1 Estimation of Transaction Costs during Tax Collection Process Prepared by: Tigran Jrbashyan Armenian Director AEPLAC Davit Harutyunyan Senior Capacity.

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Estimation of Transaction Costs during Tax Estimation of Transaction Costs during Tax Collection ProcessCollection Process

Prepared by:Prepared by:

Tigran JrbashyanTigran JrbashyanArmenian DirectorArmenian Director

AEPLACAEPLAC

Davit HarutyunyanDavit HarutyunyanSenior Capacity Building Expert Senior Capacity Building Expert

AEPLACAEPLAC

44thth International AIPRG Conference on Armenia International AIPRG Conference on ArmeniaWorld BankWorld Bank

January 14-15, 2006January 14-15, 2006Washington D.C.Washington D.C.

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Compliance and Transaction CostsCompliance and Transaction Costs

“…“…Costs incurred by taxpayers, or third parties such as Costs incurred by taxpayers, or third parties such as businesses, in meeting the requirements laid upon them businesses, in meeting the requirements laid upon them in complying with a given structure and level of taxin complying with a given structure and level of tax … ” … ” (Sandford, C)(Sandford, C)

“…“….The costs of functioning of an economic system i.e. .The costs of functioning of an economic system i.e. any costs are derived as a result of interrelation of any costs are derived as a result of interrelation of economic agents regardless where it occurred …”economic agents regardless where it occurred …”

“…“…Transaction costs derived during tax compliance…”Transaction costs derived during tax compliance…”

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The main types of The main types of transaction coststransaction costs

Costs of obtaining information Costs of obtaining information Costs of negotiationCosts of negotiation Costs of measurementCosts of measurement Costs of protecting of property rightsCosts of protecting of property rights Costs of opportunistic behaviorCosts of opportunistic behavior

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Costs of obtaining informationCosts of obtaining information

Indispensable expenses incurred by economic entities Indispensable expenses incurred by economic entities related to the acquisition of all documents necessary related to the acquisition of all documents necessary for submission to the tax authority and for tax for submission to the tax authority and for tax inspection proceduresinspection procedures..

Cash operation books, sales books and incoming Cash operation books, sales books and incoming goods booksgoods books

Publications or e-packages on tax legislation Publications or e-packages on tax legislation (including expenses for updating of these packages) (including expenses for updating of these packages)

Advisory servicesAdvisory services Personnel trainingPersonnel training

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Costs of negotiationCosts of negotiation

Financial resources and time needed to establish Financial resources and time needed to establish “good” relations with representatives of the tax “good” relations with representatives of the tax authority.authority.

Business meetings (lunches)Business meetings (lunches) GiftsGifts Extra salaries paid to an accountant or other Extra salaries paid to an accountant or other

employeeemployee Other expendituresOther expenditures

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Costs of measurementCosts of measurement

Time and related expenses Time and related expenses for preparation of a for preparation of a package of documents to be submitted to the package of documents to be submitted to the tax authority.tax authority.

Salary paid to accountantsSalary paid to accountants Salary paid to managersSalary paid to managers Salary paid to other specialistsSalary paid to other specialists E-packages costsE-packages costs Documents submission costsDocuments submission costs

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Costs of protection of property rightsCosts of protection of property rights

Time and related expenses for Time and related expenses for protection of protection of property rights of economic entities during property rights of economic entities during lawsuits and tax inspection processes.lawsuits and tax inspection processes.

Costs of hiring of lawyers Costs of hiring of lawyers Costs of hiring of accountantsCosts of hiring of accountants Costs related to lawsuits procedures Costs related to lawsuits procedures Salary to skilled accountantSalary to skilled accountant

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Costs of opportunistic behaviorCosts of opportunistic behavior

Costs emerged due to asymmetric information Costs emerged due to asymmetric information between the economic entity and the tax between the economic entity and the tax authority.authority.

