Romania remains an attractive destination for investors from the point of view of its fiscal policy, but the constant hiking and cutting of various taxes in recent years has seen companies call for a more coordinated approach from the government when it comes to major changes in this field. Moreover, firms fear that some taxes will go up if the government is not able to keep the budget deficit below 3 percent this year.
“The last three-four years have been marked by a lot of changes, successive increases and reductions of taxes, without any coherence on the long term,” representatives of the Foreign Investors’ Council (FIC) told BR. The association has 123 member companies whose combined investments represent around EUR 35 billion.
“From the experience of previous years, the business community is trying to avoid a situation in which the government is not able to meet its deficit targets and will then decide to increase taxes in order to balance the budget,” added the FIC.
In short, the association says that the business environment would be supported by the simplification of procedures and the application of legislation aiming to reduce and prevent fiscal evasion.
In its turn, the government has made some progress with the prevention draft bill, which will prohibit the authorities from fining firms immediately for minor offenses. Instead, public servants will have to help the companies fix these problems, and only if they see that nothing has changed will they be able to apply sanctions. This bill should be approved in Parliament in the current session, according to the leaders of the ruling coalition.
Although some progress has been made in terms of the stability of legislation, companies continue to point out that the changing of laws overnight remains a challenge. The government had started talking about replacing the profit tax with a turnover tax, suggesting that in this way companies would pay their fair share of taxes. Firms warned that such a dramatic change would hit Romania’s competitiveness and attractiveness to investors, potentially leading to insolvencies among local companies, and PM Mihai Tudose told the European Commission president, Jean-Claude Juncker, directly that the change would not be approved.
The list of fiscal changes announced and later dropped includes the solidarity tax, which would have been paid by those earning ten times the minimum wage, and the replacement of income tax for individuals with a household taxation system.
Additional costs for companies over split VAT
But there is one change the government is sticking with, which is the split VAT system. With a VAT gap of around 38 percent – the uncollected amount – the authorities say that this would eliminate fraud and bring more funds into the state coffers. According to Eurostat, the statistics office of the EU, Romania had over EUR 7 billion in uncollected VAT in 2014 alone.
On the other hand, tax specialists say that companies will see their costs go up as they will have to update their systems and train their staff to properly use the fresh provisions.
Aside from the implementation costs, businesses will have to cover the additional costs of managing the split payment mechanism on a day-to-day basis, especially where taxpayers need to split numerous payments received in cash or via debit/credit card (such as retailers).
Firms will also have to cover the cash blocked in their VAT account, which, in principle, cannot be used for payments other than VAT, according to Costin Manta, senior manager in the tax advisory department at EY Romania, the professional services firm.
“Based on our discussions with bankers, the VAT split payment mechanism may actually reduce the taxpayer’s credit rating, as they will have less cash available to pay the installments,” Manta told BR. “In some cases these costs will be compensated by the tax incentives granted to taxable individuals who opt to apply the VAT split payment mechanism from October 1 2017. However, even in this case there is room for discussion over how it will apply: if a taxpayer has taxable profit during Q4 2017, but overall is in a tax loss position, will the 5 percent profit tax reduction apply (on the nominal value of the profit tax)? The VAT split payment ordinance does not clarify this aspect.”
Other issues might emerge in practice as the implementation stage is short and companies might end up guessing how to apply the law.
“As an example, how will the VAT split payment work in the case of payment compensations or third party payments? And these are just some of the questions that will pop up during a taxpayer’s day-to-day operations,” said the EY representatives.
The Romanian Business Leaders (RBL) association claimed that the update to the VAT legislation will not solve the systemic issue of tax evasion. The RBL went on to say that hundreds of thousands of fair-dealing smaller entrepreneurs will be “choked” by the additional red tape, leaving them less time to focus on development and job creation.
In a survey carried out by the National Council of Small and Medium-sized Enterprises in Romania (CNIPMMR) 97.5 percent of responding companies said that the split VAT system would have a negative impact on their activity next year.
The new VAT system has also been criticized by the main business associations representing the largest foreign investors in the country.
For instance, the French Trade and Industry Chamber in Romania (CCIFER) has warned that the new system creates red tape that will hit both private companies and state-owned enterprises.
“Romanian products and services will lose their competitiveness on the local and global markets and the economy will be burdened with new non-performing loans due to the wave of new insolvencies,” said the CCIFER about the risks of the split VAT system.
Meanwhile, the Austrian investment community in Romania says it supports the government’s attempt to reduce VAT fraud, but warns that the swift enforcement of the new system could create unforeseen issues for firms.
“On a broader scale, we will have to see if these additional administrative burdens together with the expected additional cost of a VAT account could negatively influence Romania’s perception as a highly attractive investment destination,” Gerd Bommer, commercial counselor at Advantage Austria, told BR.
He added, “Although Austrian investors generally support the Romanian government’s intention to further prevent VAT fraud, there is reasonable doubt that the measures chosen will have a sufficient cost-benefit ratio, if any at all. From an administrative point of view, they will be a huge burden for all the companies that have so far reported and paid their VAT obligations properly.”
