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The New Taxation Act – Tax Obligation or Tax Injustice?

The government of Estonia has approved of the new changes to the Taxation Act. From now on, the taxman will hold entrepreneurs to responsibility with a new, simplified procedure regarding tax arrears in cases where the entrepreneur has intentionally incurred debts, and the company is unable to pay. The Act is to come into effect January 1st of next year.

Äripäev states the new Act should render use of straw men pointless in business and cut down on cheating involving tax incentives, but the Estonian Creditors Association disagrees.

The Tax and Customs Board can now impose simplified administrative acts on executives avoiding repaying debts, using automated mechanisms and electronic seals; unfortunately, this alteration only serves the interests of the taxman – reducing resource costs and increasing tax revenues.

Let’s tell it how it is. The Taxation Act is an Act for the Tax and Customs Board, with the aim of improving tax revenues, not combating use of ‘front men’. Tax arrears and unpaid taxes add up to appr. 700 million euros this year, at an all-time low, set to reduce even further now that the changes are to be implemented.

Worst case scenario – tax arrears will ‘move house’ to the private sector

You could agree with the anticipation that the use of fronts will become pointless in case of tax arrears. But companies that do not have tax arrears and yet have debts to other entrepreneurs – how is the Taxation Act helping out here?

The only gain foreseeable for entrepreneurs is the state earning better tax revenues and maybe then, entrepreneurs will be left alone, new taxes will not be invented or the current ones increased.

But even this benefit can be nullified by the worst-case scenario – no more debts to the Tax and Customs Board, but all the more debts in the private sector. To think that this one-sided change in the Taxation act will eliminate all debts in entrepreneurship is obvious naivete. It is a known fact that tax revenues are used as circulating capital – as credit – if necessary. It may be that creditors’ battles with straw men will escalate due to these recent alterations.

I tidy up my own house so everyone else’s will be sparkling clean? All is not that simple!

I have heard representatives of the state say ‘What are you moaning about – get to work like we do. Go to court and defend your rights – that’s what the courts are for!’

But for a moment, let’s compare a plain company to the Tax and Customs Board. Whichever comparison you use, it simply does not add up. The Tax and Customs Board is a giant of an organisation, with over a thousand employees. They have their own laws (the Taxation Act). They have lower resource costs, thanks to mass procedures, and available finances. They do not know the daily survival challenge of the enterprises, with no end in sight. Add to this the lack of available funds that is a severe hindrance to winning any long and demanding court case, and I think that any person in their right mind will see that you cannot compare the incomparable.

Tax injustice for the creditor entrepreneur

Let’s make it crystal clear with an arithmetic example so that nothing is left unexplained, from the creditor’s point of view.

All of the enterprises active in Estonia are clients of the Tax and Customs Board, which earns its revenue through taxes. For example, the VAT paid to the state, the difference between the entrepreneur’s VAT on sales and the input VAT. Even if the taxman does not get the difference of VATs, it is marginal to the loss shouldered by the creditor when an invoice goes unpaid. This is ten or more times the loss compared to that of the Tax and Customs Board.

EXAMPLE

The company HUNGER Ltd. bought ten TV sets from the company GOODS Ltd. costing 10,000€ + VAT (in total 12,000€), and sold them on for 15,000€ + VAT (in total 18,000€).

HUNGER Ltd. properly declared 2,000€ input VAT on the purchase and 3,000€ VAT on the sale. VAT (3,000€) minus input VAT (2,000€) equals 1,000€ in tax obligations for the entrepreneur.

The seller GOODS Ltd. bought the TV sets from the producer for 8,000€ + VAT (in total 9,600€). GOODS Ltd. declared VAT at 2,000€ and input VAT at 1,600€. The difference, 400€, was paid to the Tax and Customs Board.

But HUNGER Ltd. decided to avoid paying its debts by using a ‘front’ and has both tax arrears and debts to the entrepreneur. The creditor’s, GOODS Ltd., cash expenses are 9,600€ and VAT is 400€. Total loss 10,000€.

The Tax and Customs Board earned on this transaction 400€ VAT from the creditor GOODS Ltd. and did not get the declared 1,000€ VAT from HUNGER Ltd.. The Tax and Customs Board gains 400€ and loss in revenue is 1,000€.

With the new Taxation Act, the Tax and Customs Board will claim the 1,000€ from a former board member of HUNGER Ltd. and will have total revenues 1,400€ (1,000€ from the debtor and 400€ from the creditor). The creditor has losses in lost net turnover and paid VAT, which the law does not allow to be recalculated (credited).

TABLE 1

TRANSACTION

 HUNGER LTD.  

 GOODS LTD.  

 TAX BOARD planned revenue

sales

       15,000 € 

    10,000 € 

 

VAT

         3,000 € 

      2,000 € 

1,00 €

Total turnover (sales invoice)

       18,000 € 

    12,000 € 

 

 

 

 

 

purchase

       10,000 € 

      8,000 € 

 

input VAT

         2,000 € 

      1,600 € 

400 €

Total expenses (purchase invoice)

      12,000 € 

      9,600 € 

1,40 €

TABLE 2 (cash-based)

RESULTS

 HUNGER LTD.  

 GOODS LTD.  

TAX BOARD revenue today

 TAX BOARD planned revenue 

pays for the purchase

                –   €

–    9,600 €,

 

1,00 €

gets from the sale

       18,000 €

             –   €

 

 

paid in VAT to the tax board

                –   €

–        400 €

           400 €

0 €

TOTAL revenue

       18,000 € 

–  10,000 € 

           400 € 

1,400€ 

The Tax and Customs Board uses the Taxation Act to get the 1,000€ from the debtor, but what can the creditor do? Claim the 400€ VAT back from the state, paid according to the Value Added Tax Act, while no law limits the use of straw men?

All in all, is this not tax injustice, as opposed to tax obligation? What do you, dear reader, think?

Aspiring to fairness and transparency in economy!

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