Micro-enterprises: welcome tax relief for small companies?

  • 2010-04-22
  • By Markus Meyer

RIGA - Just under 12,000 businesses were created in Latvia in 2008, but this number dropped to 9,228 last year. To curb this tendency, the Ministry of Economics is working on a bill to establish a new type of company: the status of micro-enterprise could come into effect this summer and would allow small businesses to pay a flat-rate tax of 20 percent on turnover.

At the moment, companies pay corporate tax, personal income tax, social taxes for workers and a state fee that protects them in case of bankruptcy. All these taxes would be replaced by the new flat-rate tax for companies which adopt this new status.

In order to qualify as a micro-enterprise, a company cannot have more than five employees on its payroll and the turnover, during a 12-month period, has to be below 70,000 lats (100,000 euros).
Ilze Beinare is the director of the department for entrepreneurship at the Ministry of Economics. She says that the advantage of this new system is that it simplifies accounting because it allows businesses to deal with one tax, rather than four. It can also reduce the amount paid in tax by small businesses. She says that both of these measures are good ways to encourage entrepreneurs to open their own businesses.

But in the current recession, the government is struggling to balance its budget. And international lenders are calling for further cuts in state spending. So is it even feasible to slash taxes? “We are doing this to encourage people, especially unemployed ones, to create new businesses,” says Beinare.  “We believe that the loss in tax revenue will be compensated by the tax collected from the new businesses and the decrease in payment of unemployment benefits.”
Some economists welcome the move. Janis Berzins, a lecturer in economics at Riga Stradins University, agrees with the concept that is being developed by the Ministry of Economics. Berzins explains that if nothing is done, the Latvian economy will be stuck in a vicious circle of underdevelopment and low productivity because of its overvalued currency. The government should therefore help companies to become more competitive on the international market, by lowering tax.

His only criticism is that, if anything, the bill is too timid. “A 20 percent tax on turnover is too high, and restricting the size to five employees and 70,000 lats’ turnover a year will only help small local companies - that is not enough,” says Berzins. “The government should also aim to attract foreign investment by giving tax breaks to larger companies that employ 30 to 40 people and have a turnover of up to 300,000 a year.”

But not everyone is so convinced that this bill, in its present form, will actually ease the tax burden for small businesses. Self-employed accountant Ieva Alksne agrees that the government should encourage new businesses by lowering taxes and cutting bureaucracy. This bill, though, won’t necessarily do that. Alksne combed through the figures and found that a micro-enterprise could potentially end up paying more tax.

She calculated the tax paid by a fictitious company with a turnover of 70,000 lats, both as a micro-enterprise and under the current system. As a micro-enterprise, the company would pay a flat rate tax of 20 percent of 70,000 lats, which is 14,000 lats. No deductions can be made to reduce this amount, because the tax is calculated on total turnover.
With the current system, however, the amount of tax paid by the company is calculated on profit for corporate tax, and salaries for social tax. Expenses such as rent, salaries and travel expenses can be deduced from the amount that will be taxed. According to Alksne’s calculations, a company that generates a turnover of 70,000 lats and has one employee with a gross monthly salary of 500 lats, will pay 12,792 lats in tax over the year. This is 1,208 lats less than the same company set up as a micro-enterprise. And, if the company can deduct any further expenses, which in a real case is very likely, this difference would be even larger.

According to State Revenue data, companies that would fulfill micro-enterprise requirements paid an average tax of 12.3 percent from turnover in 2008. This figure includes VAT, which micro-enterprises will have to pay on top of the 20 percent on turnover.
Companies will have to consider carefully if they want to become a micro-enterprise. What looks like a tax break may turn out to be a tax hike.

Some companies may be ready to pay higher tax for the sake of simplicity. After all, paying one tax instead of four is an attractive idea. But, according to Alksne, the new system does not actually make a company’s accounts much simpler. VAT payments stay the same, and balance sheet statements still have to be made due to EU regulations.
The micro-enterprise status is optional, and companies will be free to decide which tax system they adopt. The current proposal is probably not the final version, as parliament may yet decide on changes in its final reading. But if parliament passes the bill, the new status looks set to come into effect in July.