The authorities have designed a package of incentives for firms that will start using split VAT from October, such as profit tax facilities and an exemption from the payment of penalties for VAT debts to September 30, according to Dan Dascalu, partner at law firm D&B David si Baias, the law firm affiliated to PwC Romania.
“It remains to be seen how the authorities are able to implement this system as a whole and respect the deadlines according to the law, as any breach could drive up litigation and demands from taxpayers for interest payments for these delays,” said Dascalu in a conference.
A taxing issue: Romania’s regional profile
The low corporate income tax rate and fiscal incentives for companies doing research & development are among the key provisions that could help Romania catch the eye of new investors interested in Central and Eastern Europe (CEE).
Andra Casu, director within the tax advisory department at EY Romania, cited the income tax rate of 16 percent and the tax incentives currently applicable for R&D (e.g. the additional deduction from the taxable base representing 50 percent of the R&D expenses incurred, a ten-year exemption from corporate income tax available to companies operating exclusively in the area of R&D) as some of the measures helping Romania maintain its competitive edge.
But she says that there are other issues such as the political instability, many unannounced legislative changes and a very aggressive trend of tax inspections carried out by the authorities that could downgrade Romania’s attractiveness.
“A temporary tax benefit may be deceptive if there is an existing record of changing the governing program over a short period of time and, generally, an increase in workforce taxation to cover some of the budgetary deficits,” said Inga Tigai, senior manager within the tax advisory department at EY Romania.
Romania has struggled in recent years to increase its tax take as a share of GDP, and some of the new taxes rolled out overnight were intended to plug these holes in the budget.
A report by the European Commission revealed that Romania had tax revenues of 28 percent of GDP, the second lowest rate in the EU, behind Ireland on 23.9 percent. In theory this should change by the end of the decade, when a massive overhaul of the tax administration agency ANAF should be completed. With a loan from the World Bank, the authorities want to develop a complex IT system for ANAF and move most of taxpayers’ day-to-day operations online.
“From the point of view of the FIC, the announcement of new taxes overnight with a significant impact on the business environment is not a good thing. Companies have businesses and investments on the long term and such a fiscal policy is not wanted. Something we have been saying for 20 years, since the FIC was founded, is that measures of such importance need an extensive impact study and a real consultation with all the parties involved,” said the association representatives.
Some amendments to the VAT system could also have a positive impact on the business environment. Manta of EY Romania says that the introduction of a reverse charge system for all imports would improve taxpayers’ cash flow.
“Currently this facility is available only to certain taxpayers, but general applicability may increase Romania’s tax attractiveness,” said Manta.
Big change in income tax contributions planned for 2018
The social security contribution system in Romania is poised to undergo a major change from next year, with contributions moving from the employer to the employee. The minister of labor, Lia Olguta Vasilescu, said that this change would not generate additional costs for companies, as contributions will be cut from 39.25 percent to 35 percent.
“There are many firms in Romania that don’t pay their contributions for employees; they deduct them from the salary but they don’t pay them on. Those employees don’t have medical assistance, don’t benefit from these years in their pensions. All this made us protect the employee,” said Vasilescu.
“Contributions are withheld by the employer and the company transfers them on to the state as your contributions. The state gains from this transfer by increasing the pension fund and the healthcare insurance fund,” explained the minister. As a result of this move, net wages are set to grow by around 4 percent, she added.
In late September, some trade unions were claiming that the government was planning to bring in only a partial transfer of the contributions from the companies’ side to employees. At the same time, income tax for individuals was to be slashed from 16 percent to 10 percent, but the reduction of this tax is still under review.
The change would come less than a year after the government scrapped the cap of five months’ average pay from the calculation of social security contributions.
Tigai of EY Romania said the removal of the cap had resulted in higher employment costs for companies and lower net incomes for employees.
“This particular net salary ‘loss’ was felt in the months when employees were granted additional benefits, such as regular or annual performance bonuses. Employees whose monthly gross income exceeds the value of five months of the national average gross salary (namely over RON 15,655, as at February 2017) suffered a decrease in their net income starting from the remuneration received for February 2017. So, on a monthly gross income of RON 18,000, which would have generated a net income of RON 12,940 (approximately EUR 2,875) in January 2017, the decrease as of February produces an annual ‘loss’ of RON 3,780 (about EUR 840),” said Tigai.
She said that the removal of the ceiling came as a “shock” for the skilled workforce, due to its rapid enforcement, and the costs were covered in “firefighting mode” this year. However, Romania’s competitiveness in the region could be affected by this measure on the medium and long term, according to the EY representative.
On pension funds, PM Tudose suggested in early September that contribution to the second pension pillar, which is managed by private administrators, should become optional. Under current rules, this pillar gets a mandatory contribution of 5.1 percent of the employee’s gross wage, while the rest, up to 10.5 percent, is funneled in the first pension pillar, controlled by the state. Around 7 million people are enrolled in the second pension pillar, which had assets of EUR 7.7 billion this summer. A third voluntary private pension pillar also exists, in which the state provides some tax deductions for contributors. This fund had assets of EUR 370 million at the end of June 2017.