Brazil, Russia, India and China (BRIC): Tax system structures and the effects on development and foreign trade performance – lessons and solutions

© 2011 - Agência Brasileira de Desenvolvimento Industrial - ABDI Brazil, Russia, India and China (BRIC): Tax system structures and the effects on development and foreign trade performance lessons and solutions Qualquer parte desta obra pode ser reproduzida, desde que citada a fonte. Universidade Católica de Brasília ABDI - Agência Brasileira de Desenvolvimento Industrial CGEE - Centro de Gestão e Estudos Estratégicos Supervisão Maria Luisa Campos Machado Leal (Diretora) Equipe da ABDI Marina Pereira Pires de Oliveira (Responsável Técnico) Projeto Gráfico e Diagramação Via Comunicação Editora Organizadores Marcos Aurélio Pereira Valadão Antônio de Moura Borges Autores e Colaboradores Alexander Pogorletskiy (Rússia) Antônio Moura Borges

Arnaldo Sampaio de Moraes Godoy Carolina Pancotto Boher Elias Emanuel Alves de Sousa Isaias Coelho Ivo Teixeira Gico Junior Lauriana Magalhães Silva Leila Maria Da´Juda Bijos Marcos Aurélio Pereira Valadão Maria Dolgopolova (Rússia) Maria Teresa Bustamente Maurício Muriack de Fernandes e Peixoto Maurin Falcão Paulo Borba Casella Vishwa Nath Alok (Índia) Welber Oliveira Barral Zhu Weiqun (China)

Ficha Catalográfica AGÊNCIA BRASILEIRA DE DESENVOLVIMENTO INDUSTRIAL. Brazil, Russia, India and China (BRIC): Tax system structures and the effects on development and foreign trade performance - lessons and solutions Brasília: Agência Brasileira de Desenvolvimento Industrial, 2011. 402p.: il.; graf.; tab. ISBN 978-85-61323-28-8 CDD 634.04

ABDI Agência Brasileira de Desenvolvimento Industrial Setor Bancário Norte Quadra 1 - Bloco B - Ed. CNC 70041-902 - Brasília - DF Tel.: (61) 3962-8700 www.abdi.com.br

República Federativa do Brasil Dilma Rousseff Presidenta

Ministério do Desenvolvimento, Indústria e Comércio Exterior Fernando Pimentel Ministro

Agência Brasileira de Desenvolvimento Industrial Mauro Borges Lemos Presidente

Clayton Campanhola Diretor

Maria Luisa Campos Machado Leal Diretora

Marina Pereira Pires de Oliveira Responsável Técnico

TABLE OF CONTENTS 1. Presentation

7

2. Brazil

9

2.1. Globalization Effects on the Brazilian Tax System Marcos Aurélio Pereira Valadão

2.2. Brazilian tax system: history, perspectives and critical analysis Maurício Muriack de Fernandes e Peixoto

3. Russia

3.1 The Russian Tax System and its Effects in Development and International Trade Relations: Legal and Economic Approach Alexander Pogorletskiy, Maria Dolgopolova

3.2. Lessons from Russian tax reform Arnaldo Sampaio de Moraes Godoy

4. India 4.1. Tax system and reform in India: An analysis from the perspective of economic development and international trade Vishwa Nath Alok

4.2. Introduction to the constitutional law of India Arnaldo Sampaio de Moraes Godoy

4.3. The influence of India on global issues and its relations with Brazil (pronouncement) Leila Bijos

5. China 5.1. The Chinese Tax System and its Effects in the Development and in International Trade Relations of China: A Juridical and

10 36

95 96 139

141 142 203 207

209

Economic Approach Zhu Weiqun

5.2. Introduction to chinese constitutional law Arnaldo Sampaio de Moraes Godoy

5.3. Chinese economy: development and trends

Marcos Aurélio Pereira Valadão, Lauriana Magalhães Silva

5.4. Modernization of China Leila Bijos

6. Analysis and Perspective

6.1. Executive summary and conclusions of the seminar 6.2. BRICs tax systems convergence

210 267 277 285

289

289

Maurin Almeida Falcão

293

7. About the authors

301

7.1. Curriculum of authors and contributors

301

8. Annex: Transcript of Seminar Brazil, Russia, India and China (BRIC): Structures of the Tax Systems and its Implications in Development and Performance of Foreign Trade 307 8.1. The Brazilian Tax System and its Impact on Development and International Trade 8.2.Taxation and Development in India: Historical and Economical Evolution

8.3. Taxation and Development in Russia: Historical and Economical Evolution 8.4. Taxation and Development in China: Historical and Economical Evolution 8.5. Taxation and Development in Brazil: Historical Evolution and Economic 8.6. Tax System and Integration in the BRIC 8.7. International Taxation in BRIC: History and Prospects

307 332 347 359 374 387 393

1. Presentation This publication is the result of a research project underway in the Master’s Program in Law at the Catholic University of Brasilia (UCB) entitled Brazil, Russia, India, and China (BRIC): Tax system structures and their effects on development and foreign trade performance - lessons and solutions. Such research project is an institutional partnership between the Brazilian Agency for Industrial Development (ABDI) and UCB. This project, among other steps, included an international seminar, held on August 13th and 14th, 2009, in Brasilia, attended by experts from the participating countries. This work was developed under the ABDI’s Legal Environment, Investment and Innovation project. It aims at increasing the number of pro-business institutions in Brazil. Tax system has been discussed on several occasions, both by the government and society, as one of the fundamental and structural issues in Brazil. A comparative study between Brazil and other countries in a similar development level is very timely, and will hopefully contribute to a better understanding of the issue and support a strategic work of the government and society in this regard. This book contains works developed by the UCB staff, and by foreign experts, including a summary of several discussions in the international seminar (2009). It represents a research effort about the BRIC countries and the reasons why their economies have developed more than the average worldwide, focusing on aspects such as taxation and its economic effects. We hope that the outcomes of this research are useful for companies operating in the BRIC’s markets or that are influenced by the economic performance of these countries. Such facts provide lessons and examples (positive and negative) and enable a broader view that will help them to plan strategic actions. The first part of the book contains analytical texts with critical views on each of the BRIC countries. In the end of the first part, there is an executive summary with the conclusions from the seminar. Also, there are two studies focusing on the BRIC countries’ socio-economic scenario.

7

The second part is a summary of the discussions that took place on the two-day seminar held in August 2009 in the UCB auditorium of postgraduate studies, attended by several experts in this field. The opinions of speakers and authors do not necessarily represent the views of UCB and ABDI or related institutions We hope you enjoy this!

Mauro Borges Lemos President - ABDI

Marcos Aurélio Pereira Valadão & Antonio de Moura Borges (Organizers)

2. Brazil 2.1. Effects of Globalization on the Brazilian

Tax System

Marcos Aurélio Pereira Valadão*

CONTENTS 1. The Globalization Process and Its Impact On Corporate and States Structures: A Brief Approach 2. A Very Brief Introduction to the Brazilian Tax System 3. The Globalization Effects on the Brazilian Tax System 3.1. Effects on the Constitutional Text 3.2. Effects on General Rules of the Tax Law 3.2.1. Needs for General Anti-Avoidance Rule – Amendment of the Brazilian Tax Code 3.2.2. Reflections on Exchange Information System and the Access Form to Infor mation – Changes in the Brazilian Tax Code 3.2.2.1. Information Exchange System 3.2.2.2. Information Access System 3.2.3. New Bankruptcy Law and General Rules of Tax Law 3.2.3.1. New System for Rescuing Companies 3.2.3.2. The Tax Impact of the New System And How the Provisions of Brazilian Tax Code Were Affected Regarding this Issue 3.2.4. Law No. 11,638/2007 (International Accounting Rules) 3.3. Effects on the Types of Taxes 3.3.1. Income Tax * SJD (SMU - USA, 2005), Master of Laws – Public Law (UNB, 1999), Master of Laws - International and Comparative Law (SMU, 2003); Expert in Tax Administration (PUC-GO, 1992), MBA in Financial Management (IBMEC - DF, 1996), Bachelor of in Law (PUC-GO, 1993). Tax Auditor – Federal Revenue Secretariat of Brazil. Professor of Law and Researcher at School of Law of the Catholic University of Brasília (UCB). Member of the Committee of Experts on International Cooperation in Tax Matters of the United Nations.

9

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

3.3.1.1. Effects of the Need to Attract Foreign Capital and the Internatio nal Tax Competition 3.3.2. CPMF 3.3.3. IOF 3.3.4. Effects on other Taxes 3.4. International Tax Treaties 4. Effects on Taxation Arising From Other Aspects of Globalization 4.1. Environmental Taxation 4.2. Increase of the use of soft law 5. Final Considerations 6. References

1. The Process of Globalization and Its Impact on the Structures of Corporations and States: A Brief Approach

In the current meaning globalization scenario of the phenomenon of globalization, we must recognizeit must be acknowledged that Portugal is at the forefront. Portuguese caravels, in the 14th and 15th centuries, were followed by the Spanish caravels and later by the British caravels, which started the process. They would not make conquest war warsof conquest as , like the tours of the Greeks and Romans, from centuries before and after the birth of Christ did. They traveled to make business. Their main purpose concern was trade; ,and to the pursue the to acquisition of unknown lands was a consequence. And the trade is the one that what drives globalization. In some moments, thethat process decreases;, in other moments, it increases., but certainly However, and considering a leap ofafter a five-hundred-year hiatuss, the 1980´s and 90´s of the last quarter of the 21st century had been permeated by showed a growing, and irreversible interpenetration of international commercial activitiesy, along with the internationalization of financial markets, the expansion of transnational corporations, and other factors such as cultural colonization and economic domination (although these last two factors have gradually evolved from since the end theof the Second Industrial Revolution).

This process imposes on the contemporary world, and more specifically especially on the contemporary states, measures of structural adjustment in order to adapt to new requirements, increasingly stringent, of international competition; strong competition, in short, for everything that hasall economically valuable phenomenae, especially their own capital (financial capital). The struggle for the capital to direct investment or security market leads to the so-called international tax competition, a fiscal/economic phenomenon well- and already known by the federal states, in the extent of the federation itself. , and that in In the last twenty years, it has been intensifying spread in the at an international level scenario1. Countries tend to reduce the taxation of the esults of foreign capital outcomes, exempting from taxation the local incomes locallyobtained 1

10

See, e.g., BISWAS, Rajiv (Ed.). International Tax Competition: Globalisation and Fiscal Sovereignty. London: Commonwealth Secretariat, 2002; AVI-YONAH, Reuven S. Globalization and Tax Competition: Implications for Developing Countries. CEPAL Review, n. 74, 2001, p. 59-66, available at http://www.eclac.cl/ publicaciones/xml/9/19999/lcg2135i_Avi-Yonah.pdf, and regarding the tax competition in the European Union, see PALMA, Clotilde Celorico. O Controle da Concorrência Fiscal Prejudicial na União Européia. Revista Fórum de Direito Tributário, Belo Horizonte, n. 15, mai-jun/2005, p. 49-74.

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

related to resulting from the repatriation of the results,whether in the form of including dividends, profits or interest., and also Countries have also adopted other unencumbered formsprocesses compared similar to internal taxes, in order to attract foreign capital.2 International organizations of economic and political regulations play a key role in the organization of the contemporary world, despite the relative failure to prevent armed conflicts started by countries that, with more military power , tried to impose unilateral solutions.3 The globalized world is multilateral; a national sovereignty has become a relative concept, and competition is swift and dire – this is an irreversible fact. The relativization of sovereignty implies effects on legal systems4, leading sometimes to changes within. Globalization also brings to the nations, as well as for business, the need to gather in economic blocks. While companies make conglomerates and mega-conglomerates, and individuals give their assets to be managed by financial megacorporations, countries are united in large economic blocks, such as Mercosur5, NAFTA and the EU. All factors above imply the need of a relativization of the traditional notion of sovereignty, due to the need of multilateral economic agreements (IMF, World Bank, etc.), commercial agreements such as GATT/WTO, and agreements of regional economic integration, such as the ones already mentioned. More than that, globalization has also enabled the significance of other aspects, especially those resulted from the so-called fundamental rights of the third and fourth generation. They include social solidarity rights and the right to a healthy, balanced environment – though their supporters often “paddle against the stream”, as they do not face the contradictions arising from the exercise of those rights.6

2 TANZI, Vito. Globalization, Tax Competition by Future of Tax Systems. In: UCKMAR, Victor. (Coord.). Diritto Tributario Internazioale. 3a ed. Padova: Cedam, 2005, p. 25-45. Vito TANZI states that “Tax competition aimed at attracting foreign capital is a development that deserves more attention than it has received so far.” Idem, p. 31. See also NOV, Avi. The “Bidding War” to Attract Foreign Direct Investment: The Need for a Global Solution. Virginia Tax Review, n. 25, 2006, p. 835-874. 3

E. g., the “war” between the USA and Iraq.

4

See FARIA, José Eduardo. O Direito na Economia Globalizada. São Paulo: Malheiros, 2000.

5

Within Latin America, in 1960 the Treaty of Montevideo was signed, creating the Latin American Free Trade Agreement (LAFTA), which was substituted by the Latin American Integration Association (LAIA), created from the Treaty of Montevideo, in 1980. The LAIA allowed, in its extent, the emergence of Mercosur, which occurred through the Treaty of Asuncion in 1991 (at that time restricted to Brazil, Argentina, Uruguay and Paraguay). LAFTA and LAIA did not result in great strides and wider implications unless agreements and tariff preferences, but favored the formation of Mercosur, which has a wider scope and a more ambitious project. However, the evolution of Mercosur is quite different from the historical evolution of the European Union. It is noteworthy that Mercosur has evolved, although within the LAIA, from a bilateral relationship between Brazil and Argentina, and includes, in relation to EU, differences of economic nature (objectives), policies (strategic) and even cultural that imply a notable disparity between the two systems today. 6 According to José Marcos DOMINGUES: Today the Environment raises some fundamental questions connected to political and economic issues. The first one relates to Human Rights and the Environment which projects itself in the spectrum of North-South relations, involving the question of industrialization and development of some few at the cost of does-industrialization and underdevelopment of many others, followed by an increasing degradation of life quality standards in most parts of the Planet. Yet, this is not a new or recent issue, for the tension development vs. exploitation of natural resources and of people (notwithstanding the human right to a healthy, clean, environment) is an old problem that dates back to the Roman Empire, the Great Navigation, the Colonialism, the Liberalism; it also relates to tariff and non-tariff trade barriers imposed by developed countries in times of neo-liberal globalization... After all, if natural resources and poverty are found in the same places, one may reasonably argue: are the resources of the so-called Third World being developed to its people’ benefit? DOMINGUES, José Marcos. Environmental Fees and Compensatory Tax in Brazil. Law and Business Review of the Americas, Dallas, v. 13, n. 2, Spring/2007, p. 279-304, p. 280.

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Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

Another fundamental aspect for the increasing speed of changes is the unprecedented development of information technology. Computer sciences and the Internet phenomenon have brought a new status to the human being since the late 20th Century and the beginning of 21st Century. Human evolution, in certain respects, is always difficult to predict. The speed and volume of trade transactions, especially banking transactions, are an important factor in a globalized world. Thus, the current globalization has imposed on all countries worldwide, especially the developing countries, new challenges of adaptation and evolution; hence the need of more modern structures, including the regulation and monitoring of economic agents. Changes in tax structures – a state instrument for fund-raising and intervention in the economic field(extra control) – are also necessary. As an example, the increase of the complex negotiations and the increasing number of transaction opportunities in transnational environments make it difficult for tax authorities to collect taxes. Due to the huge number of possibilities of negotiation as a result of the globalization process, it is easy to conceal the occurrence of a triggering event; that’s why a general antiavoidance rule is necessary in addition to the traditional specific anti-avoidance rules. This study did not include the social evils of globalization, which are not few. It has been considered that the process leads to a deterioration of income distribution, both internally (considering the population of a country) and internationally (considering the number of rich and poor nations). Such scenario tends to worsen the economic conditions of developing countries.7 Globalization has had, under the economic aspect, a liberal profile the so called neoliberalism8- and has weakened structures of social security over concentration of capital, though the world economy, as a whole, has shown economic growth.9 One may say that the adopted tax measures tend to reinforce such trends, since they are part of an adaptation process.10

2. A Very Brief Introduction to the Brazilian Tax System

A brief introduction to the Brazilian tax system is necessary for an accurate analysis of the definition of international movement in this study. The Brazilian tax system is

7

Brazil, considering the most recent period, from 2003 to 2007, when it presented increasing growth rates, it has reversed the negative aspect of income concentration, mainly through increased public spending on social programs targeted directly to the poorer classes of the population. In Europe, the poorest countries have been benefited from the consolidation of the EU, avoiding impoverishment due to globalization.

8

It is the policy of minimum state, which advocates a market free of rules and attacks the social welfare state, with the economist Friedrich Hayek (1899-1992) as the herald. See the insightful approach of the revival of liberalism in PAULANI, Leda Maria. Leda Maria. Economia e retórica: o capítulo brasileiro. Revista de Economia Política, jan-mar/2006, vol. 26, no.1, p.3-22, p. 4-13.

9

Aldemario Araujo CASTRO highlights the harmful consequences of globalization in the new international division of labor, the overcome of the social achievements and the process of debt collection worldwide that affect social and economic policies of the least developed countries (particularly because of the conditionality of the IMF). See CASTRO, Aldemario Araujo. As Repercussões da Globalização na Tributação Brasileira. Master’s thesis defended at the Masters Law Course at the Catholic University of Brasilia (maio/2006 – not published), p. 39-46. (Available at http://www.bdtd.ucb.br/tede/tde_busca/arquivo.php? codArquivo=326).

10

12

See LEROY, Marc. Reflexion Sociologique Sur La Globalization Fiscale. In: _______. (Org.). Mondialition et Fiscalité: La Globalisation Fiscale. Paris: L´Harmattan, 2006, p. 263-280.

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

regulated by the Federal Constitution, which demands a strict distribution of tax competencies and sets analytical limits and conditions for taxing.11 Brazil, as a federation, has its Constitution as a regulator of tax jurisdiction over the Union, the States and the Municipalities following specific tax bases of duties. The Union is responsible for the extraordinary and residual contributions and the so-called parafiscal contributions, based on three basic types: social, professional or economic, and those for intervention in the economic area(until December 2007, the Union also applied a tax called Provisional Contribution on Financial Transactions (CPMF), over financial transactions within the financial system).12 The Union’s competence to regulate contributions is not totally exclusive. States and Municipalities can regulate contributions for security and social assistance collected from their own servers to support them. The Union, States and Municipalities may also tax fees (through the police power and the public and divisible services) and contributions to the improvement (through public works that result in real estate valuation) of their respective spheres of competence. In addition, the Municipalities and the Federal District may regulate street light taxes. The current areas of competencies regarding taxes: Union: I. II. III. IV. V.

import of foreign products (II); export of national or nationalized products to other countries (IE); income and earnings of any nature (IR); industrial products (IPI); credit, exchange, insurance operations, and bond or securities-related operations (IOF); VI. rural property (ITR); VII. large fortunes, according to the supplemental law (IGF); VIII. by supplementary law, taxes not previously mentioned, as they are noncumulative and do not have a taxable event or calculation basis, different from those specified in this Constitution;

11

The Brazilian Tax Constitution is contained especially in Title VI of the Constitution of 1988, which has the name “The Taxation and Budget,” Chapter I - “The National Tax System”, which is divided into six sections, namely: I - General Principles; II - Limitations to Taxing Powers; III - Country’s Taxes; IV - Taxes of the States and the Federal District; V - Municipal Taxes; VI - Allocation of Tax Revenues. In addition, there are also other devices related to the discipline of earning revenue by the country that are not found in Title VI. It refers to the article 177, § 4º, which deals with the contributions of intervention in the economic domain; the article 195, which deals with social contributions; the article 212, § 5º, which establishes the social contribution of the wage-education; the article 239, which deals with contributions to PIS/ PASEP, and to CPMF, which was created by insertions in the ADCT articles (articles 74, 75, 84, 85 and 90), whose collection existed until December 2007. See VALADÃO, Marcos Aurélio Pereira. Limitações Constitucionais ao Poder de Tributar e Tratados Internacionais. Belo Horizonte: Del Rey, 2000, p. 49-140 (for a more detailed description of the Brazilian tax system).

12

The CPMF tax was instituted in 1996, replacing the provisory tax, IPMF; it was charged from 1997 to December 2007, having been extinguished due to the rejection, by the Congress, of the proposed constitutional amendment that would extend its collection, what had been going on successively since its establishment. We will approach the CPMF tax in this chapter because of its importance in the context of the analysis. The extinction of the CPMF, which had revenues used in the funding of social security (public health, social security and assistance through the Fund for Combating and Eradicating Poverty), follows the same lines of neoliberal objectives in reducing taxes and tax burden, in spite of the fact that the Brazilian tax burden, according to economic theory, is considered high for a developing country. The health sector of the Federal Government has cogitated to establish a new contribution on the same basis of the CPMF, but with a lower rate, with revenue to be used exclusively for health (a sort of CSS - Contribuição Social para a Saúde, Social Contribution for Health), but the project faces strong resistance in the Congress.

13

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

IX. in imminent or during foreign wars, extraordinary taxes, whether or not included in its tax competence, which will be abolished gradually as their causes cease. (competences in items VIII to IX have never been applied) (the competences of items VIII to IX be never used) States: I. inheritance and donation of any property or rights (ITCD); II. operations on movement of goods and services of interstate and Inter-municipal transportation and communication, or operations and renderings from abroad (ICMS); III. vehicle ownership (IPVA). Municipalities: I. urban building and land tax (IPTU); II. inter vivos transmission of any kind, by onerous acts, of real estate, by nature or physical accession, and of rights in real property, except for guarantee, as well as the assignment of purchase rights (ITBI); III. services (ISS). The most affected taxes by globalization are related to foreign trade (II and IE), income tax, CPMF and IOF – considering that they affect transnational operations. However, all taxes on circulation (consumption), including some social contributions, are directly and indirectly affected by globalization. It should also be mentioned that the Brazilian Constitution, Article146,states that the national tax system will be regulated by general rules over the Union, States and Municipalities (supplementary laws to the Constitution over all Brazilian federation). Furthermore, the Constitution also regulates the so-called constitutional limitations to the taxing power – limiting the authoritative power of taxing entities, in general taxrelated, products and specific operations.13 Besides, there are constitutional rules that require the allocation of tax revenues from several union taxes to the States, the Federal District and the Municipalities, and from States to Municipalities (Articles 157 to 162 in the Brazilian Constitution).

3. The Effects of Globalization on the Brazilian Tax System

It is possible to say that there are general effects and specific effects on tax policy. Such effects result in changes from the higher levels of the national tax system, through changes in the Constitution and the Brazilian Tax Code, or in the lower levels, with changes in tax laws. In some cases, there are changes in decrees, normative instructions,

13

14

See Marcos Aurélio Pereira VALADÃO, Limitações..., note 10 supra, p. 113-140.

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

and other non-statutory acts. One of the most important general effects of globalization is the need of the Union to meet international commitments, especially international loans, and to show willingness to meet internal commitments, especially the payment of debt service. The scenario above increased the need to accumulate tax revenues administered by the Union through more non-shared taxes (security contributions). This is certainly a result of globalization, which has developed an international economic scenario that charges high prices of governments that do not meet their commitments. Table 1 shows the evolution:

1985

1987

1993

1995

1997

1998

1999

2001

2003

2004

45.7

49.3

44.8

43.0

57.4

55.5

56.6

59.18

60.01

56.35 57.14

57.42

58.18 57.89

STATES**

39.6

35.5

37.4

38.7

27.5

27.4

27.6

25.01

24.66

27.11 26.57

26.41

25.74 25.75

MUNICIPALITIES

14.7

15.2

17.8

18.3

15.1

16.9

15.7

15.81

15.33

16.54 16.29

16.18

16.09 16.35

TOTAL

100

100

100

100

100

100

100

100

100

100

100

100

2005

1980

UNION

100

2002

1970

Table 1: Percentage of Net Tax Revenues after Constitutional Transfers (Available Revenue)*

100

*It includes revenues from contributions. ** States and Federal District. Data from 1970 to 1987: ROSA, José Rui G., “Impacto financeiro da reforma tributária nos recursos disponíveis da União, Estados e Municípios”. In: PISCITELLI, Roberto B. (org.). O Sistema Tributário na Nova Constituição: da crise financeira às perspectivas com o novo sistema. 2ª ed., Brasília, UnB, 1989, p. 132; de 1993 até 1997: MINISTÉRIO DA FAZENDA. Coordenação-Geral de Estudos Tributários da Secretaria da Receita Federal do Ministério da Fazenda Distribuição da Carga Fiscal Líquida. Brasília: Ministério da Fazenda, s.d.; de 1998 e 1999: MINISTÉRIO DA FAZENDA, Coordenação-Geral de Política Tributária da Secretaria da Receita Federal – COGET/SRF/MF. Carga Tributária no Brasil – 2002 (Estudos Tributários 11) Brasília: Ministério da Fazenda, 2003, p. 16, Tab. 5; de 2001 a 2005: MINISTÉRIO DA FAZENDA. Coordenação-Geral de Política Tributária da Secretaria da Receita Federal – COGET/SRF/MF. Carga Tributária no Brasil – 2005 (Estudos Tributários 15). Brasília: Ministério da Fazenda, 2006, p. 12, Tab. 5 Data from the Treasury Department, available at: http://www.receita.fazenda.gov.br/Historico/EstTributarios/Estatisticas/ default.htm

Several factors are responsible for what may be called the forced conformance of tax systems. Some factors have diffuse causes, such as attraction and investment factors. Others, such as the GATT/WTO rules, come directly from the organization’s treaty , imposing restrictions on the granting of tax benefits with internal taxes and prohibiting discriminatory tax treatment discriminatory effects. According to Victor UCKMAR, three prohibitions that affected the tax systems resulted from the WTO treaty: discriminatory taxation, tax protectionism, tax subsidies.14 The same author also states that, compared to other issues, trade policy is increasingly intertwined with tax policy.15 This study does not focus on the causes or sources of specific modifications imposed to the tax system due to globalization.16 However, this study does focus on their effects, which will be examined in the following pages.

3.1. Effects on the Constitutional Text

Apart from its original text, the 1988 Constitutioncontains 62 amendments (including six revised amendments, 1994);17 of them (more than 25%) affect the Tax Constitution (although certain changes are more targeted to tax effects on tax

14

UCKMAR, Victor. Aspeti Fiscali Nelle Regole Della Organizzazione Mondiale del Commercio OMC/WTO). In:_______. (Coord.). Diritto Tributario Internazioale. 3a ed. Padova: Cedam, 2005, p. 1069-1096, p. 1091.

15

Ibidem, p. 1095.

16

A detailed investigation of the causes or sources deserves to be the object of other researches. For purposes of this study, the determination of these sources and causes in its macro aspect is sufficient.

15

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

collection). Some of these constitutional changes were clearly resulted from the effects of globalization. One of the most significant changes is the aforementioned concentration of revenues under the administration of the Union, which was created basically through two concomitant modes. First, social contributions and those of intervention in the economic domain caused an increase of tax burden, which was not shared with the States and Municipalities.17 On the other hand, measures were adopted to change fiscal/financial-related regulations in the Constitution, resulting in concentration of budget resources in charge of the Union by applying certain revenues in different areas from their original destination, through the creation, via constitutional amendments, of the so-called Fundo Social de Emergência, FSE [Emergency Social Fund] (1994-1997), Fundo de Estabilização Fiscal, FEF [Fiscal Stabilization Fund] (1997-1999), and the Desvinculação de Recursos da União, DRU [Untying of Union Resources] (1999 - 2007), recently extended until 2011 (Amendment No. 56 of 2007).18 Another important change concerns the non-cumulative social contributions levied on the gross receipts or sales and imports of goods and services from abroad. The change introduced by Amendment No. 42 of 2003 does not impose an exhaustive requirement of non-cumulative – only allows contributions to be non-cumulative –. It is an authorizing norm. In fact, the non-cumulative of contributions for PIS/PASEP and COFINS had already been implemented by ordinary legislation, even before the constitutional amendment.19 This is the urgent need to relieve the tax on exports of indirect taxes. Note that the IMF was already long-standing “conditioning” Brazil in the renegotiation of contracts to take such measures.20 Thus, PIS/PASEP and COFINS, which are contributions levied on the sales or gross revenue, have become non-cumulative, although non-cumulative does not reach all goods and services, all businesses and all economic activities. ICMS had its constitutional basis amended by Amendment No. 42 of 2003, immunizing the tax exports. Previously, the constitutional text contemplated only industrial goods and some semi-finished products, as defined in complementary law. However, the Complementary Law No. 87 of 1996 had excluded the charge of ICMS in all exports of goods (whether or not industrialized products) and services. The

16

17

In the original format of the Constitution of 1988, the contributions are not shared with other entities of the Federation. On the other hand, the two main tax revenue collection of Brazil, the IR and IPI, have 48% of its revenue shared with states and municipalities (with 10% more of the IPI’s revenue being given to the exporting states), alongside other hypotheses of revenue sharing (see articles 153, §5º, and 157-159 of the Federal Constitution). However, more recently, in order to amend the original design of the Constitution of 1988, it was established the possibility of instituting the contribution to pay the costs of street lighting by the Municipalities and Federal District (Amendment No. 39, 2002), CIDE-Combustíveis with the revenue shared between States, Federal District and Municipalities (Amendment No. 41, 2003, and 44, 2004) and an increase of 1% of the Municipal Participation Fund (Amendment No. 55, 2007). The last three amendments mentioned is a clear reaction of the federative entities against the movement of income concentration in the hands of the Union.

18

See, in general, a more detailed description of these changes in VALADÃO, Marcos Aurélio Pereira. Comentários sobre as Alterações Tributárias à Constituição Brasileira de 1988. Ciência e Técnica Fiscal, Lisboa, 2004, n. 413, p. 7-133.

19

The non-cumulative system for PIS/PASEP was established by Law No. 10,637, 2002 and for the COFINS, by Law No. 10,833, 2003. The Constitutional Amendment No. 20, 1998, authorized the differentiation of tax rates and calculation base according to the economic activity (article 195, §9º of CF/88), supporting the common law for the creation of the new regime. However, the act of non-accumulate tax for social contributions is mentioned expressly in the Constitution only after the Constitutional Amendment No. 42 of 2003 (article 195, § 12).

20

See Aldemario Araujo CASTRO, op. cit., note 9 supra, p. 166.

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measure aimed at removing or minimizing the tax burden on exports – an imposition of a globalized world.21

3.2. Effects on General Rules of the Tax Law 3.2.1. Needs for General Anti-Avoidance Rule ± A mendment of the Brazilian Tax Code As previously mentioned, globalization imposes the need for general anti-avoidance rule22. In this sense, it was promulgated the Complementary Law No. 104 of 2001, which introduced the article 116 of the Brazilian Tax Code, introducing the following provision: Article 116. ... Sole paragraph. The administrative authority may disregard acts or legal transactions done to dissimulate the occurrence of the event which generates the tax or the nature of the constituent elements of the tax obligation, subject to the procedures to be regulated in ordinary law. The general anti-avoidance rule brings an open concept of taxation because it tends to include events that would not be taxed if there were not distortions in the negotiating forms used by the taxpayer (usually classified as abuse of rights, abuse of legal form or evasion of the law). As already stated, such legal form is not new in the tax laws. Much has been discussed about the scope of the term “deception” (deceptive acts or acts with the “purpose of dissimulating the occurrence of the event that generates the tax or the nature of the constituent elements of the tax obligation”).The nature of the norm referred to the last part (“the procedures to be established by ordinary law”) has also been discussed. This provision has been criticized before the Supreme Court and is in sub judice status at the moment.23 The provisional measure which ruled the provision (the last part refers to the regulation by ordinary law – which can, therefore, be provided by edition of the provisional measure) when passed as a law, had part of its regulations rejected by the Congress24. It was, therefore, the provision of the Brazilian tax code 21

It is important to remember that at the beginning of the 20th century, taxes on exports made up a significant amount of tax revenues - which has become unthinkable in terms of tax policy one hundred years later. See VALADÃO, Marcos Aurélio Pereira. Evolução da discriminação das rendas tributárias no constitucionalismo brasileiro: aspectos históricos e conceituais. Direito Em Ação, Brasília - DF, v. 1, n. 1, 2000, p. 57-87.

22

But even in the United States, a country of common law, the Internal Revenue Code provides general anti-avoidance rule, although it applies only to income tax, in its Section 269 (anti-abuse provision) (strict general anti-avoidance rule). Actually, the main difficulty lies in distinguishing between legitimate activities, illegal tax avoidance activities and abusive tax avoidance schemes. One should not confuse the issue of general anti-avoidance rule with the theory of disregard of legal entity, which concerns the question of tax liability (passive submission) and the non-structural aspects of the taxable event (the constituent elements of tax obligation) - the latter aspect refers to the general anti-avoidance rule.

23

Ação Direta de Inconstitucionalidade (ADIn) No. 2446 [Unconstitutional Direct Law], proposed by the National Trade Confederation on April 18, 2001. The doctrine of positivist nature is affirmed in the strict taxation legality, under the argument that in the Tax Law only allows the closed typicality and that the general anti-avoidance rule gives dictatorial powers to the state (actually, the first anti-abuse tax laws came under the aegis of fascist European regimes). However, it must be remembered that in the hodiernal world, with multi and multi-hybrid negotiations, in a highly dynamic environment, the existence of a general anti-avoidance rule also becomes an instrument for achieving equality of taxation, so as to prevent those who have sophisticated means to evade the tax incidence, while the remaining majority, which is attached to traditional forms, remains subject to taxation.

24

The Provisional Measure No. 66, August 20, 2002, had its article 13-19 that regulate the sole paragraph of article 166 of Brazilian tax code, eliminated in the conversion to the Law No. 10,637 of December 30, 2002. It is important to remember that part of the doctrine says that such a rule is unnecessary, and the pictures of abuse of legal form, and covert acts can lead to a non consideration of the acts performed under the practices of tax avoidance. Actually, what is concrete is that the general anti-avoidance rule gives to the Tax Administration

17

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without the a procedure discipline and, consequently, without a practical application. Circumstances indicate that the Executive Power is waiting for a final judgment by the Supreme Court to propose a new legislation to the National Congress. The general anti-avoidance rules of the first half of the 20th Century was proposed to cover up abuses by the State, enabling the State to arbitrarily create events that would generate taxes to meet the whims of authoritarian rulers. Nowadays, this is no longer a hateful plea. There is a need for a general anti-avoidance rule due to the practical impossibility of the State to develop specific anti-avoidance rules for all possible circumventions, because these possibilities have grown with globalization, both in number and complexity, particularly due to a boom in the number of negotiating forms.

3.2.2. Reflections on the Exchange Information System and on the Access Form to Information ± C hanges in the Brazilian Tax Code 3.2.2.1. Information Exchange System Another change in the Brazilian Tax Code by the Supplementary Law No. 104 (2001) concerns the improvement of information exchange on international level, adding the sole paragraph in Article 199: Article 199 ... Sole paragraph. The Treasury of the Union, as established in treaties, agreements or ovenants, may exchange information with other nations in order to collect and verify taxes. It is seen that the provision of the general tax rule allows, under international treaties, the breach of confidentiality of taxpayers. This occurs due to the need to increase the efficiency of systems and control, hindered by the volume of international transactions. The access and sharing of information are a constant topicin the legislation and in the recent changes.25 Globalization demands an exchange of information on international level, what is precisely stated in the sole paragraph of Article 199 of the Brazilian Tax Code. According to the provision, there is no possibility to exchange information with foreign states in

greater range of action, within the fluid (and dangerous) open legal figure for tax (although linked to legal standards). 25

18

The Federal Constitution in its article 37, item XVIII, informs that the “treasury administration and its officers shall, within their areas of authority and jurisdiction, precedence over all other administrative sectors, as provided by law”. This provision gives preponderance to obtaining information and access to information by tax authorities (municipal, state or federal) in search of information that will be used as the base for tax collection. The § 1 of Article 145 of the Constitution ensures that the Tax Administration have the power to identify the income, property and economic activities of the taxpayer, respecting individual rights and under the law. Regarding the administration with the private sector, the foundations of action for obtaining information (which are subject to confidentiality), are based on general rules from the Brazilian tax code. It is also noted that the new Civil Code (Law No. 10,406, 2002) points out that the restrictions on business information access (under the Company Law), applicable to people in general does not apply to tax authorities, according to the article 1193. The Brazilian Tax Code addresses this matter in its articles 195-197. These three articles, which stipulate that the trade secret does not remain against the Tax Administration, were not directly affected by recent modification laws of the Brazilian tax code. Among the provisions introduced, the one which generates more controversy refers to access to bank information (bank secrecy). The provision of Brazilian Tax Code was compatible with the article 38 of Law No. 4,595/1964, which was repealed by the Supplementary Law No.105, of 2001 (the bank secrecy law). These aspects are examined hereafter. More recently, the Federal Constitution was altered to allow local, state, county and federal tax authorities integrate effectively in order to increase efficiency by determining the sharing of records and tax information, increasing access to information by tax authorities in general. It what is written on the item XXII of the article 37 of the Constitution, including the Constitutional Amendment No. 42, 2003. It is noticed that the new provision is in the same level of the article 199, caput, of Brazilian tax code.

