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POSITION PAPER OF THE REPUBLIC OF LATVIA
Chapter 10: "TAX POLICY"

Setting the time frame for the process of adoption and implementation of the European Union (EU) acquis communautaire, the Latvian Government adopted 1 January 2003 as the time when Latvia will be prepared for accession to the European Union.

The Republic of Latvia fully accepts the EU acquis communautaire in the field of tax policy, including the acquis adopted during 1999 and 2000, and is ready to implement all relevant EU legislation by January 1, 2003 with the exception of the following requirements where, based on economic and financial considerations respectively, it requests one transition period and one derogation:

1. The Republic of Latvia requests a 7 year transition period, i.e. till January 1, 2010, for implementation of the minimum excise tax rate on cigarettes provided for in the Council Directive 92/79/EEC.

2. The Republic of Latvia requests a permanent derogation from the requirement of Article 24 of the Council Directive 77/388/EEC on the VAT registration and exemption threshold. The Republic of Latvian requests that on its territory the threshold be fixed at its present level of 10000 LVL (approximately 20000 EUR).

The above requests are substantiated in respective chapters of the position paper.

VALLUE ADDED TAX /VAT/

The law "On Value Added Tax" was adopted in 1995 in the framework of the overall reform of the tax system. The law provides for two rates of the value added tax: general rate of 18% and 0% rate for export and transit deals

As a result of comprehensive amendments to the law introduced during the last years, it is now in compliance with the main provisions of the EC directives. Activities to complete the implementation of other requirements of the EC directives encompass: 1) abolition of the restrictions to deduct input tax which are not in compliance with the EU requirements; 2) abolition of the exemptions which are not in compliance with the EU requirements; 3) introduction of the input tax refund system for foreign legal persons.

The amendments to the law "On Value added Tax" which remove a great deal of the above mentioned non-compliance were adopted by the Saeima (the Parliament) on November 23, 2000. The amendments will enter into force on January 1, 2001.

These amendments:

1. harmonise the terminology used in the law with the EC Directives through introduction of editorial improvements to the existing terms (supply of goods, supply of services, input tax, intermediary, lease purchase, taxable amount, self-consumption). The definition of internal territory is clarified as well;

2. clarify the place of supply of services in the context of rendering transportation services, services related to immovable property and telecommunication services;

3. provide for single procedures of imposition of the VAT on books printed in Latvia and the imported ones as of January 1, 2003 thus abolishing the discrimination;

4. abolish the exemption for services of printing houses as of January 1, 2003;

5. cancel the existing restrictions on input tax deduction. Thus the amendments provide for an opportunity to deduct the input tax after reception of the tax invoices but before the tax invoices have actually been paid (this refers to supply of goods). They will also allow non-restricted deductions of input tax for the services received from a non-resident during the taxation period when the tax invoice has been issued.

From January 1, 2001 it is envisaged to refund to foreign legal persons - international haulers - the value added tax paid on fuel purchased in Latvia which will be the first step towards introduction of the VAT refund system for all foreign legal persons (completion of the work is scheduled for January 1, 2003).

As far as the exemptions for supply of drugs and medical appliances, funeral services, for payments made by physical persons for heating, water supply, etc. are concerned, the law "On VAT" will be gradually amended so as to exclude the above exemptions by 2003.

The Latvian position

Latvia requests a permanent derogation from the requirement of Article 24 of the Council Directive 77/388/EEC on the VAT registration and exemption threshold and requests to fix it at the current level of LVL 10000 that does not exceed EUR 20000.

Basis for the position

After accession to the EU, Latvia would like to retain the existing threshold for value added tax registration, equal to the total sum of taxable deals during 12 months, at 10 000 LVL (approximately 20000 EUR). As regards the threshold applied to farms which is now equal to 30000 LVL (approximately 60 000 EUR), it is envisaged to reduce it to 10 000 LVL as of January 1, 2002. At the same time, the Latvian side notes that all businesses have rights to register as VAT payers even if the total sum of taxable deals is below that provided for in the law.

According to estimates of the Ministry of Finance and the State Revenue Service (SRS), the reduction of the threshold standard level to that of the EU will not give rise to growth of revenue from the VAT. Just the opposite, it could lead to contraction of the VAT revenue. This statement is based on the two major factors: 1) unproportionate growth of administration costs; 2) increased risk of fraud.

