Paper delivered at an international conference “Tax Competition and Competitiveness,” Vilnius

 

Lithuanian economy constantly undergoes different structural changes, and companies have to adjust not only to the new market trends but also to a continuous revision of legislation which regulates economic activity. New Laws on Corporate Tax, Value Added Tax, and Personal Income Tax have been adopted recently, which allows speaking about an essentially new system of taxation.

 

The most frequent official reason for amending legislation is an effort to set up better environment for business, although, in fact, any amendment brings about a lot of misunderstandings and disputes. Only with the law being active for a longer period can company experts and tax administrators calculate taxes correctly.

 

Transition to a new system of taxation raises many problems for economic entities and taxpayers in general. Within a comparatively short period of time new Laws on Corporate Tax, VAT, and Personal Income Tax entered into force. A lot of new concepts were introduced; however, their practical enforcement was not clear and was differently interpreted not only by taxpayers but also by tax administrators. These Laws were written in a complex legal language, their commentaries or interpretations were published with a delay, and, what is still worse, their totally different interpretations would be sometimes offered several times a year. Within this context, company finance managers become inferior advisers to company management in decision-making and frequently offer to do nothing, since the whole benefit from economic operations can be lost through confiscation in the form of fines or late payments.

 

Even the Head of the State Tax Inspectorate of the Republic of Lithuania acknowledged that “any new thing requires time and knowledge to be realised and duly materialised” when she spoke in a consultative meeting with the Lithuanian Confederation of Industrialists. Therefore, it would be reasonable to adopt a practice that following amendments of the law of this kind fines for errors made in the process of implementation of the legal act regulating new taxes would not be applied at all, and late payments should be only by few points higher than the price of a bank loan. It is not a big problem for a company with the history of no less than two or more years of operation to get a bank loan with 7-8 % of an annual interest rate, however, late payments for each day of delay in tax payments is 0.04 %, which makes up 14.6 % of an annual interest rate.

 

Laws sometimes fail to regulate the procedure for taxation of the entire processes taking place in economy. Therefore, several blocks of processes are often singled out and the government is charged with establishing a procedure for their taxation by a government resolution or a minister’s order. That is why it is also important to have the right understanding of economic processes and make no attempts to tax even the costs borne.

 

The procedure for recognition and evaluation of income in kind, which has been recently drafted and approved by the Minister of Finance, foresees taxation of fringe benefits given by an employer to an employee after the full or partial payment for treatment, health enhancement or other similar services. Opinions are also voiced that such measures will result in more expensive labour force in our country. Indeed, the costs of retaining and training of highly skilled labour force will rise, thus, the possibilities for employers to mobilise their staff with the help of different events leading to good working environment and morale will lessen.

 

When such decisions are made, there should be a real understanding and comprehension of a potential outcome. Evidently, the enforcement of these legal acts will result in additional dozens of thousand Litas of payments into the budget of the Republic of Lithuania. Although the result is clearly understandable and estimable, this process has a much larger impact on socio-economic life of people, and negative consequences apparently exceed this easily estimable tax benefit of several dozens of thousand Litas. Firstly, the society will have to spend money on administration of this tax, which includes changing software, explaining different legal acts, and retaining inspecting tax administrators. Secondly, the accounting staff of companies will be forced to spend more of their working time on the implementation of these relatively insignificant provisions.

 

Moreover, some procedures related to the recognition of costs should be simplified, too. They are mostly linked with fixed operational costs of companies, which are generally strictly controlled by their owners. They are consequently connected with the procedures for writing off of different representation expenses, fuel consumption, and worthless inventory items of the company. Generally, accounting staff of companies is made to rewrite invoices in different forms, which is, in fact, waste of both material and human resources. I believe that it is reasonable that a company which provides transportation or cargo shipment services has a procedure approved by the manager for the writing off of fuel on the grounds of itineraries, however, such a procedure is absolutely needless in a service providing company. An invoice should be a sufficient document.

