What countries are good for taxpayers to live in?

Villi Tõntson

PricewaterhouseCoopers

Leader of Tax Services

May 2009

What countries are good for taxpayers to live in?

Is Estonia a tax paradise or is our tax burden too high? Which is more important for entrepreneurs – is it the simplicity and promptness of communication with the Tax Board or is it low taxes? Is the tax burden lower for Estonian companies than it is for Finnish companies?

PricewaterhouseCoopers, a global network of auditing and business consultancy companies, is together with the World Bank issuing a comparative study of tax environments, Paying Taxes, in which already for the third year running attempted to rank the tax environments of the world countries by the tax burden of companies, the number of state and local taxes payable in a year and the time spent in paying the taxes, based on activities and tax obligations of a hypothetical medium-sized production company meeting the predefined conditions (see Appendix 1 Case study company) in the legal environment of 181 countries.

The results of the study showed that the countries with the simplest tax system included the Maldives, Qatar and Hong Kong (China). The businesses found it the hardest to pay taxes on Belarus, Ukraine and Congo. (see Appendix 2 Ease of paying taxes rankings)

The upper decile of the ranking chart (18 countries with the best tax environment) contains 6 Arab oil countries, 5 European countries (Ireland, Denmark, Luxemburg, United Kingdom and Norway), 3 small island states in the Indian /Pacific Ocean region, two Asian “tigers” (Hong Kong and Singapore), one African country (Botswana) and New Zealand.

The lowest decile (18 countries with the worst tax environment) contains 9 African countries, 5 Latin American countries and 2 Asian countries, as well as Belarus and Ukraine as already mentioned above.

Of the seven leading industrial countries, the tax environment is remarkably good in the United Kingdom (16^th place) and Canada (28^th), rather good in the USA (46^th), France (60^th) and Germany (80^th) and rather poor in Japan (112^th) and Italy (128^th). At the same time, Italy and France have the highest corporate tax burden in the European Union, but determined efforts towards developing e-taxation and reducing the number of payments have ensured France a considerably better tax environment ranking. In general, all the large countries rather stand out by their high corporate tax burden and are placed in the second part of the table, apart from the United Kingdom. However, the tax environments of the four developing countries with large country ambitions (the so-called BRIC) fall into the lowest third of the table: China 132^nd, Russia 134^th, Brazil 145^th and India 169^th.

It is clear that favourable tax environment reflects the specific features of countries and regions as well as intentional choices (see also Appendix 3 What makes a good tax system?). Rich oil countries may see the tax revenue received from (small-scale) entrepreneurship as completely irrelevant, but large countries consider it as an important source of financing for the state budget. For small countries, low tax burden may constitute a significant competitive advantage, which simultaneously with the reduction of potential tax revenue considerably increases the receipt of income from other sources.

Estonia’s high tax burden is balanced by simplicity in official communication

The amount the company studied in Estonia had to pay in taxes was 48.6% compared to its annual profit (corporate income tax 8.8%, labour taxes 38.3% and other taxes 1.5%), which places the country in the 122^nd place, ranking behind the majority of the EU Member States, including Finland, Latvia and Lithuania.

At the same time, the corporate tax burden is one third lower than in Estonia in countries such as Macedonia (18.4%) and Montenegro (31.8%) who are still building up their economy, in Croatia (32.5%) and Latvia (33%) who were in a similar starting position to us, and in the wealthy Luxemburg (21%), Iceland (26.8%), Ireland (28.8%) and Denmark (29.9%).

In conclusion, the Estonian tax system is by its simplicity and business-friendliness still placed in the fair 34^th place in the context of the world and in the 6^th place in the context of the European Union (after Ireland, Denmark, Luxemburg, United Kingdom and Holland).

According to the study methods, the “company operating” in Estonia had to pay 10 different taxes during a year, which gave us the 26^th ranking among countries. The European countries to precede us in this were Sweden (3^rd place: 2 taxes), Norway (4^th place: 4 taxes), Latvia (7^th place: 7 taxes), Spain, Portugal, United Kingdom (all in the 10^th place: 8 taxes) and Holland, Ireland and Denmark (all in the 16^th place: 9 taxes).

The Estonian tax system gained its highest ranking in the category of time spent on the payment of taxes (17^th place: 81hours), only falling behind such European countries as Luxemburg (59 hours), Switzerland (63 hours), Macedonia (75 hours) and Ireland (76 hours).