It is estimated that in case of a lower threshold the number of VAT payers would increase from 50600 (on 01.11.2000) to more that 75000. Subsequently, administration costs would grow by 2.5-3.5 MEUR per year. Moreover, it is estimated that tax administration of the businesses that are now below the threshold, in case of their inclusion in the list of the VAT payers, would cost in relative terms (costs per 1 LVL of revenue) 20 to 30 times more than is the case with the businesses registered for VAT purposes currently. At the same time, the Latvian side points out that the "below-the-threshold" tax-payers do not fall beyond the scope of the SRS control. All economic agents engaged in entrepreneurial activities shall register in the Tax-payers Register; thus the SRS has the power to control their compliance with the legal framework.

Another negative impact of raising the threshold is that the risk of fraud related to refund of input tax would grow considerably. One should take in mind that for economic agents with small turnover the place of business is very often the same as the place of living. Thus it is just not possible to distinguish between VAT payments related to private consumption and consumption connected with entrepreneurial activity. Now there is no such a risk since very small economic agents are not VAT taxable persons.

Taking into account the above mentioned, it is possible to conclude with quite high degree of confidence that if the current registration threshold was reduced the total VAT revenue would most probably decrease.

Latvia commits itself to pursuing all measures that are necessary so as to remove any potential negative influence of the derogation on competition and the EU own resources (the EU budget):

• the amendments to the law "On value added tax" providing for that all economic agents involved in export-import operations shall be registered as the VAT payers irrespective of the volume of their turnover will be adopted. Thus, respective requirements of the Council directive 77/388/EEC will be implemented and the risk of distortion of competition in trade will be eliminated;

• according to the Regulation (EEC, Euratom) No. 89/1553/EEC, the corrections to the VAT base for calculation of the VAT payments to the EU budget will be made.

EXCISE TAX

As a result of the reform of the excise duty system commenced in 1997, the provisions of the Latvian legal acts (law "On Excise Tax on Mineral Oils", "On Excise Tax on Tobacco Articles", "On Excise Tax on Alcoholic Beverages" and "On Excise Tax on Beer") include the requirements of respective directives as regards application of the excise tax on groups of taxable goods, tax rates and also tax payment procedures introducing the system of excise tax warehouses and envisaging suspended tax payment procedure using tax guarantees.

In accordance with the aforementioned laws, the minimum excise tax rates for alcoholic beverages already now exceed the minimum level set by the EC directives, except for beer with respect to which a lower rate will be applied till the end of 2002. Till 1 January 2003, the excise tax rate on beer will be gradually raised up to the EU level as it is envisaged in Article 6 of the law "On Excise Tax on Beer".

Regarding mineral oils, the EU defined minimum level is in general already achieved (for some types of mineral oils the current rates are higher than those of the EU, for some âÀ“ somewhat lower). Necessary corrections of the rates will be made according to the EU methodology by the moment of accession to the EU.

The only exception refers to kerosene, gas oil and heavy fuel oil where the current excise tax rate is lower than that stipulated in the EC directive. The rate will be brought in compliance according to the transitional provisions containing a precise time schedule of gradual raising of the rate during the time period until January 1, 2003.

The EU minimum excise tax rate on smoking tobacco will be introduced by 2003 through amending the law "On Excise Tax on Tobacco Articles" in accordance with the EC directive 92/80/EEC.

As regards the excise tax rate on cigarettes, currently the authorities settle legal and other issues in order to switch from the fixed rate to the combined one (fixed + ad valorem) as required by the EC directive 92/79/ECC. Though the combined rate will be introduced as of January 1, 2003, respective provisions could be included in the law well in advance so that the SRS and tax-payers could prepare themselves for administration and compliance respectively.

The authorities have already made several steps in order to establish an inventory of data on the most popular retail prices of cigarettes because the introduction of the combined rate is not possible without having such information. According to the Cabinet of Ministers regulations No. 298 "Regulation on Trade with Tobacco Products" (adopted on 29.08.2000), enterprises involved in operations with tobacco products (importers, producers etc.) will submit to the SRS reports on deals with tobacco products on a monthly basis. These reports and other relevant information (data and research of the customs, THE Central Statistical Bureau and market research) will give a basis for the research of the tobacco market in Latvia in order to find out the most popular retail price.

The Latvian position

Latvia requests a transitional period until December 31, 2009 for implementation of the Council directive 92/79/EEC with respect to the rate of the excise tax on cigarettes. 

Basis for the position 

Currently the fixed rate not exceeding 40% of the most popular retail price of cigarettes is applied in Latvia. The rates of the excise tax for cigarettes are:

1. cigarettes with filter - 5,1 LVL per 1000 cigarettes;
2. cigarettes without filter âÀ“ 6,1 LVL per 1000 cigarettes.

