitations on what types of expenses can be included. |
| Fixed and immaterial assets acquired at an initial cost of more than 20,000 rubles
|| Reported as a non-recurring sum in the expense section at the initial cost – the fixed assets from the moment of first use, and immaterial assets from the moment of being carried over to the accounting records.
|| Reported as amortization expenses within the course of its useful life.|
|| Object of Taxation
The taxpayer chooses between:
- income minus expenses.
| Received profit (income minus expenses) is taxed for Profit Tax purposes.|
| Taxes Due
STS taxpayers are exempt from the following taxes:
- Profit Tax, except for on income earned from dividends and certain types of debt operations;
- Property Tax;
- Value-Added Tax (VAT), except VAT on goods imported into Russia, and VAT on transactions made under simple partnership agreements.
As part of adopting STS, a single tax is paid instead of all those listed individually.
- Taxes owed as a tax agent (including for VAT, profit tax, and personal income tax).
Lowered contribution rates apply for 2010:
- for mandatory social insurance – 0%;
- for mandatory medical insurance – 0%;
- for the pension fund – 14%.
Other taxes are paid in accordance to current legislation.
| All taxes listed on the left must be paid in full.|
| Tax Accounting
|| Only as a Single Tax in the journal of income and expenses.
Tax accounting records must be kept for the following taxes:
On the basis of the Tax Code's official tax ledgers.
| Tax Rates
Tax rates depend on the chosen object of taxation:
If income is chosen as the object of taxation, the tax rate is 6% of income. In 2010, the amount of tax is reduced by the amount of contributions to the pension fund, insurance against on the job injuries, and sick leave. Beginning in 2011, the amount of tax may additionally be reduced by contributions to disability insurance, maternity funds, and mandatory medical insurance. However, the sum cannot be reduced by more than 50%. If income minus expenses is chosen, then the tax rate is 15% of income, minus expenses (but not less than 1% of income).
| Profit tax rate – 20%.|
| Tax Reporting
Businesses on STS need not submit the following reports to the Tax Authorities:
- property tax declarations.
The following reports are required only if applicable during that fiscal period:
- VAT declarations;
- Profit Tax declarations.
Tax declarations paid in connection with STS are submitted to FNS once a year according to the results of the fiscal period.
Taxes are reported as required by legislation.
The following must be submitted to the tax authorities quarterly:
- profit tax declarations (advance calculations);
- VAT declarations;
- property tax declarations (advance calculations).
Other tax accounting is done as the legislation dictates.
From this basic comparison of STS vs. the regular tax system, we can see that STS has both advantages and disadvantages.
Advantages of STS
- Accounting records are maintained in a simplified form.
- It is no longer necessary to submit accounting records to the Federal Tax Service.
- Tax declaration is filed once a year instead of 12 times (a tax declaration is filed once a year for the STS’s Single Tax, as opposed to quarterly filing of reports for UST, VAT, property tax, and profit tax).
- One can choose the object of taxation.
- The tax base is lowered by the full cost of both fixed and immaterial assets and the deduction is made at the moment the item is first used in business production or when it is entered into the company's accounting records.
- Tax accounting is simplified.
- The tax burden is reduced to one tax instead of three.
Disadvantages of STS
- The right to use STS could be lost at any time if certain conditions are not met. If that happens the accounting records for the entire period that STS was applied must be recalculated under the regular tax system.
- The right to open a branch or representative office is forfeited.
- The right to engage in certain types of activity (for example, insurance) is forfeited.
- There are limitations on profits, depreciated value of fixed assets, and immaterial assets, number of employees, etc.
- There are fewer expenses that can lower the tax base.
- Advance payments received from purchasers, which may later turn out to be incorrect sums, are included in the tax base (for example, refunds for goods or services that the purchaser pays for but then refuses, or sums that are miscalculated and returned to the purchaser, or if the purchaser accidently transfers the sum using the wrong bank account).
- Only paid expenses are counted as expenses (for example, back pay). Sometimes this makes calculating the total amount of expenses that can lower the tax base extremely complex. For example, only those materials that are already paid for and being used in production can be considered expenses.
- Being exempt from VAT may lead to some protests from VAT-paying clients who view VAT deductions as a tax advantage. They may request that a supplier using STS reduce their prices by the cost of VAT in order to compensate them for the last deduction. This is, of course, unprofitable because VAT has never been added to the price to begin with. While illogical, those switching to STS should brace themselves to hear this argument from at least a few customers.
- Assets acquired under STS cannot be sold without recalculating the tax base and paying additional taxes and fines (for taxpayers that have chosen “income minus expenses” as their object of taxation).
- If income minus expenses is chosen as the object of taxation, minimum tax (1% of total revenues) must be paid even if no profit is recorded. There is also the accounting nuance that, because advance tax payments and minimum tax payments are distributed differently by the government, that advance tax payments cannot be applied to the minimum tax obligations. There is currently a mechanism used to safeguard against this, but your accountant should know about this in advance and become familiar with Article 78 of the Tax Code.
Anytime that a company changes its accounting or tax system there are additional expenses that might be incurred or accounting nuances that might need to be navigated.
If a company transitions to a new tax system, losses incurred during the transition period cannot be used to offset taxes under the new tax system.
For example, complications arise when transitioning between the accrual basis of regular taxation and the cash basis of STS. With the accrual basis, expenses are reported when a good is sold or a service rendered. With the cash basis, the expense is reported on the day funds are received. This can result in some expenses being lost in the transition.
There are also even more complications and expenses in transitioning back to regular taxation. For example, the depreciated book value of fixed assets that are acquired before use of STS must be determined at the moment of transition to the regular tax system. This can be an additional expense.
Is STS Right for your Company?
Choosing an optimal tax system for your company requires considering a wide array of factors and making careful calculations.
As a general rule, we can say that STS is generally advantageous for companies with low expenses, the majority of which can be used to offset the tax base for the Single Tax; It is also advantageous for small companies working with clients for whom VAT deductions are not as important (for example, retail businesses).
STS is not advantageous for loss-making companies or for companies that have significant expenses that are not recognized under STS. STS is also not advantageous for companies that plan to develop beyond the limits set for STS.
To make sure you consider all the facts in making your choice, and to make sure that you can implement your choice without incurring losses due to the complexities of the tax systems, we recommend that you turn to a professional who is well-versed in tax and accounting legislation to assist you in your choice and transition.
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