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order to collect and verify taxes. The term “transfer” seems to mean “exchange”. In other words, Brazil receives information but is also required to provide information. Tax Administration faces the issue of verification of antinomies between tax secrecy and international treaties on taxes that allow the exchange of information between the contracting States26. Information such as accounting records, tax effects, etc. can be normally obtained by the Tax Administration, , according to Article 195 of the Brazilian Tax Code. The possibility of conflict between constitutional and conventional provisions seems unlikely, although there could be problems when reciprocity is verified, an intrinsic element to these treaties. All treaties that avoid double taxation signed by Brazil include an information exchange-related clause , in accordance with the convention model of the Organization for Economic Cooperation and Development (article 26). On the other hand, the Article 10 of the Agreement on the implementation of Article VII of GATT 1994 (customs valuation), stated by Decree No. 1,355, 1994, also states the confidentiality of all information exchanged between two contracting states.27 The problem also affects banking secrecy, which can be converted into tax secrecy. The share of bank secrecy may cause problems regarding the countries that impose a different legal and constitutional treatment from Brazil’s, whether it is more strict(highly confidential) or more flexible (relative secrecy), because a state could claim that another state is not completely respecting the treaty when it comes to banking information of taxpayers. Each state should be limited, within the bilateral relationship, to what other states (more restrictive) can offer regarding information under the custody of financial institutions thus, enabling the implementation of the treaty (see Article 26, Section 2, letter “b” of the Model Convention of the OCDE). Therefore, the sole paragraph of Article 199 in the Constitutional Law 104/2001, which states that the “Treasury of the Union, as established in treaties, agreements or covenants, may exchange information with other nations in order to collect and verify taxes”, enables the exchange of information with foreign states. So, it is impossible to question the legality of such conventional provisions. However, the Tax Administration shall only convey, to the authorities of another State, information that could be obtained from the other contracting state in its own territory (principle of reciprocity). The tax information exchange issue can be discussed. Due to the nature of the taxation distribution in Brazil, it would be under the control of the State, the Federal District, and the Municipalities. These entities are not obliged by treaty to provide information under tax secrecy to a foreign State or to any international organizations. However, Brazil should provide it. Thus, the States, the Federal District and the Municipalities shall convey information to the Union, which, on behalf of the Brazilian state, will honor the treaty. A practical way to solve any possible resistance from the States, the Federal District, and Municipalities, by law or agreements, is provided in the Article 199 caput of the Brazilian Tax Code. Also, due to the increasing need for the exchange of financial information on international level, and due to the investigation and prosecution of transnational crimes, 26

See Marcos Aurélio Pereira VALADÃO, Limitações... note 10 supra, p. 276-282.

27

Article 10. All confidential information or information provided on a confidential basis for customs valuation purposes, shall be treated as strictly confidential by the authorities, which will not disclose it without the permission of the person or government that has provided such information, except if, in the context of legal proceedings, it is required to be disclosed.

19

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such as terrorism and drug trafficking-related crimes, the information exchange system has been greatly developed.

3.2.2.2. Information Access System The Complementary Law No. 105 (2001) changed the treatment of bank secrecy, facilitating the access of the Tax Administration to bank data (although the matter is already included in the Article 197 of the Brazilian Tax Code, but a serious controversy over its constitutionality was raised).28 The Complementary Law No. 105 (2001) is an attempt of the State to reverse the jurisprudence of the Supreme Court and to facilitate access of the Tax Administration to information protected by bank secrecy. The Supreme Court has settled the understanding that banking secrecy is not absolute, and that all information can be transferred to the Tax Authorities. However, there is a reservation of jurisdiction to the Judiciary and the Legislature (CPIs – Congressional Investigative Commissions). In other words, the Administration could not require information by itself. The Executive Power sought to change this situation by modifying the matters of tax secrecy and bank secrecy at the complementary legislation. Therefore, the Constitutional Law 105/2001 rejected the Article 38 of the Law 4,595, 1964 (which was approved as a supplementary law by the CF/88, which dealt with bank secrecy and with the assumptions of its relativization, breaking or transfer), and set up situations in which information under a bank secrecy in the hands of financial institutions and similar information could be transferred under administrative request to the Tax Administration. The possibility of access to bank information through judicial request (by an specific order of the judge) did not face serious challenges. What taxpayers and most lawyers criticize is the possibility for tax authorities to do it without the Judiciary’s consent.29 28

29

There are also several direct actions of unconstitutionality against the Complementary Law No. 105. Several arguments are used, having as background the allegation that the bank secrecy either for individuals or corporations have a constitutional basis. However, no injunction was granted in those actions, which enables the application of the Supplementary Law. Most recently, it was edited the Normativa RFB [Brazilian Federal Revenue Normative] No. 802, of 12/27/2007, based on Decree No. 4489 of 28/1/2002, which regulates the article 5 of the Complementary Law No. 105. It is the provision of information to replace those provided based on CPMF, extinguished in December 2007. The matter is sub judice, but in my view, the knowledge of the financial transactions of taxpayers (I am referring only to the number base) does not violate any kind of secrecy based on intimacy or privacy, and they are information needed to control and detect fraud of all kinds.

The Brazilian Constitutional Law No. 105/2001, in its article 1, stipulates that financial institutions shall maintain secrecy in its operations; the article 2 says that the duty of confidentiality extends to the Central Bank of Brazil; the article three deals with the provision of information ordered by the Judiciary Power and; the article four deals with information provided to the Legislature. The articles 5 and 6 of the Constitutional Law No. 105, 2001, were regulated by Decree No. 3724, 2001 and 4489, 2002, respectively. It is noteworthy that the article 6 demands the breach of banking secrecy to have an “administrative process introduced or a tax process another words, it is not necessary a judicial request, being only necessary to have started the tax procedure or that this examination is considered necessary by the administrative authority - ie, the breach of banking secrecy depends on administrative request, even in the initial or investigative stage of the fiscal procedure. The Brazilian Constitutional Law 105/2001 was the target of three direct actions of unconstitutionality: 1) No. 2386, proposed by the National Confederation of Commerce - CNC, attacking the articles 5 and 6; 2) No. 2390, proposed by the PFL [Social Liberal Party] - , attacking the articles 1, §4, 5 and 6 and the Decree No. 3724/2001; and 3) No. 2397, proposed by the CNI [National Confederation of Industry], attacking the article 3, §3; article 6 and the reference made to it in article 1, §3, VI; article 5 main section and §§. Two basic constitutional issues are raised: a) bank secrecy is an absolute guarantee; b) there is the reservation of jurisdiction for the breach of confidentiality. Given the identity of objects, it was determined its joint processing and trial. These actions were proposed against the Supplementary Law No. 105/2001 that so far has not been assessed on their merits. The Supreme Court in Brazil also granted no suspensory injunction of both legal provisions attacked under the argument that it is a complex matter of law. Thus, the Tax Administration has applied the Complementary Law No. 105/2001 based on regulatory decrees. This maneuver has been accepted by the Supreme Federal Court and the Superior Court of Justice (STF - AI 528539/PR - Agravo de Instrumento and STJ - REsp 691601/SC). According to the trial above, it was refused the reservation of jurisdiction, so that the Tax Administration does not need judicial authorization to have access to bank information, and

20

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One of the most eloquent arguments to support Tax Administration on free access to information protected by bank secrecy is that they would be protected by tax secrecy. In other words, it would be a transfer of bank secrecy (held by a private corporation) to a state body (legal person of Public Law), which has legal obligations to provide higher protection to information kept in secrecy than financial market institutions do. The Decree No. 4,489, of 2002, which regulated the Article 5 of the Constitutional Law No. 105/2001, regarding the provision of information to the Internal Revenue Service by financial institutions and entities similar to them, and related to financial transactions made by users of their services, includes a series of regulations of restrictive nature related to that information. Decree No. 3,724, 2001 (changed by the decree No.6,104, 2007), which regulates the Article 6 of the Constitutional Law No. 105/2001 regarding request, access and use, by the Internal Revenue Service, of information concerning operations and services of financial institutions and entities similar to them, also states similar provisions.30

3.2.3. New Bankruptcy Law and General Rules of Tax Law 3.2.3.1. New System for Rescuing Companies The process of globalization greatly influences the legal system, not only the regarding taxes , but also in a general view, especially regarding developing countries which depend on the developed economies. The changes that occurred in the Brazilian Bankruptcy Law due to the Law 11,101 of February 9, 2005 (New Bankruptcy Law, which regulates the judicial, extra-judicial recovery and bankruptcy of the entrepreneur and business), and the consequent repeal of the former Bankruptcy Law (Decree-Law 7,661 of June 21, 1945) are phenomena that fit this trend. Therefore, Rubens Approbato MACHADO states: Bankruptcy (with a forethought of continuing business) and the arrangement with creditors, allowed the search for the company’s recovery, the long age of the Decree-Law 7,661/45 and before the changes in the world economy, including globalization. This scenario led to a necessary ,substantial reform in the Bankruptcy Law, aiming at the company’s preservation within its new concept of source of assets, economic and social benefits.31

it was established that bank secrecy is not an absolute guarantee, and it can be relativized due to public policy. While taxpayers argue in favor of bank secrecy based on the Constitution and in favor of protection of citizens against abuses of the state, the Tax Administration argues in another line, the line of the need to equip the state, arguing that the growth of tax evasion through the use of financial system is an indisputable fact and is tied to the growing interpenetration of economies and to the ease of movement of economic factors, especially capital (globalization). In addition, tax evasion facilitates the action of all sorts of criminals, from the evader seeks to pay less taxes through illegal ways, to those who deal with other activities such as drug trafficking, arms trafficking or terrorism. Hence the need to implement measures to restrain such unlawful practice, both domestically and in international level, and the feasibility, effectively, of this action necessarily involves the relativization of bank secrecy. However, the guarantees of individual contributors must be preserved; otherwise it would defile the democratic state of law. The end of this clash is still undefined. 30

The two decrees present explicit restrictions to saving and handling of information and to the accountability of the agents who handle them, practically configuring a special tax secrecy for such information if compared to other information that does not come from the financial system. In this case, the “transfer“ of the bank secrecy for tax secrecy is done with great regulatory care.

31

MACHADO, Rubens Approbato. Visão Geral da Nova No. Lei 11.101. In: _______. (Coord.) Comentários à Nova Lei de Falências e Recuperação de Empresas – Doutrina e Prática. São Paulo: Quartier Latin, 2005.

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The New Bankruptcy Law ended the traditional process of agreement with creditors and introduced the judicial and extrajudicial recovery, broadening the means in which management and recovery of companies can be held. The New Bankruptcy Law also caused major changes in the traditional process of bankruptcy assessment.32

3.2.3.2. The Tax Impact on the New System and How the Provisions of Brazilian Tax Code Were Affected Regarding this Issue The New Bankruptcy Law makes specific references to the tax aspects of bankruptcy and judicial recovery, which caused changes in several provisions of the Brazilian Tax Code through the Complementary Law No. 118,2005 (the Brazilian Tax Code and Constitutional Law No. 118/2005 are both of February 9, 2005).33 Article 83 of the New Bankruptcy Law has changed the preference order of claims; this is perhaps the most striking change from the New Bankruptcy Law to the Tax Law. Traditionally, the tax credits preferred all others except labor (the bankruptcy legislation provided to tax credits the status of privileged claims by a provision of special law, provided in Article 186 of the Brazilian Tax Code).34 In the new system, tax credits are preceded by labor (although limited to one hundred and fifty minimum wages to the

32

The ones which stand out: the introduction of the General Assembly of Creditors, already used in other countries, which may deliberate on judicial recovery and bankruptcy; b) either in recovery or bankruptcy there will be a custodian trustee; c) a number of forms of judicial recovery, which may be, among others, the granting of special terms and conditions for payment of obligations matured or maturing; the division, merger or transformation of society, establishment of wholly-owned subsidiary, or transfer of quotas or shares, respected the rights of the shareholders, under current legislation; and the change in corporate control; d) change in order of preference of credits in bankruptcy; e) lack of tax and labor inheritance, and work accidents in the sale of the company assets, f) suspension of all actions against the debtor, except the tax ones - in cases of bankruptcy protection.

33

Article 6 caput and §7 of NLF resulted in the alteration of the article 187 of the BRAZILIAN TAX CODE, so that regardless of license in process and bankruptcy or participation in a meeting of creditors, the Public Treasure can pursue the recovery of their claims. Article 57 of NLF resulted in a change of the article 191 and in the introduction of article 191-A of BRAZILIAN TAX CODE, remaining consistent with the objective of a new system to facilitate business recovery, which can be done even with the existence of tax debts, since they are with suspended liability, which also includes the division. Article 60 of NLF resulted in the addition of three paragraphs to article 133 of the Brazilian tax code, eliminating the transfer of responsibility in judicial disposals occurred in bankruptcy process or judicial recovery, but also avoiding fraudulent transfers and discouraging businesses that do not have the scope of the bankruptcy process; thus, the §2 prohibits the non-accountability for succession is extended to certain class of buyers who have specific linkages with the debtor. An important note: in case of judicial recovery, the exoneration of liability only applies to sale of the subsidiary or productive unit alone, it does not apply to other types of assets (which is applied to bankruptcy). 3§ is actually a rule of Bankruptcy Law establishing a reserve for funds to resources from the sale in form of what the article requires; in case of bankruptcy, the denial of their use for the payment of tax credits (except the expenses of the estate not subject to bankruptcy rules). Article 68 of new bankruptcy law presented changes to the Brazilian tax code related to the application of installment (article 155-A) in order to suit the new system. Due to the article 83 of the new bankruptcy law, the article 186 of the Brazilian Tax Code was altered by the Constitutional Law No. 118/2005 in order to embrace the new order of credits preference in bankruptcy. It is noted the shift of the fine to the penultimate place in line of preference, giving preference only to subordinated credits (those provided by law or contract and the credits of shareholders and directors with no employment). The new bankruptcy law puts the tax for employees as those not subject to bankruptcy (they were the third ones, after the taxes). The tax charges for employees (resulting from the process of bankruptcy) are put in last place among those not subject to bankruptcy. In that sense, article 188 of Brazilian tax code also has its writing changed. The article 161 of the new bankruptcy law states that tax credits are not likely to be traded in place of extra-judicial recovery procedure.

34

Likewise, it is the article 186 of Brazilian tax code (changed by the Constitutional Act 118/2005): Art. 186. The tax credit comes first than any other, whatever its nature or time of its formation, except those from employment law or work accident. Sole Paragraph. In bankruptcy: I – the tax credit does not prefer to claims not subjected to bankruptcy neither to amounts subject to restitution under the bankruptcy law, nor to claims with real guarantee, in the limit of the value of the encumbered asset; II – the law may establish limits and conditions for the preference of claims arising out of employment law; and III – tax fine only prefers subordinated tax credits.

22

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creditor), by those arising from accidents at work and also by the secured credits. Claims for accidents at work were already treated as claims by labor law. Regarding claims with collateral, it is an old demand of the financial sector, which considers loans with collateral being preceded by tax credits. The financial sector argues that if collateralized loans have precedence, there will be fewer risks and, therefore, bank spread will be affected. This particular aspect is in accordance with the globalization tendency to give privileges to financial capital in order to increase guarantees and transit facilities. There are, consequently, indirect effects on the increase of international confidence in the Brazilian financial system.

3.2.4. Law No. 11,638/2007 (International Accounting Rules) The Law No. 11,638/2007, which came into force on January 1, 2008, seeks to adapt the Brazilian accounting rules to the international standards, approaching the standard used in the International Financial Reporting Standard (IFRS), according to the Amendment of the Lei das S.A.(Stock Corporations Act; Law No. 6,404/1976) and of the Law which regulates the securities market, securities, and the CVM (Law No. 6,385/1976). The adaptation of Brazilian accounting to international standards is an effect of globalization, in order to make rules and accounting language universal. This aspect has a strong relationship with the phenomenon of soft law. The International Accounting Standards Board (IASB)35, which regulates accounting standards (IFRS), is an entity of private law; however, countries can incorporate those rules to their national law. In order to alter the criteria for the accounting of a number of transactions, the result of the companies will also be changed, but the Law No. 11,638/2007 introduced the 177 of the Law No. 6,404/1976, stating that the changes stemming from the Law shall not be taxed. However, the provision is unclear whether this non-effect refers to the year it came into force (classification/adaptation adjustments), or it is undefined, because the new system defines revenue as certain facts that was previously defined as such. Also, other not previously considered accounting facts currently have an impact on property, thus steadily affecting profit. The effects of this law will be accounted more in taxes than in general rules of tax law, but they have not been totally understood, so the topic was addressed in general.

3.3. Effects on the Types of Taxes 3.3.1. Income Tax Among direct taxes, income tax was the most affected by the globalization. In the mid-nineties, two major changes were introduced in legislation in order to minimize the negative effects of globalization in tax collection. Law No. 9,249, (1995) extended the concept of worldwide income taxation to legal entities (previously, only applied to individuals living in Brazil. Later, the Law No. 9,430, (1996) introduced the transfer pricing legislation, imposing to international transactions the arm’s length principle. 35

IASB, based in London, succeeded the International Accounting Standards Committee (IASC), from 2001.

23

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Such modifications - specific anti-avoidance rules - are important because they aim at curbing the practice of tax avoidance by companies with transnational operations, a fact that, as stated earlier, has been intensified with globalization. By formatting the taxable event and the basis of calculation, the Brazilian tax code has also been amended in the part that deals with the Income Tax. Thus, in 2001, two paragraphs were added, by the Constitutional Law No. 104 (2001), to the Article 43 of the Brazilian Tax Code, which deals with the calculation basis of the Income Tax, with the following text: Article 43... ... § 1 The tax incidence is independent on the name of revenue or income, location, legal status, or nationality of the source, origin, and mean of acquisition. § 2 In the event of revenue or income from abroad, the law shall regulate the conditions and the moment it will be available for the purpose of the tax referred to in this article § 1 prescribes the incidence, on a worldwide basis, of the Brazilian income tax, extinguishing doubts raised in the courts. The provision refers to the territorial aspect of income, making it clear that the income earned abroad (regardless of location, legal status, or nationality of the source) is taxable. Although prior to the issue of the Constitutional Law No. 104, 2001, the income taxation had already been made based on world income, i.e., regardless of territorial origin of the income. Such provision has more stability to the Income Tax Law. Furthermore, § 1 reinforces the preexisting legislation in the sense that, regardless the name of the revenue and mean of acquisition, it must be taxed. Undoubtedly, this provision enhances the universal character of Income Tax taxation. As provided in § 2 of Article 43, it implies a higher degree of complexity. This provision allows the extension of the concept of universality beyond territorial limit, but also extends the temporal aspect of Income Tax incidence. Thus, in accordance with the legislation edited to support such provision, profits earned, but not yet distributed abroad, may be taxed in Brazil, under the conditions established by law. Such procedure is a source of intense debate. The same provision delegates to the ordinary law the fixation of conditions and of the time the economic availability of revenue or income from abroad will occur, in order to determine the incidence of income tax. In accordance with what was mentioned, there is a state in Article 74, caput and sole paragraph of the Provisional Measure No. 2,158-35, (2001) that defines the calculation basis of the Income Tax and of CSLL (social contribution on net income). Profits earned by a parent company or an affiliate abroad are considered available to the parent or affiliate company in Brazil, on the balance sheet date in which they were collected. This provision, which allows the taxation of income earned abroad but not available to the parent company in Brazil, is the subject of strong controversy in the doctrine and in the Judiciary. 36The provisory measure described above is being debated in the Supreme Court, in ADIn No. 2,588/FD.

36

24

See, e.g., SOUZA JÚNIOR, Alberto Pinto. A Disponibilidade de Lucros Oriundos do Exterior. Revista Fórum de Direito Tributário, Vol. 2 mar./abr. 2003. p. 49 a 74; NUNES, Renato. Tributação de Lucros Auferidos por meio de Coligadas e Controladas no Exterior: Regime de Disponibilização (MP n. 2.158-35/01) e Resultados de Equivalência Patrimonial. In: TORRES, Heleno Taveira (Coord.) ________. (Coord.) Direito Tributário Internacional Aplicado. V. 1. São Paulo: Quartier Latin. 2003, p. 583-604; OLIVEIRA, Ricardo Mariz de. Lucros de

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It is important to remember that income remittances made to residents and domiciled in countries with favored37 taxation have their Income taxed by 25 percent , subject to withholding at source, regardless of the tax rate regularly applicable to operations with countries that do not fit the concept (the rates are usually less than 25 percent, depending on the bonding of the income earned by the resident abroad). Transactions involving individuals or entities, though not bound, from countries with favored taxation, by the individuals or legal entity resident or domiciled in Brazil, are also subject to the rules of transfer pricing. These measures combat harmful international tax competition through tax havens, and that prevents tax avoidance strategies (specific anti-avoidance rule) and tax evasion.

3.3.1.1. Effects of the Need to Attract Foreign Capital and the International Tax Competition Several changes have been made to the Income Tax legislation in order to relieve taxation and attract investment38 within the context of international tax competition. In general, changes within Tax Income, in cases of financial investments and other investments, affect both resident and non-residents taxpayers. Foreign investors are generally subject to the same taxation rules as the residents (article 78 of Law No. 8,981, 1995). However, that has been changed, and as this study shows, although there are measures that benefit only the foreign capital invested in Brazil, there are also measures aimed at the so-called international tax competition. The international tax competition phenomenon has worried countries, due to the erosion of a tax base and to the volatility of capital flows.39 The attraction of foreign capital in Brazil happens not only because coligadas e controladas no exterior e aspectos de elisão e evasão fiscal no Direito brasileiro e no internacional. Revista Dialética de Direito Tributário, São Paulo, n. 102, Março/2004, p. 95-122. 37

The term is euphemistically used to refer to tax havens. Normative Instruction of the Federal Revenue Secretariat No. 188 of August 6, 2002 lists the countries or dependencies with favored taxation that are not those who did not tax income or that tax rates below 20%, or even where domestic law imposes relative secrecy to the corporate composition of legal persons or of their ownership : I - Andorra; II - Anguilla; III - Antigua and Barbuda; IV - The Netherlands Antilles; V - Aruba; VI - Commonwealth of the Bahamas; VII - Bahrain; VIII Barbados; IX - Belize; X - Bermuda; XI - Campione D’Italia; XII - The Channel Islands (Alderney, Guernsey, Jersey and Sark); XIII - Cayman Islands; XIV - Cyprus; XV - Singapore; XVI - Cook Islands; XVII - Republic of Costa Rica; XVIII - Djibouti; XIX - Commonwealth of Dominica; XX - United Arab Emirates; XXI - Gibraltar; XXII - Grenada XXIII - Hong Kong; XXIV - Labuan; XXV - Lebanon; XXVI - Liberia; XXVII - Liechtenstein; XXVIII - Luxembourg (regarding the holding companies governed in Luxembourg law by the Act of July 31, 1929); XXIX - Macao; XXX Madeira Island; XXXI - Maldives XXXII - Republic of Malta, XXXIII - Isle of Man; XXXIV - Marshall Islands; XXXV - Mauritius; XXXVI - Monaco; XXXVII - Montserrat; XXXVIII - Nauru; XXXIX - Niue; XL - Sultanate of Oman; XLI - Panama; XLII - Federation of Saint Kitts and Nevis; XLIII - American Samoa; XLIV - Western Samoa; XLV - San Marino; XLVI - Saint Vincent and the Grenadines; XLVII - St. Lucia; XLVIII - Seychelles; XLIX - Tonga; L - Turks and Caicos Islands, LI - Vanuatu; LII - U.S. Virgin Islands; LIII - British Virgin Islands.

38

In addition to investments in fixed income bonds (or equivalent operations), in general public with federal securities, one should distinguish between two types of foreign investments. There are foreign direct investments, which are designed to direct participation in the activities of the company, with direct reversal in machinery and equipment and the construction industries (is the most desirable form of investment because it promotes development and involvement of foreign capital), and the second type corresponds to the foreign investment portfolio. In the latter case the investment happens through the purchase of shares, debentures and bonds that finance the national companies, financial market and capital.

39

According to John CHRISTENSEN and Sony KAPOOR: Hidden from the public eye financial capital has been completely reconfigured over the past thirty years in order to bypass nationallybased tax and regulatory regimes. Using the 70 plus tax havens dotted across the globe, wealthy individuals and transnational businesses have adopted highly aggressive tax avoidance strategies, whilst also forcing the governments of mainstream nations to engage in a harmful tax competition to attract direct and portfolio investment capital. The existing global framework for cooperation on tax affairs is totally inadequate to its task, and the political will to tackle this problem is virtually non-existent as governments acquiesce to pressures from financial capital. Whilst poor countries lose an estimated US$500 billion annually to dirty money flows, which includes tax avoidance and related capital flight, neo-liberal pressure groups in the United States have been lobbying against the OECD initiative to stem harmful tax competition. Civil society is now mobilising to counter the tax avoidance industry and to challenge

25

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of investment, but also because of the public debt financing system , which is fairly dependent on foreign capital - hence the need of tax incentives to attract buyers of public securities issued by the Federal Government. This dependence on foreign capital has consistently declined; consequently,, in January, 2008, the sum of Brazilian assets abroad (consisting of international reserves) exceeded the value of Brazil’s foreign debt, turning the country from debtor into foreign creditor. Also, by the end of April, 2008, rating agency Standard and Poor ranked Brazil in the level of investment grade. Among the measures that benefit taxpayers in general (both resident and nonresident), the elimination of taxation on the distribution of profits or dividends is mentioned. It abolishes economic double taxation and the possibility of deduction of interest on equity (and a 15 percent tax rate of when distributing)40 Such measures are provided in Articles 9 and 10 of Law No. 9,249, of 1995. However, whereas the non-taxation of profits and dividends also covers quantities remitted abroad (including remittance to tax havens), and although not all countries release the distribution of profits or dividends, the measure sets up a strategy of tax competition.41 The structure of rates of tax income to investors in capital markets has been altered, and although there is withholding at source, it implies a lower tax burden for investors, but higher cost to short-term funds. Rules that benefit only foreign investors who invest in Brazil are not uncommon. Provisional Measure No. 1,753-16 (1999) reduced to zero the tax income rate for foreign investments applied to the acquisition of securities of the Federal Government for a certain moment (Transitory Provision from 09/01/1998 to 06/30/1999). Provisional Measure No. 2,189-49(2001), a reissue of Provisional Measure No. 1,990 (1999), excluded from the impact of income tax the capital gains earned by individual or group investors residing or domiciled abroad. Capital gains, in this case, are transactions on stock exchanges, commodities, futures and similar, and operations with gold, financial assets, outside the stock exchange.42 The Provisional Measure No. 281, 2006, converted into Law No. 11,312, 2006, reduced to zero income tax rates on investments by non-residents in government securities and other investments, such as the Investment Funds in Participations and Investment Fund in Emerging Companies, though the focus is on investments in government securities (but the benefit did not extend to the investors based in tax havens)43. This situation the idea that tax competition can play a useful role in development strategy. CHRISTENSEN, John; KAPOOR, Sony. Tax Avoidance, Tax Competition and Globalisation: making tax justice a focus for global activism. Accountancy Business and the Public Interest, Vol. 3 No. 2, 2004, p. 1-16, p. 1. See also LOPEZ, Christian. La Fiscalite Come Vecteur de L´Attactivite du Territoire. In: LEROY, Marc. Mondialition et Fiscalité: La Globalisation Fiscale. Paris: L´Harmattan, 2006, p. 245-262, esp. p. 247-250.

26

40

The deduction of interest on capital applies to companies that calculate the IR by actual profit, thus it does not generally benefit the taxpayers, but only companies subject to this form of taxation.

41

The mechanism works like a magnet for direct investment, but it is also a form of tax competition. The creation of export processing zones (EPZs) provided with tax favors, among other ways, also serves as an attractive to direct investment. Avi NOV notes that the OECD has tried to curb tax competition to attract foreign investment in the capital market (foreign portfolio investment), but has intentionally overlooked tax competition to attract foreign direct investment. See Avi NOV, op. cit., note 2 supra, p. 839.

42

Normative Instructions of the Federal Revenue Secretariat No. 208, September 27, 2002.

43

See STUBER, Walter Douglas. Isenção Tributária – Novas regras em benefício dos investidores estrangeiros. Revista Jurídia Consulex, Brasília, n. 220, março/2006, p. 32-33.

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took place for two reasons: a) the fact that the major economic changes occurred over the 1990s generated a sharp increase in the Brazilian public debt; b) the Brazilian government’s fiscal policy was re-addressed to the production of primary surplus in order to show to the country’s creditors the solvency situation of the country – a typical feature of globalization. That ensures credibility for the placement of public bonds required for debt rollover.

3.3.2. CPMF The amendments made in the CPMF legislation (which lasted until December, 2007) as a result of the globalization process were also adopted in order to internally relieve the financial capital and, in some cases, to specifically relieve the foreign investor44. Provisional Measure No. 179(2004), converted into Law No. 10,892, 2004, dismissed the taxation of CPMF from the changes in investment, so that investors would not be taxed when they change types of investments in the financial market. On February 16, 2006, Provisional Measure No. 281 was passed and converted into Law No. 11,312, 2006. It reduced to zero the CPMF rate on debit entries in the current account for settlement of acquisition of shares in public offering held outside the premises or trading systems of the stock market (but registered in the Securities Commission), which also benefited residents and non-residents.

3.3.3. IOF The IOF (Tax on Financial Operations) is a tax with strong extra fiscal effects, being widely used as an instrument of fiscal intervention in the economic domain. That intervention can be either a reward or relieve by non-collection or reduced collection of tax.45 IOF on foreign exchange operations to the changes arising from the extinction of the CPMF tax46 was levied only on purchases of foreign currency to pay for international purchases with a credit card. This is a tax barrier to prevent the escape of foreign currency, indirectly curbing imports and international finance transactions with a maturity of less than 90 days. Due to these changes, foreign investors’ operations in the market and the variable income securities were not included in the list of taxable operations. However, given the growing appreciation of the Brazilian currency (REAL), this scenario may change. IOF is hardly charged in the market for securities (primarily in fixed income transactions maturing in less than 30 days), aiming at encouraging the application of resources in this market (which also trades government bonds) both by residents and 44

Take as an example the Normative Instructions of the Federal Revenue Secretariat No. 173 of July 11, 2002, article 4, sections IX and X, which excludes the impact of the CPMF on financial transactions for the variable income market when the owner is a foreign investor; commandment also constant of the Normative Instructions of the Federal Revenue Secretariat No. 450, September 21, 2004, which repealed it.

45

See VALADÃO, Marcos Aurélio Pereira. Intervenção no domínio econômico e tributação – extrafiscalidade – aspectos. In: DIAS, João Luis Fischer, et al. Estudos de Direito Público: homenagem aos 25 anos de Mestrado em Direito da UnB, Brasília: Brasília Jurídica, 2000, p. 223-248, 237-239.

46

This scenario has changed a little because of the need to increase the collection of the IOF in order to compensate the loss of CPMF, which ceased to be charged from January 10, 2008. However, changes in the rates of the IOF, promoted in early 2008, have kept foreign investors with tax reduced to zero, while other operations had their rate increased. See decree No. 6339 of January 3, 2008; decree No. 6345, January 4, 2008; and decree No. 6391 of March 12, 2008.

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by nonresidents. Through the conformation of charging the IOF, which actually has five separate incidences (loans, with securities, foreign exchange, insurance and financial gold assets or negotiable instrument), there is a treatment that tends neutralize financial market operations and the entry of foreign funds – which are matters arising from the globalizing transformations and that impact on extra fiscal aspects of the IOF.

3.3.4. Effects on Other Taxes Several internal taxation measures to improve export performance, in the struggle for integration into the global economy, and which do not constitute subsidies prohibited by the GATT/WTO, were adopted by the Federal Government. Among these measures, those adopted to relieve the Brazilian exports of domestic indirect taxes are significant. The return of PIS/PASEP and COFINS, cumulatively charged, was enabled by the granting of credit presumed on IPI (a non-cumulative federal tax).47 The federal states also use strategies to reduce the ICMS, aiming at attracting investments. Although this “fiscal war” happens within the federation, it brings international implications; reduced taxation on the level of states is a further attraction for transnational enterprises. Thus, the fiscal war benefits tax imports, which become less taxed than the domestic production. that implies the loss of competitiveness of the domestic industry in the domestic market. This is one of the reasons why there was proposal sent to the Congress in early 2008 to finish the tax war.48 The limitations imposed by the treaty of GATT/WTO, particularly the clause of nondiscrimination against imported products (national treatment), those that prohibit subsidies (particularly those related to direct taxes),as well as the formatting of import tax rates, affect taxation of domestic and international transactions, representing a weakening of tax sovereignty.49 Likewise, the regional integration agreements, especially the Mercosur, impose serious restrictions on freedom to regulate tax matters. The Common External Tariff (CET), applicable to all countries of the bloc, is the most important import tax. A Mercosur Customs Code is under discussion, and it shall impose common fiscal rules related to the import and export tax, and common custom procedures to the members of the bloc. As a practical example of the interference of multilateral treaties of commerce in the internal taxation, there is a case in which the State of Rio de Janeiro required a differentiated IPVA rate due to the local car manufacturing system (higher taxes on imported cars). The Superior Court of Justice believes that such taxation is incompatible with constitutional provisions dealing with the taxation uniformity and with the GATT/

28

47

They are called the IPI presumed credit as compensation for the contribution for PIS/PASEP and COFINS, under the Law No. 9,363, of 1996, and under the Law No. 10,276, 2001. These mechanisms have arisen when the PIS/PASEP and COFINS taxes were cumulative. However, as the non-cumulative procedure does not apply to all companies, the system remains in force.

48

It is currently in process the PEC No. 233/2008, which brings changes to the ICMS [Services and Merchandise Circulation Tax] to eliminate the so-called “fiscal war” among the states.

49

See BRITO FILHO, Washington Juarez. O Gatt como Norma de Direito Internacional Tributário. In: Heleno Taveira (Coord.). Direito Tributário Internacional Aplicado. V. 4. São Paulo: Quartier Latin. 2007, p. 631-671.

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WTO treaty (automobile taxes are not a turnover tax, but a tax equity).50 The interference of the global agreement in the tax system is clear. The establishment of EPZs aims at increasing the competitiveness of Brazilian exporters and at attracting international investment to areas with differentiated taxation, due to an intensification of international competition for capital and markets caused by globalization. The EPZs cause an impact not only in the tax payment, but also in the tax-related auxiliary obligations levied on imports, meaning greater facilitation. Notably, several Asian countries, such as Taiwan, South Korea, and China, have used these areas for self-promotion on the international trade environment and on development, with great success. Regarding Brazil, a more effective regulation is necessary to the market’s need; that has been through changes, as mentioned above. Attempts followed by the establishment of Export Processing Zones (EPZ) in Brazil, with several changes in tax legislation related to the IPI and II, the PIS and the COFINS, and the Income Tax (especially for services provided in the EPZ, which equate to export) have not had the result expected by the Brazilian Government.51 More recently, the Law No. 11,508(2007) was passed, and updated the model, approaching the existing models in other countries and changing the EPZs’ tax, exchange and management system (especially customs control). However, the Executive Power vetoed several provisions, which were revised and reissued in the form of interim.52 The Manaus Free Zone, established before the current wave of globalization, includes a number of tax benefits, including the ICMS. The period of its existence considered, it has not achieved the desired result. Although some of these tax occurrences are not a direct effect of globalization, one may say that this is an indirect effect. Besides, the effort to capture and maintain foreign exchange reserves to cope with the international financial and market scenario is an imposition of the globalization process, affecting tax laws. These laws shall be ordered so as to facilitate and encourage an increase on such reserves. This situation is also reflected in the export sector, going beyond the ordinary commercial aspects of the conquest of markets.

3.4. International Tax Treaties

In addition to the taxing-related treaties (treaties to avoid double taxation of capital income and to prevent tax avoidance), there are several types of tax treaties that affect air and maritime navigation53. There are several constitutional and legal factors that

50

The controversy of differentiation of differentiated rate of automobile taxes (IPVA, standing for tax on property and on motor vehicles), for imported vehicles by applying a higher tax rate, was resolved at the ROMS (STJ) No. 10906/RJ of 02/05/2000, where the Superior Court of Justice decided that it is not feasible to differentiate with footstool in the GATT/WTO Agreement (non-discrimination clause) and also in the article 152 of the Constitution.

51

Decree-law No. 2542, 1988, which dealt with the Export Processing Zones, providing tax regimes, foreign exchange and special administrative, has been amended several times, having been repealed by Law No. 11,508, 2007.

52

Provisional Measure No. 418, February 14, 2008.

53

See Marcos Aurélio Pereira VALADÃO, Limitações..., note 10 supra, p. 203-222.

