Local businesses fear VAT hike will spell disaster

Newsroom 05/07/2010 | 12:11

The VAT increase that came into force on July 1 has alarmed the Romanian business community. Tax specialists predict that the measure will produce few positive effects – higher state budget revenues – and more negative consequences, in the form of high prices, decreased consumption and purchasing power, high inflation and tax evasion as well as headaches in making the necessary bureaucratic changes.

Dana Ciuraru


The much feared VAT increase that many thought would be applied by the government from this fall has been put into effect much sooner. The authorities decided to hike the tax rate from 19 to 24 percent starting July 1, after the Constitutional Court ruled the 15 percent pension cut – a Boc government idea to cut public spending and reduce the public deficit – unconstitutional.


VAT hike worries

Tax analysts says that raising VAT in these troubled times might have more negative consequences than positive ones, as hoped for by the government. “It is fair to assume that the VAT hike will inevitably be associated with a shrinkage in consumption. At times of crisis, there is always a very delicate balance between the state’s need to attract more revenues – necessary for the financing of the public sector, social protection, as well as investments in the economy – and the need to ensure the framework for stimulating economic growth, which at a fiscal level generally translates into tax incentives and lower tax rates,” Raluca Rusu, tax manager at Deloitte Tax, tells Business Review.

Moreover, Daniel Anghel, partner in indirect taxation at PricewaterhouseCoopers Romania (PwC), adds that the VAT increase will have a direct effect on the level of inflation, as the prices of all products available on the market will also rise. “As VAT represents an indirect tax borne by final consumers, any increase in it results in higher prices, thus reducing the purchasing power of consumers and the level of consumption,” says Anghel.

Tax specialists say that even though on the short term, the increase in the standard VAT rate could be viewed by the tax authorities as an easy-to-implement tax measure to boost budgetary income, on the long term it will serve to further tax evasion.

“It would be interesting to see whether on the long term such potential negative effects could be balanced by the tax authorities putting in place specifically designed measures against tax evasion. Another probable long-term implication of the VAT rate increase is the potential negative effect on the foreign exchange market,” Andra Casu, manager for taxation advisory and compliance services at Ernst &Young (E&Y), tells BR.

However, specialists also fear that the move will not increase budgetary revenues as much as expected by the authorities. “In theory, any tax increase means higher budgetary revenues, at least on paper. But in reality, this must be reflected in actual revenues. As economic activity will be affected by the VAT increase, this could mean reducing sale volumes and thus reduced VAT paid to the tax authorities. So, on the long run, it is possible that budget revenues will not increase by the raising of the VAT level,” Florin Gherghel, certified tax adviser at Noerr Finance & Tax, tells BR.


Overnight changes

The hasty implementation of the hike has put pressure on the business community, as most companies have found themselves in the position of having to modify their IT systems virtually overnight. Apart from the costs involved, this also entails an administrative effort, especially for firms in retail with an extensive store network.

“In addition, most companies have not had the time to properly consider the applicability of the transitory provisions to their specific activities and to determine in which cases the 19 percent rate is still applicable or whether the new rate of 24 percent should already be used,” says Rusu.

Moreover, Adina Vizoli, tax manager with NNDKP Tax Advisory Services, tells Business Review that for ongoing contracts the dates are a major issue.

“We have to deal with ongoing contracts to which will be applied both the standard rate of 19 percent for those operations which produced effects until June 30 and the 24 percent rate for operations that will take effect on July 1. It is important to note that the issue of bills ahead of time for these operations will produce effects that will not trigger the maintenance of the 19 percent rate in VAT, but the VAT rate in force at the time of the operation must be applied,” said Vizoli.

PwC’s Anghel thinks that some companies will be obliged to pre-finance VAT and will face cash-flow problems, since the pre-financed amount of VAT will increase by 5 percent. “As such, if firms do not have cash available, it will be very difficult for them to continue with ‘business as usual’. Companies performing investments in this period will face the biggest impact, as they will encounter only input VAT, without registering any revenues,” said Anghel.


No business-as-usual for businesses

All economic fields will probably be affected by the measure, say tax specialists. One fear is the probable deterrent effect that the move may have, discouraging altogether or reducing the volume of future foreign investments in Romania – especially considering the lower VAT rates adopted by some of the neighboring countries. For instance, companies performing exempt without credit operations (eg, banks, insurance companies, medical units) would be affected in the sense that they will incur a VAT cost of 5 percent more.

Recently, Mariana Gheorghe, president of the Foreign Investors Council (FIC), stated, “To offset some of the negative effects of the rise in VAT and to stimulate growth, the government should implement a wider package of measures to encourage investment. It should also further reduce public spending, reduce bureaucracy and improve efficiency in the public sector.”

The banking sector will be hit as well. “Crediting activity will obviously continue to be affected, due to the decreased reliability of the companies and their increased reticence when applying for credit. Additionally, the quality of banking portfolios is expected to deteriorate. Banks will have to become even more cautious, as provisioning costs are also expected to grow,” Catalina Molnar, chief economist with RBS Romania, tells BR.

Casu of E&Y says that the food industry will probably be significantly affected due to the price increase triggered on staples – especially as in some other countries food does not attract VAT. The hotel and transport industry will be hit even harder, as they are discretionary purchases.

PwC’s Anghel says that retailers will probably opt to bear the cost of the extra VAT for a while, rather than increase product prices immediately. Competition between retailers will intensify and be most evident in the promotion of no-frills lines.

He added: “Moreover, the new VAT rate will also affect taxable individuals not registered for VAT purposes and financial institutions, such as banks and insurance companies, since the value of the VAT bill represents a cost at the level of such entities.”

Sectors with reduced VAT rates (such as book shops) or exemptions (airlines for international fares) ostensibly will not be directly impacted by the government measure, says Rusu of Deloitte. “But as everything is interlinked, we know this is not exactly true. Especially in cases where the client base is mainly composed of private individuals or the public at large, constraints are likely to appear due to the decreased purchasing power of end-consumers,” she says.

And Gherghel is adamant that tax evasion will grow – a fact of which the authorities can be in no doubt. “More companies will not register their incomes and expenses because of the VAT increase context. As such in the long run the purpose of this measure – higher revenues to the state budget – will not reach the expected level,” predicts the Noerr Finance and Tax specialist.



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