INSIGHT: Changes Ahead for Russian VAT Rate from 2019

On June 16, 2018, a draft law on increasing VAT from 18 percent to 20 percent was submitted to the State Duma. The first reading of the draft is scheduled for July 3. Taking into account that the legislative initiative was proposed by the Government of the Russian Federation, there is a high probability that the draft law will be adopted and that this will be done before the summer holidays of the Federal Assembly. This is confirmed by the fact that the draft law has already been approved by the State Duma Council for adoption in the first reading.

Textually, there will be no substantive changes in the law. Technical replacement of “18 percent” by “20 percent” will take place. “16.67 percent” will be specified instead of “15.25 percent” where the tax was calculated using the estimated tax rate (applicable for settlements with foreign buyers who have no tax registration in the Russian Federation and for the purposes of “Google tax”).

Dispelling rumors about the innovations that will follow the increase in the VAT rate, it should be noted that the preferential rate of 10 percent applied to social goods, medicines and medical products will not be replaced by any compensation. Introduction of the compensation mechanism would add a lot of difficulties for businesses in the process of returning their funds from the budget and would very likely entail financial losses as a result of administrative barriers.

Since the tax is calculated ad valorem, i.e. as a percentage of the price determined by the seller, tax increase will cause increase in prices which will therefore primarily and inevitably affect consumer purchasing power. At the same time, it is not expected that such increase will entail any significant increase in prices and the same significant decrease in the purchasing power. Against the background of rising prices associated with fluctuations in the Russian currency exchange rates against US$/euro, the price increase of 2 percent is likely to be noted only in the debates in political circles and not to affect the national economy.

At the same time, according to preliminary estimates, the increase in VAT up to 20 percent will lead to additional revenues to the budget in the amount of 620 billion rubles (8.4 billion euros) annually. Despite the absence of such explanations to the draft law, additional budget revenues are expected to be used for implementation of the RF President’s May decree on Russia’s strategic development for the period up to 2024. Other instructions of the head of state include the following sectors of social and economic development: demography, healthcare, education, science, ecology, infrastructure, small- and medium-sized businesses, digital economy, international cooperation and exports.

The law is expected to come into force on January 1, 2019. Thus, when the law is signed by the RF President and published before November 30, 2018 (which is very likely given the fact that this measure is a government initiative), the Russian buyers will see the rate of 20 percent starting as early as January 1, 2019.

Impact of the VAT Rate Increase

Taking into account the fact that VAT is an indirect tax or, as it is also called, a consumption tax, the increase in this tax rate, as noted above, will affect consumers to a greater extent and the business to a lesser extent. However, there will also be unpleasant consequences for the business. Thus, given that VAT is one of the most automated taxes, the increased rate will require reconfiguration (i.e. paid change) of software used by the businessmen and enterprises to calculate, declare and pay taxes. It will also require resetting all the equipment used to receive cash and payments by bank cards.

Total amounts of tax disputes on the relevant tax will also grow. And if we take into account the fact that criminal prosecution in connection with failure to pay taxes is mainly expressed in absolute figures, since the criminal law criteria for bringing to responsibility have not been changed, we can conclude that the increase in the VAT rate will slightly move the business closer to the risk of criminal prosecution.

It is also important to pay attention to the procedure of transition to the new rate. As mentioned above, under normal conditions, the rate of 20 percent will be applied starting from January 1, 2019. Following the text of the draft law, this means that the new rate will be applied to goods (work and services) supplied after enactment of the law (i.e. after January 1, 2019). However, the law does not provide any details on what is to be done with down payments received which are separately subject to VAT and in case when supply of goods (work, services) is subject to deduction from the seller. After all, it is quite possible that upon receiving payment at the rate of 18 percent in 2018, it will be required to pay to the budget VAT on delivery at the rate of 20 percent in 2019. Thus, if the law does not undergo any changes in this regard in the process of adopting the changes, it is likely that the businesses not only will have to regulate resolution of this collision between themselves, but also to be ready for tax disputes with tax authorities.

Insurance Contributions

Returning to the changes expected with the adoption of the draft law, it is important to note another initiative which the government has not fortunately refused from, i.e. reduction in the rate of insurance contributions from 26 percent to 22 percent. In this case, if previously the rate of 22 percent for the limit value of the base for assessing contributions was set as a temporary benefit (until 2021), with the adoption of amendments the rate of 22 percent will be set permanently. The rate of 10 percent for the amount exceeding the limit value (815,000 rubles/11,071 euros for social insurance and 1,021,000 rubles/13,870 euros for pension insurance in 2018) will remain unchanged. According to preliminary estimates, decrease in insurance contributions will lead to shortfall in budget revenues in the amount of up to 27 billion rubles (0.36 billion euros). Since the main category of insurance contribution payers is subject to a preferential rate of 22 percent, favorable conditions will in fact occur only starting from the year of 2021 when the tax relief will be canceled under the current laws.

Assessing the impact of increasing the total VAT rate up to 20 percent, it should be noted that the innovations will not entail any significant increase in the tax burden on business, although they will require additional attention and financial costs in transit to the new rate. Administration of the new rate will not entail any significant costs for the state either. The only ones to be affected by the changes in this situation both in the short and long-term will be consumers. At the same time, we can only hope that the new source of additional funding will be used for the purpose declared (by covert means) and, as a result, will return to society in the form of social benefits like more advanced science, healthcare, international integration, and a lot more.

Planning Points

To comply with the forthcoming amendments, the following points are recommended to plan and to execute, especially taking into account the additional time and financial costs that will be required from business to adjust its tax system to the increased VAT rate:

• contact with the distributor of equipment and software and specify required terms and costs to adjust equipment and software applied to receive cash and payments by bank cards and to calculate, declare and pay taxes considering the amount and type of operations; and

• audit operations which are planned at the end of the last tax period of the year. Amend contractual obligations in order to complete advance payments and delivery, if possible, in the same tax period.

Denis Zaytsev is Attorney at Law and Head of Tax Practice at DS-Law. Attorneys, Russia.