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cause an impact in the implementation of these treaties and, because of globalization, become more evident, due to its growing figures. Brazil has signed several treaties to avoid international double taxation of income and capital (direct taxation) and to exchange information. These treaties have become a more pressing need as globalization evolves. Some legal problems of double taxation on transnational operations are properly solved only through treaties, since the solutions based only on domestic laws are insufficient. So, Brazil has substantially increased the number of double tax treaties and of information exchange.54 However, these treaties do not affect the global tax harmonization, in order to curb international tax competition, although, in bilateral terms, it brings beneficial effects. Undoubtedly, the incredible expansion of tax treaties and treaties with various tax effects (such as the GATT/WTO), agreements on air and maritime navigation, and even agreements such as the Vienna Convention of Diplomatic Relations tend to work as tax harmonization. However, it does not retrain the overall tax competition as it is practiced today in relation to direct taxes (income and assets).55 Consequently, it is thought in currently multilateral tax treaties – which are difficult to be implemented, even in economically integrated 56 communities,simply because those who do not take part of the treaty end up with more advantages

54

The Convention between the Federative Republic of Brazil and the Portuguese Republic for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income, signed in Brasilia on May 16, 2000, was approved by the Congress by the Legislative Decree No. 188 of 2001, and subsequently promulgated by the President through the Decree No. 4012, 2001. Currently, Brazil has signed 25 bilateral treaties to avoid double taxation (28 if we consider separately the Czech and Slovakia, which were one country at the conclusion of the treaty, in 1986).

55

See, in general, Rajiv BISWAS, op. cit, nota 1 supra.

56

Indeed, the EU has achieved some progress in the area of direct taxes. But even the researchers of this subject acknowledge that the increase was less than expected. The European Union, which is by far the most developed community integration, finds several obstacles to progress in this matter – and this leads us to believe that, globally, solutions to harmonize taxes in order to curb harmful tax competition through multilateral treaties are still in a process of long term, though necessary and desirable. See, for example, Paula Rosado PEREIRA, who analyzes some progress of the European Union on taxation of companies in EU (by means of Directives 90/434/CEE, 90/435/CEE and by the Convention 90/436/CEE and most recently by the Fiscal Package approved in the ECOFIN on July 3, 2003, containing the Directives 2003/49/CE and 2003/48/CE), but she states that there are difficulties due to the fact that the States insist on a high level of fiscal sovereignty, which actually is eroded by harmful tax competition, which has hampered progress in this direction (also due to the rule of unanimity in the decision and to a generality of legal instruments). Paula Rosado Pereira, dealing with corporate taxation in the EU, states that: The process of harmonization of corporate taxation also contrasts greatly with the progress made in harmonization of indirect taxes. Effectively, the harmonization of taxation in society has been marked by a series of delays and setbacks, culminating in the great slow to deliver results. Furthermore, and unlike what happens in the field of indirect taxation, the measures implemented at the level of taxation of societies are not aimed at a complete reform of taxation, remaining confined to specific matters. PEREIRA, Paula Rosado, A Tributação das Sociedades na União Europeia: Entraves Fiscais ao Mercado Interno, e Estratégias de Atuação Comunitária. Coimbra: Almedina, 2004, p. 214. Specifically in relation to MERCOSUR, see SILVA FILHO, Antonio Rodrigues da; CATÃO, Marcos Sodré Vinhas. Harmonização Tributária no Mercosul. São Paulo; Aduaneiras, 2001.

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han its signatories 57. The real prospect of such a treaty occur in the OECD 58 – what would leave Brazil outside, since it does not belong to the group. Since it is not always possible to relate tax harmonization and direct taxes, the OECD has recently released a study, the results of which showed: a) the jurisdictional limits of the tax authority powers restrict their scope to curb some forms of harmful tax competition; b) it is believed that a country, as its residents are taxed in order to neutralize the benefits of certain forms of tax competition, might leave taxpayers in a competitive disadvantage; c) the need to monitor all forms of harmful tax competition and to effectively strengthen countermeasures impose administrative costs to the countries affected by such competition; d) uncoordinated unilateral measures may increase the costs of taxpayers’ flexibility (transaction costs) ; e) the need for coordinated action on international level is also apparent in the high degree of mobility of the activities that are aimed at harmful tax practices.59 Given this context and the lack of international cooperation, there is little incentive for a country that already offers a harmful preferential regime to eliminate it, because that scenario might be encouraging to move the activity to another country where preferential treatment is provided. There are problems related to treaties that grant State and local tax , which are repeated economic cooperation treaties (bilateral or regional) with a special purpose. There are examples such as the Tratado de Itaipu (the Itaipu Treaty)- a partnership between Brazil and Paraguay for the construction of a hydroelectric power plant ) and the Acordo para Isenção de Impostos Relativos à Implementação do Projeto do Gasoduto Brasil-Bolívia (the Agreement for Exempting Taxes on the Implementation of the Brazil-Bolivia Gas Pipeline Project).60 They are economic partnerships, but their results must be taxed The problems stem from controversy over possibility, whether or not tax benefits for tax jurisdiction of states and municipalities in Brazil are granted by means of an international treaty. 61 A multilateral tax treaty concerns to 57

As mentioned in the note above, the EU made some progress in this direction. However, in the context of Mercosur, it is still relatively early for such measures, since even the indirect taxes are in an embryonic process of harmonization. Anyway, some measures can be effectively adopted. As an example, we have what is said by the article 55 of Law No. 10,637, 2002, when addressing the conventions on double taxation of income within Mercosur: Article 55. The Conventions for the avoidance of double taxation of income, to be signed by Brazil with the countries member of the Southern Common Market (Mercosur), will be included in the clause providing the granting of credit from income tax on profits and dividends received by a legal entity domiciled in Brazil, which should be paid in the other signatory country, but that has not been a matter occurred due to the law of temporary incentive to economic development, national, regional or sector. The credit, observing the other terms and conditions for granting and others that may be established in specific legislation, will only be allowed when profits or dividends distributed come directly from activity performed in the foreign signatory country, related to the sectors: a) industrial, except the tobacco industry and drinks in general, including its branches; b) agricultural, forestry or fishing industry.

58

See Reuven S. AVI-YONAH, note 2 supra, p. 64-65.

59

See OCDE. Harmful Tax Competition – An Emergin Global Issue. Available at: http://www.oecd.org/dataoecd/33/0/1904176.pdf. Access on June, 20, 2007. The OECD’s recommendations fall into three categories. The first relates to domestic legislation and to the need of increasing its effectiveness. The second relates to the treaties on tax matters in order to use models that make them more effective in combating harmful competition. The third category, finally, relates to the increase of international cooperation in order to combat this issue. In practice, even with these efforts of the States, either in drafting measures or pressing the regions that offer tax benefits to provides information and breach the secrecy for criminal purposes, the investor’s cunning remains. A complex tax planning, involving states which have concluded treaties with a view to eliminating double taxation, combined with the existence of tax havens, may render ineffective the mentioned measures to control international tax competition.

60

_ Promulgated by the decree 72,707, of August 28, 1973, and the decree 2,142, of February 5, 1997, respectively.

61

The controversy says that the Brazilian Federal Constitution contains a provision that expressly prohibits the Union to grant tax exemptions to the jurisdiction of States, Federal District or the Municipalities (article 151, item III). However, much of the doctrine considers that such provision refers to laws enacted by the Union and not to those carried by the Federative Republic of Brazil, while representing Brazilian states of which the federative entities are part – which is the case of the international treaties. Thus the treaties would not be affected by such prohibition. The Supreme Court has evolved in this matter since the beginning of this century. For instance, the RE 229096/RS,

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transactions via the Internet, especially in cases involving several fiscal jurisdictions in the same transaction for the purpose of payments/receipts and shipment/delivery of goods. It is especially more complex when it comes to intangibles – but it is also a future perspective.

4. Effects on Taxation Arising From Other Aspects of Globalization 4.1. Environmental Taxation

Globalization is a wide phenomenon, with aspects that sometimes do not belong to the same sphere of impacts. The need for environmental preservation and its international consequences, leading countries to sign treaties that compromise the internal taxation in favor of the environment, also happens in the context of globalization. The movement to preserve the environment today is a global need, no longer restricted to cases of preserving a highly polluted river in a country and that is causing local problems. The best and most significant example is global warming, which is caused by everyone and, therefore, demands everyone’s work together to solve it. This situation shall impose consequences on taxation of all countries. The Kyoto Protocol is a good example: it states that polluters should pay higher taxes in order to discourage polluting activity. This taxation enables the correction of externalities, which can be made possible with the more costly tax collection from corporate polluters (Pigouvian taxation), also called the polluter pays principle.

Although there is no formal framework in this sense, there are several proposals for adoption of taxes that would be charged in the least expensive mean for less-polluting activities, encouraging industries to adopt less environmentally damaging models. In Brazil, an extra fiscal tax system can be used in order to benefit low-polluting business and products62, although there is not specifically a “green tax”.63 There are, however, environmental taxes adopted to control and supervise polluting agents. There is also the imposition of compensation for environmental damages; according to some authors, that must be taxed.64

4.2. The use of the Soft Law: an Increase

The Globalization process brought regulatory niches, non-governmental organizations with effective power, etc., enabling the creation of innovative regulatory aspects that do not fit the traditional concepts, such as the soft law. The soft law is not a source of tax law, at least not an immediate one. However, the use of soft law as a non-immediate

unanimous decision, affirming the possibility of exemption from state tax by international treaty, which does not characterize it as a heteronymous exemption.

32

62

See José Marcos DOMINGUES, op. cit., note 6 supra. See also SALIBA, Ricardo Berzosa. Fundamentos do Direito Tributário Ambiental. São Paulo: Quartier Latin, 2005, p. 305-328.

63

_ This form of taxation is found in some countries, especially those belonging to the OECD and European countries. See CESifo. Environmental Taxes (Report | 02.11.2007), available at http://www.cesifo-group.de/portal/page/portal/ifoHome/a-winfo/d3iiv/_DICE_ division? _id=6745571&_div=6745626, access on February 02, 2008.

64

See José Marcos DOMINGUES, op. cit., note 6 supra.

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source of tax law is becoming more common and noticeable as far as international tax laws are concerned. Yet, that could be noticed more often even in the domestic tax law cases.65 It is the case of the use of tax rules in the terminology of the financial market, which consists of terms whose precise meaning comes from the adoption of a specific glossary by agents of the stock exchanges (private organizations) around the world. For example, terms like “day trade transaction” or “box operations”, used in the tax legislation jargon have their meaning (and therefore, the tax impact)defined by private entities despite their regulation by the CVM [Securities and Exchange Commission]. Incoterms used in trading can be referred to the terms of Free on Board (FOB) and Cost, Insurance and Freight (CIF), widely used in tax legislation. There are other aspects of soft law that may affect taxation, particularly in relation to international aspects, but their details are beyond the subject of this study. 66A side effect of the influence of soft law in the tax law is the high number of complex rules.

5. Final Considerations

The first impression concerning the changes in the tax system caused by globalization is that, in general, the alterations follow a common pattern in all countries. Some examples are: taxation on a universal basis, transfer pricing regulation, bilateral treaties on double taxation of income and capital, limitation of import tax rates, effects of tax policies on tax systems under the influence of international financial institutions, especially the IMF and the World Bank, and the limitation of discriminatory tax policies due to the GATT/WTO, also present in the processes of economic integration (which is different in each economic bloc, depending on the stage of the integration process). However, Brazil shows some specific needs to attract foreign capital, because of the way of financing public debt (public deficit accumulated), policy maintenance/expansion of reserves in foreign currency, and the need to attract foreign capital, that resulted in privileges for foreign capital invested in Brazil.. Such aspects tend to be modified as Brazil’s economy grows stronger. Another characteristic that has become more evident is that globalization encourages the use of extra fiscal taxation, either because of international tax competition or because of the use of special tax regimes for exports; it also encourages the control of investment flows through relief or encumbrance of taxation of foreign exchange operations and securities. It happens due to international competition, and specially for the growing unpredictability of market behavior – encouraging the use of regulatory taxation with short-term effect. In addition to the economic extra taxation, globalization encourages the adoption of tax techniques to accommodate international trends in environmental preservation, leading to the emergence of the “green tax”, although this aspect has not yet provoked significant impact on the Brazilian tax system.

65

_ See VALADÃO, Marcos Aurélio Pereira. Pode o Soft Law ser considerado fonte do Direito Internacional Tributário? Revista de Direito Internacional Econômico e Tributário, v. 2- N.1, p. 13-47, 2007.

66

Idem.

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References

AVI-YONAH, Reuven S. Globalization and Tax Competition: Implications for Developing Countries. CEPAL Review, n. 74, 2001, p. 59-66, disponível em http://www.eclac.cl/ publicaciones/xml/9/19999/lcg2135i_ Avi-Yonah.pdf. BISWAS, Rajiv (Ed.), International Tax Competition: Globalisation and Fiscal Sovereignty. London: Commonwealth Secretariat, 2002. CASTRO, Aldemario Araujo. As Repercussões da Globalização na Tributação Brasileira. Tese de Mestrado defendida no Curso de Mestrado em Direito da Universidade Católica de Brasília (maio/2006 – não publicada), p. 39-46. (Disponível em http://www.bdtd.ucb.br/tede/tde_busca/arquivo.php?codArquivo =326). CESifo. Environmental Taxes (Report | 02.11.2007), disponível em http://www.cesifo-group.de/portal/ page/portal/ifoHome/a-winfo/d3iiv/_DICE_division?_id=6745571&_ div=6745626, acesso em 02 fev. 2008. CHRISTENSEN, John; KAPOOR, Sony. Tax Avoidance, Tax Competition and Globalisation:making tax justice a focus for global activismi. Accountancy Business and the Public Interest, Vol. 3 No. 2, 2004, p. 1-16. DOMINGUES, José Marcos. Environmental Fees And Compensatory Tax In Brazil. Law and Business Review of the Americas, Dallas, v. 13, n. 2, Spring/2007, p. 279-304. FARIA, José Eduardo. O Direito na Economia Globalizada. São Paulo: Malheiros, 2000. LEROY, Marc. Reflexion Sociologique Sur La Globalization Fiscale. In: _______. (Org.). Mondialition et Fiscalité: La Globalisation Fiscale. Paris: L´Harmattan, 2006, p. 263-280. LOPEZ, Christian. La Fiscalite Come Vecteur de L´Attactivite du Territoire. In: LEROY, Marc. Mondialition et Fiscalité: La Globalisation Fiscale. Paris: L´Harmattan, 2006, p. 245-262. MACHADO, Rubens Approbato. Visão Geral da Nova Lei 11.101. In: _______. (Coord.) Comentários à Nova Lei de Falências e Recuperação de Empresas – Doutrina e Prática. São Paulo: Quartier Latin, 2005. MINISTÉRIO DA FAZENDA. Coordenação-Geral de Estudos Tributários da Secretaria da Receita Federal do Ministério da Fazenda. Distribuição da Carga Fiscal Líquida. Brasília: Ministério da Fazenda, s.d. _______. Coordenação-Geral de Política Tributária da Secretaria da Receita Federal – COGET/SRF/MF. Carga Tributária no Brasil – 2002 (Estudos Tributários 11). Brasília: Ministério da Fazenda, 2003. _______. Coordenação-Geral de Política Tributária da Secretaria da Receita Federal – COGET/SRF/MF. Carga Tributária no Brasil – 2004 (Estudos Tributários 14). Brasília: Ministério da Fazenda, 2005. NOV, Avi. The “Bidding War” to Attact Foregin Direct Investment: The Need for a Global Solution. Virginia Tax Review, n. 25, 2006, p. 835-874. NUNES, Renato. Tributação de Lucros Auferidos por meio de Coligadas e Controladas no Exterior: Regime de Disponibilização (MP n. 2.158-35/01) e Resulados de Equivalência Patrimonial. In: TORRES, Heleno Taveira (Coord.) ________. (Coord.) Direito Tributário Internacional Aplicado. V. 1. São Paulo: Quartier Latin. 2003, p. 583-604. OCDE. Harmful Tax Competition – An Emergin Global Issue. Disponível em: http://www.oecd.org/ dataoecd/33/0/1904176.pdf. Acesso em: 20 de junho de 2007. OLIVEIRA, Ricardo Mariz de. Lucros de coligadas e controladas no exterior e aspectos de elisão e evasão fiscal no Direito brasileiro e no internacional. Revista Dialética de Direito Tributário,. São Paulo, n. 102, Março/2004 , p. 95-122. PALMA, Clotilde Celorico. O Controle da Concorrência Fiscal Prejudicial na União Europeia. Revista Fórum de Direito Tributário, Belo Horizonte, n. 15, mai-jun/2005, p. 49-74. PAULANI, Leda Maria. Economia e retórica: o capítulo brasileiro. Revista de Economia Política, janmar/2006, vol.26, no.1, p.3-22, p. 4-13. PEREIRA, Paula Rosado, A Tributação das Sociedades na União Europeia: Entraves Fiscais ao Mercado Interno, e Estratégias de Actuação Comunitária. Coimbra: Almedina, 2004. PISCITELLI, Roberto B. (org.). O Sistema Tributário na Nova Constituição: da crise financeira às perspectivas com o novo sistema. 2ª ed., Brasília, UnB, 1989. ROSA, José Rui G. Impacto financeiro da reforma tributária nos recursos disponíveis da União, Estados e Municípios. In: PISCITELLI, Roberto B. (org.). O Sistema Tributário na Nova Constituição: da crise financeira às perspectivas com o novo sistema. 2ª ed., Brasília, UnB, 1989. SALIBA, Ricardo Berzosa. Fundamentos do Direito Tributário Ambiental. São Paulo: Quartier Latin, 2005.

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SOUZA JÚNIOR, Alberto Pinto. A Disponibilidade de Lucros Oriundos do Exterior. Revista Fórum de Direito Tributário, Vol. 2 mar./abr. 2003. p. 49 a 74.

SILVA FILHO, Antonio Rodrigues da; CATÃO, Marcos Sodré Vinhas. Harmonização Tributária no Mercosul. São Paulo; Aduaneiras, 2001. TANZI, Vito. Globalization, Tax Competition by Future of Tax Systems. In: UCKMAR, Victor. (Coord.). Diritto Tributario Internazioale. 3a ed. Padova: Cedam, 2005, p. 25-45. STUBER, Walter Douglas. Isenção Tributária – Novas regras em benefício dos investidores estrangeiros. Revista Jurídia Consulex, Brasília, n. 220, março/2006, p. 32-33. VALADÃO, Marcos Aurélio Pereira. Limitações Constitucionais ao Poder de Tributar e Tratados Internacionais. Belo Horizonte: Del Rey, 2000. _______. Intervenção no domínio econômico e tributação – extrafiscalidade – aspectos. In: João Luis Fischer Dias, et al. Estudos de Direito Público: homenagem aos 25 anos de Mestrado em Direito da UnB, Brasília: Brasília Jurídica, 2000, p. 223-248. _______. Evolução da discriminação das rendas tributárias no constitucionalismo brasileiro: aspectos históricos e conceituais. Direito Em Ação, Brasília - DF, v. 1, n. 1, 2000, p. 57-87. _______. Comentários sobre as Alterações Tributárias à Constituição Brasileira de 1988. Ciência e Técnica Fiscal, Lisboa, 2004, n. 413, p. 7-133. ________. Pode o Soft Law ser considerado fonte do Direito Internacional Tributário?. Revista de Direito Internacional Econômico e Tributário, v. 2- N.1, p. 13-47, 2007. UCKMAR, Victor. Aspeti Iscali Nelle regole Della Organizzazione Mondiale del Commercio OMC/ WTO). In:_______. (Coord.). Diritto Tributario Internazioale. 3a ed. Padova: Cedam, 2005, p. 1069-1096. _

Idem.

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2.2. Brazilian Tax System: History,

Perspectives and Critical Analysis Maurício Muriack de Fernandes e Peixoto*

CONTENTS 1. The Brazilian Tax System: Conceptual Presentation 2. A Brief Historical Analysis of the Brazilian Tax System 3. A Brief Analysis of the Brazilian Tax System in the Constitution of 1988 and Its Acquired Physiognomy, Even After the Constitutional Amendments Which Altered It 4. The Current Brazilian Tax System: A Brief Critical Analysis: The Decalogue of Ten Disadvantages of the Brazilian Tax Order and the Need to Improve Them 5. Conclusions 6. References

1. The Brazilian Tax System: Conceptual Presentation

Initially, before the meaning of the expression “Brazilian tax system” is defined, it is urgent to learn and acknowledge the meaning of the word “system”. Accordingly, Professor Faissal Yunes Junior warns that “the word ‘system’ has been widely used and assumed in legal language. It has different meanings, becoming a multivocal word with several meanings; thus, the interpreter can choose the meaning best suits. In fact, we can easily find in the legal system the term “system” with different meanings, which actually turns it into an ambiguous, vague word, either in Law or in the science of Law.1 Therefore, although it is acknowledged that the doctrinal concept of the word “system” is multi modal and can involve several subtle different significances from each other, a legal-positivist bias shall be approached with a semantic focus on the word “system”. System, then, is an organized set of standard-rules and standard-principles on legislative procedures. Human and the State conduct are based on an organized doctrinal, authentic and judicial interpretation of the application of law. Accordingly, within this parameter, one may say that the concept of tax system is related to a set of principles and standards, especially constitutional, which rule, organize, limit and enable the granting and use, legally conditioned, of power to tax

* Attorney the Union (special category), Professor of Financial Law, Constitutional Law and Tax Law of the Course of Law at Catholic University of Brasília. MA in Public Law and Constitutional Order from Federal University of Ceará (UFC), Researcher of UCB’s project on the BRIC’s. 1

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NUNES, Faissal Junior, Sistema Constitucional Tributário, Revista de Direito Constitucional. Editora Fórum, No. 25, p. 165.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

through according to the legal order by the imposition of constitutional limitations to the taxing power, and through the procedural rules regarding taxation. Tax system, therefore, is the States’ logical-legal organization of the power to tax. Taxing power, in turn, can be considered as a segment of sovereignty, which is revealed as a cover to charge individuals, a superior will, ex lege obligation, and leads to the establishment of legal-tax relationships. Such taxing power makes it mandatory to pay taxes to the State; the Constitution is a means to define and limit it, that is, to set the limits of taxing power, which spreads among political entities, endowed with legislative powers. Taxing power, set and limited, becomes similar to tax competency, which is presented in a more specific way as taxing powers shared by the Union, its States, the Federal District, and the Municipalities. Eventually, they would merely regulate the corporate taxes on their areas of competence.2 Therefore, the national tax system is a legally organized conformation of the taxing power prerogatives and limits , characterized by logical system, which is a preestablished organization. It is a preset political and regulatory structure with a rationally developed structure and political, economic, social and legal goals perfectly identifiable and mutually compatible.3Different from a chaotic jumble of tax rules, tax system is a pre-established legal planning. Different from randomness rules, a system is the result of a legally established, rationally conceived plan, with a configured ,coherent structure. However, not any “normative plexus” can be inferred as a “tax system”, and not any “set of rules” must be considered a “good, efficient” tax system. Indeed, some aspects may help to analyze and to identify tax systems of good stock.4 The tax system should be totally efficient, showing minimum cost and high collection rates. Levy is sufficient to meet structural and conjectural public needs. An efficient system, therefore, shall collect reasonable, moderate income, enough for the financial

2

“The allocation of taxing powers characterizes the principle of tax competence. It is exercised ordinarily by law. Tax competence means, in HENSEL’s lesson, the right to exercise the powers of taxation, the material point of view on a particular sector. Thus, the constitutional distribution of tax power - formal and material delimitation of taxing power - links the creation of legal rules of taxation. (...) The tax competence is therefore a constitutional limitation and authorization for the exercise of taxing powers. Although it is an emanation of taxing power, it is not to be confused with it. The concepts of taxing power and tax competence do not match”(BORGES, José Souto Maior. Isenções Tributárias. 2ª ed. São Paulo, Sugestões Literárias, 1980, pp. 18/19).

3

For Owaldo Othon de Pontes Saraiva Filho, “Tax System can be defined in two ways: as a set of broken, exigible taxes on a certain country and at certain times, such as taxes and contributions, or as a set of principles and legal rules governing taxes and the legal relationship of taxation in a certain place and at one time” (in O conjunto de diplomas legais e de tributos que compõe o sistema tributário brasileiro, artigo publicado Biblioteca Digital Revista Fórum de Direito Tributário - RFDT, Belo Horizonte, ano 4, n. 23, set. 2006).

4

According to Aliomar Baleeiro, “The tax system should be productive, flexible, and consistent with a country’s national income and their ideas of justice. There should be a national responsibility to the broader base of taxes (income, consumption, customs). It is appropriate to avoid double taxation, so that the same tax will not charge the same person and eventually,, simultaneously by the Union and its States and Municipalities. It shall protect the commerce against discrimination” (Baleeiro, Aliomar. Uma introdução à Ciência das Finanças. 16ª Edição. Rio de Janeiro, 2006). Later, the author recalls the basic ideas of Adam Smith from his famous formulation about the four principles or “canons” for taxation, namely: fairness, certainty, convenience, and economy (Id., p. 234). “Fairness” would be the equal distribution of tax burden, according to the economic situation of each individual taxpayer; “certainty” would be the State’s good faith , providng the contributors with the knowledge of value and a deadline to pay taxes, through non-surprise in changes of tax legislation; “convenience” would be the obligation of the State to require the payment of taxes through the less bureaucratic and unnecessarily lengthy means; “economy”, correlative of the latter principle, means that the State should always provide the most efficient,reasonable means of tax collection, an activity that should be the cheapest.

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performance of the State, without unreasonable limits to economic activities of the nonstate sector, and without excessive fiscal voracity. Also, a tax system should encourage and facilitate economic and social development, i.e., not only to promote national economic growth , but also to induce, by fiscal or extra fiscal mechanisms,5 asocially fair environment, where the least for human dignity and survival is guaranteed. Therefore, generality, uniformity, and dynamic mechanisms shall be applied to generate equity and taxing justice. On the other hand, a consistent tax system should also promote a regulatory environment of legal certainty; it should also maintain a regulatory framework that enables individuals, corporations and investors to plan their economic activities. To do so, the delimitation of taxing powers grants and the enumeration of state fiscal prerogatives must be assertive and clear, in order to ensure the taxpayer formal and material prerrogatives – the constitutional limitations to the taxing power, as Aliomar Baleeiro6 superbly stated. Still, a regular, reasonable isonomic practice of power to collect and control taxes should be available. Finally, a stable political pact should be made to prevent or solve latent political, economic or social conflicts, which would otherwise dilapidate the tax mark, especially with their loss of social effectiveness. Baleeiro points the following requirements as necessary for good taxing systems: a) productivity; b) elasticity; c) compatibility with the economic structure and development encouragement; d) compliance with the moral ideas of the people; e) simplicity; f) elimination of regressiveness; g) suppression and solution for double or multi taxation. The “tax system” is an intellectual, rationally organized work, and, as such, it is an organic system with goals, methods and reasons for existence. Meanwhile, the Brazilian tax system is a logical-legal construction of a legal, constitutional framework that regulates Brazilian State’s taxing power.

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5

Still, on the main and more common extra fiscal scopes, there is a valuable lesson from master José Souto Maior Borges (In “Introdução ao Direito Financeiro”, Editora Max Limonada, 2ª edição, 1998, São Paulo, pg. 57), in verbis: Among the objectives collimated by the extra fiscal approach, some may be cited as examples: a) to combat depression, inflation, and unemployment; b) to protect domestic production (e.g., industrial stimulus through exemptions to new industries, protective tariffs, etc.); c) absorption of saving and restoring the propensity to consumption; d) fragmented taxation of unproductive landholdings by strongly progressive rural land tax and taxation on the operation of games of chance; e) incentives for urbanization by the taxation of waste land and fallow fields; f) strongly progressive general tax on large fortunes, revenues and heritages (political leveling and redistribution); g) sumptuary taxes of luxury repression; h) to combat celibacy by imposition, establishment of exemptions in favor of prolific families and increase of tax on childless couples. Having made such propaedeutic observation, and considering that to conceptualize means to explain positively a given object in order to distinguish it from others, it can be stated that the extra fiscal is the extra collection function of taxes serving as a means to achieve directly, in the field of public revenue, the fundamental goals of the State, such as the promotion of social welfare, the redistribution of incomes, the balance of payments, the composition of domestic prices and the short, medium, and long term planning of crop plantation in order to regulate the market, optimizing the national economic activity, aiming at meeting the interestsof the community.

6

Baleeiro, Aliomar. Limitações Constitucionais ao poder de tributar. Rio de Janeiro: Forense, 1998.

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In this article ,the particular, peculiar aspects of the Brazilian system will be studied within a historical ,critical perspective, in order to discover which current trends and demands are required by the State and Society.

2. A Brief Historical Analysis of the Brazilian Tax System

First, it is necessary to mention that taxation has occurred in Brazil since its colonial period, including taxation on the Brazilwood, spices and fish, as well as gold, silver and gemstone mining sites, which eventually led to a fiscal practice of the spill, which led to mining conspiracy and tithes of crops and trade with foreign countries. That could only be performed through the intermediation of the Portuguese Metropolis.

Still, the colonial period, according to Aliomar Baleeiro, was marked by “strong Municipalities that had already exercised the power to tax with greater force than the their monarchs, originally confined to the domain and privilege income. The Portuguese crown often resorted to the good trade of the Municipal Council from Brazil to be create taxes for common interests with the metropolis, or only for it.” 7He finally lists cases in which local taxing jurisdiction was used by the King’s direct intervention not to meet nonlocal needs, but the Crown’s. Some examples are the payment of wages of the troops that fought the Dutch in the 17th Century; Infanta Catherine’s dowry, the future Queen of England; and the reconstruction of Lisbon, devastated by an earthquake in 1755. Finally, during the colonial period, municipal taxation and tax centralization by the Metropolis were mutually levied. Later, with the arrival of the Royal Court in Brazil in 1808, Brazilian ports were opened to friendly nations (especially the British Empire). Also, imported good and stamps were taxed (taxation on stamps was only abolished in the 20th Century)and low rates were applied in taxes on urban real estate in the capital of Brazil at that time, Rio de Janeiro. In 1822, the Empire regime was adopted as the result of Brazil’s independence. Due to the adoption of an unitary form of State, there was great centralization of taxing power, focusing on the taxation already existent at the time. there was no register, in constitutional diction until then granted, of any news of literal expression greater than the existence of “contributions and national incomes” to be administered by the Federal Government8. 7

Idem, p. 36.

8

It is a good idea to transcribe the following provisions of the Constitution of 1824: Art. 36 It is the Chamber of Deputies’s Initiative. I. Taxes. (...) Art. 170. Federal Revenue and expenditures of the National Treasury will be entrusted to a Court, under the name of the “National Treasury”. Their administration, collection and accounting will be regulated by the Court in reciprocal correspondence with the Treasury and Authorities of the Provinces of the Empire. Art. 171. All direct taxes, except those applied for interest and amortization of the public debt, will be established annually by the General Assembly, but will continue until the publication of their derogation or their replacement by others. Art. 172. The Minister of Finance, having received the budgets of other Ministers concerning the departments’ expenses , shall annually present in the Chamber of Deputies, once it is assembled, an overall balance of receipts and expenditures from the National Treasury of the previous year, and also the general budget for all future public expenditures of the year, and the figures of all

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For obvious reasons, nothing on this matter was mentioned in the Imperial Constitution, not even the existence of such tax system, so the analysis of its organization and effectiveness was impossible. On the contrary, the absence of a constitutional paradigm for extravagant taxation resulted in a coexistence between central taxing power and the provincial taxing power, with a tax superposition between government and the provinces, which Baleeiro properly called a “chaotic phase of national finances.”9 The first Republic constituent, in 1891, aimed at defining taxing powers for the Union and its States in order to avoid double taxation. These tax rules, regulated in Articles 7, usque 1210 of the Constitution of 1891, although they cannot be called a “logical and systemic” plexus, there was a first draft of the tax system. Some of the arrangements can be considered wrong, as they grant the States the authority to levy the tax on exports concomitantly with the Union, which prevented the formulation of a uniform custom policy in the period. That scenario remained until the Amendment No. 18/65 to the Constitution of 1946. However, it was the first attempt to apply a strict tax power division.

contributions and public pensions. 9

Baleeiro, Aliomar. Uma introdução à Ciência das Finanças. 16ª Edição. Rio de Janeiro, 2006, p. 236.

10

It is a good idea to transcribe the aforementioned precepts of the Constitution of 1891: Art 7º - It is the sole responsibility of the Union to grant: 1 º ) taxes on the import of foreign origin; 2 º ) rights of entry, stay and departure of ships, with free coasting trade to domestic goods, as well as foreign goods whose taxes on imports are already been paid; 3 º ) stamp fees, unless the restriction of art. 9, § 1, section I; 4 º ) charges of mail and federal telegraph. § 1º - Also, it is the sole responsibility of the Union: 1 º ) the institution of issuing banks; 2º) the creation and maintenance of customs. § 2º - Taxes enacted by the Union should be uniform for all states. § 3º - The laws of the Union, the acts and statements of its officials will be implemented throughout the country by federal officials, having, however, the implementation of the first of them being assigned to the Governments of the States, upon their consent. Art 8º - It is prohibited to the Federal Government to make, in all cases, distinction and preferences in favor of the ports of one State against other States. Art 9º - It is the sole responsibility of the States to enact taxes: 1 º ) on the export of goods of its own production; 2 º ) on rural and urban real state; 3 º ) on the transfer of property; 4 º ) on industries and occupations. § 1º - Also, it is the sole responsibility of the States to enact: 1 º ) rates of seals on the acts emanating from their respective governments and businesses of their economy; 2 º ) contributions pertaining to their post and telegraphs. § 2º - It is exempt from taxes, in the State where it is exported, the production of other States. § 3º - A state is only allowed to tax imports of foreign goods when destined for consumption in its territory, reversing, however, the tax revenue to the federal treasury. § 4º - The states have the right to establish telegraph lines among the various points of its territories, among these points and other states’ points, which do not have federal lines, having the Union the right of evict them when is of the public interest. Art 10 - It is prohibited to the States to tax federal goods and income or services of responsibility of the Union, and vice versa. Art 11 - It is prohibited to the States, as to the Union: 1 º ) to create taxes for transit through the territory of a State, or when crossing from one to another, on products from other State of the Republic or foreigners, as well as on land and water vehicles that carry them; 2 º ) to establish, to subsidize or to embarrass the exercise of religious cults; 3 º ) to prescribe retroactive laws. Art. 12 - In addition to the sources of revenue described in Arts. 7 and 9, it is allowed to the Union and the States, together or not, to create others sources, in accordance with the provisions of Articles 7, 9 and 11, No. 1.

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However, Baleeiro states that the Union, using a residual taxing power in the Article 12 of the 1891 Constitution , incorporated gradually into the budget taxes on consumption, income, sales and consignments in such a way that “the Revolution of 1930 came to meet the Union’s peaceful possession of more than 60% of tax collection”11 although the original design of 1891 had the objective to privilege the State tax autonomy. Thus, taking into account a lack of systematic tax rules of the Constitution of 1891, the centralization of tax collection occurred gradually, reinforced by the fact that Municipalities did not have to tax autonomy in that period, in contrast to the autonomous tradition since the colonial period. This characteristic of tax centralization became stronger after the Constitution of 1891 until the Constitution of 1934, which imposed new taxing powers for the Union, States and Municipalities.12 11

Baleeiro, Aliomar. Uma introdução à Ciência das Finanças. 16ª Edição. Rio de Janeiro, 2006, p. 236.

