Benefits of Introduction of the New Tax Regime for Self-employed

Tax Arbitrage and the Growth of the Tax Gap

Every country employs several tax regimes depending on the category of the taxpayer, e.g., individuals, legal entities, and individual entrepreneurs. Taxation may also be dependent on the amount of income, commercial activities, and other factors. Lower rates, deductions and simplified tax accounting should support microbusinesses and small businesses so they can grow more quickly. But preferences create a temptation. Large businesses want to optimize their tax burden by transferring it into smaller entities. Most businesses also want to continue to use the benefits after they grow beyond the regime’s limits. Consequently, entities using the main tax systems engage in tax arbitration.

They involve fictitious contractors to decrease taxable profit and pay fewer taxes along with the cash-outs. Using individual entrepreneurs on simplified regimes and self-employed who do not pay taxes helps to achieve this goal. Therefore, tax advantages for one taxpayer increase the tax gap for others and increase the cost of tax administration.

To combat fraudulent tax optimization schemes and minimize the tax gap, several tax administrations are considering the introduction of new tax systems. For example, to address the expansion of cross-border online trade, which eludes VAT/GST collection, and the growth of informal employment. But what is the best approach to addressing key issues and reforming the tax regimes?

To answer that, we should start with a look at what makes up a tax regime and its major influencing factors.

Factors Influencing New Tax Regimes

Each state must control the shadow economy. It may grow because of the holes in a legislative framework or the expansion of novel forms of doing business. New tax regimes are emerging through systematic work, and we can show this by the example of the “self-employed tax”, implemented in one of our projects. Started as an experiment in a few country regions, today it covers several million taxpayers across entire country.

An earlier study of the country’s labor market found that millions of citizens have used informal employment. Informal self-employed are the citizens performing illegal work because of the lack of suitable tax regimes. They do not want to deal with tax bureaucracy, visit tax authorities in person, and file tax returns. The new tax regime could address those anxieties by creating comfortable conditions to legalize professional income.

Another impetus for the government was the idea of creating a tax system for younger generations of workers. Governments have developed existing tax systems for older generations of individuals and entrepreneurs. Young people are immersing in digital and mobile technologies and are not even trying to understand the complexity of old taxation systems.

To involve the younger generation of taxpayers, there is no point in applying coercion and punishment. Tax administrations must first understand the course of their thoughts. Then they can create comfortable conditions to fulfill their civic duties.

To understand the target audience, the national tax administration conducted the market research. The results showed that 75% of those questioned were willing to pay taxes under the following conditions.

• Registration as a taxpayer and conducting business should not require visiting tax administration.
• It is not necessary to file a tax return.
• The tax rate should not be above 5% of the professional income.

From Idea to Implementation

The insights from the surveys allowed the tax authorities to develop the concept of a new tax regime. It should promote the principles of maximum simplicity, accessibility, and transparency.

Fun fact, but at the project launch, the most heated debate related to the name of the mobile app. The consultants tried to convince the tax authorities to refer to the application as “My income” instead of “My tax”. Survey data showed that majority of citizens perceive the word “tax” negatively. However, the leadership of the tax administration did not support this initiative.

To register as a self-employed person (professional income taxpayer), a citizen just needs to install “My Tax” application on the smartphone. Upon receipt of income, the taxpayer registers its amount in the application. The application generates a receipt that taxpayer can (but not must, if not asked) transfer to the client. As the payment for their work or services, taxpayers can accept cash payments and use personal banking accounts with no restrictions.

The application collects information from the taxpayer to calculate the taxes and informs the taxpayer of the tax payment cutoff dates. After the reporting period (calendar month) is over, the tax administration automatically calculates the sum of professional income and accrues the amount of the tax payable. A self-employed can pay the tax in the same application with a linked credit card in a few seconds.

The tax regime does not require tax returns, using cash registers, visiting tax authorities, and opening special business accounts. The self-employed taxpayer has only two obligations: to register professional income in the application on time and to pay the tax monthly.

Tax administration implemented this new regime, keeping in mind the expectations of the citizens and those key principles:

• Fairness. There is one simple rule: “got income—must pay the tax”. No advance payments, charges on shipment. Taxpayers pay only after they receives income from the professional activity.
• Reasonable level of taxation. The average tax ratio is 5%, depending on the source of income—the individuals or legal entities and individual entrepreneurs.
• Online registration Most taxpayers’ registrations take only 5 minutes, including the time to find and install the tax application from the app store. To register as a self-employed person needs only a passport. An important feature of this regime is that the tax authorities first time trusted banking KYC regulation and accept applications from the banks, not only taxpayers!
• Simplicity. The taxpayer no longer needs to resubmit information about his income to the tax authorities. He records it in “My Tax” mobile application or in the partner applications from the banks, online platforms, and aggregators (for example, taxi aggregators).
  The tax authorities will independently calculate the amount of tax payable based on the taxpayers’ data and reflect this information in the application.
• Accessibility. The absence of tax returns (tax declaration) allowed to reduce the tax period to one calendar month. This decision reduced the absolute amount of tax payable and made it comfortable for the taxpayer.
• No direct contacts with tax inspectors. Non-filing of tax returns, automatic tax accruals, mobile tax payment by a credit card as a monthly subscription—all these features eliminate the need for personal communication between taxpayers and tax inspectors.
• Technical support. The creation of a modern technical support service for taxpayers enables quick and timely problem resolution for the tax and third-party applications.

Is the Play Worth the Effort?

Introducing a tax regime based on these principles was a revolutionary step for the tax administration system. Outcomes exceeded expectations and encouraged all efforts. The successful implementation of this project has legalized several million taxpayers.

Since its inception, there were about 200,000 thousand new monthly registrations of self-employed taxpayers. All of this did not require special advertising campaigns from the state. The only remaining problem is the lack of motivation among the clients of self-employed to demand fiscal receipts. States should find and introduce incentive mechanisms for the emergence of public control over the integrity of the self-employed. This will result in higher registered income and higher tax revenues.