 

With the introduction of the concept of associated companies in the new Law on Corporate Tax and giving special power to tax administrators to adjust transactions of associated companies, the issue of management of groups of companies has remained unsolved. It should be recognised that there is quite a big number of such groups of companies in Lithuania that are linked by ownership and joint management ties. Shareholders who strive for a more effective company management establish a group of companies and concentrate highly skilled labour force in the managing (parental) company for running the remaining companies in the group. Financial resources are needed to this end, and they are not earned by the managing company itself as the latter neither produces nor trades. Generally, the companies in the group are taxed with the management tax. In this respect, the conflict of associated companies is relevant, there are also different disputes with tax administrators on the documentation of management services and recognition of these expenditures as costs in managed companies. I believe that it is reasonable to establish that in cases where companies pay the same taxes, i.e. work on the grounds of the same tax base, transactions among associated companies cannot be subject to adjustments.

 

Attention should also be paid to the fact that the procedure for taxing dividends, which is valid at the moment, is totally inapplicable to group of companies. According to the currently valid Law on Corporate Tax, a three-tier company group has to calculate and pay profit tax trice on the dividends paid to a parental company. No consideration is taken of the fact that a part of these dividends in a parental company can turn into operational costs and a part can be invested into the founding of new companies. Therefore, it is absolutely evident that with such a non-transparent and unfavourable procedure for taxing dividends in force potential investors will pass by Lithuania because of both business management and dividend taxation arrangements, since managing indicators set for return on investment does not mean managing companies.

 

The analysis of the valid Law on Value Added Tax shows that some of its provisions directly require setting up groups of companies. According to the Law, transactions with securities are not subject to VAT, however, deeper examination of the mechanism of deduction estimation shows that after more than two transactions in securities a significant part of VAT deduction from operational costs may be lost. In practice, this means indirect taxation of these transactions. These transactions are known as those related to the change of ownership, management of a part of a market share, thus, more than two transactions often take place due to those processes and their whole volume can make up more than 50 % of income from operational activity of the company. Therefore, it would be reasonable to apply “0” VAT rate to these transactions.

 

The newly adopted Law on VAT has made a negative impact on long-term investment decisions which had been made by enterprises in relation to car lease before the Law entered into force. This Law does not allow VAT deductions from the car value and costs of lease in the case of leasing. The impact of these decisions on investment decisions of wholesale companies has been totally disrespected. There is more than one company in Lithuania which took the decision in 2001 to conclude contracts with leasing companies on the lease of a considerable number of cars for a period of 3 – 5 years. Investment decisions are linked to the maintenance of competitiveness of the company, establishing better working conditions, and quicker servicing of customers, which all of a sudden grew in price for these companies by 18 % following the entry into force of the Law. A conclusion can be drawn that this Law retroactively taxed with VAT the decisions made before the date of its entry into force.

 

Political parties and their programmes also make a big impact on legislation regulating business environment and economic activity in the country. Ongoing democratic processes mean that ruling parties that run the country keep on changing and so do state officials. It is preferable that with their change understanding remains that the previous government had its own economic policy and economic programme which it tried to implement in compliance with legal norms. This became particularly relevant with the adoption of the new Laws on Corporate Tax, Value Added Tax, and Personal Income Tax. The new concepts, such as “economic benefit” or “economic sense”, “adjustment of value of transactions” were introduced. A business community of the country is now worried that these concepts would be increasingly applied retroactively to the activity which had taken place prior the date of the enforcement of the Laws. Firstly, this demonstrates disrespect to the political party of the previous government and the economic policy it pursued and, secondly, it is disrespect to businessmen and company managers who in their decision making followed the rules for evaluation of transactions which were established at that time and were understood in the same way by everybody. I believe that such sensitive concepts should be implemented in view of the future, and efforts to try and apply something retroactively in different forms should not be made. 

 

Therefore, when amending the existing legal acts which regulate taxes it is utmost important to target and implement them to future business taxation processes only, and where efforts are made to tax as many processes of economic activity as possible, it is also necessary to have a broader view of possible consequences of such decisions and to evaluate their benefits and costs borne to achieve those benefits.