12

Here are the rules of the Constitution of 1934 on the tax competences: Art 6º - It is sole responsibility of the Union: I –to enact taxes: a) on imported goods of foreign origin; b) of consumption of any goods, except engine fuels ; c) of income and earnings of any nature, except for the net income of properties; d) of transfer of funds to other countries; e) on actions emanating from the government, domestic businesses, and tools for contracts or acts regulated by federal law; f) also in the territories, the Constitution assigns to the States; II –to charge telegraphic, postal and other federal services fees; taxes of entry, exit and stay of ships and aircraft, being free the ship trade of national goods and foreign goods which have already been paid import tax. (...) Art 8º - It is also responsibility of the States: I –to enact taxes on: a) land ownership, except urban; b) transfer of property by death; c) transfer of real property inter vivos, including its incorporation into the society’s capital; d) engine fuel for consumption ; e) sales and assignments made by traders and producers, including manufacturers, leaving free the first operation of the small producer, as defined in state law; f) export of domestic goods to a maximum of ten per cent ad valorem, prohibited any further; g) industries and occupations; h) acts emanating from local government and businesses or regulated by the state law; II - charge fees for state services. § 1º - Sales tax will be uniform, without distinction of origin, destination, or type of products. § 2º - The tax of industries and occupations will be released by the State and collected by it and the Municipality in equal parts. § 3º - In exceptional circumstances, the Senate may authorize, for a specified time, the increase in export tax, beyond the limit set in the letter F of number I. § 4º - The tax on transfer of tangible goods is responsibility of the State in the territory these taxes are located, and the transfer by death of intangible assets, including titles and credits, to the State where one may opened the succession. When it is opened abroad, the tax charged will be due to the State in whose territory the heritage values are liquidated or transferred to heirs. Art 9º - It provided the Union and the States to conclude agreements for better coordination and development of their services, and especially for the standardization of laws, rules or practices, tax collection, prevention and prosecution of crime and information exchange. Art 10 It is the responsibility of the Union and the States: (...) VII - to create other taxes, apart from those assigned to them privately. Sole paragraph - The collection of the taxes referred to in section VII shall be made by States, which will deliver, within the first quarter of next year, thirty percent to the Union, and twenty percent to the Municipalities where they are collected. If the State misses the payment of due revenues to the Union or to the municipalities, collection will be made by the Federal Government, which will, in this case, assign thirty percent to the State and twenty percent to the Municipalities. Art 11 - Double taxation is forbidden, prevailing tax enacted by the Union where the jurisdiction is concurrent. Without any harm to judicial resource used, it is responsibility of the Senate, ex officio or upon the initiative of any taxpayer, to declare the existence of double taxation and determine which of the two taxes prevails. Art 13 - Municipalities will be organized so that their autonomy is ensured in all matters concerning their peculiar interests, and

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This type of tax norm may be considered as the first more solid attempt to effectively avoid double taxation or multi taxation and to establish the typical strictness of good tax systems. This same concern can be found in the Brazilian subsequent Constitutions (1937, 1946, 1967 and 1988). However, this set of rules of the 1934 Constitution can be criticized on three most relevant aspects: 1) The possibility of double taxation was not abolished, since, in the Article10, Section VII, it is expressly provided the residual tax jurisdiction competing between the Union and States, which led to the possibility of tax conflicts that would be accepted and “refereed” by the Senate, in accordance with the Article 11, which plainly showed that the system was not exactly a masterpiece of strict division of tax responsibilities; 2) The most significant concern was simply to grant taxing powers to the Union, States and Municipalities, bypassing formal or material constitutional limitations so that one cannot understand this plexus as a modern tax system, minimally complete; 3) The odd division of the Union taxing power to tax imports and of the States to tax exports was kept, preventing a uniform, systemic custom policy; Such characteristics of the 1934 constitutional rules can also be found in synoptic rules of the 1937Constitution , in which only minor tax arrangements were made in the tax system conception engendered only three years before, as well as the extinction of the municipal tax on income of rural properties and the transfer of jurisdiction over the tax on the fuel consumption of engines. In 1934, it was the States’, , but in 1937, it became a tax of the Union. Obviously, such arrangement, apparently strict, can be analyzed under the same prism of the 1934Constitution : many concerns in granting tax powers and virtually no conception of constitutional mechanisms to limit taxing power, revealing the incipient significance , of the tax system.13 Moreover, it did not adequately solve the residual tax competition between the Union and the States. especially: (...) II - the enactment of their taxes, the collection and use of their incomes; (...) § 2º - In addition to those that participate, ex vi of arts. 8, § 2, and 10, sole paragraph, and of those that were transferred by the State, belong to the Municipalities: I – tax on licenses; II - taxes and urban land, first charged in the form of tenth or net income; III - tax on public entertainment; IV - tax on the income of rural properties; V - fees on municipal services. § 3º - It is optional for the State to create a body of technical assistance to municipal administration and oversight of its finances. § 4º - It is also allowed the interference in the Municipalities in order to make them regulate their finances, where there is no punctuality in loan services guaranteed by States or by the failure to pay its debt for two consecutive years, observed, in that they are applicable, the rules of the Art. 12. 13

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Here are the tax rules of the Constitution of 1937: Art 20 - It is the sole responsibility of the Union: I –to enact taxes: a) on the import of foreign goods; b) on the consumption of any goods; c) on income and earnings of any nature;

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

Furthermore, under the aegis of the 1937Constitution , there was the “nominal” federalism phenomenon because the strict tax granting hid a remarkable political and constitutional fact: the possible federal intervention in the State and local governments, creating a controversial political centralization with clear repercussions on state tax policies. However, with the end of the Vargas dictatorship period and with the promulgation of the a Constitution in1946, a new age in politics and in the Brazilian state fiscalism will come.14 d) on transfer of funds to other countries; e) on actions emanating from the Government, businesses and instruments or contracts governed by federal law; f) also in the territories, the Constitution assigns to the States; II - charge telegraphic, postal and other federal services fees; taxes of entry, exit and stay of ships and aircraft, being free the ship trade of national goods and foreign goods which have already been paid import tax. Art 23 - It is the sole responsibility of the States: I - the enactment of taxes on: a) land property, except the urban ones; b) transfer of property by death; c) transfer of property inter vivos, including its incorporation into the capital of the society; d) sales and assignments made by traders and producers, including manufacturers, leaving free the first operation of the small producer, as defined in state law; e) export of goods of its production to a maximum of ten per cent ad valorem, prohibited any further; f) industries and occupations; g) acts emanating from its government and businesses of its economy or regulated by the state law; II - charge fees for state services. § 1º - Sales tax will be uniform, without distinction of origin, destination or type of products. § 2º The tax of industries and occupations will be released by the State and collected by the State and the Municipality in equal parts. § 3º - In exceptional circumstances, the Senate may authorize, for a specified time, the increase in export tax, beyond the limit set in item F of I. § 4º - Regarding the tax on transfer of tangible goods, it is the responsibility of the State in where these taxes are located, and the transfer by death of intangible assets, including titles and credits, to the State where one may open the succession. When it is opened abroad, the open tax charged will be due to the State where heritage values are liquidated or transferred to heirs. Art 24 - States may create other taxes. Double taxation Is forbidden, however, prevailing tax forbidden tax by the Union, where the jurisdiction is concurrent. It is the responsibility of the Federal Council, on its own initiative or on behalf of the taxpayer, to declare the existence of double taxation, suspending the collection of the state tax. Art 28 - In addition to the assigned in Articles 23 § 2 of this Constitution and of those which were transferred by the State, belong to the Municipalities: I - tax on licenses; II - tax on property and on urban territory; III - tax on public entertainment; IV - tax on municipal services. 14

Here are the constitutional tax rules of 1946: Art 15 - The Union shall have the power to institute taxes on: I - imports of goods of foreign origin; II - goods consumption; III - production, trade, distribution and consumption, as well as import and export of lubricants and liquid or gas fuels from any source or nature, extending this scheme, as applicable, to the country’s minerals and electricity; IV - income and earnings of any nature; V - transfer of funds to other countries; VI - business, actions and instruments governed by federal law. § 1º - It is exempted from consumption tax items that are classified by the law as the minimum indispensable for housing, clothing, food and medical treatment of people of limited economic capacity. § 2º - The taxation reported on Section III shall take the form of flat tax, which would focus on each kind of product. The resulting income, at least sixty per cent, will be delivered to the States, the Federal District and to the Municipalities in proportion to their size, population, consumption and production, according to and for the purposes set forth in federal law. § 3º - The Union may tax income from public debits of States or Municipalities and from the earnings of the agents of States and Municipalities, but may not do so within limits above those established for their own obligations and for the proceeds from its own staff. § 4º - The Union shall give to the Municipalities, excluding those of the Capitals, ten percent of the total tax levied according to the tax referred to on section IV, equally distributing it and applying at least half of the amount in benefits for rural purposes. § 5º - It is not included in the provisions of section VI the legal acts or their instruments when the parties are the Union, States or

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Initially, there is a tendency to strictly divide the constitutional and tax allocation of the Union, States and Municipalities. This division was not merely nominal, as in 1937, since it ratified the political autonomy of States and Municipalities. However, the first steps to limit taxing power are guaranteed, rights of taxpayers against the tax legislator, such as: a)

the provision of the Article 15, Section III, of the CF/46, combined with its second paragraph, regulates the single tax on production, trade, distribution and consumption, making it difficult the double taxation or multi taxation; the establishment of tax immunity of the “basic living standards” necessary for a person of limited economic resources to survive, when it comes to housing,

Municipalities, or when it is included in the tax competence regulated in the Articles 19 and 29. § 6º - In the imminence, or in the case of foreign war, the Union shall be provided with the enactment of extraordinary taxes, which will not be shared in the form of Article 21 and which will gradually be eliminated within five years from the date the peace treaty is signed. Art 16 - It is also a responsibility of the Union to enact the taxes provided in the Article 19, which must be charged by the national territories. Art 17 - The Union is prohibited to enact taxes that are not uniform throughout the national territory or that imply a distinction or preference for any particular port, rather than any other State. Art 19 - It is a responsibility of the States to enact taxes on: I - land ownership, except for urban; II - transfer of property by death; III - transfer of real property inter vivos, including its incorporation into the society’s capital; IV - sales and assignments made by traders and producers, including manufacturers, leaving free the first operation of the small producer, as defined in state law; V - export of goods from their production to other countries, to a maximum of five per cent ad valorem, prohibited any further; VI - acts governed by state law, those of the service of its Justice and the business. § 1º - The territorial tax is not applicable to sites smaller than twenty acres, when cultivated alone or within a family, by the owner who has no other property. § 2º - Taxes on the transfer of tangible goods (Sections II and III) are for the State in the territory they are situated. § 3º - The tax on transfer of intangibles by death, including titles and credits, belongs to the State in whose territory the heritage values are liquidated or transferred to heirs, , even if the succession has been required abroad,. § 4º - States shall not tax government bonds issued by other legal entities of internal public law, in upper limit established for its own obligations. § 5º - Tax on sales and assignments will be uniform, without distinction of origin or destination. § 6º - In exceptional circumstances, the Senate may authorize the increase, for some time, of export tax to a maximum of ten per cent ad valorem. Art 20 - When the collection of state taxes (except export taxes) exceeds, the total local revenues of any kind in a city other than the Capital, the State shall annually give thirty percent over the collected amount. Art 21 - The Union and the States shall enact other taxes than those assigned by this Constitution, but the federal tax will exclude the same tax state. The States will make the collection of such taxes, and as taxes are effective, they will deliver twenty percent of the product to the Union and forty percent to the Municipalities where the collection was held. Art 22 - The financial management, especially the budget execution, will be monitored in the Union by the Congress, with the assistance of an Audit Court, and in the States and Municipalities according to the established in the state constitutions. Art 27 - It is forbidden for the Union, the States, the Federal District and the Municipalities to establish limitations to the interstate or intermunicipal traffic of any nature through taxes, except for the collection of fees, including tolls, dedicated exclusively to compensation for the costs of construction, maintenance, and improvement of roads. Art 29 - Besides the income that is attributed to them by virtue of §§ 2 and 4.11 of the Article 15, and the taxes, in whole or in part, that are transferred to them by the State, the Municipalities shall be benefited with the taxes: I - of territory and urban building,; II – of the license; III – of industries and occupations; IV – on public entertainment; V - on economic acts or matters within its competence. Art 30 - It is a responsibility of the Union, the States, the Federal District and Municipalities to tax: I - contributions for improvements, where there is an appreciation of the property as a result of public works; II - rates; III - any other income which may arise from the exercise of their powers and use of their goods and services. Sole paragraph - The improvement fees may not be required in the limits superior to the expenditure incurred, neither to the addition of value from the work to the benefited property.

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clothing, food and medical treatment, expressed in the Article 15, §1, of the 1946 Constitution; b) a constitutional prohibition on differentiated tax treatment, by the Union, in relation to income from public debit of State or Municipalities and the earnings of the agents of states and municipalities, since the tax could not be higher than the similar taxation in the sphere of federal income securities or taxation of income from federal server (Article 15, §3, of the 1946Constitution); there was also explicit extension of the same prohibition to the States (see Article 19, §4, of the 1946Constitution); kabbalistic term of five years after peace treaty is signed in order to suppress any extraordinary taxes of war (see the Article 15, §6 of the 1946 Constitution); c) the seal of the Union to levy taxes that are not uniform throughout Brazil, as well as to establish differential tax treatment before the origin or destination of goods, which could lead to a discriminatory tax among Brazilian States and Municipalities and their respective citizens (see the Article 17 of the 1946Constitution; he prohibition of taxation by States through the rural land tax, on small rural areas up to twenty hectares, when operated under household economy (see the Article 19, § 1, of the 1946 Constitution); d) the determination of uniformity of the state tax on sales or assignments, without distinction of origin or destination (see the Article 19, §5 of the 1946 Constitution); e) the determination that the financial administration, particularly the implementation of the budget, would be reviewed by the Congress, with the assistance of the Court, pursuant to the Article 22 of the 1946 Constitution - guarantee that could be required in the implementation of fiscal policy, something good for the taxpayer; f) the prohibition of double taxation through the imposition of new taxes by the Union and States, being automatically excluded the tax state when a similar one is created by the Union (see the Article 21 of the 1946 Constitution); g) the prohibition of taxing the traffic of people and property, except for charging fees, including tolls, exclusively dedicated to indemnification for the costs of construction, maintenance, and improvement of roads(see the Article 27 of the1946 Constitution); h) the establishment of individual and collective limits to the collection of the improvement fees (see the Article 30, sole paragraph, of the 1946 Constitution). In addition to these major innovations with respect to legal and constitutional limits to tax practices, it is mentioned that the 1946 Constitution can be praised, still, for the following initiatives: the creation of the contribution on improvement of immovable property and of the fees (in general to be considered as “tax”), with could be levied (competitive jurisdiction) by the Union, States and, Municipalities (see the Article 30 of the 1946 Constitution), something which imposed plurality of tax types, and also the regulation of constitutional tax transfers between federal entities, obeying the principle of necessity of fiscal cooperation (see the Articles 15, §§ 2 and 4, 20 and 21 of the 1946 Constitution ).

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Undoubtedly, given its complexity and systemic nature, while still pending major improvements, the 1946 Constitution started in Brazil the age of modern tax systems, marked by a strict division of tax powers, by the sedimentation of constitutional limitations to the taxing power, by the plurality of tax types, associated or not to state activities, and by the existence of a fiscal cooperative federalism between the federal entities. These essential features will not be modified in its ontological core, in the future, either by the tax reform provided by the Constitutional Amendment No. 18/65 or by the Constitution of 1967 and its Amendment No. 01, or by the Constitution of 1988. However, such posterior constitutional texts would increasingly deepen, sharpen and perfect these four fundamental systemic axes. it must be acknowledged that the constitutional text of 1988 represents another level of the tax system, due to its complexity, unpublished until its enactment. Therefore, the historical study of the modern Brazilian tax system inaugurated by the 1946Constitution must be deeply studied, for it represented the respective impacts of the CF 18/65 of the 1967 Constitution and the Amendment No. 01/69, for the complete knowledge of their own organic system inaugurated by the 1988 Constitution. Initially, the Constitutional Amendment No. 18/65 is the first literal constitutional document to use the term “constitutional tax system,” as if to designate that henceforth there would be a document provided an organized according to the tax system of norms and complementary principles in order to form an organic whole. Not that this feature did not exist in the original Constitutional Order of 1946 because, as it was seen, in fact, it had already existed in the original rules, and initially promulgated, an evident concern in establishing strict separation of the taxing powers, in enumerating new tax types, in establishing material and formal limitations to the taxing power and, finally, in presenting a set of incipient mandatory constitutional transfers. all considered, it seems an exaggeration the statement given by professor Leon Frejda Szklarowsky that the Brazilian tax system was created only with the Constitutional Amendment No. 18/65; in literis: The current Brazilian tax system was created with the Constitutional Amendment No. 18 on December 1, 1965, inasmuch as the previous system sinned by lack of harmony between the various trends, aspirations and needs of various political and constitutional entities (9). According to Bernardo Ribeiro de Moraes, the 1967 onstitution structured the taxing power with the discrimination of tax revenues, marked with great accuracy the limit of this power granted to the entities. It eventually imposed the individual guarantees which support the same taxing power15. Finally, it might be inaccurate to state that the current systematization of the Brazilian constitutional tax law was born only with the amendment,16 though there has been

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15

Szklarowsky, Leon Fredja. A reforma tributária para um novo século. Jus Navigandi, Teresina, ano 7, No. 65, maio 2003. Availableat: . Access on June 7, 2010.

16

Here is the text of the main articles of the Constitutional Amendment No. 18/65: Art. 1st The national tax system consists of taxes and special contributions, and is regulated by the provisions of this Amendment in complementary laws, in resolutions of the Senate, and in the limits of the respective competences, in federal, state or municipal laws. Art. 2ndThe Union, the States, the Federal District and the Municipalities are prohibited:

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

I - to establish or to increase tax without the imposition of the law, except for the cases provided in this Amendment; II - to charge tax on property and income, based on law posterior to the starting date of the financial year that it corresponds to; III - to establish limitations on the traffic within the national territory of persons or goods by means of interstate or intermunicipal taxes; IV –to tax: a) equity, income or services from each other; b) temples of any cult; c) equity, income or services of political parties and of institutions of education or social assistance, subject to the requirements defined in a supplementary law; d) the paper used exclusively to the printing of newspapers, periodicals and books. § 1st The provision in Subsection A of Section IV shall extend to the Municipalities, solely in relation to property, income or services connected to their essential purpose, or arising from it. § 2nd The provisions in the item A of Section IV shall not be extended to public services whose tax treatment is established by the grantor with respect to taxes under its jurisdiction, except in the federal public services granted, whose general exemption from tax may be imposed by the Union, through special legislation and in view of the common interest. Art. 3rd It is forbidden: I - for the Union to institute taxes that are not uniform throughout the national territory, or which gives distinction or preference in favor of a particular State or Municipality; II - for the States, the Federal District and the Municipalities to regulate a tax difference between goods of any nature by virtue of its origin or destination. Art. 4th Only for the Union, in exceptional cases defined by a supplementary law, to establish compulsory loans. CHAPTER II Taxation SECTION I General Provisions Art. 5º The taxes composing the national tax system are exclusively those in this Amendment, with the competences and limitations contained therein. Art. 6º Compete: I - to the Federal District and States not divided into Municipalities, cumulatively, the taxes assigned to States and Municipalities; II - to the Union, in federal territories, the taxes assigned to the States, and if those are not divided into Municipalities, cumulatively allocated to these. SECTION II Taxes on Foreign Trade Art. 7º It is responsibility of the Union: I - the tax on imports of foreign products; II - the tax on exports to other countries of national or nationalized products. § 1º The Executive Branch shall, subject to conditions and limits set by law, alter the rates or the bases for calculating the taxes referred to in this article in order to adjust them to the objectives of exchange rate policy and foreign trade. § 2º Net income of the tax referred to in Section II of this article is intended for the formation of currency reserves, according to the law. SECTION III Taxes on equity and income Art. 8º It is responsibility of the Union: I - the tax on rural property; II - the tax on income and earnings of any nature. Art. 9º It is responsibility of the states to tax the transmission of any type of real estate by nature or by physical transfer, as defined by law, and of rights on real property, except guarantee rights. § 1º The tax is imposed on the assignment of rights for the purchase of goods specified in this article. § 2º The tax is not imposed on transfer of property or rights mentioned in this article, to its incorporation into the capital of corporations, except for those whose main activity, as defined in a supplementary law, is the sale or lease of real property or the assignment of rights relating to its acquisition. § 3º The tax is a responsibility of the state of the situation of the property on which there is the transfer of assets, even if this results from the succession opened abroad. § 4º The tax rate will not exceed the limits set by resolution of the Senate, pursuant to a supplementary law, and the amount due will be deducted from the Union, under the tax pursuant to Article 8, No. II, about earning due to the same transmission. Art. 10. It is responsibility of the municipalities the tax on the urban and land priority. SECTION IV Taxes on Production and Circulation Art. 11. The Union shall have the power to institute taxes on industrialized products. Sole Paragraph. The tax is selective based on the essentiality of products, and non-cumulative, deducting, in each operation, the amount collected in the previous one. Art. 12. It is responsibility of the States to tax transactions related to the movement of goods held by traders, manufacturers and producers. § 1º The tax rate is uniform for all goods, not exceeding, in operations that destined them to another State, the limit established in resolution of the Senate, pursuant to a supplementary law. § 2º The tax is non-cumulative, deducting, in each operation, pursuant to a supplementary law, the amount collected in the past, by

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the same or another State, and it will not focus on the retail sale, directly to consumers, the staples, defined as such by act of the State Executive Branch. Art. 13. It is responsibility of the Municipalities to collect the taxes specified in the article based on state law relating to it, and by rate not exceeding 30% (thirty percent) established by the State. Sole Paragraph. The tax provided in this article is limited to transactions occurring in the territory of the Municipality, but regardless of the effective collection, by the State, of the tax referred to in the preceding article. Art. 14. The Union shall have the power to institute taxes: I - on credit, foreign exchange and insurance transactions, and on transactions in securities and real estate values; II - on transport and communications, except those strictly municipal. § 1º The Executive Branch shall, subject to conditions and limits set by law, alter the rates or the basis for calculating the tax, in the cases of Section I of this Article, in order to adjust it to the objectives of monetary policy. § 2º Net income of the tax in cases of No. I of this Article, intended for monetary reserves. Art. 15. It is responsibility of the Municipalities to tax services of any nature not included in the tax competence of the Union and States. Sole Paragraph. A supplementary law shall establish criteria to distinguish the activities referred to in this article from those provided in Art. 12. SECTION V Special Taxes Art. 16. The Union shall have the power to institute taxes on: I - production, import, circulation, distribution or consumption of fuels and lubricants and gas from any source or nature; II - production, importation, distribution or consumption of electricity; III - production, circulation and consumption of minerals in the country. Sole paragraph - The tax is levied, once, on one out of the operations under each item in this article, and is excluded any other taxes, whatever its nature or competence, levied on those operations. Art. 17. It is responsibility of the Union, in the imminence or in the case of foreign war, to establish, temporarily, extraordinary taxes, whether or not included in the enumeration contained in the Articles 8 and 16, gradually suppressed within five years from the conclusion of peace. CHAPTER III Taxes Art. 18. The Union, the States, the Federal District and the Municipalities shall have the power, within their respective jurisdictions, to charge taxes according to the regular exercise of the police power, or by using the actual or potential presence of specific and divisible public services rendered to taxpayer or made available to them. Sole Paragraph. Taxes will have the calculation base identical to one that matches the tax referred to in this Amendment. CHAPTER IV Contributions to Improvement Art. 19. The Union, the States, the Federal District and the Municipalities shall have the power, within their respective jurisdictions, tax contribution to improvement to cover the cost of public works in which there is real estate appreciation, having as a total limit the spending and as individual limiting the addition of value resulted from the work for each property benefited. CHAPTER V Distributions of Tax Revenues Art. 20. It shall be distributed by the Union: I - to the Municipalities of the location of the property, the proceeds from the collection of tax referred to in the Article 8º, No. I; II - to the States and Municipalities, the proceeds from the collection at source of tax referred to in the Art. 8, No. II, levied on income from its public debt and on the proceeds from its servers and Municipalities. Sole Paragraph. Authorities collectors of taxes to which this article refers shall deliver to States and Municipalities the amounts received related to these taxes, as they are being collected, regardless of the order of higher authorities, within a period not greater than thirty days from the date of the payment of such taxes, under penalty of dismissal. Art. 21. The proceeds from the collection of taxes referred to in the Article 8, No. II, and Article 11, 80% (eighty percent) constitute revenue of the Union and the remaining part shall be distributed at a 10% rate to the Participation Fund of the States and the Federal District, and 10% to the Participation Fund of Municipalities. § 1º The application of funds provided in this article shall be regulated by a supplementary law that will commit to the Audit Court the calculation and budgetary authorization or any further formality, by performing the delivery, monthly, through official credit establishments. § 2º Of the total received under the previous paragraph, each participating entity shall allocate 50% (fifty percent), at least, to their capital budget. § 3º For the purposes of calculating the percentage destined to the Participation Funds is excluded, from the proceeds of the tax referred to in art. 8, No. II, the portion distributed under art. 20, No. II. Art. 22. Without prejudice to art. 21, states and municipalities that enter into agreements with the Union to ensure broad and effective coordination of their investment programs and public services, especially in the field of tax policy, may participate in up to 10% (ten percent) of the collection made on their territories from the income tax of individuals, and in art. 11, excluding the tax on tobacco and alcoholic beverages. Art. 23. From the proceeds of the tax referred to in art. 16, shall be distributed to the states, to the Federal District and to municipalities 60% (sixty percent) of which is taxed on transactions relating to fuels, lubricants and electricity, and 90% (ninety percent) of those on transactions relating to minerals of the country.

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Sole Paragraph. The distribution under this article shall be governed by resolution of the Senate, pursuant to a supplementary law in proportion to the area and production and consumption in their territory of products as the tax is referred to. Art. 24. Federal law can attribute to the states, Federal District, municipalities the burden of collecting taxes, of the competence of the Union, whose product should be distributed in whole or in part to them. Sole Paragraph. The provision applies to the collection of taxes of competence of the states, whose product is distributed by them, in whole or in part, to their respective municipalities. 17 Here are the rules established by the Constitution of 1967 and its constitutional amendments: Art. 15. The municipal autonomy shall be ensured: I - by direct election of mayor, vice-mayor and councilmen held simultaneously throughout the country (wording of the CA No. 22, 1982); II - by the administration itself, with respect to its peculiar interest, especially referring to: a) the enactment and collection of taxes within their jurisdiction and the application of their income, regardless of the obligation to report and publish balance sheets within the time allowed by law; and b) the organization of local public services. CHAPTER V TAX SYSTEM Art. 18. In addition to the taxes provided in this Constitution, the Union, the states, the Federal District and the Municipalities shall have the power to institute: I - fees collected due to the exercise of police power or the effective or potential use of specific and divisible public services rendered to taxpayers or put at their disposal; and II - improvement fees, collected from the owners of property benefited by public works, which will have as a limit the total expenditure incurred. (wording of the CA No. 23 of 1983) § 1º A supplementary law shall establish general rules of tax law, shall provide the conflicts of competence in this matter among the Union, the States, the Federal District and the Municipalities, and shall regulate the constitutional limitations on the power to tax. § 2º For charging fees, the calculation base that has served to increase the incidence of taxes cannot be used as a model. § 3º Only the Union, in exceptional cases defined by a supplementary law, may establish compulsory loan. § 4º It is responsibility of the Federal District and the States, cumulatively, the taxes allocated to the States and Municipalities; and it is responsibility of the Union, in federal territories, the taxes allocated to the States and, if the territory is not divided into Districts, the municipal taxes. § 5º The Union may, as they have no calculation basis and generating fact identical to those set forth in this Constitution, regulate other taxes, besides those mentioned in the Articles 21 and 22 and which are not of the private power to tax of the State, the Federal District or the Municipalities, as well as transfer to them the exercise of the residual powers relating to taxes, whose incidence is defined in the federal law. Art. 19. It is forbidden for the Union, the States, the Federal District and the Municipalities: I - to establish or to increase a tax without a regulating law, excepting the cases provided in this Constitution; II - to establish limitations to the traffic of people or goods by means of interstate or intermunicipal tributes; and III - to impose taxes on: a) equity, income or services from each other; b) the temples of any cult; c) equity, income or services of political parties and of institutions of education or social welfare, subject to the requirements of the law; and d) the book, newspaper and periodicals, as well as paper for printing them. § 1º The provisions of the Subsection of the Section III is extended to Municipalities, in relation to property, income and services connected to their essential purposes or arising therefrom; but it does not extend to public services provided, neither relieves the prospective buyer of the obligation to pay tax on property subject of promise of sale. § 2º The Union, through supplementary law and meeting the relevant national economic or social interest, may grant exemptions from State and local taxes. Art. 20. It is forbidden: I - to institute a tribute which is not uniform throughout the entire national territory or which implies a distinction or preference regarding a State, the Federal District, or a Municipality over another; II - for the Union to tax income from public debt bonds of the states, of the Federal District and of the Municipalities, as well as earnings of the remuneration and the respective public agents, at levels above established for bonds and agents; and III - for the States, the Federal District and the Municipalities to establish tax difference between goods of any nature by reason of their origin or destination. Art. 21. The Union shall have the power to institute taxes on: I - import of foreign products, having the Executive Power the power to, in the conditions and limits set by law, change the rates or the calculation basis; II - export to other countries national or nationalized products, observing the provisions at the end of the previous item; III - rural property; IV - income and earnings of any nature, except living allowance and charge per day paid by public funds as provided by law; V - manufactured goods, also observing the provisions in the end of Section I; VI - credit transactions, foreign exchange and insurance, or relating to bonds or securities; VII - communications services, except those strictly local (wording of the CA No. 27,1985); VIII - production, import, circulation, distribution or consumption of lubricants and liquid or gas fuels and electricity, tax which will be imposed only once on any of these operations, excluding the impact of other tax on them; and IX - extraction, circulation, distribution or consumption of minerals in the country listed in the law, tax which will be imposed only

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once on any of these operations, observing the provisions in the end of the previous item. X - transport, except those strictly municipal. (Included by the Constitutional Amendment No. 27, 1985) § 1º The Union may institute other taxes in addition to the items mentioned above, provided that there is no similar taxable event or calculation basis to those provided in Articles 23 and 24. § 2º The Union may institute: I - contributions, observing the option under Section I of this article, with a view to intervention in the economic domain or the interest of professional groups and to meet directly the part of the Union in the costing of the burden of social security (wording of the CA No. 8, 1977). II - compulsory loans, in special cases defined by a supplementary law, to which will be applied the constitutional provisions relating to taxes and the general rules of tax law. § 3º The tax on industrialized products will be selective due to the essentiality of products, and non-cumulative, deducting, in each operation, the amount collected in previous ones. § 4º The law may allocate the proceeds from the taxes enumerated in Sections II and VI of this article to the formation of monetary reserves or of capital to finance economic development program. § 5º The Union may transfer the exercise of its power to tax to the States, the Federal District and the Municipalities. § 6º The tax mentioned in Section III of this article does not focus on rural lands smaller than twenty-five acres, when cultivated by one person or with a family, the owner who has no other property. § 7º - The Union shall disclose, at the Official Gazette, until the last day of the subsequent month, the amounts of individual taxes and contributions, encompassing the extras collected and the amounts transferred to the States and the Municipalities (included by the Constitutional Amendment No. 27,1985). Art. 22. The Union shall have the power to, in the imminence or in the case of foreign war, institute, temporarily, extraordinary taxes included or not in its taxing power, which will be gradually abolished as the causes of its creation cease. Art. 23. The States and the Federal District shall have the power to institute taxes on: I - transmission of any type of real estate by nature and physical accession and of real rights on property, except those of guarantee, as well as on the assignment of rights to its acquisition; and II - operations related to the movement of goods held by manufacturers, industrialists and traders, tax which will not be cumulative and which will strike, pursuant to a supplementary law, the amount collected in the past by the same or another State. The exemption or no-collection, unless otherwise determined by law, will not involve tax credit for relief operations following that incident (wording of the CA No. 23,1983). III - ownership of motor vehicles, prohibited the levying of taxes or charges on car use (included by the Constitutional Amendment No. 27,1985) (Validity). § 1º - It is the responsibility of the States and the Federal District the proceeds from the collection of the tax referred to in Section IV of Article 21, levied on income from employment and from bonds of the public debt they paid when they are required to withhold tax (wording of the CA No. 17,1980). § 2º The tax referred to in Section I is for the State where the property is located, even if the transmission is the result of succession opened abroad, its tax rate will not exceed the limits established by resolution of the Senate by proposal of the President, as provided in law. § 3º The tax referred to in Section I is not levied on the transfer of property or rights incorporated into the assets of a corporation in carrying out capital, neither on the transfer of assets or rights arising from merger, consolidation or abolition of capital of a corporation, unless the main activity of that entity is the trading of goods or rights or lease of property. § 4º A supplementary law may regulate, besides those mentioned in section II, other categories of taxpayers of that tax. § 5º - The tax rate referred to in Section II shall be uniform for all goods in interstate and internal operations, as well as in interstate performed with the final consumer; the Senate, by a resolution taken by the President, shall fix the maximum rates for each operation and for export (wording of the CA No. 23,1983). § 6º Exemptions from tax on transactions involving the movement of goods will be granted or revoked under the terms of agreements concluded and ratified by the States, as provided in complementary law. § 7º The tax mentioned in Section II shall not be levied on the operations aiming at sending abroad industrialized products and others indicated by the law. § 8º - From the proceeds of the tax mentioned in Section II, 80% shall constitute the income of the States, and 20%, the income of the Municipalities. The installments belonging to the Municipalities shall be credited to special accounts opened in official credit establishments (wording of the CA No. 17, 1980). § 9º - The installments of revenues belonging to the Municipalities, referred to in the preceding paragraph, shall be credited according to the following criteria (included by the Constitutional Amendment No. 17,1980): I - at least three quarters, according to the proportion of the value added to transactions involving the movement of goods held in their respective territories(included by the Constitutional Amendment No. 17,1980); II - up to one quarter, according to the state law (included by the Constitutional Amendment No. 17,1980). § 10 - From the proceeds of the tax mentioned in Section I, 50 % shall constitute the income of the States and 50% shall constitute the income of the Municipality where the property to be transferred lies, on which the tax is levied on. The installments belonging to the Municipalities shall be credited to special accounts opened in official credit, according to and within the time limits established in federal law (included by the Constitutional Amendment No. 17,1980). § 11 - The tax referred to in Section II shall be levied also on the entry, in a commercial establishment, industrial or producer, of goods imported from abroad by its owner, even in case of goods for consumption or fixed assets of the establishment (included by the Constitutional Amendment No. 23,1983); § 12 - The amount of tax referred to in Section V of Art. 21 shall incorporate the calculation basis for the tax mentioned in Section II,

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enormous progress in streamlining and organizing the system, as well as the following relevant aspects: a) Topographic condensation, in the same sequence of constitutional precepts, of the great mass of tax rules that were previously non-sequential in the Constitution, working with the concept and visualization of a “tax system”;

except when the operation set case of incidence of both taxes (included by the Constitutional Amendment No. 23,1983). § 13 - From the proceeds of the tax mentioned in Section III, 50% shall constitute the States’ revenue, and 50% , the Municipalities’ revenue where the vehicle is licensed; the installments shall belong to the Municipalities and shall be credited to special accounts, opened in official credit in accordance to and within the time limits established in federal law (included by the Constitutional Amendment No. 27,1985) (Validity). § 14 - The State shall disclose at the Official Gazette until the last day of the subsequent month, the amounts of individual taxes, encompassing the extras collected and the amounts transferred to the Municipalities (included by the Constitutional Amendment No. 27, 1985) (Validity). Art. 24. The Municipalities shall have the power to institute taxes on: I – real estate and urban land; and II - services of any nature not included in the power to tax of the Union or the States, defined by complementary law. § 1º It shall be destined to the Municipalities the proceeds from the collection of taxes mentioned in Section III of the Article 21, levied on property situated in its territory. § 2º It shall be distributed to municipalities, as provided by law, the proceeds from the collection of taxes mentioned in Section IV of Article 21, levied on income from employment and bonds of public debt paid by them when they are required to withhold tax. § 2º - The Municipalities shall receive the proceeds from the collection of tax referred to in Section IV of Article 21, levied on earned income and bonds of public debt paid by them when they are required to withhold tax (wording of the CA No. 17, 1980). § 3º Regardless of a higher order, within a period not greater than thirty days from the date of collection, and under penalty of dismissal, the authorities collectors of taxes mentioned in § 1 shall deliver to the Municipalities the sums belonging to them as these taxes are being collected. § 4º A supplementary law may establish the maximum tax rate that is referred to in the Section II. Art. 25 - From proceeds of the collection of taxes mentioned in Sections IV and V of Art. 21, the Union shall distribute 33% as follows (wording of the CA No. 27,1985) (Validity): I - 14% to the Participation Fund of the States, the Federal District and territories (wording of the CA No. 27, 1985) (Validity); II - 17% to the Municipal Participation Fund (wording of the CA No. 27,1985) (Validity); III - 2% to the Special Fund, which shall have its application governed by law (wording of the CA No. 27, 1985) (Validity). § 1º - For purposes of calculating the percentage for the Participation Funds, the share of income and earnings of any nature shall be excluded, which, pursuant to Article 23, § 1, 24, § 2, belongs to the States, the Federal District and the Municipalities (wording of the CA No. 17, 1980). § 2º - The application of funds referred to in Sections I and II shall be governed by federal law, which shall give the Audit Court the responsibility to calculate quotas (wording of the CA No. 17,1980). § 3º - The transfer of resources shall depend on the collection of federal taxes collected by the States, the Federal District and the Municipalities, and the settlement of the debts of those entities or their boards of indirect management, to the Union, including those from the provision of security (included by the Constitutional Amendment No. 17,1980). § 4º - Municipalities shall apply to healthcare programs 6% of the amount credited to them under the provisions of Section II (included by the Constitutional Amendment No. 27, 1980) (Validity). Art. 26 - The Union shall distribute to the States, the Federal District, the Municipalities and territories: (wording of CA No. 16,1980): I - 40% of the proceeds of the tax on lubricants and liquid or gas fuels mentioned in Section VIII of the Article 21; I - 60% of the proceeds of the tax on lubricants and liquid or gas fuels referred to in Section VIII of Article 21, as well as of the additional and other charges federal taxes on these products (wording of the CA No. 23, 1983) (see Art. 4 of the Constitutional Amendment No. 23,1983); II - 60% of the proceeds of the tax on electric power referred to in Section VIII of Article 21; and III - 90% of the proceeds of the tax on the minerals of the country mentioned in Section IX of the Article 21. IV - 70% of tax on transport mentioned in Section X of Art. 21, and 50% for the Federal District and territories, and 20% to the Municipalities (included by the Constitutional Amendment No. 27, 1980) (Validity). § 1º The distribution shall be made under federal law, which may provide on the form and purpose of the application of distributed resources, according to the following criteria: a) in cases of Sections I and II, proportional to the area, population, production and consumption, adding, when appropriate, with regard to Section II, compensatory quota of area flooded by reservoirs; b) in the case of Section III, proportional to production. § 2º The industries that consume minerals in the country shall be able to decrease the tax rate referred to in Section 21 of the Article IX of the tax on the movement of goods and the tax on industrialized products, to the extent of 90% and 10%, respectively. § 3º - To the Federal District and territories, two thirds of the planned transfer of Section I shall be allocated; to the Municipalities, one third (included by the Constitutional Amendment No. 23,1983).