Interest accrued on VAT advance payments to the Interest accrued on VAT advance payments to the State BudgetState Budget

Accrued interest of VAT on exports subject to a Accrued interest of VAT on exports subject to a refund from the State Budget refund from the State Budget

Percentage over the sum of positive difference Percentage over the sum of positive difference between the prepaid profit taxbetween the prepaid profit tax and real profit tax and real profit tax which is the subject of reimbursementwhich is the subject of reimbursement by the stateby the state

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Structure of transaction costsStructure of transaction costs

Costs of measurement – 74.4%Costs of measurement – 74.4% Costs of obtaining information – 17.4%Costs of obtaining information – 17.4% Costs of opportunistic behavior – 3.9%Costs of opportunistic behavior – 3.9% Costs of protecting property rights – 2.5%Costs of protecting property rights – 2.5% Negotiation costs – 1.9%Negotiation costs – 1.9%

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Considering the taxes paid per employee, taxes paid by Considering the taxes paid per employee, taxes paid by companies with one employee are nearly 3.5 times more companies with one employee are nearly 3.5 times more than those paid by companies with more than 101 than those paid by companies with more than 101 employees.employees.

TTax burden (ratio of taxes paid by the relevant sectors to ax burden (ratio of taxes paid by the relevant sectors to the volume of sales) accounts for 20% in industry, 3.3% the volume of sales) accounts for 20% in industry, 3.3% in construction, nearly 2% in wholesale and retail trade, in construction, nearly 2% in wholesale and retail trade,

and 6.4% in services.and 6.4% in services.

Main findingsMain findings

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Transaction costs per employee in an entity with one Transaction costs per employee in an entity with one employee is 51 times more than in companies with more employee is 51 times more than in companies with more than 101 employees.than 101 employees.

In companies with less than 1 million AMD turnover the In companies with less than 1 million AMD turnover the ratio of transaction costs to taxes paid exceeds 21 times ratio of transaction costs to taxes paid exceeds 21 times the figure of the companies with more than 500 million the figure of the companies with more than 500 million AMD turnover, while in the entities with one employee AMD turnover, while in the entities with one employee it exceeds 20 times the same indicator for companies it exceeds 20 times the same indicator for companies employing more than 101 people.employing more than 101 people.

Main findingsMain findings

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Transaction costs at national levelTransaction costs at national level

The average level of transaction costs as a percentage The average level of transaction costs as a percentage share in the total taxes paid is 11.5%.share in the total taxes paid is 11.5%.

The overall transaction costs of economy accounted The overall transaction costs of economy accounted to 13,538.4 million AMD or about 0.8% of GDP for to 13,538.4 million AMD or about 0.8% of GDP for 2003.2003.

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The cost of collection ratio increased by 93.4% and The cost of collection ratio increased by 93.4% and reached from 1.7% to 3.24%reached from 1.7% to 3.24%

The ratio of % change of tax revenues to % change of The ratio of % change of tax revenues to % change of administrative expenses was 0.1administrative expenses was 0.1

The tax buoyancy was 0.58The tax buoyancy was 0.58 Transaction costs of businesses are large relative to Transaction costs of businesses are large relative to

tax administration costs approximately 3.6 timestax administration costs approximately 3.6 times

An efficiency of tax administration in An efficiency of tax administration in Armenia for 2002-2003Armenia for 2002-2003

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ConclusionsConclusions

The database of the State Tax Service needs to be The database of the State Tax Service needs to be regularly updated.regularly updated.

Tax administration is one of the painful and sensitive Tax administration is one of the painful and sensitive issues for economic entities.issues for economic entities.

““Business culture” is still at quite a low level in Business culture” is still at quite a low level in Armenia’s business reality.Armenia’s business reality.

The largest expenditures on information gathering fall The largest expenditures on information gathering fall to the share of companiesto the share of companies running in the industry running in the industry

sector.sector.

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The better the entities are informed about the tax system, The better the entities are informed about the tax system, the less they are exposed to the opportunistic behaviour the less they are exposed to the opportunistic behaviour of tax authorities.of tax authorities.

An increase in the number of software users may An increase in the number of software users may contribute to the decrease of measurement costs.contribute to the decrease of measurement costs.

The availability of skilled specialists within the staff of The availability of skilled specialists within the staff of economic entities leads to a decrease in the level of economic entities leads to a decrease in the level of “expensiveness” of contacts with tax authorities and “expensiveness” of contacts with tax authorities and reduces the number of companies dissatisfied with the reduces the number of companies dissatisfied with the behaviour of tax officers.behaviour of tax officers.