Therefore the excise tax rate is lower than the combined rate (ad valorem + fixed) which shall not be lower than 57% of the most popular retail price of cigarettes as it is provided for in respective directive. Introduction of the combined rate of 57% in a short time period (by 2003) would be too hurriedly. In fact, in case of a rapid rise of the tax rate to 57% there is the risk that Latvia could encounter problems with meeting another important EU requirement that is to ensure collection of the tax. The Latvian side has come to this conclusion after investigation into the market conditions following rapid increase of the tax on cigarettes in other countries. Rapid growth of rates provokes increases in volumes of smuggled cigarettes that, in turn, makes the authorities allocate more resources to control the illegal market whereas gradual growth of the tax rates as proposed by the Latvian side will undoubtedly ensure even and constant increases in tax revenue.

Another important factor to be taken into account is the purchasing power of the population. Theoretical research[1] dealing with possible impact of the excise tax rate growth on the main macro-economic indicators undertaken at the end of 1999-beginning of 2000 reflected that in case of reaching the EU level of the excise tax rate on cigarettes by 2003 their retail price would increase more than three times in a short time period. By contrast, the purchasing power of the population would not grow so fast. In case of a gradual increase of the excise tax rates up to the EU level (i.e. by 2010) the gap between growth of the price for cigarettes and purchasing power of the population is much lower (app. 80%) than in case of rapid increase of the excise tax rate (app. 170%). To sum up, if the excise tax rate is raised gradually until 2010, the growth index of the purchasing power will be much closer to that of the price..

The steady harmonisation scenario would allow limiting the negative impact on the labour force employed in the tobacco industry. It would give more time to the enterprises to adjust to the consequences of growth of the excise tax rate on cigarettes.

Finally, the gradual increase of the excise tax rates implies a more lenient pressure on inflation.

Taking into account the above mentioned facts and findings, Latvia requests a transitional period till 31 December 2009. From 1 January 2010, a 57% excise tax rate on cigarettes will be applied. The rate will be gradually increased by this date.

Latvia commits itself to pursuing measures that are necessary to remove any possible distortions of competition in the Internal Market.

DIRECT TAXATION

Legal preconditions for implementation of the EC directives in the field of direct taxation (69/335/EEC, 90/434/EEC, 90/435/EEC) will be ensured by 2003 incorporating the necessary norms into the Latvian legal acts. Insofar as the provisions of these directives can only be applied by a member-state, their practical implementation will be ensured upon accession to the EU.

Latvia can join the multilateral EU Arbitration Convention also only after becoming a member-state carrying out the necessary preparatory activities in the meantime before 2003.

Latvia commits itself to observing the Code of Conduct for business taxation in its entirety, abstaining from introduction of new tax measures that can be regarded as distortions of competition in the Internal Market.

STATE AID OF FISCAL NATURE

The Republic of Latvia will not introduce any state aid of fiscal nature that would be in conflict with the requirements contained in the acquis.

The existing problems will be solved by 2003 according with the commitments undertaken in the process of negotiations under the chapter "Competition".

MUTUAL CO-OPERATION AND ASSISTANCE IN TAX ADMINISTRATION 

General information on building up the capacity of the tax administration

In Latvia, the State Revenue Service (SRS) is responsible for implementation of the state policy in the area of tax and customs administration.

To comply with the National Programme of the Latvian Government, the EU Charter of 1985 and the standards of the EU tax administration systems, the State Revenue Service in collaboration with the World Bank experts elaborated a long-term development and action program called the State Revenue Service Modernisation Project 1998âÀ“2002. The main purpose of the State Revenue Service Modernisation Project is to establish the SRS as a professional, client oriented modern organisation, improving the system of providing services to taxpayers, promoting observance of the principle of voluntary payment of taxes, duties and other mandatory payments, as well as preventing the opportunities for violation of tax legislation.

One of the key focuses of the SRS Modernization Project is the structural re-organisation of the institution leading to the introduction of the functional structure. The two level structure is being gradually replaced by a three level one that will allow removing some deficiencies still existing in tax administration and servicing clients. The new organisational set-up will also increase the level of confidentiality of information related to the tax-payers.

The implementation of the EU Fiscal Blueprints is going on in close connection with the realisation of the SRS Modernisation Project. After GAP analysis (11.1999) and Needs identification (03.2000) had been completed according to the IOTA methodology, the Business Change Management Plan was approved. Its implementation will be completed in 2003.