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b) The name expresses the “national tax system,” which greatly contributed to the intellection of the system rationale(see the Article 1 of the CA No. 18/65); c) The expressed grant to the laws and other infra-constitutional rules, in the different federal entities, as members of the same unit, should remain consistent: the national tax system (see the Article 1 of the CA No. 18/65); d) the institution of the constitutional tax principles of the tax legality and of nonretroactivity taxation (see the Article 2, Sections I and II of the CA No. 18/65); e) The modern institutionalization of mutual immunity, of the immunity of the temples of any cult, political parties, social assistance institutions, books, newspapers and periodicals (see the Article 2, Section IV and §§ 1 and 2, CA No. 18/65); f) The expressed authorization for the Union to establish heteronymous exemptions to benefit the federal public services (see the Article 2, Section IV, in fine, of the CA No. 18/65); this rule represents an option for the centralization of taxation, something to be corroborated by the 1967Constitution and subsequently revised by the Constitutional Order of 1988, which will expressly reject it; g) The institution of Union competence to create forced loans by a supplementary law, a new kind of payment obligation, different from tax, rate and benefit charges (see the Article 4 of the CA No. 18/65); h) The expressed stipulation of the depleted character of the list of taxes provided in the Constitution (see the Article 5 of the CA No. 18/65); i) The grant to the Union for export tax, which is no longer the responsibility of the States, and the stipulation of its extra fiscal purpose of cooperating in the composition of monetary reserves in Brazil (see the Article 7, Section II, § 2, CA No. 18/65); j) The stipulation that it is a responsibility of the Executive Power to alter the rates and calculation bases of taxes on extra fiscal trade, with extra fiscal and noncollective purposes (see the Article 7, § 1, CA No. 18/65); k) The stipulation of the competence of the States to impose and collect the tax on transfer of real state and its non-incidence hypothesis, as well as the allocation of the Senate to provide its maximum rate and the possibility of this tax to be deductible from the earnings of any nature (see the Article 9 of the CA No. 18/65); l) The stipulation that the tax on industrial products would be selective and noncumulative (see the Article 11 of the CA No. 18/65); m) The regulation of state tax and non-cumulative tax on the movement of goods (see the Article 12, CA No. 18/65); n) The competence of the Union to create a tax on financial operations and its extra fiscal role of composing the Brazilian monetary reserves (see the Article 14 of the CA No. 18/65);

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o) The enumeration of municipal powers to levy the tax on services of any kind to be established in supplementary federal law (see the Article 15 of the CA No. 18/65); this reinforces the new tax autonomy; p) The prevision of special jurisdiction of the Union to tax, by the individual and in one phase, the liquid and gas fuels, electricity and minerals (see the Article 16 No. CA 18/65); q) The theoretical possibility that the extraordinary taxes of war could “double tax” Federal, State or Municipal taxes (see the Article 17, CA No. 18/65); r) The prevision that rates could only be charged due to the exercise of police power or to the potential of specific and dividable public services, as well as the inability to use the calculation base of the tax to collect it (see the Article 19, CA No. 18/65); s) The enumeration of a complex system of tax cooperation with the enumeration of mandatory constitutional transfers, of the creation of funds for the participation of States and Municipalities, of the provision that States, the Federal District and Municipalities could levy and collect federal taxes (see the Arts 20, 21, 22, 23 and 25, CA No. 18/65); t) The prevision of extending, to the Amazon region, the tax and credit benefits created by law in the Northeast, the constitutional provision that is characterized as a true forerunner of the future “free trade zone of Manaus” (see the Article 27 of the CA No.18/65); Therefore, the range of relevant “news”, created by the Constitutional Amendment No. 18/65, is awkward, either by quantity or by systemic quality of hypotheses then newfangled and vanguard; it is not surprising that part of the doctrine states that, before this amendment, the Brazilian tax system did not officially exist, which is a questionable statement, because the minimum requirements of a modern tax system are already present, though less significantly, in the constitutional provisions of the 1946 Constitution. Nevertheless, the tax reform in 1965 led the systemic organization to a level of complexity never experienced before, especially the constitutional limitations to the taxing power that engendered new tax tools that are lifted to the constitutional level. Some examples are the heteronymous exemption, the extra fiscal function of rates, and the alteration and calculation bases of federal taxes by the Executive Power, the stratified taxation of consumption (through the creation of the ICM, the IPI and ISS, the extensionality of the tax system to infra-constitutional norms). However, this legal framework, confirmed by the promulgation of the Brazilian Tax Code, Ordinary Federal Law No. 5,172/66, became a new paradigm, on which the future tax orders will be created by the 1967 Constitution and the 1988 Constitution . Indeed, the 1967 Constitution and its amendments, including the Constitutional Amendment No. 01/6917 followed essentially the same structure as the established by 17

Here are the rules established by the Constitution of 1967 and its constitutional amendments:

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Art. 15. The municipal autonomy shall be ensured: I - by direct election of mayor, vice-mayor and councilmen held simultaneously throughout the country; (Wording of the CA No. 22, 1982) II - by the administration itself, with respect to its peculiar interest, especially referring to: a) the enactment and collection of taxes within their jurisdiction and the application of their income, regardless of the obligation to report and publish balance sheets within the time allowed by law; and b) the organization of local public services. CHAPTER V TAX SYSTEM Art. 18. In addition to the taxes provided in this Constitution, the Union, the states, the Federal District and the municipalities shall have the power to institute: I - fees collected due to the exercise of police power or the effective or potential use of specific and divisible public services rendered to taxpayers or put at their disposal; and II - improvement fees, collected from the owners of property benefited by public works, which will have as a limit the total expenditure incurred. (Wording of the CA No. 23 of 1983) § 1º A supplementary law shall establish general rules of tax law, shall provide the conflicts of competence in this matter among the Union, states, Federal District and municipalities, and shall regulate the constitutional limitations on the power to tax. § 2º For charging fees the calculation base that has served to increase the incidence of taxes cannot be used as a model. § 3º Only the Union, in exceptional cases defined by a supplementary law, may establish compulsory loan. § 4º It is responsibility of the Federal District and states, cumulatively, the taxes allocated to the states and municipalities; and it is responsibility of the Union, in federal territories, the taxes allocated to the states and, if the territory is not divided into districts, the municipal taxes. § 5º The Union may, as far as they have no calculation base and generating fact identical to those set forth in this Constitution, establish other taxes, besides those mentioned in articles 21 and 22 and which are not of the private power to tax of the state, the Federal District or the municipalities, as well as transfer to them the exercise of the residual powers relating to taxes, whose incidence is defined in federal law. Art. 19. It is forbidden for the Union, the states, the Federal District and the municipalities: I - to establish or to increase a tax without the law establishes it, excepting the cases provided in this Constitution; II - to establish limitations to the traffic of people or goods by means of interstate or intermunicipal tributes; and III – to impose taxes on: a) equity, income or services from each other; b) the temples of any cult; c) equity, income or services of political parties and of institutions of education or social welfare, subject to the requirements of the law; and d) the book, newspaper and periodicals, as well as paper for printing them. § 1º The provisions of the subsection of the section III is extended to municipalities, in relation to property, income and services connected to their essential purposes or arising therefrom; but it does not extend to public services provided, neither relieves the prospective buyer of the obligation to pay tax on property subject of promise of sale. § 2º The Union, through supplementary law and meeting the relevant national economic or social interest, may grant exemptions from state and local taxes. Art. 20. It is forbidden: I - to institute a tribute which is not uniform throughout the entire national territory or which implies a distinction or preference regarding a state, the Federal District or a municipality to the detriment of another; II - for the Union to tax income from public debt bonds of the states, of the Federal District and of the Municipalities, as well as earnings of the Remuneration and the respective public agents, at levels above established for Those ITS own bonds and agents; and III - for the states, Federal District and municipalities to establish tax difference between goods of any nature by reason of their origin or destination. Art. 21. The Union shall have the power to institute taxes on: I - import of foreign products, having the Executive Power the power to, in the conditions and limits set by law, change the rates or the calculation base; II - export to other countries national or nationalized products, observing the provisions at the end of the previous item; III - rural property; IV - income and earnings of any nature, except living allowance and charge per day paid by public funds as provided by law; V - manufactured goods, also observing the provisions at the final of section I; VI - credit transactions, foreign exchange and insurance, or relating to bonds or securities; VII - communications services, except those strictly local; (Wording of the CA No. 27 of 1985) VIII - production, import, circulation, distribution or consumption of lubricants and liquid or gaseous fuels and electricity, tax which will be imposed only once on any of these operations, excluding the impact of other tax on them; and IX - extraction, circulation, distribution or consumption of minerals in the country listed in the law, tax which will be imposed only once on any of these operations, observing the provisions at the end of the previous item. X - transport, except those strictly municipal. (Included by Constitutional Amendment No. 27, 1985) § 1º The Union may institute other taxes in addition to the items mentioned above, provided that there is no taxable event or calculation base similar to those provided in articles 23 and 24. § 2º The Union may institute: I - contributions, observing the option under section I of this article, with a view to intervention in the economic domain or the interest of professional groups and to meet directly the part of the Union in the costing of the burden of social security. (Wording of the CA No. 8 of 1977)

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II - compulsory loans, in special cases defined by a supplementary law, to which will be applied the constitutional provisions relating to taxes and the general rules of tax law. § 3º The tax on industrialized products will be selective due to the essentiality of products, and non-cumulative, deducting, in each operation, the amount collected in previous ones. § 4º The law may allocate the proceeds from the taxes enumerated in sections II and VI of this article to the formation of monetary reserves or of capital to finance economic development program. § 5º The Union may transfer the exercise of its power to tax to the states, Federal District and municipalities. § 6º The tax mentioned in section III of this article does not focus on rural lands area not exceeding twenty-five acres, when cultivated, alone or with his family, the owner who has no other property. § 7º - The Union shall disclose, at the Official Gazette, until the last day of the subsequent month, the amounts of individual taxes and contributions, encompassing the extras collected and the amounts transferred to states and municipalities. (Included by Constitutional Amendment No. 27 of 1985) Art. 22. The Union shall have the power to, in the imminence or in the case of foreign war, institute, temporarily, extraordinary taxes included or not in its taxing power, which will be gradually abolished, ceased the causes of its creation. Art. 23. The states and the Federal District shall have the power to institute taxes on: I - transmission of any type of real estate by nature and physical accession and of real rights on property, except those of guarantee, as well as on the assignment of rights to its acquisition; and II - operations related to the movement of goods held by manufacturers, industrialists and traders, tax which will not be cumulative and which will strike, pursuant to a supplementary law, the amount collected in the past by the same or another state. The exemption or nocollection, unless otherwise determined by law, will not involve tax credit for relief operations following that incident. (Wording of the CA No. 23 of 1983) III - ownership of motor vehicles, prohibited the levying of taxes or charges on car use. (Included by Constitutional Amendment No. 27 of 1985) (Validity) § 1º - It is belonged to the states and the Federal District the proceeds from the collection of the tax referred to in section IV of art. 21, levied on income from employment and from bonds of the public debt they paid when they are required to withhold tax. (Wording of the CA No. 17 of 1980) § 2º The tax referred to in section I is for the state where the property is located, even if the transmission is the result of succession opened abroad, its tax rate will not exceed the limits established by resolution of the Senate by proposal of the President, as provided in law. § 3º The tax referred to in section I is not levied on the transfer of property or rights incorporated into the assets of a corporation in carrying out capital, neither on the transfer of assets or rights arising from merger, consolidation or abolition of capital of a corporation, unless the main activity of that entity is the trading of goods or rights or lease of property. § 4º A supplementary law may establish, besides those mentioned in section II, other categories of taxpayers of that tax. § 5º - The rate of tax referred to in section II shall be uniform for all goods in interstate and internal operations, as well as in interstate performed with the final consumer; the Senate, by a resolution taken by the President, shall fix the maximum rates for each operation and for export. (Wording of the CA No. 23 of 1983) § 6º Exemptions from tax on transactions involving the movement of goods will be granted or revoked under the terms of agreements concluded and ratified by the states, as provided in complementary law. § 7º The tax mentioned in section II shall not be levied on the operations aiming at sending abroad industrialized products and others indicated by the law. § 8º - From the proceeds of the tax mentioned in section II, eighty percent shall constitute the income of states and twenty percent, the income of municipalities. The installments belonging to municipalities shall be credited to special accounts opened in official credit establishments. (Wording of the CA No. 17, de 1980) § 9º - The installments of revenues belonging to the municipalities, referred to in the preceding paragraph, shall be credited according to the following criteria: (Included by Constitutional Amendment No. 17 of 1980) I - at least three quarters, according to the proportion of the value added to transactions involving the movement of goods held in their respective territories; (Included by Constitutional Amendment No. 17 of 1980) II - at maximum one quarter, according to the state law. (Included by Constitutional Amendment No. 17 of 1980) § 10 - From the proceeds of the tax mentioned in section I, fifty percent shall constitute the income of states, and fifty percent shall constitute the income of the municipality where is situated the property to be transferred, on which the tax is levied on. The installments belonging to the municipalities shall be credited to special accounts opened in official credit, in the manner and within the time limits established in federal law. (Included by Constitutional Amendment No. 17 of 1980) § 11 - The tax referred to in section II shall be levied also on the entry, in a commercial establishment, industrial or producer, of goods imported from abroad by its owner, even in case of goods for consumption or fixed assets of the establishment. (Included by Constitutional Amendment No. 23 of 1983) § 12 - The amount of tax referred to in section V of art. 21 shall incorporate the calculation base for the tax mentioned in section II, except when the operation set case of incidence of both taxes. (Included by Constitutional Amendment No. 23 of 1983) § 13 - From the proceeds of the tax mentioned in section III, 50% (fifty percent) will constitute the state revenue and 50% (fifty percent), the municipality revenue where the vehicle is licensed; the installments belonging to the municipalities shall be credited to special accounts, opened in official credit in the manner and within the time limits established in federal law. (Included by Constitutional Amendment No. 27 of 1985) (Validity) § 14 - The state shall disclose, at the Official Gazette until the last day of the subsequent month, the amounts of individual taxes, encompassing the extras collected and the amounts transferred to the municipalities. (Included by Constitutional Amendment No. 27 of 1985) (Validity) Art. 24. The municipalities shall have the power to institute taxes on: I – real estate and urban land; and II - services of any nature not included in the power to tax of the Union or the states, defined by complementary law.

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The Amendment 18/65. However, the following legal characteristics state that tax autonomy is inherent and essential to its municipal autonomy, a principle nominally established in the Constitution, albeit with low social effectiveness in during the Brazilian dictatorship period (see Art. 15, Section II, Subsection “a” of the FC/67): a) the provision, hitherto unpublished, that the federal supplementary law would have at least three functions: to establish general rules of tax law, to resolve conflicts and tax competency, and to establish constitutional limitations to taxing power (see Art. 18, § 1 of the 1967 Federal Constitution); b) the provision that the Union could create new residual taxes and, by federal law, delegate this task to states (see Art. 18, § 5 and 21 of the 1967 Federal Constitution); c) the expressed provision that the reciprocal immunity did not extend to public services provided and neither to the prospective buyer of public assets (see Art. 19, § 1 of the 1967 Federal Constitution); d) the expressed provision that the Union, in any case of national or corporate interest, could establish by law heteronymous exemptions of State and local taxes, extending a similar rule that had been provided in the Constitutional Amendment No. 18/65 and considerably extending the framework for centralizing tax in line with the autocratic character of the political regime then in force (see Art. 18, § 2 of the 1967Federal Constitution); e) the corroborated competence of the Union to institute compulsory loans, being noteworthy that the prevailing view in the Supreme Court was to the effect that such charges was not taxing nature and constitute coercive contracts18 (see Art. 21, § 2 of the 1967Federal Constitution of); f) The Union’s competence to create contributions of intervention in the economic domain, contributions in the interest of professional groups and contributions § 1º It shall be destined to the municipalities the proceeds from the collection of taxes mentioned in section III of article 21, levied on property situated in its territory. § 2º It shall be distributed to municipalities, as provided by law, the proceeds from the collection of taxes mentioned in section IV of article 21, levied on income from employment and bonds of public debt paid by them when they are required to withhold tax. § 2º - The municipalities shall receive the proceeds from the collection of tax referred to in section IV of article 21, levied on earned income and bonds of public debt paid by them when they are required to withhold tax. (Wording of the CA No. 17 of 1980) § 3º Regardless of a higher order, within a period not greater than thirty days from the date of collection, and under penalty of dismissal, the authorities collectors of taxes mentioned in § 1 shall deliver to the municipalities the sums belonging to them, as these taxes are being collected. § 4º A supplementary law may establish the maximum tax rate that is referred to in the section II. Art. 25 - From proceeds of the collection of taxes mentioned in sections IV and V of art. 21, the Union shall distribute 33% (thirty three percent) in the following manner: (Wording of the CA No. 27 of 1985) (Validity) I - 14% (fourteen percent) to the Participation Fund of the states, the Federal District and territories, (Wording of the CA No. 27 of 1985) (Validity) II - 17% (seventeen percent) to the Municipal Participation Fund; (Wording of the CA No. 27 of 1985) (Validity) III - 2.0% (two percent) to the Special Fund, which shall have its application governed by law. (Wording of the CA No. 27 of 1985) (Validity) § 1º - For purposes of calculating the percentage for the Participation Funds, it shall be exclude the share of income and earnings of any nature which, pursuant to Article 23, § 1, 24, § 2, belongs to the states, Federal District and municipalities. (Wording of the CA No. 17 of 1980) § 2º - The application of funds referred to in sections I and II shall be governed by federal law, which shall give the Audit Court the responsibility to calculate quotas. (Wording of the CA No. 17 of 1980) 18

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See the trial in the Court of the Extraordinary Appeal No. 111954/PR

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to social security .It is also relevant to mention that the Federation Supreme Court, after the Constitutional Amendment No. 08/77, established that such legal obligations would have to tax nature2019(see Art. 21, § 2 of the Federal 1967Constitution ); g) the provision that tax on the export and on financial transaction would function as an extra fiscal tax, besides composing the monetary reserves, to serve as capital to finance economic development programs (Art. 21, § 4 of the 1967Federal Constitution); h) the possibility of supplementary exercise of the taxing power of the Union by the Federal District and the Municipalities (Art. 21, § 5 of the 1967 Federal Constitution ); i) the determination of transparency in the monthly release of the amounts of taxes collected (Art. 21, § 7 of the 1967 Federal Constitution); j) the abolition of the cabbalistic term of five years, from the conclusion of peace, for the elimination of extraordinary taxes of war, which led to partial abrogation of the Article 76 of the Brazilian Tax Code (see Art. 22 of the 1967 Federal Constitution); k) the provision of the creation of a tax on the ownership of motor vehicles (IPVA) of state jurisdiction (see Art. 23, Section 2 of the 1967 Federal Constitution); l) the prevision of the specific tax immunity of ICMS, unable to focus on the export of manufactured goods (see Art. 23, § 7 of the 1967 Federal Constitution); m) the establishment of a complex system of mandatory constitutional transfers and connections to the revenue from taxes, in accordance with Arts. 23, 24, 25 and 26 of the 1967 Constitution. Therefore, it is clear that the 1967 Constitution deepened the logical structure ventilated by the Constitutional Amendment No. 18/65, strictly dividing the powers to tax, stipulating new rules to protect taxpayers by instituting relevant situations of mutual tax cooperation, and linking the revenue from taxes and the stipulation of new hypotheses of using extra fiscal taxes. It is a complex, detailedtax system. However, it markedly centralize revenue and tax initiatives, being basically pro-tax without major normative focus on taxpayer protection. Therefore, that is an institutional environment in transition, where several tax types coexist mutually and where tax levy overrides the rights of taxpayers, from which the New Constitutional Order rose in 1988, deeply influenced by the environment of redemocratization, what is dealt by the tax system in a very bold and surprising way, and, indeed, unprecedented anywhere in the world.

19

See the trial of the Supreme Court in Extraordinary Appeal No. 149524/RJ - RIO DE JANEIRO.

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3. A Brief Analysis of the Brazilian Tax System in the Constitution of 1988 and Its Acquired Physiognomy, Even After the Constitutional Amendments Which Altered It The new tax institutional rearrangement conceived by the 1988 Constitution turned out to reveal the democratic and social-liberals roots of the original constituent of 1988.

Indeed, there was an expressed concern in keeping the national tax system in a separate chapter of the constitutional text, as well as in stipulating all the possible and necessary rules and principles on tax law, while maintaining its strictness and its participation in tax cooperation among political entities. Meanwhile, we understand that the New Brazilian Tax System is marked by three outstanding characteristics: 1) The legal status quo granted to the normative, political, economic and social Role, and even the social role of constitutional limitations to the power to tax; 2) The strict, complex granting of powers to tax, belonging to various types and subtypes of taxes (granting real tax autonomy to all federal entities); 3) The achievement of instruments conceived to ensure an effective tax and financial solidarity between the entities, which serves as an anchor of stability for the proper work of the federal agreement and of the operational capacity of the State, when absorbing and overcoming possible mutual tensions of the entities regarding the tax basis of their respective powers and tax allocation of public revenue. Indeed, the first essential character of our tax system is the relevance assumed by the constitutional limitations on taxing power. In the previous constitutions, they were always sprawling among other articles of the tax constitution. The 1988 Constitution , in contrast, sets limits in Articles 150, 151 and 152, and does not hesitate to establish the creation of other legal limits scattered throughout the Constitution, being relevant to a literal manner of the caput of Article 150 of the 1988 Constitution, which acknowledges other guarantees to taxpayers spread in many segments of the text in the Constitution. Incidentally, before they simply profiled a systematic enumeration of the rights of taxpayers, it is known that the 1988 Constitution alters the status quo of the tax principles and immunities, giving them a function of real “fundamental rights of taxpayers”, labeling true immutable clauses by jurisprudence of the Supreme Court20 protected in its essential core. 20

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Here is the amendment of the paradigmatic trail of the Supreme Court in the ADI 939, Rapporteur, the Minister Sydney Sanches, in verbis: “Summary: - Constitutional Law and Tax Law. Direct Action of Unconstitutionality of Constitutional Amendment and Supplementary Law. I.P.M.F. Provisional Tax on the Movement or the Transmission of Values and of Credits and Rights of a Financial Nature - I.P.M.F. Articles 5., Par. 2., 60, Par. 4., Subsections I and IV, 150, Subsection III, “b”, and VI, “a”, “b”, “c” and “d”, of the Federal Constitution. 1. A Constitutional Amendment, issued therefore of Constituent derived, incurring the violation of the Constitution, may be

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

That alone would be enough to acknowledge the merits of the current Brazilian tax system, on the desirability of achieving a reasonable ,balanced compatibility between the fiscal needs of the State and the innate vulnerabilities and personal interests of taxpayers. However, other achievements of taxpayers can be mentioned, revealing that the constitutional limitations on taxing power have been qualitatively and quantitatively hypertrophied with the new legal regime in 1988. Also, there was the establishment of new cases of tax immunities and the creation of several tax principles to protect the taxpayer. However, such list of innovations created by the 1988 Constitution had positive impacts on the economic, social and political sectors and on activities covered by them, as well as on the entire category of taxpayers: a) The provision of tax immunity to the foundations created by political parties, with respect to their essential purposes, as well as the creation and specific standard of immunization for labor unions (see Art. 150, Section VI, Subsection “c” of the 1988 Constitution); b) the granting of “subjective” character to religious immunity, which is no longer restricted only to freedom of cult and to temples of any cult and has begun to cover the religious freedom and to protect the assets, income and services for religious organizations (see art. 150, section VI, subsection “b” c/c § 4 of the Constitution of 198821); c) Even in its objective aspect, the protection was extended to religious places of burial22; declared unconstitutional by the Supreme Court, whose primary function is to guard the Constitution (Art. 102, I, “a”, FC). 2. The Constitutional Amendment No 3, 03.17.1993, in Art. 2, authorized the Union to establish the IPMF tax, occurred in the addiction of unconstitutionality, available in Paragraph 2 of such provision, which, for such a tax, is not applicable “in Art. 150, III, “b” and VI” of the Constitution, because, thereby, breached the following principles and immutable norms (only they, not others) 1. - The principle of prior, which is an individual guarantee of the taxpayer (Art. 5., Par. 2., Art. 60, Par 4., Section IV, Art. 150, III, “b” of the Constitution); 2. - The principle of reciprocal tax immunity (which prohibits the Union, the States, the Federal District and the Municipalities to impose taxes on property, income or services from each other) and that is guaranteed by the Federation (Art. 60, Par. 4., Section I; and Art. 150, VI, “a”, FC); 3. - The rule that, establishing other immunities, prevents the creation of taxes (Art. 150, III) on “b”): temples of any cult, “c”): assets, income or services of political parties, including their foundations, of worker unions, institutions of education and social work, nonprofit, complying with the requirements of the law, and “d”): books, newspapers, periodicals and paper for printing them; 3. In consequence, it is unconstitutional, too, the Complementary Law No. 77,07.13.1993, reduction of texts, at the points in which was determined the incidence of tax in the same year (Art. 28) and failed to acknowledge the immunity provided for in Art. 150, VI, “a”, “b”, “c” and “d” of the CF (Arts. 3, 4 and 8 of the same law, CA No 77/93). 4. Direct Action of Unconstitutionality considered true, in part, for such purposes, by majority voting, pursuant to the Rapporteur, maintained with respect to all taxpayers, in a definitive manner, the protective order, which suspended the collection of the tax in 1993. 21

See the summary of the trial of the Supreme Court that was corroborated in literal in the fourth paragraph of article 150 to extend this immune standard that historically only covered the temples of any cult: The tax immunity granted to temples of any cult under art. 150, VI, b and § 4, of the Constitution, comprehends the assets, income and services related to the essential purposes of religious institutions (FC, art. 150: “Notwithstanding any other guarantees ensured to the taxpayer, it is forbidden for the Union, states, the Federal District and municipalities: ... VI - institute taxes on: ... b) temples of any cult. ... § 4 The prohibitions contained in sections VI, subsections b and c encompass only the property, income and services related to the essential purposes of the entities mentioned therein”). With this understanding, the Court, by majority, has found extraordinary appeal and has provided, building immunity, to reform the Court of Justice of São Paulo that, except the temples where religious celebrations are held and dependencies directly serving these purposes, shall be considered as legitimate the charge of IPTU relatively on commercial buildings and vacant lots of religious entity. Overdue Ministers Ilmar Galvão, reporters Ellen Gracie, Carlos Velloso and Sepúlveda Pertence, which in a systematic interpretation of the Constitution in view of its art. 19, which forbids the state the subvention of religious cults or churches, maintained the appeal that restricted the tax immunity of religious institutions to reconcile the constitutional value that seeks to protect, which is freedom of worship, with the principle of denominational neutrality of the secular state. RE 325.822-SP, rel. orig. Min. Ilmar Galvão, red. to the judgment of Min. Gilmar Mendes, 18.12.2002. (RE-325822).

22

See trial of Extraordinary Appeal No. RE 578562/BA - BAHIA, whose summary is below, in literis:

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

d) the maintenance of the character of the constitutional principle of tax legality, of non-retroactivity and of the prior tax (see art. 150, sections I and III, subsection “b”; e) the constitutionalization of the principle of tax equality and ability to pay; the latter extended to other tax types than those imposed by the diffuse constituent power, exercised with creativity by the Supreme Court23 (see art150, section II, and 145, § 1º of the Constitution of 1988); f) the maintenance of constitutionalization of the principle of prohibition of confiscation and of tax free for the traffic of people and goods (see art. 150, sections IV and V of the Constitution of 1988); g) the establishment of the specific ninetieth principle (noventena) for the contributions to social security and welfare, and then creating a general ninetieth for the other types of taxes, being both reinforcements to the previous legal situation (see art. 195, § 6 and 150, section III, subsection “c” of the Constitution of 1988)24; h) The constitutional determination of the measure for consumers to obtain the knowledge and transparency about the incidence of taxes, the amount of funds raised and the sectors covered by tax expenditures (see Art. 150, § 5, 6 and 162 of the 1988Constitution);

SUMMARY: EXTRAORDINARY APPEAL. CONSTITUTIONAL. TAX IMMUNITY. IPTU. ARTICLE 150, VI, “B”, CB/88. CEMETERY. EXTENT OF AUTHORITY OF RELIGIOUS NATURE. 1. The cemeteries of entities that consubstantiate extensions of religious nature are covered by the guarantee contemplated in article 150 of the Constitution of Brazil. Impossibility of the incidence of IPTU in relation to them. 2. The tax immunity to the temples of any cult is designed based on the interpretation of the totality that the text of the Constitution is, particularly the provisions of Articles 5, VI, 19, and 150 I, VI, “b”. 3. The areas of incidence and tax immunity are antipodes. Extraordinary appeal provided.

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23

Verify the following statement: “The Court, by majority, holding the contested decisions, understood constitutional the rate referred to. It was considered: 1) the fact that the rate varies according to the company’s net function does not mean that equity constitutes its calculation base - it serves only as an informative element of the amount to be paid when the application of the table under the law; 2) the criterion adopted for charging the tax is in accordance with the principle of ability to pay, which can also be applied to this type of tax, especially when it has as motivation the use of police power of the State (...) ADInMC 1.910-DF, rel. Min. Sepúlveda Pertence, 22.4.99.

24

The Constitutional Amendment No. 42/2003, when modifying the wording of section II and the first paragraph of article 150 of CF/88, added a new measure of protection for the taxpayer: it is the requirement of ninetieth general principle, the one which will be applied generically in all cases where it is compulsory to use the principle of precedence, except for income tax, which obeys the principle of precedence, but an exception to the ninetieth general principle, as well as in relation to the Tax on Industrialized Products, which is an exception to the principle of precedence and must obey only the ninetieth general principle. The ninetieth general principle should be applied always as an additional guarantee of the principle of precedence, aiming at avoiding the famous “institutional coup” to increase or create a tax at the end of the financial year (December) and charge the increase or institution already in January of another financial year. If the tax rate is raised by December 1, 2003, the new rate will only be used for events that occurred from March 2, 2004 (combination of general ninetieth principles and prior). In turn, the social pension contributions shall continue to obey only the special ninetieth principle, under article 195, § 6, the CF/88, that is, if increased or imposed, they may be charged in the same financial year, provided that they exceeded the period of ninety days. The general social security contributions have one more difference from the “pension”” social contribution: they must obey the principle of prior combined with the general ninetieth principle. It is necessary to comment that before the Constitution of 1988, the Supreme Court did not recognize the nature of social contributions after the Constitutional Amendment No. 08/77. Therefore, there was no constitutional interstice between the increase of social contribution and its recovery, and in that sense, an advance, the stipulation of article 195, § 6, Constitution of 1988.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

i) The establishment of specific immunity to rates as fundamental rights of taxpayers (see Art. 5 of the 1988 Constitution)25; j) The stipulation of a number of cases of specific immunity comprehending other tax types26; k) The creation or maintenance of a number of specific immunities27. 25

The following can be enrolled as cases of specific immunity: a) Immunity of IPI tax on industrialized products intended for export (Article 153, § 3, Section III of the FC/88); b) Immunity of the ITR tax on small rural areas operated by sole owner (Article 153, Section V, and § 4): legal definition of small rural area (see Article 2 of the Federal Law No. 9,393/96): 100 hectares (Western Amazon area and the Pantanal); 50 hectares (Brazil’s drought polygon and Eastern Amazonia); 30 hectares (in any other Municipalities); c) Immunity of Gold as a financial asset or negotiable instrument (Article 153, § 5 and 155, § 2, Section X, “c” of the FC/88), only the IOF tax focuses on gold in this event; d) Immunity of ICMS tax on industrialized products intended for export, “excluding semi-processed products (Article 155, § 2, Section X, “a” of the FC/88). The Complementary Act 87/96, in Article 3, Section II, “included” in the immunity the semi-developed, which is why the exporting member States receive a “compensation”; the Supreme Court, in Adin’s trial No. 1,622/UF, respondent Nelson Jobin (see Informativo STF No. 90/97) decided that such legal provision was constitutional; ATTENTION: CONSTITUTIONAL AMENDMENT No. 42/2003 ENDED THE CONTROVERSY BY CHANGING THE WORDING OF THE SUBSECTION “A”, removing from it the reference to the semi-finished products; in addition, it was included in the benefit, specifically, the services provided to foreign and ensured the use of tax credit transactions. However, according to the new wording of Article 155, § 2, Section X, “a”: “The ICMS tax shall not be taxed: a) on transactions transferring “goods” to other countries, on services provided to beneficiaries abroad, ensuring the maintenance and recovery of the tax charged on previous transactions and installments”; today, the financial compensation of the States by the exclusion of the ICMS tax on semi-finished products for export is regulated by the new Article 91 of the ADCT, which accepted the use of the Kandir Law until its final rule (Article 91 § 3 of the ADCT); e) Immunity of the ICMS tax on interstate transactions of fuels, lubricants, liquid and gas fuels and electricity (Article 155, § 2, Section X, “b” of the FC/88); the Article 9, § 2, of the Supplementary Law No. 87/96 stipulated that the exemption shall be valid only if the product is intended for distribution and marketing. If it is to the final consumer, there is payment of the ICMS; THE ARTICLE 155, § 2, SECTION XII, SUBSECTION “H” OF THE CF/88 STATES THAT SUCH BENEFIT IS ALSO NOT AN EVENT APPLIED IN THE EVENT OF A single incidence of the ICMS on fuel and lubricants; f) Immunity of the ICMS and sound broadcasting services and of sound and images: the Constitutional Amendment No. 42/2003 (TAX REFORM), when including the Subsection “d” to Section X of the second Paragraph of the Article 155 of the Constitution, added a new hypothesis of tax immunity, by asserting that the ICMS does not cover “d) the provision of communication free services in terms of radio broadcasting and reception of sound and pictures”; in short, the concessionaires of television and radio that have open reception are immune to the payment of the ICMS; cable TV broadcasters do not have immunity, because they are not free service; g) Immunity of the ICMS on the amount of the IPI tax when the operation presents generating event for both taxes and is intended for commercialization and industrialization (Article 155, § 2, Section XI of the FC/88). See Supplementary Law No. 87/96, Article 13, Section X, § 2; h) Immunity of the operations of electric power, telecommunications, petroleum, fuels and minerals; the ICMS, II and IE are the only ones to be charged; no other “tax” shall be charged on such operations; such immunity does not prevent the collection of special contributions, improvements, taxes and compulsory loans (Article 155, § 3 of the CF/88), the Supreme Court named this benefit as “the principle of exclusivity”(see RE 224957 AgR / AL – ALAGOAS); i) Immunity of the ITBI on real rights of guarantee: non-charge on mortgage and antichresis (Article 156, Section II of the FC/88); j) Immunity of the ITBI on the transfer of property or rights incorporated into the assets of the company in carrying out capital and transfer of assets or rights related to consolidation, merger, division, or dissolution of a corporation, unless the main activity is the acquisition of the company property or rights, the lease of movable assets, or leasing (Article 156, § 2, Section I of the FC/88); Article 37, § 1, of the Brazilian Tax Code defines “main activity”; k) Immunity of the ISS on services exported in terms of complementary law (Article 156, § 3, Section II of the FC/88); according to the sole Paragraph of Article 2 of the Supplementary Law No. 116/93, the ISS shall be charged on the services developed in Brazil, whose result is found within the country, even if the payment is made by a resident abroad; l) Immunity of the operations of transfer of property expropriated for agrarian reform: there is no payment of federal, state and local taxes (Article 184, § 5 of the FC/88).

26

There are circumstances in which the Constitution authorizes double taxation: in Article 154, Section II of the Constitution, it was allowed the extraordinary taxes of war to step into the powers of tax of other federal entities or to replicate taxes already included in the competence of the Union. However, since the trial of the Extraordinary Appeal No. 200788/MG, the jurisprudence of the Supreme Court has decided that there is no double taxation between taxes and contributions with similar calculation basis.