In the mid-1990s, Estonia took prompt and important steps in reforming the tax system, where the simple and business-friendly tax system then created and the subsequent removal of corporate income tax on reinvested profit ensured the receipt of taxes and favoured investments. However, as at today we seem to have positioned ourselves among the stable welfare states rather than the rapidly developing “tigers”. Whether this conforms to our interests and benefits our sustainability and competitiveness in the long run, is another question. In promoting the corporate tax system, we may be too focussed on the income tax of legal persons, while we should be looking at the taxes applicable to companies in a broader perspective, also paying attention to the labour taxes that also influence the companies’ tax burden.

Belarus – taxation hell

Of the EU Member States, Romania (146^th) and Poland (142^nd) have the lowest ranking tax system. But for entrepreneurs in Ukraine and Belarus, which are at least geographically placed in Europe, the tax environment is worse than in Africa. Particularly Belarus stands out on the negative scale, ranking among the last in all three categories. During a year, the Belarus company observed has to make 24 payments of corporate income tax and labour taxes and 64 other taxes (112 payments in total), which takes the total of 1,188 hours, or 30 working weeks (to compare with Estonia’s 10 payments and 2 weeks). The tax burden for Belarus companies was 117.5%, i.e. the company observed would not be able to operate profitably in Belarus with the predefined profit margin of 20%.

It is not easy to point out regional differences between continents or groups of countries with simple or cumbersome tax systems. It can be said that by business-friendliness, the tax environments of almost all of the countries with strong protestant work ethics, i.e. the “ideal capitalist countries” are among the TOP 50 in the world: the Scandinavian countries, Holland, Switzerland, United Kingdom, USA, Canada, Australia and New Zealand as well as Estonia and Latvia. Germany (80th) and Finland (97^th) are the only exceptions here.

As already mentioned before, many Arab oil countries have a very good tax environment, although the number of negative exceptions among them is also higher than in the previous example. Asia and Oceania provide both success stories and warning examples, while in Africa and Latin America countries with a good tax environment form an obvious minority.

As a rule of thumb, it can be said that in countries where people find it good to live, entrepreneurs also find it easy to pay taxes.

This statement especially applies when we compare regions by the complexity of paying taxes.

The corporate tax burden is the lowest in the Arabian North Africa and the Near East. Eastern Europe does stand out by its income tax being lower than in other regions, but the level of labour taxes being considerably higher than in other regions makes the overall tax burden in our area relatively high, even compared to rich OECD countries. Africa ranks as the first by the overall tax burden and particularly by various other taxes.

Tax reforms are popular

It impossible to say with utmost certainty whether the economic and social success of countries is ensured by their good tax environment or is the latter rather the result of a well-functioning social order – in any case the recent trend in the world has been clearly towards reducing and simplifying the corporate tax burden. Nearly a half of the countries in the world have made their tax system more business-friendly in the last 4 years, with 40% of them doing it only last year. 21 countries reduced the corporate income tax rate, 12 simplified the procedure or system for submitting tax returns and 8 reduced the number of taxes and duties payable by companies. The biggest reformers include the “New Europe” and Central Asia (28 countries), with 44 simplifying changes made in the last 4 years. This is followed by Africa (46 countries) with 22 reforms and 24 high-income OECD countries with 18 reforms.

The electronic tax return system so elementary for Estonians is also spreading more widely. E-tax board has been established already in a third of the world countries in all continents and the number is growing steadily.

Only two countries in the world increased their corporate tax burden last year by imposing additional taxes: Botswana with its best tax environment in Africa and Venezuela with its worst tax environment in South America.

Corporate income tax does not equal corporate tax burden

This study again confirms that the amount of corporate income tax should not be over-emphasised in assessing the tax and business environment, as on the average it forms only 37% of the total tax burden for employers and 26% of the time spent on taxes.

 

On the average, the “case study company” studied had to pay nine different types of taxes. Of the European Union countries, the number of taxes was the lowest in Sweden (5) and the highest in Austria (16). The Estonian company had to pay 10 types of taxes: in addition to corporate income tax it was subject to value added tax, social taxes, taxes withheld from employees, land tax, heavy vehicle tax, packaging excise duty, fuel excise duty, advertising tax and state fees.

One of the aims of the study was to facilitate the exchange of ideas in and between the countries in regards to tax reforms and to support that with specific data. Indeed, one of the main conclusions indicates that tax reforms important for the competitiveness and sustainable development of countries have to be carried out in a complex manner, considering as many factors as possible and in line with the broader fiscal and tax policies.

Dialogue between tax collector and taxpayer is important

The majority of entrepreneurs are not against paying taxes regardless of the fact that disagreement over the fair tax rates and the tax collection methods will probably never cease. As both the business activities of companies’ and the functioning mechanisms of states – often also including the tax laws – are becoming ever more complicated, the tax policy related challenges bear a more and more determining weight. State powers want the taxes to be paid, but entrepreneurs want the tax revenue to be used for the benefit of the entire society and in a transparent manner. Entrepreneurs naturally prefer low taxes that are based on simple rules, but they expect the public sector to operate economically and efficiently also when taxes are high.