Measures to ensure tax collection

Latvia has a fully computerised tax accounting system both by each tax-payer and by tax type. Each tax has its own code compliant with the classification of budget revenue and expenditure. If necessary, it can be broken down by taxes and types of goods. Since autumn 1999, payments related to the budget have been cleared by the Bank of Latvia that ensures higher safety and facilitates accounting.

In order to ensure administration of the VAT in accordance with the EU requirements, beside the Tax-payers Register the State Revenue Service effectively employs also the VAT Tax-payers Register. Each VAT tax-payer is assigned a unique 13-symbol identity number that is in full compliance with the EU practices.

The mechanism of collection and enforcement is being constantly improved.

The SRS capacity in auditing the taxpayers is being persistently enhanced. To introduce a single approach to this kind of audit, the SRS Audit Division published a Tax Audit Manual. Currently, the Tax Audit Manual is being improved so as to include new methodological guidelines on certain types of taxes, revise audit techniques taking into account special features of certain industries and incorporate provisions on simultaneous international audit. Risk analysis techniques in audit are being upgraded. The approach of cross-checks elaborated by the National Tax Board has been effectively used in auditing VAT payments. Computerisation of audit is going on under the auspices of the general SRS computerisation strategy. It is envisaged that audit will be fully computerised in line with the EU practices in 2001. At the moment, a technical specification of the system is being worked out in co-operation with the EU experts.

In parallel, internal audit techniques and methods of combating corruption are being constantly upgraded.

The SRS computerisation has been successfully going on.

Mutual assistance in the area of tax administration: legal and institutional aspects

Mutual assistance and administrative co-operation in the area of tax administration between the competent authorities of the Republic of Latvia and the EU (as well as other states) is carried out under the framework of conventions "On the Avoidance of Double Taxation and the Prevention of Fiscal Evasion". Exchange of information under the framework of these conventions is possible with 21 countries including Denmark, Sweden, Ireland, the Netherlands, the United Kingdom and Germany (the mechanism is, in fact, equivalent to the mechanisms inside the EU).

Similar conventions with France, Italy and Belgium have been ratified by Latvia, but they are not in force yet (ratification procedures in the above countries are under way). Negotiations with Portugal are completed, the convention is signed by the experts. Negotiations on conclusion of the convention are continuing with Austria and Spain.

Supplementary agreements "On Mutual Administrative Assistance and Automatic Exchange of Information" under the framework of the conventions have been signed with Sweden, Denmark, Lithuania and Estonia.

An agreement between the tax administrations of the three Baltic States "On Organising Simultaneous Audits" was signed in June 1999. The agreement envisages much broader possibilities for co-operation between the tax administrations concerning effective control of the taxpayers in the Baltic States.

Though currently the Latvian legislation does not provide for the types of mutual assistance with respect to the value-added tax which are stipulated in the EC directives, preparatory and training activities are carried out to be ready to fulfil respective requirements at the moment of accession.

The Business Change Management Plan provides for comprehensive measures to establish the SRS IT system compliant with the EU requirements that will facilitate compatibility with the IT systems employed in the EU. It is envisaged:

• to create the data warehouse

• to introduce the specific IT systems used also in the EU (INTRASTAT, VIES, SEED, Fiscal Scent)

• to introduce the Central Liaison Office

• to improve exchange of information between tax and customs administrations

• to improve exchange of information with tax administrations of other countries

• to introduce an information system for the purposes of tax control

• to introduce a system for uniform application of tax legislation

To continue the creation of a legal base for efficient mutual co-operation in the area of tax administration that would correspond to the EU practice, further harmonisation steps are being made. Amendments to the law "On the State Revenue Service" have been elaborated. The amendments improve the procedures for exchange of information between the competent authorities. They also entitle the local competent authority to go to court by assignment of the competent authority of another country for the recovery of funds and/or mandatory execution of the claim.

The above comprehensive measures will ensure full preparedness of the SRS to comply with the requirements of the EC directives in the area of mutual co-operation and administrative assistance at the moment of accession.

Taking into account the above, the Republic of Latvia invites the EU to open negotiations in chapter "Tax Policy" on granting a permanent derogation from the requirement of Article 24 of the Council Directive 77/388/EEC on the VAT registration and exemption threshold and on granting a transitional period with respect to achieving the minimum excise tax rate on cigarettes according to the Council Directive 92/79/EEC.    

Annex

Action Plan for implementation of the EU requirements in the field of Tax Policy

[1] The research was conducted on the basis of the current price of the traditonally most populat brand of cigarettes.