27

The following can be enrolled as cases of specific immunity: a) Immunity of IPI on industrialized products intended for export (article 153, § 3, section III, of FC/88); b) Immunity of the ITR on small rural areas operated by sole owner (article 153, section V and § 4): legal definition of small rural area - see article 2 of Federal Law No. 9,393/96, 100 hectares (Western Amazon and Pantanal); 50 hectares (polygon of drought and of eastern Amazonia); 30 hectares (in any other municipality); c) Immunity of Gold as a financial asset or negotiable instrument (article 153, § 5 and 155, § 2, section X, “c” of FC/88), only the IOF focuses on gold in this event; d) Immunity of ICMS on industrialized products intended for export, “excluding semi-processed products (article 155, § 2, section X, “a” of FC/88) Complementary Act 87/96, in article 3, section II, “included” in the immunity the semi-developed, which is why the exporting Member States receive a “compensation”; the Supreme Court in the trial of Adin No. 1,622/UF, respondent Nelson Jobin - see Informativo STF No. 90/97 - decided that such legal provision was constitutional; Now, ATTENTION: CONSTITUTIONAL AMENDMENT No. 42/2003 ENDED THE CONTROVERSY WHEN CHANGING THE WORDING OF THE SUBSECTION “A” and remove from it the reference to the semi-finished products; in addition, it was included in the benefit, specifically, the services provided to foreign and ensured the use of tax credit transactions, but let’s see the new wording of article 155, § 2, section X, “a”: “The ICMS will not

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

Therefore, the Brazilian tax system is clear in protecting the taxpayer, and this is one of its main characteristics. However, beyond such stipulation, this unprecedented level of relevance of the constitutional limitations on taxing power, one should not forget that, concomitantly, the New Tax Order in 1988 made the Brazilian tax system more complex. This is the second hallmark of the Brazilian tax system. Indeed, the tax competencies were granted in a strict, horizontal manner to federal entities, greatly reducing the possibility of double taxation28, establishing distribution which is not legally flexible. Besides, several tax types and subtypes were created, which allowed a better distribution of tax responsibilities among the federal entities. On the other hand, it made the organic set rather simple and more complex than it should actually be. Indeed, we can mention the following tax type: 1) Federal, State, District and Municipal taxes (Arts. 147, 153, 154, 155 and 156 of the 1988 Constitution); 2) Federal, State, Municipal and District fees, depending on the taxing power to charge fees, on the administrative competence to exercise regular police power be taxed on: a) on transactions transferring “goods” to other countries, on services provided to beneficiaries abroad, ensuring the maintenance and recovery of the tax charged on previous transactions and installments”; today, the financial compensation of the states by the exclusion of ICMS on semi-finished products for export is regulated by the new article 91 of the ADCT, which accepted the use of Law Kandir until its final rule (article 91 § 3 of ADCT); e) Immunity of ICMS on inter-state transactions of fuels, lubricants, liquid and gaseous fuels and electricity (article 155, § 2, section X, “b” of FC/88); article 9, § 2, of Supplementary Law No. 87/96 stipulated that the exemption will be valid only if the product is intended for distribution and marketing, if it is to the final consumer, there is payment of ICMS; ARTICLE 155, § 2 SECTION XII SUBSECTION “H” CF/88 STATES THAT SUCH BENEFIT IS ALSO NOT AN EVENT APPLIED IN THE EVENT OF A single incidence of ICMS on fuel and lubricants; f) Immunity of the ICMS and sound broadcasting services and of sound and images: The Constitutional Amendment No. 42/2003 (TAX REFORM), when including the subsection “d” to section X of the second paragraph of article 155 of the Constitution, has added a new hypothesis of tax immunity, by asserting that the ICMS does not cover “d) the provision of communication free services in terms of radio broadcasting and reception of sound and pictures”, in short, the concessionaires of television and radio that have open reception are immune to the payment of ICMS; the cable TV does not have immunity, because they are not free; g)) Immunity of ICMS on the amount of IPI when the operation presents generating event for both taxes and is intended for commercialization and industrialization (article 155, § 2, section XI of FC/88). See Supplementary Law No. 87/96, in its article 13, section X, § 2; h) Immunity of the operations of electric power, telecommunications, petroleum, fuels and minerals; the ICMS, II and IE are the only ones to be charged, no other “tax” will be charged on such operations; such immunity does not prevent the collection of special contributions, improvements, taxes and compulsory loans (article 155, § 3, the CF/88), the Supreme Court named this benefit as “the principle of exclusivity”- see RE 224957 AgR / AL – ALAGOAS; i) Immunity of ITBI on real rights of guarantee: non-charge on mortgage and antichresis (article 156, section II of the FC/88); j) Immunity of ITBI on the transfer of property or rights incorporated into the assets of the company in carrying out capital and transfer of assets or rights related to consolidation, merger, division, or dissolution of a corporation, unless the main activity is the acquisition of the company property or rights, the lease of movable assets or leasing (article 156, § 2, section I, of FC/88); article 37, § 1, of the Brazilian Tax Code defines what is “main activity”; k) Immunity of ISS on services exported in terms of complementary law (article 156, § 3, section II of FC/88); according to the sole paragraph of article 2 of the Supplementary Law No. 116/93, ISS is charged on the services developed in Brazil, whose result is found inside the country, even if the payment is made by a resident abroad; l) Immunity of the operations of transfer of property expropriated for agrarian reform: there is no payment of federal taxes, state and local (article 184, § 5 of the FC/88). 28

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There are circumstances where the Constitution authorizes the double taxation: in article 154, section II of the Constitution, it was allowed the extraordinary taxes of war to step into the powers of tax of other federal entities or to replicate taxes already included in the competence of the Union. It is noteworthy, however, that since the trial of Extraordinary Appeal No. 200788/MG the jurisprudence of the Supreme Court has positioned itself in the sense that there is no double taxation between taxes and contributions that have similar calculation base.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

or to provide specific and divisible public services (Arts. 145, Section II; and Art.147 of the 1988 Constitution); 3) Improvement fees to be charged by all federal entities, according to its competence to perform public works (Art. 145, Section III of the 1988 Federal Constitution); 4) Compulsory loan, which became a tax after the 1988 Constitution, and can only be imposed and collected by a supplementary law of the Union (Art. 148 of the 1988 Constitution29); 5) Special or parafiscal contributions with the following subtypes30. 5.1) Social Contributions 5.1.1) General social contributions: intended for any of the social rights of Article 6 of the Constitution, such as the social contribution of education-wage and contributions to the system of autonomous social services (Arts. 149 and 212, § 5; and Art. 241 of the 1988 Constitution); 5.1.2) Social Contributions to Social Security: intended for healthcare, social assistance and social security, such as the contributions mentioned in Article 195, Sections I, II, III and IV; Articles 239 and 7, Section XXVIII of the 1988 Constitution; 5.1.3) Contributions intended only for expenditure on social security (Arts. 40; 149, § 1º 167, Section XI; and 195, Section I, Subsection “a” and II of the 1988 Constitution); 5.2) Professional and economic corporate contributions charged in the interest of professional groups or economic categories (Art. 8, Section IV and 149, caput, of the 1988 Constitution); 5.3) Interventional contributions in the economic domain (Art. 149, caput and 177, § 4, of the 1988 Constitution); 5.4) Sui Generis31 Contributions, a new type of contribution created by the Constitutional Amendment No. 39/2002, which focuses on the municipal street 29

See trial by the Supreme Court of the Interlocutory Appeal No. 435914 AgR/MG.

30

Se trial of Extraordinary Appeal No. 396266/SC, whose summary is relevant to transcribe, in verbis: SUMMARY: CONSTITUTIONAL. TAX. CONTRIBUTION: SEBRAE: CONTRIBUTION OF INTERVENTION IN THE ECONOMIC DOMAIN. Act 8,029 of 04.12.1990, art. 8, § 3. Act 8,154 of 12.28.1990. Act 10,668 of 05.14.2003. C.F., art. 146, III, art. 149; art. 154, I, art. 195, § 4. I. - The contributions of art. 149, FC - social contributions of intervention in the economic and interest of professional or economic categories since they are subject to the supplementary law of art. 146, III, FC, this does not mean it should be established by a supplementary law. The social contribution of art. 195, § 4, FC, due to “other sources”, for its institution shall be observed the technique of residual powers of the Union: FC, art. 154, I, ex iv of the former provisions of art. 195, § 4. The contribution is not a tax. Therefore, there is no requirement that the supplementary law defines their hypothesis of charging, the tax base and contributions: FC, art. 146, III, a. Precedent: RE 138.284/ CE, Minister Carlos Velloso, RTJ 143/313; RE 146.733/SP Minister Moreira Alves, RTJ 143/684. II. - The contribution of SEBRAE - Act 8,029/90, art. 8, § 3, wording of the Acts 8,154/90 and 10,668/2003 - is contributing to intervene in the economic domain, although the law refers to it as additional to the rates of general social contributions related to entities mentioned in art. 1 of D.L. 2,318/86, SESI, SENAI, SESC, SENAC. It is not, therefore, included the contribution of SEBRAE in art. 240, F.C. III. - Constitutionality of the contribution of SEBRAE. Constitutionality, therefore, of § 3 of art. 8 of Act 8,029/90, with the wording of the Acts 8,154/90 and 10,668/2003. IV. - R.E. known, but improvisation.

31

See trial by the Supreme Court of Special Appeals No. 573675/SC - SANTA CATARINA, in literris: SUMMARY: CONSTITUTIONAL. TAX. RE INTERPOSITION AGAINST DECISIONS TAKEN IN DIRECT ACTION OF STATE UNCONSTITUTIONALITY. CONTRIBUTION TO THE FUNDING

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lighting service which cannot be taxed by the general activity of the State (Art. 149-A of the 1988 Constitution. Therefore, it remains clear that the second moment of striking features in the new Brazilian tax system, inaugurated through the 1988 Constitution 1988, lies in its strictness in grants and division of tax powers, while imposing itself with an unprecedented degree of complexity, given the unprecedented amount of many types and subtypes of taxes, which, if it is provided a specific taxation for certain sectors and activities, they also create an environment of apparent tax excess, without simplicity and without greater transparency to people. In the meantime, however, it is relevant to mention that this second characteristic, complexity, has been significantly impacted by the perennial and constant phenomenon of “tax reform” that has been implemented since the early 1990s. Indeed, one may not forget that the tax reform, a phenomenon so publicized and decanted, is actually a process waiting for a future time to occur, and it is not a phenomenon that occurred in a neutral way in the Brazilian post-1988 tax system. On the contrary, there have been several tax and constitutional reforms and, however, that in all topical or comprehensive tax reforms which occurred in Brazil from the Constitutional Amendment No. 03/93 to the Constitutional Amendment No. 42/2003, the last significant tax intervention of the derived constituent power, the main victim of this process has been the simplicity of the system, smaller, and the sphere of interests of taxpayers. Indeed, contrary to what one might imagine at first, the tax reform has been somewhat systematic and common in our legal order since the 1988Constitution , given the endless legislative production of the derived constituent power and the additional federal legislator. Thus, it would be more accurate to talk of “tax reforms” than simply “tax reform”, as referred to recently when the advent of the very Constitutional Amendment No. 42/2003, which consolidates important additional topic changes to those previously undertaken in an almost imperceptibly way, by many constitutional amendments.32 OF PUBLIC LIGHTING SERVICES - COSIP. ART. 149-A OF THE CONSTITUTION. SUPPLEMENTARY LAW 7/2002 OF THE MUNICIPALITY OF SÃO JOSÉ, SANTA CATARINA. COLLECTION ON THE ELECTRICITY BILL. UNIVERSE OF TAXPAYERS THAT DOES NOT MATCH THE UNIVERSE OF BENEFICIARIES OF THE SERVICE. CALCULATION BASE THAT TAKES INTO ACCOUNT THE COST OF LIGHTING AND ENERGY DEMAND. PROGRESS IN OF THE RATE THAT EXPRESSES THE APPORTIONMENT OF THE EXPENSES INCURRED BY THE MUNICIPALITY. OFFENSE TO THE PRINCIPLES OF ISONOMY AND ABILITY TO PAY. NON-OCCURRENCE. EXACTION THAT RESPECTS THE PRINCIPLES OF REASONABLENESS AND PROPORTIONALITY. EXTRAORDINARY RESOURCE IMPROVE. I - Law restricting taxpayers of COSIPA to consumers of electricity in the city does not offend the principle of equality, the impossibility of identifying and taxing all recipients of public lighting services. II - The progressivity of the tax rate, resulting from the apportionment of the cost of street lighting among consumers of electricity, does not offend the principle of ability to pay. III - Tax of sui generis character, that is not confused with a tax because its income is for a specific purpose, not with a fee, since it does not require the consideration of an individual taxpayer service. IV - Exaction, moreover, that is shaped in accordance with the principles of reasonableness and proportionality. V - Extraordinary appeal known and improve . Plenary, 03.25.2009 32

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We might mention how constitutional amendments changed in a way the Brazilian tax system: Amendment No. 03/93; Amendment review No. 01/94; Amendment No. 10/96; Amendment No. 12/96; Amendment No. 14/96; Amendment No. 17/97 Amendment No. 20/98; Amendment No. 21/99; Amendment No. 27/2001; Amendment No. 29/2000; Amendment No. 31/2000; Amendment No. 32/2001; Amendment No. 33/2001; Amendment No. 37/2001; Amendment No. 39/2002; Amendment No. 41/2003; Amendment No. 44/2004. All these constitutional amendments had in the tax law its principal object or accessory, modifying the tax system. Still, besides all these constitutional amendments on the subject, one cannot forget the alteration of the tax system that was gradually and “technically” implemented (non-political) for several additional federal laws, such as the Complementary Law No. 87/96 (the KandirLaw, which gave a minimally rational structure to the ICMS and was modified several times), the Complementary Law No. 100/2000 (which allowed the taxation by the ISS of the franchise of public maintenance of roads and toll collection), the Complementary Law No. 101/2000 (which

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So, it is not an irony to state that the Brazilian tax system today is already quite different from the original one, brought by the Constituent Assembly and, in most cases, the alterations made do not affect the tax; actually, they increased their tax and administrative competences, created new chances for exactions, created new chances of exacerbation of existing taxes, et caterva, which allowed the huge jump in the tax burden of the nineties, when the taxation of GDP jumped from 26% (1994) to approximately 38% (2004). Thus, we can cite several benefits to taxpayers proceeding of the tax reforms, such as the extension of the principle of transparency (Article 150, § 6 of the Constitution), the establishment of the general or generic ninetieth principal, and the recent introduction of the national system of differentiated taxation applied to small businesses, having as guaranteed that all these additional guarantees to the taxpayer lived with extensions of tax powers and of inspection administrative powers of the tax authorities, whose interests have always prevailed, despite all the cries of society, increasingly suffocated. Therefore, it seems significant to mention that the impact of small tax reforms, made gradually in recent years in Brazil through constitutional amendments, supplementary laws and ordinary statutes, broaden the range of fiscal and administrative action of the Treasury, generating more tax burden. Therefore, it does not seem over affected neither prosaic to put the following transcript of the last book written by Alfredo Augusto Becker in the transcript that appears to behold enough current aspects, despite its metaphorical language, in literis: “Fiscal Shipwreck: the irrational taxation of recent years has led taxpayers (especially the employees) to such a state that now they only have the underwear. And, besides the underwear, they have just keep faith and hope in changing this state of things simultaneously with the change of the Ministers of Finance and Planning. However, if these taxpayers were taxed even the underwear, then they will lose faith and hope. Unfortunately, there are solid reasons for this to happen”33 Finally, the second prominent characteristic of the Brazilian tax system, namely its complexity and systemic stiffness, was significantly impacted by alterations and that only expanded the range of the Brazilian National Treasury and made our system even more costly for taxpayers. Finally, it is also a prominent characteristic of the Brazilian tax system, created by the 1988 Constitution, the institutionalization of a federal tax-sharing of financial and tax cooperation, which is translated in the rules for transfers referred to in the Articles 157, 158 and 159 of the Constitution in determining mutual and priority aid among the various Treasuries, according to the terms of Art. 37, Sections XVII and XXII, of the Lex Fundamentalis, the stipulation of Article 100, § 16 of the “Lei Maior” [Major Law] which describes the tax liability for the creation of taxes provided in the taxing power and also the difficulties in reducing the tax burden in Brazil), the Complementary Law No. 104/2001 (which amended several provisions of the Brazilian Tax Code), the Complementary Law No. 105/2001 (which expanded the surveillance powers of taxation of tax agents to the point of determining the tax privilege to get directly to financial institutions the bank secrecy of taxpayers), the Complementary Law No. 116/2003 (which created new comprehensive legislation on the incidence and recovery of the ISS), the Complementary Law No. 118/2005 (which amended several articles of the Brazilian Tax Code and expanded the powers of the tax supervision) and the Complementary Law No. 123/2006 (which created the differential tax regime for micro and small businesses). Still, due to its impact, it is relevant to mention the Law No. 11,457,March 16, 2007, which created the Federal Revenue in Brazil, called “super-Revenue”, with significant impacts on tax supervision and administration. 33

Carnaval Tributário. 2ª ed. São Paulo, Lejus, 1999, p. 15.

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authorizes the Union to take district and municipal unpaid debts of precarious States, and the provision that is the obligation of the Federal Senate to examine the functionality and efficiency of national the tax system, according to the Article 52, Section XV of the 1988 Constitution . Such tax solidarity is remarkable to determine the autonomist process in public finances that the 1988 Constitution tends to implement, although there have been impediments during the 1990s of the last century, when a process of re-concentration of tax burden in the Union almost destroyed the good institutional environment inaugurated by the 1988 Constitution. In conclusion, these prominent characteristics of the Brazilian tax system do not seem to be blurring over time – unlike, as one may see, but it will be very relevant to the critical analysis that will be presented on the next topic of this study.

3. The Current Brazilian Tax System. A Brief Critical Analysis: The Decalogue of Ten Disadvantages of the Brazilian Tax Order, and the Need to Improve Them The Brazilian tax system, as presented, has its peculiarities and essential characteristics, which were seen in the previous topic and which is its structural axis and its foundation. However, a brief analysis and a critical approach of the Brazilian tax system is necessary and recommended, noting its main advantages, its points that deserve improvement and its peculiarities in general. Sometimes, in an overview, there is nothing in the world like the Brazilian tax system. It is not common to compare the Brazilian tax system to a “jabuticaba,” but perhaps we should do it. The positive and negative characteristics of the tax system are really unique and peculiar. Initially, we recall some doctrine aspects about the tax systems that are considered of good stock. According to the doctrine, each tax system should be efficient. But how? It should have minimum cost, a good collection of taxes; enough levy to meet public needs. It should encourage both economic and social development. It should ensure legal certainty, maintain a regulatory framework enabling individuals, corporations, and investors to plan their economic activities. It should ensure privileges, formal and material, to the taxpayer. It should enable the regular, reasonable and isonomic practice of the taxing power and, finally, it should come from a political pact that ensures the non-existence of conflicts that end up, in some way, destroying the legal-tax mark. Is the Brazilian tax system endowed with all these characteristics briefly mentioned? It will be briefly analyzed hereafter. Initially, I should note that, historically in Brazil, there is resistance to taxation. Quickly, we can point out two prominent historical events:

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Inconfidência Mineira and Revolução Farroupilha. The Inconfidência Mineira, in the 18th Century, occurred because of the excessive taxation during thats period, the tax charged by the Portuguese crown, representing one fifth of the value of gold produced at the mines. It is the origin of the idiomatic expression “quinto dos infernos” [the deep hell]. Portugal eventually decided to collect older taxes at once. This situation resulted in the Inconfidência Mineira. In turn, the Farroupilha Revolution was a tax problem related to the agribusiness in the Rio Grande do Sul State. Historically, taxation in Brazil was born already in conflict. Nowadays, we can say that the tax system, as an organized system of rules on taxation, only rises in Brazil through the 1946 Constitution; before that, there were sparse rules that cannot be considered a “tax system”. This system had an initial reform, the famous reform by the Amendment No. 18 in 1965, which was discussed earlier in this study. Since then, it has emerged in Brazil a fiscal Sebastianism. The solution to the country, its panacea, is to carry out a tax reform… as usual, the next tax reform will redeem us. The tax reform is the goal. Since then, we have made tax reforms without having yet reached a completely balanced point to satisfy the taxpayers and federal entities. But we must remember that, after the 1988 Constitution, which already rationalized it and brought more organization to the Brazilian tax system, we have already had at least two dozen constitutional amendments on tax reform, directly or indirectly; they are concerned to formally constitutional tax changes, apart from impacting changes in infra-constitutional legislation, as discussed earlier in this paper. Most of these changes have worsened the tax reform, which has come to increase the taxing power of the state rather than the interests of taxpayers. Evidently, even after the latest constitutional amendments, one must acknowledge the valuable aspects of the Brazilian tax system. Firstly, it makes a list of detailed division of tax powers. We know what the competence of the Union, States, and Municipalities is; at least we know what the competence of each one is. Still, it is found in our Constitution a comprehensive list of constitutional limitations of the taxing power: tax principles, classic and general immunities, and specific immunity. Furthermore, we have an excellent structure of cooperative and of fiscal federalism. That is, tax revenues of the Union are passed on to the States and the Municipalities; without previously hearing the States, several constitutional transfers are passed on to the Municipalities, and although it is true that there is a lot of tax centralization, this feature turns out to be understated by this movement towards decentralization of income earned in a nuclear way, especially in the Union. However, despite these positive characteristics, which were already analyzed in this article, there are points that need to be improved.

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The first negative point or disadvantage: excessive constitutionalization

In the world, there is not a constitutional tax system as meticulous as the Brazilian. There is not anything in the world as detailed and meticulous as the second Paragraph of Article 155 of our Constitution. Detailing operational and practical aspects of collecting a tax could be in ordinary or supplementary law. This excessive constitutionalization allows an excessive administrative, judicial, and litigable discussion; all of them are matters of constitutional tax law. An ironic subject has been created, “unconstitutional tax law,” because all you can claim that is unconstitutional is opposed, goes against a principle, against the rules. So, is it wise to dwell on the next lesson, which was given by Marçal Justen Filho about the constitutionalization of our tax system, in verbis: It is established that the characteristic nature of the Brazilian tax system is its constitutionalization. From a study of precursor ATALIBA1, there has been an absolute awareness of the uniqueness of the national tax system. All other States have adopted different configurations for their tax order. While abroad, the tax system consists of infra-constitutional level, the Brazilian Constitution has a detailed, complex set of tax rules and principles. The Constitutions of other countries contain a few provisions to tax. They refer, to the ordinary law (or even to administrative acts), the development of the tax system. In Brazil, the situation is completely different. The Constitution contemplates hundreds (or thousands) of tax provisions. There is a “constitutional statute of the taxpayer,” built from the set of limits on the taxing power. Furthermore, the Brazilian system contemplates the picture of a “supplementary law”, widely used for tax purposes and, which does not have exact parallel in the comparative law. It is noteworthy that even the more recent Constitutions of the European States have not incorporated the fruits of the Brazilian experience in this matter. It is even possible to deem that the Constitutions of Portugal and Spain are much more detailed than the letters issued by other European countries concerning, in particular, the tax law. But it is impossible to identify the scattered provisions about tax law with rigorous, comprehensive and thorough discipline of the FC/88. It is clear that this constitutionalization of the tax system in Brazil does not portray casual or anomalous phenomenon. It is not about circumstances related to the current Constitution. The model of the FC/88 is consistent with the Brazilian “constitutional tradition”. This experience has been developed since at least the 1891 Constitution. Analyzing the contents of the various constitutions, we find that the issue of a new Constitution has always produced expansion of the stiffness and exhaustibility of the tax constitutional system. The peculiarities of the Brazilian constitutional tax system have influenced the development of doctrinal studies and the process of interpreting-application of the infra-constitutional rules. It would not be excessive to state that it has been pro-

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duced the development of indigenous legal knowledge in Brazilian tax law as an immediate consequence of the absence of a line with other jurisdictions. All comments made by ATALIBA in 1965 remain fully valid years after34. Therefore, this excessive constitutionalization is a bad aspect because it undermines rationality and system flexibility, allowing an exorbitant degree of constitutional discussion. Indeed, since many subjects of taxation are constitutionalized, the re-adaptation and modernization of the tax system involve the enactment of constitutional amendments whose approval depends on a qualified quorum, not always available, especially if the alteration is not in the fiscal interest of federative entities, which affects the interests of taxpayers and explains the predominance of constitutional amendments that led to the increase of tax burden, and, most relevant and disgusting, this excessive constitutionalization makes our legal-tax order more rigid than necessary and ideal. The second disadvantage of the Brazilian tax system is its excessive tax type and subtype, generating unnecessary complexities in material and operational aspects. There is not in the world a tax system with so many tax types and subtypes. There are taxes, fees, loans and contributions to improvements (to be immovable properties), special or parafiscal contribution subdivided into social contributions, which is only social security, or general social and social security; corporate contributions that can be professional or economic; interventional contribution and contributions sui generis, as previously presented in this chapter. This huge amount of tax type generates an unnecessary litigious focus, because the discussion is often whether it is a type or other subtype, which will have different legal consequences, and make the rationality of the system, its organicity, and even the visualization of these tax revenues something difficult to cope. Evidently, if there were fewer tax types and subtypes, including sui generis, there is greater simplicity in the Brazilian tax system. For example, we have three taxes on consumption, each with taxing authority granted to different federal spheres: the IPI (for the Union), the ICMS (for the States) and the ISS (of the Municipalities). If there were a single consumption tax, focusing on whether or not the added value, which is another discussion, we would be less complex and more effective. Finally, the Brazilian system is more complex and rigid than what is expected in terms of quantity and quality of tax types and subtypes. In this sense, it is also a consequential disadvantage to this proliferation of tax type: overuse of provisions that obstruct the knowledge or the application of tax laws. In Brazil, it is provided in the Article 13, § 1 of the Supplementary Law No. 87/96, that a tax might be charged on the same tax, that is, its calculation basis will include its own 34

JUSTEN, Marçal Filho. Sistema Constitucional Tributário: Uma Aproximação Ideológica, Biblioteca Digital Interesse Público - IP, Belo Horizonte, ano 1, n. 2, abr. 1999.

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value. More specifically: the ICMS on the same calculation basis is a tax that focuses on its own basis!35 But there are other cases of a lawsuit of incidence of taxes camouflaged of exaction on an exaction, such as the case of the COFINS, the ICMS, the IPI, etc.36 Such devices are unnecessary and avoidable, generating an additional, inertial tax burden, powered without any systemic justification, besides generating legal uncertainty incompatible with the necessary rigor for a proper planning of the state budget and a good tax planning by taxpayers, all affected by uncertainty that comes from trials that may take years to come37. Finally, the excessive quantity and “depth” of tax types and excessive creative tax criteria raised to differentiate them, or make them unique and maximally collectable, are a disadvantage of our tax system, which becomes cloudy and little simplistic. Meanwhile, we also consider provisions which hamper the knowledge and application of tax laws, as well as the excessive use of indirect taxes. However, due to their importance, this overuse of types and subtypes that utilize indirect tax is pointed out a third disadvantage of the Brazilian tax system. Indeed, the regular Brazilian citizens do not know how much they pay. If they did, we would certainly have another revolution, a Brazilian one. We have many indirect taxes, and this is very negative for the economy, society, and Brazil. Meanwhile, it is a good idea to transcribe a major study on the impact of indirect taxes on the Brazilian tax ratio, being the Cofins identified by this study as the most relevant, as well as the contribution to the PIS, the IPI, taxes on import, the ICMS, and the ISS, in literis: Tax burden in Brazil reached 35.80% of the GDP in 2008, raising the amount of R$ 1,034 trillion. This amount includes the portion of R$500 billion in the category of

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In the trial of Extraordinary Appeal No. 582461 RG/SP - SÃO PAULO, The Supreme Court recognized the general repercussion of the discussion of the constitutionality of this unique methodology of calculation of ICMS. However, it must be remembered that, about ten years ago, the very Supreme Court corroborated with this approach, deeming it constitutional, but let’s see the summary of the trial of Extraordinary Appeal No. 254202/SP, in verbis: “TAX ON CIRCULATION OF GOODS AND SERVICES - ELECTRICITY - CALCULATION BASE - INCLUSION OF PROPER VALUE. In the opinion of the majority, understanding to which I have some considerations, the Tax on Circulation of Goods and Services is calculated by integrating the value resulting from it. Previous: Extraordinary Appeal No. 212.209-2/RS, which I reported in the plenary, and judged on June 23, 1999, having been appointed editor for the ruling Minister Nelson Jobim”. Finally, it should be mentioned that the Constitutional Amendment No. 33/2001, among other changes, stipulated the introduction of the subsection “i” to section XII of the paragraph 2 of article 155, explicitly authorizing this self-referential incidence of ICMS on their calculation base, in an apparent attempt to “constitutionalize” this matter.

36

In the trial of Extraordinary Appeal No. RE 574706 RG/PR - PARANÁ, the Supreme Court thought it should have considered as “Recognized the general repercussion of the constitutional issue concerning the inclusion of ICMS in the calculation base of COFINS of contribution to PIS. Pending trial in the plenary of the Supreme Court of Extraordinary Appeals No 240 785”.

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Meanwhile, we have as an illustrative example the recent trial of the issue of order in a Declaratory Action of Unconstitutionality No. 18, which extended for six months injunction previously granted by the Supreme Court, in verbis: “Summary: Matter of order. Precautionary measure. Declaratory action of constitutionality. Article 3, § 2, section I of Law 9,718/98. COFINS and PIS/PASEP. Calculation base. Billing (art. 195, section I, subsection “b” of the Constitution). Excluding the value related to ICMS. Prolongation of the injunction. Due to the proximity of the end of the term of the injunction (art. 21 of Law No. 9,868/99), in the same terms decided by the Court which ruled in ADPF No. 130-Q, the rapporteur of the Minister Carlos Britto, it is resolved the matter of order to extend the effectiveness of the injunction for another 180 (one hundred and eighty days) from this date”. (ADC 18 QO-MC/DF; FEDERAL DISTRICT; MAATER OF ORDER IN CAUTIONARY MEASURE. DECLARATORY ACTION OF UNCONSTITUTIONALITY; Rapporteur(a): Minister MENEZES DIREITO; Judgment: 04/02/2009; Judging Body: Full Court

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taxes on goods and services, denoting a significant share of these taxes to 48.40% of the total tax revenue. The indirect taxes, following the classification from the study of the Brazilian Federal Revenue , as taxes on goods and services, include the: ICMS COFINS PIS IPI ISS Imports It is noted that the importance of the ICMS in total tax revenues of the 26 States and the Federal District is clearly identified by its shareholding of more than 82% of the total collected by them, as well as the participation of about 21% in national revenues. At the federal level, the four taxes within its jurisdiction and by laws of their own account for over 35% of the national revenue and 25% of the collection sub-categories of indirect taxes (in R$ billions). (...) The indirect taxes are usually levied on the entire production chain, having its effects on the prices paid by end consumers but not perceived by them, inasmuch as they are inseparable parts of the prices. In previous stages to the final consumption, participants in the supply chain may have the right to the rebate of taxes paid, depending on its tax form (cumulative or noncumulative). Indirect taxation, since it is incorporated into prices, also affects the competitiveness of organizations. Thus, the degree of affectation of indirect taxes on prices depends on the transfer of those taxes on the production chain that considers their operational specifics, which is not always finding the exact predictability in their legislation38. Therefore, it is striking, in its proportional weight of the Brazilian tax system, the adoption of indirect taxes, which induces the occurrence of regressive tax burden, the lack of transparency for the taxpayer and even encourages tax evasion. Finally, it remains evident that the decrease of the relevance of indirect taxes should be a goal of any serious tax change in Brazil. In the same way, which involves distortion of the Brazilian tax system, it should be mentioned as a fourth disadvantage of the Brazilian tax system the absence of major concerns with equity and fiscal justice in the instant of granting tax benefits by the ordinary legislation, which undermines the legitimacy and sustainability of the system in the long-term.

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“Tributos Indiretos no Brasil”, collective authorship of the consulting company KPMG tax advisors ltda, available at: www.kpmg.com.br/ publicacoes/tax/impostos_indiretos/Tributos_Indiretos_no_Brasil.pdf+tributo+indireto+e+carga+tribut%C3%A1ria+no+brasil&hl=pt-BR& gl=br&pid=bl&srcid=ADGEESgDoTtOw3oYQbe_ujYZ_CqDC6kAX2KDmBynOOc72UclQo8KysJPmc7RGLMqMjG4i6IVXrRebU8c3tZQEvyUOS V5bpmoJAQPVIciIchbiBkqDwD_7ysapo25-PVWo_NbWaEsna_z&sig=AHIEtbSM_6QkvU6CbMdruQ0GB5dS11-Ziw

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In this aspect, I can point out some legal provisions that bring benefits to specific groups or activities, deeply questionable from the point of view of equality, fiscal transparency, and the ability to pay. In Brazil, for example, the distributions of dividends or profits paid or credited by corporations taxed based on actual, estimated or arbitrated profit are not taxable, with such exemption granted by the Article 10 of the Ordinary Federal Act 9249/9539, useful and effective to establish, in fact, two tax benefits: 1) the distribution of profits and dividends by a corporation, which pays no income tax; 2) the remittance of profits and dividends abroad does not pay income tax in Brazil. Furthermore, the Article 9 of the same Ordinary Federal Law No. 9,249/95 established one of the most outlandish and creative tax benefits of the history, a true Brazilian tax unknown by the population, but that generates an unnecessary embezzlement of hundreds of millions of dollars per year to federal coffers: the exemption from paying income tax on the payment of interests on capital! This payment of interests on capital actually masks a new mode of distribution of profits because the company can deduct the amount of “interest” paid to its shareholders as if it were a mandatory “expense”, excluding the incidence of social contribution on the profits and income tax of legal entities, at the same time as such the payment is taxed at source by the beneficiaries, with an immutable standard ad valorem tax rate of 15% and that will not increase in the adjustment of income tax of individuals. That is, it is the value paying less tax income than wage gains, which may pay rates of up to 27.5% of the income tax. Such benefit is a real fiscal “magic” Its knowledge and use are only available to beginners in the art of the “Brazilian tax planning”, something denied to the Brazilians in general who are not aware of the real “trick” referred to in our censurable law. It is noteworthy that only these comprehensive exemptions of capital led the Union to stop collecting billions of Brazilian reais by taxing40.

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Literal transcription of the legal provisions, in verbis: Art. 10. Profits or dividends calculated based on the results compiled from the month of January 1996, paid or credited by corporations taxed based on actual profit, estimated or arbitrated, shall not be subject to the tax withheld at source, or integrate the basis for calculating income tax of the recipient, whether individuals or corporations domiciled in Brazil or abroad. Sole Paragraph. In the case of quotas or shares distributed as a result increase of capital by incorporation of profits accrued from the month of January 1996 or from reserves built up with such profits, the acquisition cost shall be equal to the portion of profit or reserves capitalized, which corresponds to the partner or shareholder.

40

About impact of these tax expenditures, there are an interesting text extracted from the website Unafisco, National Association of Independent Federal Revenue in Brazil, authored by its Department of Technical Affairs, in verbis: Tax Waiver in Favor of Capital Over the past few years, the state is giving up significant tax revenues in favor of capital income. Some of this cession is the deduction of interest on capital of business from taxable income of the income tax and social contribution. Since 1996, Law 9,249/95, article 9, allows corporations taxed on actual profits that remunerate individuals or entities, regarding interest on capital, to consider such values as expenses for purposes of calculating the Income Tax for Corporations (IRPJ) and the Social Contribution on Net Value (CSLL). Interest on capital Interest payments on capital are becoming a reduction mechanism in the collection of IRPJ and CSLL. According to the newspaper Valor Econômico (08/18/2005), while profit before income tax of 216 publicly-traded companies jumped from R$3.99 billion in 2002 to R$49.72 billion, that is, an increase of 12 times, provisions of IR and CSLL has increased only six times (from $2.19 billion to R$12.28 billion). The newspaper highlights that “the most common reason that contributes to reducing the amount of taxes paid on income was the interest on equity, alternative adopted by companies today to the distribution of profits”. Only in 2004, the distribution of interest on equity resulted in a tax waiver of $3.1 billion. In 2005 that figure might grow significantly because of the extraordinary profit of the banking system and of large enterprises. For example, this mechanism has allowed the ten

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However, some advocate in favor of these privileges, perhaps hateful, already granted to holders of monetary and financial capital, claiming that it would not even be tax benefits, but simple cases of non-incidence of income tax, which could not have “dual” nature”41. For obvious reasons, even in the face of the systemic evaluation done, we believe that these benefits are not good for the health and effectiveness of our system, particularly regarding their fiscal fairness. In addition to the censurable benefits previously described, we cannot forget that the Provisional Measure No. 1,982-67/2000, in its Article 3, § 5, determines that any payment of profit sharing to employees will be taxed as any other income source is, subjecting to the adjustment in taxable value at the end of the fiscal year, i.e., there are glaring absence of isonomy between worker and capitalist by the expressed determination of our tax legislation, which is far from being equitable and fair. But the absence of isonomy does not cease at this point.

largest banks in the financial system - that presented a profit record in the first half of this year (R$ 11.3 billion) - to pay interest on equity the amount of R$3 billion. It reduced the cost of tax charges of these banks in R$ 1 billion, representing a tax waiver of the Brazilian state in favor of the banks, totaling R$ 570.7 million in the first half of 2005. Exemption from IR on the distribution of profits and dividends Since January of 1996 (article 10 of Law 9,249/95), the distribution of profits and dividends are exempt from income tax (IR). The same law exempts from taxation the remittance of profits abroad. An estimate based on the Consolidated Report of the main registers in the Information Statement of Economic and Tax of Legal Entities (DIPJ) of 2000 (last published by the Internal Revenue Service) allows us to determine if the distribution of profits and dividends was taxed at the table of Income Tax at an average effective tax rate of 25%, the state would raise R$ 4.9 billion in 2004. Only banks have distributed profits to its shareholders the year before, profits and dividends of R$ 6 billion, which would imply a collection of IR of R$ 1.5 billion. IR on remittances of profits and dividends abroad In 2004, according to the Central Bank of Brazil, US$ 8.3 billion were sent abroad in the form of profits and dividends, with US$ 5.9 billion in income of direct investment and $ 2.4 billion in income of portfolio investment. Even the Central Bank annual report of 2004 (p. 143144) highlights the significant growth (53.4%) of remittances of net income abroad, mainly the remittance of profits and dividends in resources invested in investment portfolios. Converting the value of US$ 8.3 billion at the exchange rate of R$ 2.65 (30/12/2004) we have the amount of R$ 21.9 billion, which if it were taxed at a rate of 15% (which lasted until 1996), it would generate a tax revenue of R$ 3.3 billion. Therefore, it is estimated that in 2004 the state failed to raise about R$ 11.3 billion with only those waivers. 41

This is the text of the professor Kioschi Harada, extracted from the website http://www.uj.com.br/publicacoes/doutrinas/5609/ Tributacao_de_Lucros_e_Dividendos Taxation of Profits and Dividends The Law No. 3,007/08, authored by Deputy Chico Alencar, of PSOL of Rio de Janeiro, through the amendment of art. 10 of Law 9,249/95, establishes the tax by income tax on profits or dividends paid or credited by corporations to the beneficiary, person or entity, domiciled in the country. Its sole paragraph determines the withholding of 15%, while profits or dividends are credited to the beneficiary resident abroad. This is not the first attempt to impose this odd tax burden. And it will not be the last. There will always be a lawmaker willing to resurrect the weed buried by most legislators. In 1999, the Deputy Milton Temer presented a substitute to Law No. 377/99, introducing this tax as an alternative means to compensate the drop in tax revenues resulting from the restatement of the income tax, caused by a lawsuit. At the time, we present a contrary view on the condition Advisor of the IASP. The legislative measure has failed. After almost 10 years is it brought to the table again, at the moment that the RFB hits successive records of revenue. What a lack of sensitivity of the noble Deputy Chico Alencar! In your lame excuse, the Deputy who proposed this legislative measure makes considerations of significant financial resources remitted abroad: U$ 21.236 billion in 2007, against U$ 16.4 billion in 2006, when, in 2002, this value was only of US$ 5.2 billion. There is so much concern about the relationship investment/remittance as if the capitalization of the company were an end in itself. This type of exasperated xenophobia does not lead to economic development, to the development of the well-being of society. If there is large remittances it is because companies located here are generating large profits, fulfilling its role of inducing agents of wealth and absorption of manpower. It would be bad if the companies were breaking, rather than be referring profits. Certainly in this case there would be cause for concern, including those of a legislative nature. We need to stop waving the banner of inconsequential nationalism, and start seeing the economic phenomena with a global vision. We must act consistently. It is not possible to develop a policy to attract foreign investment, and at the same time, to propose a legislation that could scare off companies already established in the country. ... . The misguided and disastrous legislative proposal does not repeal the exemption, which does not exist, but deploys the double taxation of income earned by a partner or shareholder, what openly hurts the principles of rationality, reasonableness and of equality of taxation, distancing it from the concept of tax fairness that the author of the proposal claims to be taken into account.”

