02 May 2017

Tax Revolution or Tax Evasion “by fault”?

The household tax is a new projecyt by which the Government wants to include in the calculation base all incomes made by individuals in a calendaristic year, the amount thus obtained being reduced by a series of deductibles, with the consequence that the final result will be charged with a unique rate of 10%.

The amendments to the Fiscal Code represent a real revolution that aims to radically change the way in which the income tax is computed. There are changes to source taxation, households are defined, nominated expenses are excluded from the global tax.

This global tax system will be applied from January 1st2018, but the first tax statement will be filed one year later, in May 2019, and will imply a 10% tax on the household income.

The main change concerns the current system of withholding the due tax at the source. The employer will no longer retain the 16% from the salary as it is nowadays. The 10% calculated from the so-called global income will be paid directly by taxpayers[1], grouped in households.[2]

Each household will receive a score based on the number of family members and a non-taxable cap amount.

I. The Concept of “Household”

As there are many possible situations in practice, it is essential that the definition of “household” be as comprehensive as possible.

It is important to bear in mind that a household may also refer to persons who do not live at the same address, but have common assets.

The concept of household may include: a family composed of spouses and their children; a family composed of spouses, their children and grandparents; a family of spouses, siblings, children and grandparents sharing common assets; two partners who share assets, etc.

The common assets refer to: “the rights and obligations of economic value, as well as the movable and immovable property to which these rights relate, belonging to one or more natural persons.”[3]

Concerning the concept of “household” we raise the following questions:

i. Is this Category Clearly Defined?

In relation to the diversity of situations that might come up in practice, is the definition stated in the Draft sufficiently clear? Will the Tax Collection Authority have sufficiently well-defined directions to a unitary practice in accepting/refusing an application for the registration as a household?

ii. What Does ”Household” Mean in the U.S. system?

The project initiators gave the example of the U.S. model, namely the calculated tax for the so-called “household”.

In the U.S. system, the following categories of taxpayers are identified: „single” (the person contributing alone to the tax calculation); „Head of Household” (the person which brings the main income to the household, a single parent which has children in his sustentation), „Married Filing Jointly” (a married couple which contributes equally), „Married Filing Separately” (a married couple contributing separately), „Qualifying Widow with Dependent Child” (a widow which has a child in her sustenation) etc.

II. Household Registration at the Tax Authority

When calculating the tax on the total income, the taxed household is considered as the subject of taxation.

The duty to determine whether we are or not in the situation of a household belongs to the tax authority, which will be obliged to respond within 60 days to a request for registration of a household.

  1. Will the Taxpayers be Able to Decide if They Want to Register as a Household or not?

In the case of two spouses who have children in their sustentation, can each of them choose to contribute individually, proportionally to their sustenation costs?

Is this method of calculating income tax designed to encourage grouping in households or on the contrary?

III. Categories of Deductible Expenses

The project also lists several expenses that will be deductible from the tax base.

Such examples are: private healthcare fees, school tuition fees for children, renovation costs, housing construction, asset or life insurance, food or clothing expenses, recreational expenses, book, theater or cinema tickets purchases, certain medicines, the support of non-profit entities.

Bank loans for housing will also be included in deductible expenses, which is an important aspect given the fact that for many taxpayers they may represent a significant percentage of their revenues. The question arises whether this will apply regardless of the number of immovables owned by the person who contracts the bank loan.

IV. How is it Computed?

From the income the following contributions will be removed: health insurance, unemployment and pension fund. Following, this tax base is decreased by the deductions regulated by the law. Of the remaining amount, in the case in which it will be less than 2,000 lei, no tax will be applied and in the case in which it will be higher, the 10% will be applied.

Households will pay the global income tax twice a year, in equal installments, the first when submitting the global income statement, and the second within 60 days from the date of submission of the statement. The annual tax due will be communicated by the tax consultant to the person which represents the household in relation to the Tax Collecting Authority until the 25th of May of the tax year following that in which the revenues were attained.

V. Do We Have Tax Consultants?

The new method of computinf the tax will be performed by tax consultant. Given that there are around 7 million households in Romania, the project initiators have estimated a need for 30,000-35,000 tax consultants, referring to the 30,000 tax collectors, claiming that it would be a sufficient resource for some to be employed for these purposes.

VI. The First Tax Collection will Take Place in May 2019

Will the administration have the possibility to wait until May 2019 to collect the tax following the deductions?

As the revenues in Romania are collecting largely from salaries, in 2016, at a tax of 16%, the consolidated general budget collected from the “salary tax and income tax” 27.7 billion lei (1.7 billion lei at one point of taxation).[4]

According to the budgetary program included in the „Macroeconomic situation report for 2017 and its 2018-2020 projection”, in 2017, from the salaries and income tax, 30 billion lei will be raised to the budget, thus 11.8% of total state revenues.