Taxes are crucial for the functioning of economy and society. Without tax revenue, there would be no money for public services and states would not last. However, unfairly high taxes create a shadow economy and elicit evasion of taxes. Higher taxes cause a decrease in the citizens’ interest towards private entrepreneurship, not to even mention the drop in foreign investments and the number of new jobs, resulting in a deceleration of economic growth.

At the same time, a consistent and well-considered tax policy is a very important lever for countries in directing the social and economic development. We wish that Estonia will have a tax policy, which is namely that: increasing the competitiveness of the economy, promoting social life and strengthening the competitiveness of the tax environment - looking further than the next state budget and taking into account the wider impact of the decisions made.

APPENDIX 1: Case study company

•       The most common limited liability company (OÜ in Estonia)

•       Founded on 1 January 2006

•       Operating in the largest city in the country

•       Owners: 5 private persons who are citizens of the country

•       Start-up capital: 102 x average annual income of residents (15 million EEK in Estonia)

•       Field of activity: production and wholesale of ceramic flowerpots in domestic market

•       60 employees

•       Annual turnover: 1,050 x average annual income of inhabitants (150 million EEK in Estonia)

•       Profit margin: 20%

•       The first year of operation ended at a loss

•       At the end of the second year of operation, 50% of profit was paid out as dividends

 

(list not final)

APPENDIX 2: Ease of paying taxes rankings

1.       The Maldives

2.       Qatar

3.       Hong Kong Special Economic Zone (China)

4.       United Arab Emirates

5.       Singapore

6.       Ireland

7.       Saudi Arabia

8.       Oman

9.       Kuwait

10.    Kiribati

11.    Mauritius

12.    New Zealand

13.    Denmark

14.    Luxemburg

…

16.    United Kingdom

…

18. Norway

…

34.    Estonia

…

36. Latvia

…

42.    Sweden

…

46.    USA

…

57. Lithuania

…

97.    Finland

…

132. China

…

134. Russia

…

177. Venezuela
178. Central African Republic
179. Congo
180. Ukraine
181. Belarus

APPENDIX 3: What makes a good tax system?

States have to collect taxes to ensure the sustainable functioning of the society. In the course of the conducted study, PwC tax specialists and analysts have summarised the gathered viewpoints of practitioners and theorists and presented 20 characteristics of a good tax system for facilitating further discussion. Readers are urged to reflect at this point, which of these characteristics apply to the Estonian tax system.  

Having a clear purpose

1.       Taxes are collected to raise a specified amount of money necessary for offering public services.

2.       State budget is in balance.

3.       It considers social objectives.

4.       It has regard to the ability to pay tax.

 

Strategic

5.       The tax system is stable and consistent, to ensure that long term investment decisions can be taken, confident in the knowledge that the tax rules will not change significantly.

6.       It aims to take a fair proportion of the value of the country’s natural resources in tax revenues.

7.       It helps, rather than hinders, business and trade. The tax system is internationally competitive and has regard to how systems in other economies operate.

8.       It is flexible and responsive to economic and social change within a country. It is able not just to raise revenues, but also to encourage changes in the behaviour of people and companies, which society is agreed upon.

Efficient and coherent

9.       The tax system has mechanisms in place to allow for proper prior consultation with relevant stakeholders, helping to assist and inform policy makers and those responsible for drafting legislation.

10.    It is understandable and accessible.

11.    It ensures the interaction between taxes is fully considered (also in the international context)

12.    The tax return, processing and payment process is as simple and inexpensive as possible for both the taxpayers and the state.

Fair and transparent legislation

13.    The taxation rules and guidelines are set out in legal acts (that are freely accessible to taxpayers), rather than dependent on the interpretation tax authorities and/or court practice.

14.    The activities of officials are consistent in presenting tax claims.

15.    There is a clear and accessible method for settling disputes, which operates to a sensible timescale.

16.    The tax laws are consistent with other domestic laws and international legal norms and obligations.

A positive tone and stance by tax authorities which promotes cooperation

17.    Besides a supervisory and policing role, the tax board also has an assisting and supportive function

18.    Tax authorities and business should promote a constructive dialogue and move away from adversarial relationships.

19.    Recognition of the role of tax advisers as an important part of the smooth running of the tax system.

20.    The system operates on a basis of mutual trust and respect: taxpayers are assumed to be honest unless or until proved otherwise and respond by being open and transparent in their dealings with the tax authorities.