The Latvian tax system is very young – it is only in its twelfth year of implementation – still, we believe that we have succeeded to create a viable and effective tax system in such a comparatively short period of time, in which the fiscal aims, i.e. ensuring the state budget revenue, are balanced with the use of taxes as an instrument for economic policy.
We have succeeded in doing so, because, during the time of tax system reorganization in the mid-90’s, the new tax laws were elaborated according to the experience of developed democratic countries and taking into consideration advice and expertise from experts from international organisations. From this point of view it could be considered that Latvia, creating its tax system from the start, had certain advantages over the “old” tax systems, as we could get acquainted with them and take over all the good solutions and avoid the mistakes that other countries had made before, i.e. we could learn a lot from the mistakes of others, not from ours. That, however, does not mean that there have been no mistakes in creating the tax system. Everybody makes them, and so do we. Further – details on separate tax groups.
Taxes on Income
There are two taxes on income in Latvia – the personal income tax and the enterprise income tax, which form a united system. This means that:
· in general, any person deriving income in Latvia is either taxable with personal income tax or enterprise income tax;
· the same income is never subjected to both the income taxes at the same time.
Latvian income tax laws have been formed according to the principle that:
· the range of taxable persons and the tax base have to be wide;
· the rate has to be comparatively low.
The Latvian income tax system is comparatively neutral in terms of resources reallocation, as the laws create no special taxation advantages to one particular economic sector or another.
The fact that quite a large number of relieves has been granted under the enterprise income tax, furthermore, that the efficiency of the relieves in terms of attracting investment or solving social problems is low, could be mentioned as a to some extent negative tendency. Therefore, for purposes of promoting entrepreneurship, it has been envisaged to gradually decrease until 2004 the enterprise income tax rate to 15 per cent, at the same time cancelling separate former relieves.
The personal income tax rate of 25 per cent is also uniform to all payers and all types of income. It facilitates the administration of this tax. At the same time the problems characteristic to progressive income tax rate are absent – taxing income at a higher rate as a result of inflation-initiated increase in income, tax planning for applying a lower rate to income etc.
The income tax laws have been designed to eliminate the traditional tax avoidance methods – there are provisions in the law in connection with incomplete capitalisation, transfer pricing, governance in respect of transactions with low-tax and zero-tax states and jurisdictions. However, taking into consideration Latvian progress towards European Union, it has to be made sure that these provisions are in compliance with the united market of the European Union.
As regards personal income tax, it is necessary to address within the budget capacity the issue of increasing the exempt minimum, as the amount of it is at present the lowest not only among the Baltic countries but also among all the other candidate countries. Therefore the functioning of it in accordance with the envisaged objectives is not ensured.
The generally accepted principles of law drafting of both the European Union countries and OECD countries have been taken into consideration during the elaboration of Latvian income taxes laws. The requirements of European Union directives are gradually incorporated into them in the sphere of direct taxation – both in respect of taxation of dividends and application of income taxes laws during enterprise reorganization.
In order to settle taxation issues at an international level, to avoid double taxation and prevent fiscal evasion, intense work is being carried on in concluding tax conventions. Latvia commenced the work at concluding double taxation conventions together with both the other Baltic countries in 1992, and until the present moment negotiations with 47 countries have taken place for concluding tax conventions. At the present moment conventions with 44 countries have been initialled, 30 conventions whereof have been signed and 26 conventions are applied.
Immovable property tax
The immovable property tax reform that commenced in 1997 is still ongoing. The purpose of this reform is to ensure simple and fair taxation of immovable property, which means introducing a uniform tax rate of 1 percent, introducing a uniform tax base – the cadastral value of immovable property – and covering a wide scope of payers of immovable property tax - all persons that own immovable property in Latvia. The tax relieves provided for in the law are minimal, they can only be granted by the municipalities, the budgets of which receive the tax income (the tax is payable into the budgets of municipalities at full amount).
In order to implement the reform in accordance with the above-mentioned principles, the State Cadastre of immovable property has been created in Latvia. The analysis and recording of transactions with immovable property are done on a regular basis, and the data obtained is used at revaluation of cadastral value of immovable property.
The administration of the immovable property tax has been fully transferred to municipalities since the year 2000. Taking into account the fact that for purposes of calculating of immovable property tax the cadastral value of immovable property is determined by the State Land Service, the exchange of information between the State Land Service and municipalities is very important. The exchange of information is expanding and has also been considerably improved.