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In Brazil, the income tax is not imposed on foreign investments in the stock exchange, pursuant to article 1 of Ordinary Federal Law No. 11,132/2006. Would foreigners come to our stock market if there were no such tax benefit? Before this benefit, did they invest in our country? This is a tax benefit that was not extended to domestic investors, in inequalitarian legal treatment. Furthermore, more recently Presidential Decree No. 6,613/2008 established the exemption of Tax on Financial Operations (IOF) to transfers of foreign currency abroad, to remittances of interest, and to purchase of foreign currency by financial institutions, maintaining the general rate of 0.38% in other types of operations. Also, this benefit of zero rates extended to investment funds, portfolios and securities, funds or programs and private entities. It has been even determined tax compensation pursuant to article 14 of Fiscal Responsibility Law, and no such benefit was granted for a limited period. Still, in the same way, we cannot forget the relevant detail that, under article 85 of the Temporary Constitutional Provisions Act, the Provisional Contribution on Financial Transactions (CPMF) was paid by Brazilians workers and retirees, but it was not paid by speculators, by foreign investors in the stock market, in accordance with articles 84 and 85 of the Temporary Constitutional Provisions Act of the Constitution in force42. Moreover, it is noteworthy that this benefit was curiously regulated by the Article 3 of the Presidential Decree No. 6,140/2007, constituting a glaring exception to the provisions of The Article 146, Section II of the Constitution.

42

The Constitution says: Art. 84. A provisional contribution on circulation or transfer of values and of claims and rights of financial nature, provided for in arts. 74, 75 and 80, I, of this Temporary Constitutional Provisions Act, will be charged until December 31, 2004. (Included by Constitutional Amendment No. 37, 2002) § 1º It is extended until the date mentioned in the main part of this article the validity of Law No. 9,311 of October 24, 1996, and its amendments. (Included by Constitutional Amendment No. 37, 2002) § 2º The proceeds from the collection of social contribution that is referred to in this article will be devoted to the portion corresponding to a rate of: (Included by Constitutional Amendment No. 37, 2002) I - twenty hundredths percent to the National Health Fund to finance activities and health services; (Included by Constitutional Amendment No. 37, 2002) II - ten hundredths percent to funding the social security; (Included by Constitutional Amendment No. 37, 2002) III - eight hundredths percent of the Fund for Combating and Eradication of Poverty, referred to in arts. 80 and 81 of this Temporary Constitutional Provisions Act. (Included by Constitutional Amendment No. 37, 2002) § 3º The rate of contribution under this article shall be: (Included by Constitutional Amendment No. 37, 2002) I - thirty-eight hundredths percent, in the fiscal year of 2002 and 2003: (Included by Constitutional Amendment No. 37, 2002) Art. 85. The contribution referred to in art. 84 of this Temporary Constitutional Provisions Act shall not charge, from the thirtieth day of the publication of this Constitutional Amendment, the: (Included by Constitutional Amendment No. 37, 2002) I - bank accounts for deposits specially and exclusively used for open operations: (Included by Constitutional Amendment No. 37 of 2002) (See Law No. 10,982, 2004) a) boards and providers of clearing and settlement services that is referred to in the sole paragraph of art. 2 of Law 10,214, of March 27, 2001; (Included by Constitutional Amendment No. 37, 2002) b) insurance companies that are referred to in Law No. 9,514 of November 20, 1997; (Included by Constitutional Amendment No. 37, 2002) c) corporations whose sole objective is the acquisition of credits arising from transactions practiced on the financial market; (Included by Constitutional Amendment No. 37, 2002) II - in bank accounts for deposits, relating to: (Included by Constitutional Amendment No. 37, 2002) a) purchase and sale of shares held in places or trading systems of stock exchanges and in OTC market; (Included by Constitutional Amendment No. 37, 2002) b) contracts referenced in stocks or stock indexes, in its various forms, traded on stock exchanges, commodities and futures; (Included by Constitutional Amendment No. 37, 2002) III - accounts of foreign investors, relating to entries in the country and remittances abroad of financial resources used exclusively in operations and contracts referred to in section II of this article. (Included by Constitutional Amendment No. 37, 2002) § 1º The Executive Branch shall regulate the provisions of this article within thirty days from the date of this Constitutional Amendment. (Included by the Constitutional Amendment No. 37, 2002)

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Finally, all these tax artifices created by the Brazilian tax legislation, besides obstructing the real view of the tax burden levied on the different groups and economic activities, possibly damage, in some cases, the constitutional principle of isonomy of taxation, and generate the complete absence of simplicity of our tax system, something that should be improved and rectified. If viewed as a whole, as a plexus, they create an environment of fiscal injustice, as those who are economically less able to participate in it end having more tax burden than those who are endowed with the greater ability to pay. These are elements that lead to a regressive nature of our tax legislation, which must be avoided, including the reasons which will be better addressed later in this article. There is also a fifth disadvantage of our tax system: the tendency to maintain, over the years, various “regulatory gaps”, generating sometimes legal insecurity, unjustifiable anomie or permanence for an indefinite period of transitional regulatory solutions, which, not always, are the most appropriate. Indeed, there are several constitutional provisions that need regulation. I will mention a few major cases. First, even today, more than twenty years later, there has not been regulated the Article 153, Section VII of the 1988 Constitution, which grants to the Union jurisdiction to institute the tax on large fortunes. This gap has become particularly worse and more “hypocritical”, in systemic terms, after the enactment of the Constitutional Amendment No. 31/2000, which allocated all funds to be raised by this exaction to the fund to combat and eradicate poverty. That is, rather than extinguish the power to tax, since there has not been until today a political climate for its establishment, it was provided the tax on large fortunes as a source of income of the Fund for Combating and Eradicating Poverty, i.e., instead of decreasing the hypocrisy degree of the system, the degree of incoherence and paroxysm has been substantially increased. Indeed, a fund to combat poverty has been created. Its major source of income is a tax on large fortunes, which is not charged for the absence of regulation, i.e., if it depended on this source of income, under the Article 80, Section III of the Temporary Constitutional Provisions Act, the “poor” would be eradicated and “poverty” would remain. In the same aspect, we are now waiting for the definition of “superfluous” property for purposes of exacerbated taxation of the IPI on industrial goods in the consumption of luxury, of the ICMS on consumption of luxury goods, and of the ISS on services of luxury consumption. In other words, the absence of a federal law defining something pretty obvious, Article 80,Section II, and Article 82, § 1 and 2 of the ADCT, is today in need of regulation. There is no extra taxation to luxury consumption in Brazil because there is a lack of an ordinary law which was not voted until today describing the “superfluous” product, goods and service. Another relevant example, Article 150, 5th Paragraph of the 1988 Constitution, is an almost tragic-comic gap. The 5th Paragraph of the Art. 150 of the Constitution in force states that the federal law shall define the description of tax incidence on goods and services. We are waiting for the law that makes it compulsory to inform the taxpayers

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that when they buy beans, they pay high rates of the IPI, the ICMS, and other taxes. Until now, this “tax information code” has not been regulated, at the expense of taxpayers. Another odd gap is the Article 34, Paragraph 8 of the ADCT of the Constitution. While there is no additional regulatory law, it was determined that the Brazilian States, under a contract based on the bizarre Supplementary Law No. 24/75, will set temporary standards on institution and charging of the ICMS. Therefore, for over twenty years, based on the transitory constitutional rule, the principle of tax legality is violated, since the tax law is replaced by administrative acts of the National Council of Fiscal Policy (Confaz), and agreements among the State members. So, I understand that this institutional figure, Confaz, is monstrous, a real freak kept alive by the absence of regulation of Article 155 of the 1998 Constitution. At the Confaz, the secretaries of the State Treasury are more important than the Senators of the Republic, who held a meeting in Brasília on one occasion and decided relevant institutional aspects of the ICMS, including the grant of exemption. Another example of a lack of relevant regulations is the Article 146-A of the 1988 Constitution, with its text provided by the Constitutional Amendment No. 42/2003. So, the definition of special taxation criteria to avoid imbalance of competition is still to be regulated, that is, it is a typical instrument to facilitate taxation of the evaders because they obviously unbalance economic competition. Accordingly, it cannot even redeem the memory of Article 116of the Brazilian Tax Code, introduced and established by the Federal Supplementary Law No. 104/2001, as this also lacks mandatory regulations by statutory law. That is, there is not yet in force in Brazil a specific regulatory system for combating tax evasion as an instrument of imbalance of competition. Other Articles that need regulation are Article 195, §§ 12 and 13, of the 1988 Constitution .They provide that the social security contributions may not have accumulative character, provision that could be regulated by statutory law or incipient regulation43. Finally, we mention the need for regulation of the Article 40 of the Constitution, with the text introduced by the Constitutional Amendment No. 41/2003, which determined the creation of a (superfluous) new security system in the public sector; then, in 2003, it was created with “urgency”, so far in 2010, six years later, the date of completion of this study, we have been waiting for the regulation of this Constitution by a federal statutory law, which would substantially modify tax and social rules in a statutory sector of the Union, the States, the Federal District, and the Municipalities44.

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43

It seems that the federal ordinary law No. 10,637/02, 10,833/03 and 10,865/04, it has not yet been fully exhausted the sub oculis constitutional provisions (art. 195, § § 12 and 13 of the Constitution), in particular, the paragraph thirteenth of article 195.

44

See the summary of the trial of Extraordinary Appeal No. RE 208260/RS, in verbis: “SUMMARY TAX LAW - GENERAL RULES - LAW QUALIFIED - General rules on tax legislation shall be contained in a supplementary law. TAX ON INDUSTRIALIZED PRODUCTS - FISCAL INCENTIVES - INCREASE - REDUCTION - SUSPENSION - REVOCATION - DECREE-LAW Nos. 491/69 and 1,724/79 - DELEGATION TO THE MINISTER OF FINANCE - UNCONSTITUTIONAL. The delegation to the Minister of Finance, versed in the Article 1 of the Decree-Law No. 1,724 in December 7, 1979, was unconstitutional, considering the tax incentives provided for in the Decree-Law No. 491,March 5, 1969.”

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

Ultimately, all these absences of regulation, including those that were not expressly mentioned in this study, contribute to enlarge the legal uncertainty, complexity and lack of artificial transparency of the Brazilian tax system in force. The sixth disadvantage of the Brazilian tax system is perhaps a result from the first disadvantage already mentioned (excessive constitutionalization): it is the specific field open to interpretive, creative or unpredictable performance of the diffuse constituent power, an unorganized kind of a constituent power, which is revealed in the constitutional interpretation by the Supreme Court. This interpretive activity would not be a problem itself, but it has created many contradictions and inconsistencies in our system, either by constant amazing changes in the jurisprudential understandings already crystallized or by the action of the constituent power derived to try to overcome judicial decisions, basically when contrary to the Treasury. The most determined constitutional doctrine gives the following definition to the hermeneutics exercised by the Supreme Court: there is the original constitutional power, the derived constituent power, and the diffuse constituent power, which are the interpretation of constitutional norms held by the Supreme Court that may lead to the phenomenon of constitutional mutation. The constitutional “mutation” held by the Supreme Court barely has a systemic logic, not keeps sufficient legal certainty for the taxpayer to make their personal or business settings. Some examples of confusing situations are described below. The first example: in 1998, the Supreme Court decided, in the context of Direct Action of Unconstitutionality (trial of ADI No. 1049), and under the diffuse control of the Constitution (from the trial of the Extraordinary Appeal No. 210.246/GO), which is not constitutional damage for the principle of a due process, legal defense and of the contradictory, to charge previous deposit as a condition of eligibility for the taxpayer to appeal in the second administrative instance of tax disputes. It was recorded in our jurisprudence. Therefore, that the imposition of tolls in the second instance of discussion of the fiscal administrative litigation will not cause damage to the fundamental rights of taxpayers. After some years, the composition of the Supreme Court has changed and ruled that this same legal issue should have another direction. It has started to declare unconstitutional normative predictions that were previously considered constitutional with the ergaomnes effect of the direct action of unconstitutionality. The new decision was adopted with ex tunc effect because they did not create modulation effects, causing severe damages to the Treasury. Another emblematic case, this time with losses to the taxpayer: the question of the validity of the IPI credit premium, which had several twists in the Supreme Court and in the Superior Court, until the creation of a final solution after 25 years!

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Initially, the Supreme Court decided that this benefit would remain in force because the act of the Minister of Finance that repealed it, but an ordinance would result in an unconstitutional delegation of powers45. Then, it became a matter of infra-constitutional nature and no extraordinary recourse would be known because if there were unconstitutionality, it would be reflex or indirect46. In the meantime, the Superior Court decides that the benefit, although it could not be extinguished by the Minister of Finance, was repealed by the Art. 41 of the ADCT47. Thereafter, the Supreme Court, once again, judged the subject again, believing that the question of unconstitutionality is not reflexive, and it is identically positioned to the Superior Court of Justice. In other words, after signaling that the benefit was still valid, and even refusing to reconsider the matter, the Supreme Court comes to understand that it was extinct in 1990, after two years of the the1988 Constitution enactment48. How is it possible to see in it a legal, normative institutional stability? Note that these “mutational, jurisprudential” inconsistencies can equally reach the tax authorities or the taxpayer, that is, there are now apriori hermeneutic positions on the Supreme Court, which is good in a given point of view, but revealing, on the other, that there is no visible systemic logic in its exegetical incoherence. Furthermore, due to diffuse constituent power, we had already published several constitutional amendments to change the Brazilian tax system. That is, the performance of the diffuse constituent power is often “hit” by the derived constituent authority at the expense of legal certainty and stability. 45

See the summary of the trial of Extraordinary Appeal No. RE 208260/RS, in verbis: “SUMMARY TAX LAW - GENERAL RULES - LAW QUALIFIED - General rules on tax legislation shall be contained in a supplementary law. TAX ON INDUSTRIALIZED PRODUCTS - FISCAL INCENTIVES INCREASE - REDUCTION - SUSPENSION - REVOCATION - DECREE-LAW Nos. 491/69 and 1,724/79 - DELEGATION TO THE MINISTER OF FINANCE - UNCONSTITUTIONAL. The delegation to the Minister of Finance, versed in Article 1 of Decree-Law No. 1,724 of December 7, 1979, was unconstitutional, considering the tax incentives provided for in Decree-Law No. 491 of March 5, 1969.”

46

See trial of Extraordinary Appeal No. 577348/RS - RIO GRANDE DO SUL, in verbis: “SUMMARY: TAX. TAX ON INDUSTRIALIZED PRODUCTS. PREMIUM CREDITS. DECREE-LAW 491/1969 (ARTICLE 1). ADCT, ART. 41, § 1. TAX INCENTIVE OF SECTOR NATURE. NEED OF CONFIRMATION BY LAW POSTERIOR TO THE FEDERAL CONSTITUTION. PERIOD OF TWO YEARS. TERMINATION OF BENEFITS. EXTRAORDINARY APPEAL KNOWN AND DENIED. I - The IPI premium credit is a tax incentive of sector nature referred to in Art. 41, caput, of the Transitory Provisions of the Constitution Act. II - As the IPI credit premium has not been confirmed by supplementary law within two years after the publication of the 1988 Federal Constitution, as specified in § 1 of the Art. 41 ADCT, it is not valid. III - The tax incentive introduced by the Art. 1 of the Decree-Law 491 on March 5, 1969, expired on October 5, 1990, pursuant to the provisions of § 1 of the Art. 41 of the Temporary Constitutional Provisions Act of the 1988 Constitution, due to its sector nature. IV - Action known and denied”.

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47

See trial of the EDcl in REsp 541239/DF.

48

See trial of Extraordinary Appeal No. 577348/RS - RIO GRANDE DO SUL, in verbis: “SUMMARY: TAX. TAX ON INDUSTRIALIZED PRODUCTS. PREMIUM CREDITS. DECREE-LAW 491/1969 (ARTICLE 1). ADCT, ART. 41, § 1. TAX INCENTIVE OF SECTOR NATURE. NEED OF CONFIRMATION BY LAW POSTERIOR TO THE FEDERAL CONSTITUTION. PERIOD OF TWO YEARS. TERMINATION OF BENEFITS. EXTRAORDINARY APPEAL KNOWN AND DENIED. I - The IPI premium credit is a tax incentive of sector nature referred to in art. 41, caput, of the Transitory Provisions of the Constitution Act. II - As the IPI credit premium has not been confirmed by supplementary law within two years after the publication of the Federal Constitution of 1988, as specified in § 1 of Art. 41 ADCT, it is not valid. III - The tax incentive introduced by art. 1 of Decree-Law 491 of March 5, 1969, expired on October 5, 1990, pursuant to the provisions of § 1 of art. 41 of the Temporary Constitutional Provisions Act of the Constitution of 1988, due to its sector nature. IV - Action known and denied”.

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

For example, the constitutional amendment No. 39/2002 established a contribution to public lighting because our politicians needed to go beyond the understanding of the Supreme Court that believes that the fee to finance street lighting is unconstitutional.49 They created a bizarre “contribution to public lighting”, and even the Supreme Court, perplexed, said that it is sui generis contribution. Indeed, sui generis is the perfect description for this really surreal tax. Another example: the Amendment 33 had to state clearly in the Constitution: “Look, a person (individual) importing goods has to pay the ICMS,” because the Supreme Court stated the unconstitutionality of such as exaction50. There are several examples of constitutional amendments, which altered the jurisprudence established by the Supreme Court, to the detriment of legal stability and to the principle of separation of powers, to show that the constitutionalization of the Brazilian tax system generates a really vicious circle. The seventh disadvantage of our tax system is very serious: an institutional environment propitious to tax evasion. Basics: in Brazil, tax avoidance is worthy, as incredible as it may seem and as much controversy that externalizes this unfortunate assertion is. For example, if the taxpayer is caught cheating, which is difficult because the decline in Brazil is of five years, not 10 years as in China, what happens to the taxpayer? Recent decision of the Supreme generates the following situation – unthinkable in a country a nit more serious: just wait 5 years and it passes. If you are caught cheating, you will pay the tax amount, and the situation will be resolved, all safe and sound. Therefore, payment extinguishes criminality. Meanwhile in China, until recently, it was a cause of death penalty; now it is “only” a lifetime term. In the United States ,the penalty is prison; cheating means jail. In Brazil, in the 1990s, a funny theory was invented : the theory of civil imprisonment for debt. A given president, who was impeached, alas, has established a law that ended the extinction of punishment for the payment of tax. It transformed payment in mitigation of the sentence, affirming that this situation damages the fundamental right of an impediment of civil for debt. They have only comforted as another president, later, also named Fernando, had enacted the law that modified the tax criminal law, which stipulated that paying tax does not solve the criminal aspect of the problem of tax evasion in Brazil, and retroactively because mitiorretroactivity occurs in our tax criminal system.

49

See Leaflet STF No. 141 (RE-231 764); Title: Public Lighting Tax “The service of street lighting cannot be paid, since it does not configure utility specific and divisible provided to taxpayers or put at their disposal (CF , art. 145, II). Based on this understanding, the Court, concluding the trial of extraordinary appeal (see Leaflet 138) by unanimous vote, declared, incidenter tantum, the unconstitutionality of public lighting tax established by the municipality of Niterói - RJ (arts. 176 and 179 Law No. 480/83, the wording of Law 1,244/93, both in the city of Niterói-RJ). RREE 231,764 and 233,332-RJ-RJ, Rel. Min Ilmar Galvão, 10/03/1999”.

50

See Summary 660 of the Supreme Court.

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That is, it is like it works in Brazil: the evader has been caught red-handed, paid the debt and nothing happens. The evader reimburses the public coffers and nothing happens, unless paying the debt; what should have done from the beginning? Of course, the debt must be paid with interests added to it, but at this juncture, the social and economic risk ends up just “making up” and encouraging the evaders. This environment of fiscal laxity happens also in other parts in the tax system, and it causes a serious imbalance. Another example: the Refis I, Refis II, and now the Refis III (tax recovery program). The evader is already expecting the Refis IV and V. It has been also recently invented in Brazil, by the Federal Acts No. 10.637/2002 and 10.833/2003, a tax compensation by homologation. You pay the tax and tax authorities give you five years to see if you are doing it right or not. Now, amid the crisis triggered by the U.S. financial derivatives, the Internal Revenue has found that it was created the very “tax bank”. Some taxpayers compensate it wrongly and, in fact, it is a loan to them, and they are waiting for the tax authorities to do something, that is, it is a law totally conducive to tax evasion, with losses relevant to the good health of the Brazilian tax system. Finally, it is noteworthy that law projects and doctrinal texts that have been advocating the “legalization” of the amounts of money sent abroad and that were never declared to the Federal Revenue, even if it is possible to be derived from money laundering, corruption, crimes involving drugs, pimping and other conducts morally and legally reprehensible; it would be enough to pay a low rate income tax (3% or 6%), and the legal situation of doubtful origin of revenues would be legalized, contributing to an atmosphere of apparent tax laxity51. Finally, this environment of “anything is taxable” is extremely harmful to our tax system, and should be dismantled gradually. The eighth disadvantage is the institutional environment conducive to adventure and unconstitutional assaults of the entities. Similarly, some taxpayers take advantage of the irrationality of our system in order to avoid taxes or simply to practice tax crimes with near certainty of criminal impunity.

51

See, for example, the Law No. 5,228/2005, it is symptomatic and revealing the need to transcribe an excerpt of the report made by the Deputy In charge of examining the matter within the Committee on Finance and Taxation of the Chamber of Deputies, in verbis: “The Law No. 5,228, 2005, authored by Deputy José Mentor, seeks to promote the legalization or repatriation of funds not declared, and maintained outside the ownership of individuals or legal entities domiciled in Brazil. For this, the proposal grants amnesty to federal taxes and contributions and their ancillary charges, as well as the extinction of punishment for crimes related to these values. The legalization of undeclared resources also applies to cases where resources have already entered the country through loan operation simulated with the entity located in countries with favored taxation (tax haven). It should be noted that the measure will not reach those individuals who have been condemned of an extensive list of crimes specified in § 1 of the Art. 1, in which the proceeds from such illegal conduct could be legalized and repatriated in the conditions provided in that law, since the investigation or judicial or administrative process has been terminated because of lack of criminal offense, lack of fact, or lack of evidence. The moment when the legalization of resources is held will require only the payment of income tax at a 3% rate on the repatriated values, or 6% on the values kept abroad. During the procedure of legalization of appeals and issue of the collection document, it shall not be made the identification of the violator taxpayer, being prohibited the disclosure of the fact. It is forbidden the use of information on the repatriation of funds for the establishment of tax credits relating to other taxes and contributions. Additionally, the minimum retention period of repatriated resources will be of two years .(...)” (bolded emphasis added). Extracted from the website: http://www.camara.gov.br/sileg/integras/383875.pdf Finally, there are no major additional comments to make on the merits of this proposal, entirely contrary to administrative morality and to tax isonomy.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

There are some federal entities that do what they want, following the theory that says “let’s try and see if it works”. When the Supreme Court found that the rate of street lighting was unconstitutional, many Municipalities had been charging it, even though such tax was patently unconstitutional by repeated decisions of the Supreme Court. However, what is the legal consequence of adopting the enactment of unconstitutional tax laws? Who will go to court against a charge whose value in individual cases is not so great? Of course, the individual action of the taxpayer is often impracticable. It would be a typical situation that would fit in the collective process to protect individual interests, homogeneous or collective. Here comes the Supreme Court, a diffuse constituent power, the Supreme Court ( increasingly supreme, not sure if increasingly Court), and says: “It is not for public civil action on tax matters.” The taxpayer is not a consumer! And the Supreme Court says: “it is not a case for a writ of collective security regarding the tax, that is, tax matters cannot be discussed in a collective civil process”52. Tax collective rights do not exist; this is the shameful understanding of the Supreme Court. So it is for the taxpayers to solve their own problem, and if they do not have a private lawyer, they should give up or look for the public defender, who will have to enter with a huge amount of identical actions. In the 21th Century, our most important Court uses a procedural-individualist criterion whose essence goes back to the excessive liberalism of the 19th Century, without any acknowledgement that the defense and protection of lato sensu collective interests, either the homogeneous individual or the stricto sensu collective interests, or the diffuse rights, they are already acknowledged by our law on economic law, environmental law, consumer rights, civil law. It is as if time had stopped regarding tax collective process, something that cooperates even with fiscal irresponsibility and the adventurous nature of our federal entities and generates huge inequalities in the distribution of tax burden, because wealthier taxpayers manage to protect themselves, and the less affluent and less attentive often bear a tax burden that would not exist when patently divergent of the established legal order. All this contributes forcefully to the Brazilian tax system become a regressive tax system.

52

See summary of the trial by the Supreme Court of RE 196184/AM, ipsis verbis: CONSTITUTIONAL. CIVIL PROCEDURE. WARRANT OF COLLECTIVE SECURITY. ACTIVE LEGITIMACY CAUSE OF POLITICAL PARTY. ACCUSATION OF TAX REQUIREMENTS. IPTU. 1. A tax requirement sets interest of group or class of persons, only able to be contested by them, individually or collectively. Precedent: RE No. 213,631, rel. Min Ilmar Galvão, DJ 7/4/2000. 2. The political party is not therefore entitled to rely on the warrant for collective security to, replacing all citizens in defense of individual interests, take action against the accretion of taxes. 3. Extraordinary appeal known and denied.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

The IPEA has recently proved by statistics that in Brazil, citizens who own less have to pay more taxes; that’s the portrait of the Brazilian tax system, which demonstrates that, in the end, all this chaos has some logic. It is exactly this perverse, unobtrusive logic, at first sight, that appears as a disadvantage of our system, as we shall see. The ninth disadvantage: the inexorable trend to centralization and the increase of the tax burden. I’ll give some examples: in 1993, one of the few constitutional amendments that were good and beneficial to the taxpayers was the Amendment 3,1993, meaning “good” in parts. This constitutional provision extinguished two taxes: the additional to the income tax and to the IVVCGL. The additional to the income tax was a state tax; to the IVVCGL, there was a municipal tax. It was created, in contrast, the IPMF (temporary tax on financial transactions), which then became the CPMF (Temporary Contribution on Financial Movement). Whose temporary character was only nominal. However, it was “permanently” extended for more than a decade. The additional to the income tax was never charged because the Supreme Court did not allow it, since they did not have a supplementary federal law53. Finally, the IVVCGL (tax on retail sales of liquid and gas fuels),when it was extinguished by the Constitutional Amendment No. 03/93, was a municipal tax with a 3% rate on the amount of gas at the pump, validated by the jurisprudence of the Supreme Court54. In 2001, after many attempts, because the project was already much older, the Government creates, through the Constitutional Amendment No. 33/2001, the interventional contribution on fuel sales and import. That is a clear example of the trend toward centralization of taxation and increase of the tax burden in Brazil, a phenomenon so well-known and so praised that we would not have to go further in this theme. But since it is provocative, in order to illustrate, we transcribed studies carried out ten years ago, embedded in my Master’s thesis, in which we had demonstrated real reasons that led to the increase of tax burden and to the centralization of tax collection. However, let’s see relevant excerpts from our still unpublished55, in verbis: Indeed, it is essential to examine a new trend of the “post-modern” times in Brazilian market: it is perceived that there is a definite trend toward centralization and

53

82

See trial on the Supreme Court of the Extraordinary Appeal No. 141296/RS .

54

See trial on the Supreme Court of the Extraordinary Appeal No. 254893 AgR/SP.

55

PEIXOTO, Maurício Muriack de Fernandes e. ASPECTOS FINANCEIROS DO URBANISMO – A EXTRAFISCALIDADE COMO INSTRUMENTO DE ATUAÇÃO DO DIREITO URBANÍSTICO E INSTITUTOS JURÍDICOS AFINS. Master’s thesis in law (Constitutional Order) before the Federal University of Ceará, defended in February 2000, having as his mentor Professor Raimundo Bezerra Falcão, and as members of the Board Professors Hugo de Brito Machado and Valdir de Oliveira Rocha.

Brazil, Russia, India and China (BRIC)

Tax system structures and the effects on development and foreign trade performance - lessons and solutions

concentration of resources in the central federal sphere, after the first ten years of promulgation of the 1988 Constitution. However, the Brazilian history records a pendulum movement, having existed moments when the financial autonomy of the Municipalities was milder, and moments when the municipal economic independence was more significant, so that the latter pole reached its apex with the promulgation the 1988 Constitution. Therefore, the financial autonomy of the Municipality is patently finalized and strengthened in the contemporaneity of the origin of the 1988 Constitution, being necessary to examine a table comparing the percentage of tax funds distributed among the political entities in the previous periods: ENTITY

1964

1986

1989

UNION

57.7%

43.7%

36%

STATE

38.5%

38.2%

42%

MUNICIPALITY

3.8%

18.1%

22%1

1 MEIRELES, Hely Lopes, Direito Municipal Brasileiro, 7ª Ed. São Paulo:Maleiros, 1994, p. 101.

However, after a decade of the promulgation of the Constitution of 1988, as a reflex of the adoption of a neoliberal physiognomy in the field of public finances, we can recognize, without any thrift, that currently the trend is again the re-centralization of resources, before the following measures that had a decisive influence on municipal finances: the creation of the Emergency Social Fund by the Constitutional Amendment, Review No. 01/94 – after, denominated “Fiscal Stabilization Fund,” which reached constitutional transfers of federal exactions for municipalities, decreasing the calculation basis of the value of constitutional transfers specified in articles 158, sections I and II; 153, § 5, section II; 159, section I, “b”, and consequently, article 159, § 3; the municipal share of sacrifice lasted just six financial years until the advent of Constitutional Amendment No. 27/2000, which created, through article 76 of the ADCT, the DRU [Desvinculação dos Recursos da União, Untying Resources from the Union], not covering anymore the portions of mandatory transfers to municipalities, mitigating somewhat the centralizing movement but with no prediction of any type of financial compensation appropriate to the resources that are no longer passed as the current entitled Constitutional Fund under articles 71 usque 73 of the ADCT; the abolition of the authoritative jurisdiction of VVCLG, with the advent of the Constitutional Amendment No. 03/93; now, such a tax, of municipal jurisdiction, was excluded on the pretext of encouraging the market of fuels with a reduction of prices to consumers; however, the fiscal centralization has been so absurd that it is been cogitated in recent years the creation of a residual social contribution, of competence of the Union, whose basis of calculation would be identical to the extinct IVVC; this residual social contribution was named “green tax”

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because it would be applied to state action in the environmental area, being even authorized the provision of its creation by the Budget Guidelines Law for fiscal year 2000, article 69, the project of budget law, and the prevision of the amount of revenue related to it, which proves that such a project has not been only a simple “verbal or informal” formulation of bureaucracy planning, but an official planning of the Brazilian State, given the fact that one of the functions of the Budget Guidelines Law is exactly to point changes in tax legislation, as provided in article 165, § 2, of the Federal Constitution; if this creation occurred, it would be almost unjustifiable the change of jurisdiction of the municipal level to the federal level; with the alterations of institutional transfers proceeded by the Fund for Maintenance and Development of Fundamental Education and Valorization of Teachers (FUNDEF) – which stipulated that 15% of the Municipal Participation Fund would be delivered to FUNDEF, not to the federal entities, and 15% percent of the revenue from ICMS to the Municipalities of the place of its operation, especially damaging the large municipalities – under the Federal Law No. 9424 of December 24, 1996, article 1, § 1; with the new excessive cost of service of the municipal public debt – which affected the municipal public sector of spending and indirectly influenced the reduction of free revenues of Local Political Entities, and it is noteworthy the eventual “federalization” of the municipal finance debt, as occurred in the city of São Paulo, which had its share of net public revenues committed to this debt; the enactment of Supplementary Law No. 87/96, which was named “Law Kandir,” the latter, immediately subtracting the amount of municipal revenue, intending to relieve the export of semi-manufactured goods, while the smaller collection of ICMS was reflected in the constitutional transfers to municipalities, the financial loss caused by the non-incidence on exports has been expressly recognized by the Primary Supplementary Norm and by art. 1, § 2 of the same Federal Ordinary Law No. 9424 of December 24, 1996, under the epithet of “loss of revenue resulting from tariff reduction on exports,” why a federal financial compensation was stipulated, which was obviously not sufficient to cover any loss of state and local revenue; Finally, the Constitutional Amendment No. 29/2000, by adding the second paragraph to the article 198 of the Constitution, and by creating article 77 of the Temporary Constitutional Provisions Act ended by designing a new municipal revenue binding: fifteen percent of the levy of IPTU, ITBI and ISS and of the amount of revenue belonging to the municipalities and under articles 158 and 159, section I, subsection “b”; such binding of municipal resources, although permeated by the worthy objective of improving public health, brought a new reduction of “free” income from Municipalities; in fact, before the auspicious trend of “municipal decentralization” of health services and education, such as binding is imposed as the logic of the system, which administratively release the Union; the destination has been financially detrimental to the Federal Entities of the Third Degree, the reason why the very Constitutional Amendment No. 29/2000 provided the implementation of progressiveness of the IPTU, altering the text of article 156, § 1 of the Constitution of 1988, as we shall see in due course;

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In this aegis, in the face of such multi factors, the current division of tax revenues rightly unveils the new movement in the Brazilian financial/tax constitutionalism: there is a new guider element of accumulation of income by the central political body, namely the federal sphere. In this sense, after ten years of the promulgation of the Constitution of 1988, this is the current Federal Division of Tax Revenue: Percentage symbol of participation in total pecuniary/tax collected in 1999

ENTITY UNION

48%

STATES

27.2%

MUNICIPALITIES

16.5%

PARAFISCAL ENTITIES

8.3% 1 2

1 Source: Secretary for Tax Affairs of the National Bank of Economic and Social Development (BNDES); data published on “Jornal do Brasil”, 08/08/99, part of politics, p. 03 2 Note: Parafiscal Entities could also be methodologically encompassed by the Federal Entity, since under Article 149 of the Constitution of 1988, only the Union may impose and collect parafiscal exaction.

In a synthesis of the chart, we would have: ENTITY

1964

1986

1989

1999

UNION

57.7%

43.7%

36%

48% + 8.3%=56.3%

STATES

38.5%

38.2%

42%

27.2%

MUNICIPALITIES

3.8%

18.1%

22%

16.5%

Therefore, these statistics demonstrate that the assumption of the neo liberal model in the country represented in the fiscal field an increase of the federal participation in the distribution of tax funds obtained; in the vein, the tax activity increased considerably, reaching 30.04% of the GDP, concomitantly with the fact that the total of these resources is directed at present, in an increasingly manner, for the Union; Moreover, this is the same conclusion reached by the emeritus professor Edvaldo Brito, in verbis: “All these reforms in Brazil contradictorily represent an attempt to strengthen the financial power of the central government, nothing more; therefore, only increase and fill the coffers of the federal treasury. However, centripetal federalism is essential, but it does not mean concentration of financial powers of intra-state entity responsible for overseeing the others”56. Moreover, consider another factor: the decentralization of educational services and health, since the program of “decentralization” was, in a contradictory way, flanked by a decrease in municipal tax revenues, while the budget increase in the tax sphere federal was entirely conducted to pay off the obligations arising from accumulation of the federal public debt service, a new factor of imbalance of the

56

In “Uma reforma tributária para o município: as taxas, especialmente a de iluminação pública”, article of the journal Cadernos de Direito Tributário e Finanças Públicas, No. 28, pg. 28.

