New businesses to receive a two-year tax break

Because of the doubling of the rate of social security contributions, more than 450,000 people have canceled their business registrations this year. Source: PhotoXPress

Because of the doubling of the rate of social security contributions, more than 450,000 people have canceled their business registrations this year. Source: PhotoXPress

To encourage business activity, Russia’s Ministry of Economic Development has proposed relieving new entrepreneurs of all taxes for two years.

Beginning next year, any Russian sole entrepreneur who has registered a business for the first time will be able to receive a two-year break on all taxes. Prime Minister Dmitry Medvedev has given the order to implement the initiative, and all government ministries have already signed off on the idea in principle, according to the deputy minister for economic development, Sergei Belyakov.

The measure has been taken in response to a mass exodus of entrepreneurs, explained Delovaya Rossiya co-chairman Alexander Galushka. Because of the doubling of the rate of social security contributions, 458,000 people have canceled their business registrations this year (a total of 3.5 million sole entrepreneurs were registered as of June 1).

Sergei Belyakov, deputy minister for economic development, told RBTH that the new rules could “possibly” be applied to foreign citizens starting businesses in Russia.

The government’s social sector had insisted on the social contributions hike, according to participants in the discussions; Medvedev had supported it over warnings from Delovaya Rossiya and OPORA Russia that up to half a million sole-proprietor businesses could officially shut down.

The authorities rushed to remedy the situation during the summer, when the State Duma legislated a lowering of contributions.

However, according to Galushka, simply back-pedalling would not have been enough, as entrepreneurs had suffered too great a shock: “A forceful solution was needed.” The All-Russia People’s Front — the central staff of which Galushka is also co-chairman — came up with the idea for the tax break and collected 40,000 signatures in support of it.

Sole entrepreneurs now pay taxes under special regimes. There a several options to choose from: a simplified system (6 percent of revenue, or 15 percent of profit); unified tax on implied income; personal income tax + VAT; and a patent system. Social contributions are payable under every regime and will still be kept in place regardless.

The government will ensure that seasoned entrepreneurs do not abuse the new tax break by passing their existing businesses off as new ones, Belyakov warned. He also admitted that it remained to be seen how exactly this would be done: The details are being hammered out with the Ministry of Finance and the Federal Tax Service. Neither agency could be reached for comment.

The Ministry of Finance also has yet to comment on the amount of tax revenue that will be lost due to the two-year break for sole entrepreneurs. In any case, those amounts will be negligible, said Alexandra Suslina of the Economic Expert Group.

Suslina added, however, that the losses would be borne by regional-level budgets, which are already in bad shape. According to Galushka, the government is ready to sacrifice them, and there is a consensus among government officials that “what is going on with entrepreneurs is a catastrophe.”

The entrepreneur class — tiny in the best of times — has been steadily shrinking since 2010 (see chart). Galushka admitted that taxes are just part of the problem, as the trend started before the hike in social contributions.

“During the pre-crisis years, rapid revenue growth offset all administrative and corruption overheads,” he said. “In 2009, both froze, and, since 2010, expenses for entrepreneurs have been outpacing revenues.”

Last year, 3.7 million people quit as entrepreneurs. Some of them have left the market altogether, while others are moving into the shadows, Suslina explained.

Sole entrepreneurs contribute just 5 percent to the GDP, and the tax break will not have any macroeconomic effect, BNP Paribas Chief Economist Yulia Tseplyayeva predicted. Still, it is the social impact that is important. “In the 1990s, it was every Russian’s dream to start a business. Today, people dream about how to join the public service,” said the economist.

According to Galushka, the authorities’ suspicion of sole entrepreneurs has played a part in their dwindling numbers. He claimed, however, that officials know better now: “It’s necessary to clear entrepreneurs of the stigma of being crooks and thieves.”

“At the same time, by extending the new tax relief to novices only, the government is creating a new class of fraudsters with its own hands,” said Tseplyayeva. “Seasoned entrepreneurs will register businesses to the names of friends and relatives — everybody is mulling over such schemes now,” said a regional entrepreneur who has been active in business since the 1990s.

Government officials are aware of that, and the original plan was to make no exceptions, an official from the government’s financial and economic sector admitted. “However, political will has been only sufficient to push through a limited measure — the lobbyists decided to stop there,” said the government source.

Those who have already started a business, failed, and would like to try again will get short-changed, said Pavel Gagarin, chairman of the board at the Gradient Alfa audit firm. This creates discrimination in the market — it is not clear how experienced entrepreneurs are any worse than new ones, a federal official agreed.

Such schemes will be hard to detect. “You can set up an affiliate if you so desire — but what’s the point of such a tax break then?”  said the federal official. “All we are creating is a new reason for suspicion.”

Tseplyayeva advised leaving entrepreneurs alone and freeing them from the excessive reporting burden and harsh supervision. Suslina insisted that the fewer changes made to the law, the better: “While large businesses are normally able to cover expenditure fluctuations with short-term loans, small businesses must divert working capital for this purpose.”

“It’s not the tax burden per se — which is quite humane as far as sole entrepreneurs are concerned — that is freezing entrepreneurial activity in Russia, it’s the chaotic manner in which tax regulations are churned out,” the expert said.

First published in Russian in Vedomosti.

All rights reserved by Rossiyskaya Gazeta.

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