The postponement of implementation of several stages of the reform can be mentioned as a weakness of the reform. The postponement has been necessary, taking into account the planned reduction of municipality budget revenue, due to the reduction of the tax rate, and exemption of certain categories of immovable property from the tax. Due to the above-mentioned circumstances, the tax in respect of buildings and constructions is levied on the book value or on inventory value, and not on the cadastral value of the buildings and construction. The 1.5% tax rate is still applicable, and the tax is not levied on living houses and on immovable property belonging to institutions financed from the state budget.
The issues on the legal aspects of formation of dwelling rights also have not been completely settled in law, as well as some matters connected with maintenance of blocks of flats are unsettled. The mentioned drawbacks could create difficulties in calculation and collection of the tax in 2004, when flats will also be subjected to the immovable property tax.
Value added tax
Speaking about the indirect taxes, it should be mentioned that the value added tax and the excise taxes in Latvia are based on the corresponding EU requirements. The work on harmonization of these taxes is ongoing, and it is planned to bring the Latvian law in conformity with the EU requirements during the years remaining before the EU accession.
From the year 2003 Latvia will abolish completely the VAT exemption on supplies of goods, at the same time the reduced VAT rate of 9% will be introduced. The negotiations on the introduction of a lower 5% VAT rate on certain goods or on postponement of introduction until accession of the 9% rate are continuing.
It should also be mentioned that from the year 2003 Latvia will commence to refund the VAT paid in Latvia by non-resident legal persons, thus complying with the requirements of the 8th and 13th VAT Directives.
The problems connected with the administration of the VAT should be mentioned as a weakness in this sphere. The so-called „carrousel” schemes that are well known in EU member states can also be observed in Latvia. The schemes involve not only persons residing in Latvia, but also persons residing in neighbouring countries, thus quick and effective exchange of information is very important in counteracting the use of such schemes. At present in Latvia the work on improvement of information systems and the creation of necessary databases according to EU requirements has been commenced at the State Revenue Service, in order to be ready to become a part of a united system of exchange of information within the EU.
Excise Taxes
One of the taxes that have undergone the biggest changes in Latvia is the excise tax, which was harmonized in respect of oil products, alcoholic beverages and tobacco articles and according to EU requirements by introducing a system of excise goods warehouses, system of deferred payment of tax, implementing tax insurance and other requirements set by the directives.
The excise tax reform was commenced in Latvia in 1997 when work at drafting new excise tax law began. Although all the necessary legislative documents had entered into force by 2000, the excise tax reform cannot yet be considered completed, as the harmonization of tax rates is still carried on, and it will be completed only in 2010 in respect of cigarettes.
Such harmonization of tax should be evaluated positively according to its substance, as the excise tax system is being improved, it is becoming more consistent with the principles accepted in the EU, and it will let Latvia integrate in the united market and administer the tax according to the same principles present in other EU member countries, at the same time ensuring definite tax income to the budget.
Still, at the same time some problems in the harmonization of the excise tax have to be noted. First, excise tax rates, as in the majority of other candidate countries, are quite lower than the rates set in the EU. That means that Latvia has to significantly increase the excise tax burden in the nearest future to certain products, as a result whereof the prices of these goods will increase, expenses will increase for enterprises as well as will the desire to avoid tax – increase in illegally traded goods is anticipated.
It should be mentioned that the situation concerning introduction of the EU rates is different in each group of excisable goods. In general the rates have already been introduced on alcoholic drinks, and we do not expect any problems here. As concerns excise tax on oil products, the rates will be substantially increased on diesel fuel. This necessity stems from the fact of considerable growth of the rate of euro in the recent years.
The biggest problems connected with excise taxes for Latvia, as for other candidate countries, are those connected with the implementation of EU requirements concerning excise tax on cigarettes, since the requirements apply not only to the rate of tax, but also to the structure of the tax, procedure of price determination, and even to trade with cigarettes. Latvia will be the last of the three Baltic States that will introduce the combined rate of the excise tax on cigarettes. We are planning to commence the introduction of the combined rate from July 1, 2003. A lot of efforts shall be taken in explaining and clarifying the new system to our tax administration and to our businesses, in order to ensure that the tax is properly calculated, the maximum retail price is correctly determined and reflected, and the regulations on trade with cigarettes are observed by both the tax administration and the businesses.