However, the new project proposes, starting with 2018, a differentiated taxation in which the incomes below 2,000 lei per month are no longer taxed, and for the incomes above this amount the tax paid will be 10%. In spite of the salary increases envisaged, the income line below 2000 lei could still be quite broad.

Another problem is that if in 2018 the employer will no longer retain the tax and taxpayers will file the statement in 2019, there will be a one-year gap. How will this gap be financed and at what costs? Will banks and/or external creditors be used to cover the related costs?

VII. How Will Income from Investments, Dividends and Interest be Taxed

Dividend income will be exempt from tax (currently, this income category is taxed at 5%.) With regard to revenues from other investments – which are now exempt from tax – a 3% quota will be applied, more precisely for those that exceed the amount of 100,000 euro. Also, „the tax rate will not be applied to the transfer of securities”.

VIII. To What Extent will the “Underground” Economy Diminish?

The main advantage presented by project initiators is to stop the so-called “black” and “grey” markets.

The possibility to deduct a significant amount of expenses based on invoices and fiscal receipts is supposed to determine us to request and keep fiscal receipts for any product or service. On the other hand, any economic agent and/or service provider will have to issue a tax receipt, especially in those areas of tutoring, rent, local food, where so far, in order to get a better price, most people preferred not to request a fiscal receipt.

Also, as regards particularly the “gray area” of labor market, at least theoretically, employers will no longer have the interest to declare a lower income. However, the interest of employees to register lower incomes, in order to fall within the non-taxable cap amount of less than 2,000 lei or to work without declaring so to the state authorities will still exist.

IX. How Will Rental Revenue Taxes Change?

Article 84 para. (3) of the Fiscal Code stipulates that „the net income from the lease of goods is determined by deducting from the gross income the determined expenses by applying the 40% quota of the gross income”.

Therefore, in the present, the 16% tax applies to 60% of the rent that the lessor receives.

In the new draft, not only will the 10% general tax rate apply, but the new paragraph 3 provides for a 20% deduction instead of 40%.[5]

X. Answered Or Unanswered Questions?

1. Will Standing In Line Become A … Normality?

Approximately 5 million employees, even grouped in households, will have to file a substantial number of documents for the tax calculation.

2. Why Do We Need To Replace An Easy-To-Manage System With A Complicated One To Implement?

There is a clear disproportion between the purpose of this measure – the attempt to bring some of the “black” economy and the effort and risks of introducing this new tax system.

3. Will that Category of Taxpayers Living on the Limit of Subsistence be Able to Put Aside Tax Money?

Although there is a cap amount of 2000 lei under which a tax will not apply, in practice there will be many cases in which households will not keep track of deductible expenses, will spend in advance the money owed by way of tax etc.

Moreover, what will happen in cases where tax authorities will carry out unannounced check-ups and will have to apply sanctions to taxpayers? To what extent will many of them succeed in paying them and will not only reach an endless series of debts?

4. Will the Household Be an Entity Officially Recognized by Banks, Utilities Sppliers, Courts?

Will households be able to contract loans? Will be possible to register the goods in public registries as ownership of the household?

5. Privacy …Issues?

More or less justified, one of the criticisms of the new project was that it would impose excessive control, with taxpayers having to keep and hand over any tax receipt if they want to deduct those amounts, of course, especially considering that the expenditure sphere of deductibles appears to be wider than is currently the case for liberal or independent professions.

XI. Conclusion

A major and sudden change in the whole fiscal system considering the background of a poor financial education of the population can lead to an opposite effect to the one aimed by the initiators of the project: evasion caused by the inability/hard adaptation of people to understanding the system.

Also, in the most likely case of registering a collection deficit in the early years, new regulations will be needed that will create even more instability.

Should such a system be dismissed or regulated as optional? In this last case, until when?

  1. Article 58 (Taxpayers) of the draft submitted by the Ministry of Public Finance provides that the following categories of persons owe the household tax and are referred to as taxpayers:”a) the resident natural person, designated as the representative of the household;b) non-resident natural persons who are self-employed through a permanent establishment in Romania;c) non-resident individuals carrying out dependent activities in Romania “

  2. Article 57 ^ 1 (Meaning of Terms and Expressions) of the draft submitted by the Ministry of Public Finance defines the household as the “group consisting of one or more related or unrelated natural persons, having common assets that they manage together from an economical and financial point of view and live/do not actually live on the same cadastral number. ”

  3. Article 57 ^ 1 (Meaning of terms and expressions) of the draft of the Ministry of Public Finance.

  4. According to the Ministry of Finance.

  5. The annual net income from the lease of goods is determined by deducting from the gross income the determined expenses by applying the 20% quota of the gross income. The annual income is determined by summing the revenues based on the exchange rate of the foreign exchange market communicated by the National Bank of Romania, valid for the last day of each month, corresponding to the months in which the rental contract was in force.