Business Impact of Recent Tax Changes and Perspectives for 2011
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It has been a year of changes. In this article we discuss the dynamic Romanian tax environment in 2010 in light of the most important of these changes and explore the outlook for 2011.
In 2010 we have been confronted with the reality of a deepening recession. If, prior to that, we were reassured by the Government that the crisis was a moment in time to be passed either by the development of local business or by external means, such as the IMF loan, now the National Institute of Statistics announces that we are confronted with the seventh consecutive quarter decline in GDP. As businesses continued to adjust, measures taken by the Government, such as the 25% reduction in salaries for all civil servants started to have a material impact on the economy as a whole, by reducing the overall demand for products and services.
Social unrest is currently the order of the day in an economic environment that is fighting for survival. As predicted by all major business associations in Romania, the recession will continue to affect us all, at least for the foreseeable future. Those predictions suggest 2011 will be a year marked by the fight for survival of large and small businesses alike and a year of significant tax changes. Under these circumstances, it remains to be seen whether the 1.5% GDP increase for 2011 predicted both by the Romanian Government and by the IMF can be achieved.
What got us here? In short, the budget deficit is to blame. There are two major options for financing the increasing budget deficit: either increasing revenues to the state budget or accessing external financial aid. The Government tried both these options.
In 2010 we witnessed a general increase in taxes levied, both by increasing the level of taxes (as discussed below regarding the new VAT rate) and widening the tax base (such as income from intellectual property rights and professional activities other than employment). It is yet to be seen whether these changes have achieved their intended goals.
VAT changes
VAT rate
Perhaps the most important tax change in 2010 was the increase of the standard VAT rate from 19% to 24%. After a long period in which the Government practically vowed that major tax liabilities (i.e. the income tax rate and the VAT rate) would remain unchanged, the VAT increase happened overnight, as a result of the Constitutional Court's rejection of the measure to reduce pension payments by 15%.
We note that the 24% VAT rate also applies to: intra-community acquisitions of goods that were received in June 2010, where the related invoices were issued by the supplier in July 2010, as well as invoices for utilities, such as gas, electricity, water and telecommunications, issued after July 1st, 2010 (although the services refer to periods before July 1st).
Besides the important economic impact of this change on offer and demand forces in the wider economy, the sudden change brought numerous practical difficulties for companies that had to change quickly their IT systems and pricing strategies.
It is still to be noted that reduced VAT rates of 9% (for medicines, books, etc.) and 5% for social dwellings remain in place. Reduced rates are not applicable to food and agricultural products, however, as in other European countries. In fact, with this change, Romania introduced one of the highest standard VAT rates in the European Union.
Registry for intra-community acquisitions
Another change that affects local businesses and that stems from the desire to impose anti tax-evasion measures is the requirement for taxpayers that perform intra-community trade to register in a registry of intra-community operators. This new requirement increases the administrative burden on businesses and may have other consequences. In addition to fines, failure to comply with this requirement leads to the invalidation of the VAT number which can no longer be used for intra-community trade and, thus, VAT deductibility issues that further impact on cash flow.
Individual income tax changes
Income from intellectual property rights and professional activities: changing the change
Amendments enacted as of July 1st brought significant changes in the taxation of individual income other than employment income. These refer to enlarging the tax base of social security contributions and unemployment fund contributions by including all types of professional income.
Although the law stated clearly that the income payer should withhold and pay the contributions, conflicting norms were issued that provided for the obligation of the income beneficiary to declare and pay such contributions on a monthly basis. As a result, hundreds of thousands of people were compelled to submit individual tax returns for social security and unemployment fund contributions.
Finally, another change was enacted that clarified that only income from intellectual property rights and civil contracts are subject to social security contributions and that the income payer is obliged to withhold and pay the tax due.
An additional change in the area of intellectual property rights aimed at increasing the taxable base was the reduction of the notional deduction for intellectual property rights from 40% to 20%. Thus the effective tax rate for such income was increased from 9.6% to 12.8%.
In an attempt to pursue artificial arrangements that some people used to disguise employment income, the Government enacted rules that allow tax inspectors to reclassify an independent relationship as a dependent one (i.e. employment relationship). Under these rules, if any of a list of conditions is met, the relationship is characterised as being an employment one, with the consequence that all employer and employee social security contributions are due (adding up to a total of approximately 43% for social security, health and unemployment contributions, but the contributions are capped to five times the average salary in the economy). The employer and the employee are jointly held liable for the tax liabilities resulting from such a reclassification.