ConclusionsConclusions

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The establishment of “good” relations with tax The establishment of “good” relations with tax authorities is basically stipulated by the “expensiveness” authorities is basically stipulated by the “expensiveness” of contacts with tax authorities, drawbacks of tax of contacts with tax authorities, drawbacks of tax legislation and the “unfriendly” attitude of tax officers.legislation and the “unfriendly” attitude of tax officers.

There is no direct correlation between the amounts of There is no direct correlation between the amounts of collected taxes and the frequency of tax inspections i.e. collected taxes and the frequency of tax inspections i.e. tax inspections are “costly” for the state because they do tax inspections are “costly” for the state because they do not ensure adequate collection of tax revenues.not ensure adequate collection of tax revenues.

Dissatisfaction with the tax system depends also on the Dissatisfaction with the tax system depends also on the frequency of inspections.frequency of inspections.

ConclusionsConclusions

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The expensiveness of legal proceedings (in terms of The expensiveness of legal proceedings (in terms of both money and time) is a serious obstacle for the both money and time) is a serious obstacle for the actions of economic entities in the context of protecting actions of economic entities in the context of protecting their rights.their rights.

The main reasons for tax-related disputes are as The main reasons for tax-related disputes are as follows: drawbacks of tax legislation, advanced follows: drawbacks of tax legislation, advanced payments levied by tax authorities, the “unfriendly” payments levied by tax authorities, the “unfriendly” attitude of tax officers.attitude of tax officers.

One of the reasons for an opportunistic behaviour is the One of the reasons for an opportunistic behaviour is the drawbacks of tax legislation.drawbacks of tax legislation.

ConclusionsConclusions

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Most companies that paid advanced payments have Most companies that paid advanced payments have not filed a lawsuit since they have always agreed with not filed a lawsuit since they have always agreed with the findings of tax inspection, i.e. the opportunistic the findings of tax inspection, i.e. the opportunistic behavior of tax authorities has, in its turn, provided behavior of tax authorities has, in its turn, provided some “guaranty” for economic entities.some “guaranty” for economic entities.

In terms of the percentage share of transaction costs In terms of the percentage share of transaction costs per employee and the taxes paid, it can be noted that on per employee and the taxes paid, it can be noted that on the whole these are more “costly” for small and the whole these are more “costly” for small and medium enterprises.medium enterprises.

Small and medium-sized businesses are in an Small and medium-sized businesses are in an “unfavourable” situation in terms of the relations with “unfavourable” situation in terms of the relations with the tax authorities (in terms of “expensiveness”).the tax authorities (in terms of “expensiveness”).

ConclusionsConclusions

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The shortcomings of tax legislation and tax The shortcomings of tax legislation and tax administration have an adverse effect, first of all, on administration have an adverse effect, first of all, on medium-sized businesses, as small businesses fall out medium-sized businesses, as small businesses fall out of the focus of “attention” due to their size, while the of the focus of “attention” due to their size, while the large ones use their institutional capacity and are large ones use their institutional capacity and are

generally “inaccessible” for tax authorities.generally “inaccessible” for tax authorities.

Main conclusionMain conclusion

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RecommendationsRecommendations

To update the tax databaseTo update the tax database To exclude the possibility of personal contacts between To exclude the possibility of personal contacts between

the representatives of economic entities and tax the representatives of economic entities and tax authoritiesauthorities

To eliminate implementation of so-called “planned To eliminate implementation of so-called “planned system” of tax collectionsystem” of tax collection

To make tax legislation more precise and simplifiedTo make tax legislation more precise and simplified To change mechanism of tax inspection (separation of To change mechanism of tax inspection (separation of

large, medium and small enterprises)large, medium and small enterprises) To stop the practice of advance payment clearanceTo stop the practice of advance payment clearance

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To specify and maximally simplify the hearing To specify and maximally simplify the hearing procedures for tax-related disputesprocedures for tax-related disputes

To strengthen the factor of information within tax To strengthen the factor of information within tax authoritiesauthorities

To specify the procedure of providing accounting To specify the procedure of providing accounting services by specialized structuresservices by specialized structures

To implement structural reorganization of the tax systemTo implement structural reorganization of the tax system To simplify the VAT calculation and supervision To simplify the VAT calculation and supervision

proceduresprocedures To conduct similar studies on regular basisTo conduct similar studies on regular basis

RecommendationsRecommendations

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Thank youThank you