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public accounts. Thus, there was less spending on municipal services but there was more on the payment of the refinancing of domestic and foreign federal debt, which meant an increase in “financial expenses” of the country at the expense of administrative expenditures to respond to public needs eminently “social”. Obviously, such text, although focusing on the period until the year 1999 until about ten years after the promulgation of the Constitution of 1988, remains shamefully current, since the centralization and the continuous accumulation of the tax burden in Brazil persist as unstoppable trends of our tax system, instead of adopting measures that will precisely in the opposite direction. That is, toward a decrease of the quantity and the scope of our total tax burden. The continuity of this situation leads to the shameless perpetration, for some, in encouraging civil disobedience57 against the Brazilian Fiscal State, something that is not the right way, but that cannot be entirely out of place before the cruel reality of our tax system58. At this point, there is still an echo of wise words of Alfredo Augusto Becker, in a transcript, that appears to be holding enough current issues, despite its metaphorical language, in verbis: Fiscal Shipwreck – The irrational taxation of recent years has led taxpayers (especially the employees) to such a state that now they only have the underwear. And, besides the underwear, they have just kept faith and hope in changing this state of things simultaneously with the change of the Ministers of Finance and Planning. However, if these taxpayers were taxed even the underwear, then they will lose faith and hope.59 Unfortunately, there are solid reasons for this to happen.60 Anyway, this disadvantage of the Brazilian tax system is undoubtedly the most urgent problem that should be addressed and mitigated by the retired legislators, constitutional and infra-constitutional. Finally, as a logical and unstoppable consequence of and all the problems mentioned above, the tenth disadvantage of our tax system was created: it is a regressive tax system in which those who have less pay more, and those who have more pay less. Actually, all the disadvantages previously mentioned and described to turn the Brazilian tax system into, besides a true tax salad, original and very Brazilian, a real system of defects that distributes punch to the tax authorities and taxpayers, and that bends in a non-organized, chaotic and deeply unfair way; nevertheless, in all its nebulous framework, a perverse logic that consists of further burdening those who most need the state! 57

See article “Desobediência civil” authored by journalist Merval Pereira and publisjed on the newspaper O Globo, 09/02/2005 at : www.oab.org.br/noticia.asp%3Fid%3D3635+centraliza%C3%A7%C3%A3o+e+aumento+e+carga+e+tribut%C3%A1ria+e+braisl&cd=7& hl=pt-BR&ct=clnk&gl=br

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58

Another point that must be pointed out is article 14 of the Law of Fiscal Responsibility. Article 14 of the Fiscal Responsibility Law is very dangerous. Why? Article 14 requires compensation for any reduction of tax revenue. And it claims that decrease the rate of tax is an act of waive. If I do not have revenue prepared for this, to reduce an aliquot, I have to create another in the same tax rate or other tax. Moral of the story: the Chinese tax burden, depending on the methodology of calculation, varies from 18% to 23%. In Brazil, the tax rate ranges from 35% to 40% of GDP, depending on methodology, and the Law of Fiscal Responsibility helps the increase and maintains the tax burden on higher standards, but, it complicates and makes it difficult to reduce it later.

59

Carnaval Tributário. 2ª ed. São Paulo, Lejus, 1999, p. 15.

60

Idem.

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Anyway, in this nonsense labyrinth that the Brazilian tax system is, the most relevant and worrisome, worthy of deep reflection of the legislators and scholars, is that any system holds an underlying, perverse and non-audited logic, which is unfair and not transparent: this is a tax system that is regressive. In Brazil, the poor pay more than the rich. Until the year before, there were only two rates of income tax. Basically, the logic of the Brazilian tax system is to perpetrate an human injustice. On this aspect, it is relevant to mention an excerpt of each of the famous studies Receita Pública: Quem paga e como se gasta no Brasil [Public Revenues: Who pays and how the spending is in Brazil] and Carga Tributária Líquida e Efetiva Capacidade do Gasto Público no Brasil (Net Tax Burden and Effective Capacity of Public Spending in Brazil), both results of the covenant of IPEA (Institute of Applied Economic Research) with the Internal Revenue Service of Brazil, both members of the federal government of Brazil. Firstly, it is urgent to transcribe the conclusion of item 4 of the IPEA’s study Carga Tributária Líquida e Efetiva Capacidade do Gasto Público no Brasil, in the sense that the net tax burden in Brazil, already counting the social benefits and economic return to society through the provision of public services, and payment of the services of public debt, is the second largest among the countries reviewed and that are part of the OECD, showing that it really is quite high, in verbis: Gross Tax Burden (CTB) and Net Tax Burden (CTL), Transfer of Assistance and Social Security and Subsidies (TAPS) and Net Interest Payments in Brazil and countries selected in 2007 Countries Germany Brazil Canada South Korea Spain United States France Greece Hungary Ireland Italy Japan Norway New Zealand Poland Portugal United Kingdom Sweden

CTB

TAPS

CTL = CTB-TAPS

Net Interests

CTLinterest

39,2% 34,7% 33,1% 26,8% 32,7% 28,4% 42,3% 31,6% 39,9% 30,8% 42,5% 28,1% 42,0% 36,5% 34,1% 36,5% 6,5% 46,8%

18,1% 15,4% 10,9% 3,6% 13,4% 12,6% 18,9% 18,5% 6,9% 10,3% 18,6% 12,1% 3,5% 10,5% 14,9% 16,8% 13,8% 16,5%

21,1% 19,3% 23,2% 23,2% 19,3% 15,8% 23,4% 13,1% 23,0% 20,5% 23,9% 16,6% 28,5% 26,0% 19,3% 19,7% 22,7% 30,3%

2,4% 6,2% 0,7% -1,5% 1,2% 2,1% 2,5% 0,1% 0,5% -4,6% 4,5% 0,7% -13,3% -0.9% 1,6% 2,9% 1,8% 2,6%

18,7% 13,1% 22,5% 24,7% 18,1% 13,7% 20,9% 13,0% 23,5% 25,1% 19,4% 15,9% 41,8% 26.9% 17,7% 16,8% 20,9% 27,7%

Source: Central Bank of Brazil, OCDE (Elaboration IPEA/CFP) 7

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“In comparison with 17 other selected countries, only Greece (13.0%) registered CTL-j lower than Brazil (13.1%) in 2007. For the same year, the Brazilian CTB was 11% higher (34.7%) than Greeks’ (31.6%). According to OECD data. Brazil has CTB equivalent to Canada (33.1%) and Poland (34.1%), although the Brazilian CTL-j has been much lower. In a large extent, this is due to the heavy weight of interest payments in total public spending, which presents the highest expression among the countries analyzed.” On the other hand, it is striking to read and learn in a non-baffled way the conclusion adopted on the item “2” of IPEA’s study entitled Receita Pública: Quem paga e como se gasta no Brasil, in the sense that the tax burden is regressive in Brazil, and proportionally less affluent people pay more than twice than the richer classes, in verbis: For the year 2008, the estimate of IPEA for the gross tax rate was 36.2% of GDP. If this result is divided evenly throughout the year, the gross tax burden per capita in Brazil would amount on average to 132 (36.2%) of 365 days of 2008. It is simply known that the tax burden is not equally imposed to all Brazilians, not implying. Therefore, the same effort in contributing to finance the operations of the state and the public policies. In Brazil, the distribution of tax burden is heterogeneous, with some sectors of the population being more affected than others. It happens because we know that the important principle in any tax system is that of equity or ability to pay, for allowing that the establishment of the contribution of citizens to the state funding is commensurate with its economic capacity. That is, one should not impose on citizens of lower economic capacity – usually defined as those with lower incomes and fewer assets – the same tax effort required for citizens of greater economic capacity. Accordingly, the tax system should seek the progressive – taxing the rich more than the poor. Brazil - Distribution of Gross Tax Burden according to the band of minimum wage Monthly Family Income

Gross Tax Burden 2004

Gross Tax Burden 2008

Days Destined for Payment of Taxes:

until 2 Min wages 2a3 3a5 5a6 6a8 8 a 10 10 a 15 15 a 20 20 a 30 more than 30 minimum wages CTB, according to CFP/DIMAC

48,8 38,0 33,9 32,0 31,7 31,7 30,5 28,4 28,7 26,3

53,9 41,9 37,4 35,3 35,0 35,0 33,7 31,3 31,7 29,0

197 153 137 129 128 128 123 115 116 106

32,8

36,2

132

Source: Tax Burden by Income Class, 2004: Zockun et al. (2007); Gross Tax Burden in 2004 and 2008: CFP/DIMAC/ IPEA; Tax Burden by Income Class, 2008 and Days Destined for the Payment of Taxes (own elaboration).

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Recent studies, however, have shown that the Brazilian tax system does exactly the opposite – taxing more the poor. The poorest 10% of the Brazilian population give 32.8% of their – little – income for the payment of taxes, while for the 10% richest, the burden is estimated at 22.7% of their income. Using the minimum wage as a reference to classify levels of income, even stronger numbers confirm the regressivity of taxation in Brazil: families with incomes of up to two minimum wages pay 48.8% of their income in taxes; families with incomes above 30 minimum wages, about 26.3%. These latest figures were estimated, however, for the year 2004 when the CTB, calculated based on IBGE, was 32.8% of GDP. Thus, it is observed that between 2004 and 2008, CTB grew 3.4 percentage points, increasing by around 10% in five years. In this sense, the burden imposed to each income class must also have increased. Assuming that, just to simplify the reasoning, the regressivity in the period has not worsened nor retreated, but only remained the same; then one may consider that the cost incurred in each income class also had to grow in the same pace. That is, it is likely that in 2004 the gross tax burden on those who earned less than 2 minimum wages was 48.8% of their income; in 2008, it may have reached 54%. While, maintaining the proportions, those earning above 30 minimum wages in 2008 may have faced a charge of 29%. What means that if based on the data for CTB in 2008 the Brazilian citizen has spent an average of 132 days for the payment of taxes, there are huge inequalities that should be further studied, debated and addressed. Poorest citizens ended up being required an effort equivalent to 197 days, while the wealthiest citizens reached 106 days – three months less. Such studies, from Brazilian official bodies, are proof that the tax burden in Brazil has been increasing steadily and that the tax system is regressive, because those with lower income pay proportionally more taxes (twice) than those more affluent. It should be the opposite, and this situation is doubly unfair, because if the tax ratio has increased over the years, this increase has been supported, exponentially, by the most financially disadvantaged people. This situation is aggravated because it is contrary to the principles of tax and fiscal equality of the ability to pay (respectively, articles 150, section II, and 145, § 1 of the Constitution), something completely intolerable by the tax system. But even if it was not allowed by the tax system, this situation is, for obvious reasons, irreconcilable with two fundamental objectives laid down for the Federative Republic of Brazil: to build a free, fair and cohesive society and to eradicate poverty and marginalization, and to reduce the social and regional inequalities (article 3, sections I and II, both from the Constitution). It is time to rescue the constitutional draft that aims at establishing a true tax state, in which the fiscal freedom lives with tax justice.

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Indeed, the Fiscal Social State is also a guarantee of freedom, and the tax is revealed as the price of freedom of the individual under the inflexible equity, that is, it seeks to harmonize the conceptual poles of freedom and equality as elements of a new conception of tax, mainly represented by their extra fiscal character of redistributes of income and direct or mediate promoter of a more equitable economic development; freedom fiscal is conditioned to a character of greater tax fairness.61 Finally, we must recognize the positive characteristics of the Brazilian tax system, but also identify and promote the improvement of these ten points deemed likely to progress to ensure that the Brazilian tax policy order reach the status of an increasingly fair and efficient tool of economic and social growth, of equitable taxation and of viability of the constitutional objectives, both general and specific, of Brazil in all its federative instances.

4. Conclusions In that vein, we believe that the need for new solutions to the Brazilian tax system must necessarily undergo a change of mentality of traders and “clients” of the tax law. Thus, we must emphasize, in the lessons of Alberto Nogueira, the essence of fiscal humanism in the Brazilian system, because it will not achieve its main goals if it continually endures to remain away from the ideal dynamics of the human rights of taxation, but let’s see, in literis: The first way for the reconstruction of the Human Rights of Taxation is the effective, Direct, active participation of all segments of society in the formulation, Supervision, and control of tax rules. The basic idea is to eliminate the excesses and unfairness of the tax burden in order to make it fair and effective, in harmony with the principles of justice and rationality. In contrast, everyone, within their capacity, should pay, so in this system there is no place for tax evaders. The evasion has a double sinister effect: it benefits the author and punishes the taxpayer, since they will ultimately end up taking, with the inevitable rise in taxes, the burden not paid for the evaders. Besides this dual effect, they will suffer, diffusely, with the degradation of public services of what they depend on for their regular and satisfactory service in much of the tax revenue. With the democratization of the system, it tries to reach the right balance, which was

61

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“There is no doubt that the entire freedom of individual initiative, individualism without controls, accounts for the glaring inequalities, for the excessive concentration of wealth in the hands of a privileged few and the impoverishment of large masses of population. Therefore, it is essential, for the preservation of freedom, the formulation of its concept. It is not permissible freedom at the expense of equity. Permissible freedom is that which, in the words of Professor Eros Roberto Grau, citing the lesson of Friedmann, ‘should not lead to degradation, to the lives in slums, to the poverty of the majority as opposed to wealth and power of many’. The path is a welfare State, that is, an interventionist State. And, in this State, taxation is a tool of undeniable value.” MACHADO, Hugo de Brito, in “A função do Tributo nas Ordens Econômica, Social e Política”, artigo da Revista da Faculdade de Direito da Universidade Federal do Ceará, Volume XXVIII, II, julho-dezembro de 1987, p. 11);

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pursued in the Arts. 13 and 146462 of the Declaration on the Rights of Man and Citizen, August 26, 1789”.63 Finally, it is necessary that a new Brazilian tax system arises from the mental modification of legal tax, which would allow the emergence of a more humanistic, universalizing attitude regarding the better distribution of the burden of the financing tax of the State needs in common. I conclude this brief article quoting an author which, for me, was the greatest Brazilian tax expert of the 20th century, Alfredo Augusto Becker, who, years ago, wrote the book Teoria Geral do Direito Tributário64 (General Theory of Tax Law), in which he prophesied that the Brazilian tax system had an unstoppable potential and trend to be a “legal, tax lunatic asylum”. In 1986, 25 years later, he wrote his last work before his death, called Carnaval Tributário (Tax Carnival), in which he offers these thoughts about the need to humanize the Brazilian tax rule system: Back in 1963,the revolutionary instrument that I reviewed and recommended as decisive was (and still remains) the instrument of Fiscal Policy: the tax. Not only to raise funds to build, but also to destroy the tax. Destruction of privileged social classes and destruction of inhuman economic systems. The man, elevated to the agent of creation of the new world, should first create the instrument that, by its effectiveness, can destroy the golden calves and mold the glowing clay of humanity today. This instrument is the new legislation. The creation of these new laws is an extremely delicate, artistic activity imbued with humanism. The legislator must have culture and sensitivity to respect what is permanent in human nature and sound in the claims of man”65. Another conclusion remembering that we live in a kind of tax Sebastianism66. The “Sebastianism Tax” is currently thought that all problems of the Brazilian tax system will be redeemed by the new tax reform that is always about to happen, without changing the mentality and thinking about the legal and political basis of the system. Hopefully, forever and ever, the new law, the new constitutional amendment, the new “tax reform”; the new law is to redeem us from our current tax mistakes.

62

“Art. 13 - For the maintenance of the public force and for administration expenditures a common contribution is vital, a contribution that must be distributed among citizens according to their possibilities. Art. 14 – All citizens have the right to verify, by themselves or by their representatives, the necessity of public contribution, to freely consent it, to observe its use and to set the distribution, collection, recovery and duration” (MIRANDA, Jorge. Textos históricos do direito constitucional. Lisboa: imprensa Nacional, 1990, p. 59, apud NOGUEIRA, Alberto. A reconstrução dos direitos humanos da tributação. Rio de Janeiro: editora Renovar, 1997, p. 03).

63

NOGUEIRA, Alberto. A reconstrução dos direitos humanos da tributação. Rio de Janeiro: editora Renovar, 1997, p. 11, grifos inexistentes no original.

64

BECKER. Alfredo Augusto. Teoria Geral do Direito Tributário. São Paulo: editora Noeses, 4ª edição, 2007.

65

Carnaval Tributário. 2ª ed. São Paulo, Lejus, 1999, p. 19.

66

Sebastianism was a political and cultural movement occurred in Portugal in the late sixteenth and early seventeenth century, by which there were hopes of people around D. Sebastião, the Portuguese king who died in 1580, in battle in the East. All issues were addressed after “The King” was back.

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However, we cannot forget that the new law, new tax reform, or even a new originating constituent power will not solve the problems of Brazil, if its mind. Political and cultural attitude are not modified. If we do not change the culture, thought and essence of man and the Homo Sapiens who interprets and applies the tax law, new tax rules will be continuously promulgated and the system will remain unfair, chaotic, and disorganized - the Brazilian tax tree, constantly renewed with new unsuspected fruit. One must be suspicious in the absence of a fiscal humanism that builds new bridges between the State and taxpayers, including among the latter. I recall a phrase from Túlio Ascarelli: “in the current crisis of values, the world loses to the lawyers’ new ideas, rather than subtle interpretations.” New ideas must be based on a new paradigm: the fiscal humanism to prevail over the current fiscal insensitivity of the State and considerable amount of taxpayers. Surely, our final conclusion is that it is imperious and a priority, as an instrument of improvement and desirable development, the urgency in adopting the fiscal humanism as an indispensable tool to change our tax reality.

5. References

AGUIAR, Joaquim Castro. Regime Jurídico das Taxas Municipais. 1ª ed. Rio de Janeiro, Livros Técnicos e Científicos S/A, 1982. AMARAL, Antônio Carlos Cintra do. “Concessão de rodovias e cobrança de pedágio”. in MELLO, Celso Antônio Bandeira de(org). Estudos em Homenagem a Geraldo Ataliba – Direito Administrativo e Constitucional. 1ª ed. São Paulo, Malheiros, 1997. Baleeiro, Aliomar. Uma introdução à Ciência das Finanças. 16ª Edição. Rio de Janeiro, 2006. ________.Limitações Constitucionais ao poder de Tributar. 11ª Ed, editora Forense, Rio de Janeiro, 1998; BARROS, Luiz Celso de. Ciência das Finanças – fundamentos de Direito Financeiro e Tributário. 5ª ed. São Paulo, Edipro, 1999. BASTOS, Celso Ribeiro. Curso de Direito Constitucional. 17ª ed. São Paulo, Saraiva, 1996. ________. Curso de Direito Financeiro e de Direito Tributário. 7ª ed. São Paulo, Saraiva, 1999. BECKER. Alfredo Augusto. Teoria Geral do Direito Tributário. São Paulo: editora Noeses, 4ª edição, 2007; ________. Carnaval Tributário. 2ª ed. São Paulo, Lejus, 1999. BRITO, Edvaldo. “Uma reforma tributária para o município: as taxas, especialmente a de iluminação pública”. in Cadernos de Direito Tributário e Finanças Públicas, v. nº 28, 1999. BONAVIDES, Paulo. Do País Constitucional ao País Neocolonial. 1ª ed. Sâo Paulo, Malheiros, 1999. BORGES, José Souto Maior. Isenções Tributárias. 2ª ed. São Paulo, Sugestões Literárias, 1980. ________. Introdução ao Direito Financeiro. 2ª ed. São Paulo, Max Limonad, 1998. CALMON, Sacha Navarro Coelho. Comentários à Constituição de 1988 – Sistema Tributário. 2ª ed. Rio de Janeiro, Forense, 1990. CARRAZZA, Roque Antônio. “A Progressividade na Ordem Tributária”. RDT, v. 64, 1994. ________. Curso de Direito Constitucional Tributário. 6ª ed. São Paulo, Malheiros, 1994. CARVALHO FILHO, José dos Santos. Manual de Direito Administrativo. 5ª ed. Rio de Janeiro, Lumen Juris, 1999. CHIESA, Clélio. “A tributação dos serviços de Internet prestados pelos provedores: ICMS ou ISS?”. in Cadernos de Direito Tributário e Finanças Públicas, v. 27, 1999. COLARES, Juscelino Filgueiras. “A Globalização: algumas implicações sobre a tributação e política fiscal”. in Cadernos de Direito Tributário e Finanças Públicas, v. 23, 1998. CONTI. José Maurício. Sistema Constitucional Tributário interpretado pelos Tribunais. 1ª ed. São Paulo, Del Rey Editora, 1997. COSTA, Flávio Dino de Castro e. “Globalização e crise Constitucional”. RDA, v. 211, 1998.

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COSTA, Maria Isabel Pereira da. Constitucionalismo ou Neoliberalismo: o que interessa e a quem?. 1ª ed. Porto Alegre, Síntese, 1999. FALCÃO, Raimundo Bezerra. Tributação e Mudança Social. 1ª ed. Rio de Janeiro, Forense, 1981. FERRAZ, Anna Cândida da Cunha. Processos Informais de Mudança da Constituição: Mutações Constitucionais e Mutações Inconstitucionais. São Paulo: Max Limonad, 1986. FIGUEIREDO, Lúcia Valle. Curso de Direito Administrativo. 4ª ed. São Paulo, Malheiros, 2000. FREITAS, Juarez. Estudos de Direito Administrativo. 1ª ed. São Paulo, Malheiros, 1995. FROTA, Régis. Teoria Econômica e Direito. 1ª ed. Sobral-CE, Edições UVA, 1999. GRAU, Eros Roberto. Regiões Metropolitanas, regime jurídico. 1ª ed. São Paulo, José Bushatsky, 1974. ________. “Aspectos Jurídicos da Noção de Solo Criado”, em O Solo Criado/Carta de Embu. ________. Elementos de Direito Econômico. 1ª ed. São Paulo, Revista dos Tribunais, 1981. GUERRA FILHO, Willis Santiago. Dos Direitos Humanos aos Direitos Fundamentais. 1ª ed. Porto Alegre, Livraria do Advogado, 1997. ________. Autopoiese do Direito na Sociedade Pós-Moderna – introdução a uma teoria social sistêmica. 1ª ed. Porto Alegre, Livraria do Advogado, 1997. GIACOMONI, James. Orçamento Público. 8ª ed. São Paulo, Atlas, 1998. HARADA, KIYOSHI. Direito Financeiro e Tributário.1ª ed. São Paulo, Atlas, 1995. HORTA, Raul Machado. Estudos de Direito Constitucional. 1ª ed. Belo Horizonte, Del Rey, 1995. JANCZESKI, Célio Armando. “Iluminação Pública pode ensejar Contribuição de Melhoria?”. Cadernos de Direito Tributário e Finanças Públicas, v. 26, 1999. JARDIM, Eduardo Marcial Ferreira. Manual de Direito Financeiro e Tributário 4ª ed. São Paulo, Saraiva, 1999. JUSTEN FILHO, Marçal. Concessões de Serviços Públicos. 1ª ed. São Paulo, Dialética, 1997. ________. Sistema Constitucional Tributário: Uma Aproximação Ideológica, editora fórum de direito tributário, Biblioteca Digital Interesse Público - IP, Belo Horizonte, ano 1, n. 2, abr. 1999 KELSEN, Hans. Teoria Pura do Direito. São Paulo, Martins Fontes, 1995. LOURENÇO, Manoel dos Santos. Questões Fiscais do Município. 1ª ed. Fortaleza, Imprensa Oficial, 1966. MACHADO, Hugo de Brito. Curso de Direito Tributário. 12ª ed. São Paulo, Malheiros, 1997. ________. “Os Limites da Contribuição de Melhoria”. RDDT, v. 17, 1997. ________. “A função do Tributo nas Ordens Econômica, Social e Política”. Revista da Faculdade de Direito da UFC, v. XXVIII-II, 1987. ________. Princípios Jurídicos da Tributação na Constituição de 1988. 3ª ed. São Paulo, Revista dos Tribunais, 1994. MAIA FILHO, Napoleão Nunes. Modos de Produção – Estado e Sociedade – pequena contribuição à crítica da teoria do estado capitalista periférico. 1ª ed. Fortaleza, CEARTE, 1989. MARTINS, Cláudio. Compêndio de Finanças Públicas. 3ª ed. Rio de Janeiro, Forense, 1988. MARTINS, Ives Gandra da Silva(org). Curso de Direito Tributário. 3ª ed. Belém, Cejup, 1994. ________. Comentários à Constituição do Brasil. 6º v. tomo I. 1ª ed. São Paulo, Saraiva, 1990. MEIRELLES, Hely Lopes. Finanças Municipais. 1ª ed. São Paulo, Revista dos Tribunais, 1979. ________. Direito Municipal Brasileiro. 7ª ed. São Paulo, Malheiros, 1994. MOREIRA NETO, Diogo de Figueiredo. “Globalização, Regionalização, Reforma do Estado e da Constituição”. RDA, v. 211, 1998. MOSQUERA, Roberto Quiroga(org). Aspectos Atuais do Mercado Financeiro e de Capitais. 1ª ed. São Paulo, Dialética, 1999. MUKAI. Toshio. Concessões, Permissões e Privatizações de Serviços Públicos. 2ª ed. São Paulo, Saraiva, 1997. NASCIMENTO, Carlos Valder do. Curso de Direito Financeiro. 1ª ed. Rio de Janeiro, Forense, 1999. NOGUEIRA, Alberto. A Reconstrução dos Direitos Humanos da Tributação. 1ª ed. Rio de Janeiro, Renovar, 1997. NUSDEO, Fábio. Curso de Economia – Introdução ao Direito Econômico. 1ª ed. São Paulo, Revista dos Tribunais, 1998. NUNES, Faissal Junior, “ Sistema Constitucional Tributário”, Revista de Direito Constitucional. Ed. Fórum, nº 25, p. 165. OLIVEIRA, José Marcos Domingues de. “Poluição e Tributação”. RDT, v. 61, 1993. OLIVEIRA, Régis Fernandes de e HORVATH, Estevão. Manual de Direito Financeiro. 2ª ed. São Paulo, Revista dos Tribunais, 1997.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions OLIVEIRA, Régis Fernandes de. Receitas Públicas Originárias. 1ª ed. São Paulo, Saraiva, 1994. PEIXOTO, Maurício Muriack de Fernandes e. aspectos financeiros do urbanismo - a extrafiscalidade como instrumento de atuação do direito urbanístico e institutos jurídicos afins. Tese de mestrado em Direito (Ordem Constitucional) perante a Universidade Federal do Ceará, defendida em fevereiro de 2000 tendo por orientador o Professor Raimundo Bezerra Falcão, e por integrantes da banca os Professores Hugo de Brito Machado e Valdir de Oliveira Rocha. ROCHA, Cármen Lúcia Antunes. Estudo sobre Concessão e Permissão de serviço público no Direito Brasileiro. 1ª ed. São Paulo, Saraiva, 1996. ROSA Jr. Luiz Emygdio F. da. Manual de Direito Financeiro e Direito Tributário. 11ª ed. Rio de Janeiro, Renovar, 1997. SARAIVA FILHO, Oswaldo Othon de Pontes. O conjunto de diplomas legais e de tributos que compõe o sistema tributário brasileiro. Revista Fórum de Direito Tributário, Belo Horizonte, ano 4, n. 23, set. 2006; SARMENTO, Daniel. “Constituição e Globalização: a crise dos paradigmas do direito constitucional”. RDA, v. 215, 1999. SILVA, José Afonso. Curso de Direito Constitucional Positivo. 10ª ed. São Paulo, Malheiros, 1995. SZKLAROWSKY, Leon Fredja. A reforma tributária para um novo século . Jus Navigandi, Teresina, ano 7, n. 65, maio 2003. Disponível em: . Acesso em: 07 jun. 2010. TAVARES, Íris Eliete Teixiera Neves de Pinho. “O Município Brasileiro: sua evolução histórico constitucional”. RDA, v. 209, 1997. TORRES, Ricardo Lobo. A idéia de liberdade no Estado Patrimonial e no Estado Fiscal. 1ª ed. Rio de Janeiro, Renovar, 1991. ________. Curso de Direito Financeiro e Tributário. 2ª ed. Rio de Janeiro, Renovar, 1995. ________. O Orçamento na Constituição. 1ª ed. Rio de Janeiro, Renovar, 1995. ________. Os Direitos Humanos e a Tributação – imunidades e isonomia. 1ª ed. Rio de Janeiro, Renovar, 1995. VARGAS, Jorge de oliveira. “O Direito Tributário a serviço do Meio Ambiente”. in Cadernos de Direito Tributário e Finanças Públicas, v. 25, 1998. YAMASHITA, Fugimi. “aspectos tributários da Internet”. in Cadernos de Direito Tributário e Finanças Públicas, v. 22, 1998.

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3. Russia 3.1 The Russian Tax System and its Effects

in Development and International Trade Relations: Legal and Economic Approach Alexander Pogorletskiy*, Maria Dolgopolova**

CONTENTS 1. Introduction 2. Constitution and Tax System a) Constitutional Structure b) Tax Constitution c) General Issues on Tax Collection 3. Tax System a) Income and Wealth Taxes – Direct Taxes b) General Direct Taxation Issues c) Consumption Taxes and other Indirect Taxes d) General Indirect Taxes Issues e) Other Taxes (Contributions, Fees, etc) f) Tariffs and International Trade Duties g) Taxation and Electronic Commerce 4. Economic Development a) Background * Dr. Alexander POGORLETSKIY is professor of St.Petersburg State University (Russia), ** Maria DOLGOPOLOVA is tax lawyer in Baker & McKenzie, St.Petersburg (Russia).

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b) Important Issues c) Economic Growth d) How taxation affects the development process d.1 – Impairing d.2 – Enhancing e) External Investment Flow Issues f) Tax reforms Shaping Economic Development 5. International Trade of Goods and Services a) WTO and other International Trade Treaties – History and Development b) Tariff policy and regimes c) InternationalTrade Treaties and Internal Taxation: Effects and Limitations d) International Tax Treaty Issues e) Tax Reforms Shaping International Trade Performance 6. Conclusion

1. Introduction

The Russian tax system was completely modernized in the beginning of the 21th Century by the introduction of a new tax legislation; establishment of an appropriate tax structure with a moderate level of taxation, as well as by implementation of a new approach in tax administration1. As a result, the Russian Federation has now a wellreformed modern tax system which gives the country quite good positions in international tax competition, especially among the other BRIC countries2.

However, the world-shaking economic crisis that commenced in 2008 exerted a sufficient influence on Russia and its tax system. It is broadly known that taxes and levies constitute one of the substantial parts of the state budget revenues and, therefore, are under strict supervision of the federal government. Obviously, in the downturn period, it is extremely necessary for the state to retain control under its revenues mostly gained from tax collections and, at the same time, to defend business from unreasonable tax burden. Primarily, the anti-crisis measures taking by the Government seriously influence to national legislation in tax and financial spheres that, in its turn, predetermine methods of tax administration and court practice. In this article, we present both legal and economic approaches to the Russian taxation and its effects in economic development and international trade relations

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1

Read about the Russian tax reform in the 2000s in details in: Pogorletskiy A., Söllner F. The Russian Tax Reform // Intereconomics. 2002. No 3. May/June. P. 156-161; Pogorletskiy A., Söllner F. The Russian Tax System and Its International Competitiveness // Intereconomics. 2008. No. 5. September / October. P. 288 – 297.

2

See: Pogorletskiy A. Tax Competition and Tax Coordination in the Baltic Sea Region and the Modern Russian Tax Reform // Business Environment in Russia: Assessment by local Scholars. Ed. by V. Kapustkin. Lappeenranta University of Technology. Northern Dimension Research Centre. Publication 37. Lappeenranta, 2007. P. 49-87;Pogorletskiy A. International Tax Competitiveness of the BRIC Countries// International Scientific Conference “BRIC – a breakthrough in the world economy in th 21th century’. St. Petersburg, 2009. P. 40-43.

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nowadays, including the retrospective analysis and current situations caused by the world economic crisis.

2. Constitution and Tax System a) Constitutional Structure

The Constitution3 – the main law of the Russian Federation – provides the principal rules of Russian taxation. It is a direct, supreme legal act on the Russian territory. All other laws accepted in Russia shall not contradict its provisions and main sense. Widely recognized principles and norms of international law, as well as international treaties of the Russian Federation, are a constituent part of the Russian legal system. If an international treaty of Russia stipulates other provisions than prescribed in the national legislation, the international rules shall be applied. The Constitution guarantees the unity of economic space, free circulation of goods, services and financial instruments, competition support and freedom of economic activities in Russia (Article 8). The main principles of taxation in Russia are contained in Chapter 2, “The Rights and Liberties of an Individual and a Citizen”; Chapter 3, “The Federal Structure”; Chapter 5, “Federal Assembly” (the Russian Parliament); and Chapter 8, “Local Government” of the Constitution. Thus, according to the Article 57 of the Constitution, [e]veryone shall be obliged to pay the legally established taxes and duties. Laws introducing new taxes or deteriorating since the position of taxpayers must not have a retroactive effect4.

Federal taxes and duties, as well as the federal budget, is stated only on the federal Level, and are subject to obligatory consideration in the Upper Chamber of the Russian Parliament (Articles 75 and 106). Pursuant to the Article 104, all initiatives on establishment or abolishment of taxes, tax exemptions may be considered in the Parliament only after the Russian Government’s prior opinion. However, since the Russian Federation is a federative state consisting of 83 subjects (including 21 republics, nine lands, 46 regions, two federal cities, one autonomy region, and four autonomy districts), the general principles of taxation in the country are established in cooperation between the Russian Federation and its constituent entities. So, the Articles 71 and 72 of the Constitution state that: [t]he joint jurisdiction of the Russian Federation and the subjects of the Russian

Federation includes… establishment of common principles of taxation and duties in the Russian Federation5.

3

The Constitution of Russian Federation (adopted by plebiscite on December 12, 1993).

4

http://www.constitution.ru/en/10003000-03.htm

5

http://www.constitution.ru/en/10003000-04.htm

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Three levels budget system of the Russian Federation is worked out in three levels structure of the state (federal, regional and local authorities). At that, federal budget and federal taxes are under jurisdiction of the federal government (Article 71 of the Constitution), regional taxes are under jurisdiction of subjects of the federation, and local taxes are under jurisdiction of municipal authorities. Local state authorities independently manage the municipal property, create to confirm and execute the local budget and establish local taxes and duties (Article 132).

b) Tax Constitution. Article 75 of the Constitution stipulates that:

[t][t]he system of taxes paid to the federal budget and the general principles of taxation and duties in the Russian Federation shall be fixed by the federal law6. The main federal law in the sphere of taxation is the tax code of the Russian Federation (the “TC”). There is also the customs code of the Russian Federation (the “CC”), which regulates the process of custom duty collection6. In implementation of the constitutional principles, the TC states kinds of taxes and duties collected in Russia; grounds for tax obligations to arise (change or end), and the legal order of their performance; principles of establishment of taxes, putting them into or out of effect; taxpayers’ and tax authorities’ rights and obligations, liabilities for their violation; forms and methods of tax control. For example, the TC states that the certain corporate profits´ tax and property tax rates, accrued into the regional budget, are established at the regional level, but must not be lower than 13.5% and 2.2% correspondently. Thus, respective laws of St. Petersburg state maximum possible low tax rates, i.e. 13.5% of the regional part of corporate profits´ tax, and 2.2 % property tax. Additionally, the TC prescribes certain amounts of duties collected by the state authorities for performance of different kinds of legal acts (i.e. court fees, registration duties, etc.). Taxes and customs duties, accrued in relation to the transfer of goods through the state boarder of the Russian Federation, are regulated by the CC, and respective customs legislation accepted in accordance with the Constitution and the CC. As opposed to the tax legislation, custom duties are stated only on the federal level (Article 71 of the Constitution). The majority of custom relations are regulated by the decrees of the Russian President, resolutions of the Russian Government

6

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http://www.constitution.ru/en/10003000-04.htm

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and the Federal Customs Service accepted in accordance with the CC, and other federal laws in this sphere. The responsibility of taxpayers for tax frauds is contained in the criminal code of the Russian Federation (Articles 198, “Evasion by Natural Person of Tax and (or) Duties to Be Paid”; and 199, “Evasion of Taxes and (or) Duties to Be Paid by Organizations”)7.

c) Tax Jurisdiction and Apportionment The current Russian tax legislation does not contain a special category “tax jurisdiction”. Nevertheless, we can use the term implemented to the Russian Federation according to the Article 67 of the Constitution: 1) 2)

The Russian Federation territory shall include the territories of its subjects, inland waters and territorial sea, and the air space over them; The Russian Federation shall possess sovereign rights and exercise the jurisdiction on the continental shelf and in the exclusive economic zone of the Russian Federation according to the rules fixed by the federal law and the norms of international law.8

The same treatment of tax jurisdiction of the Russian Federation is contained in the texts of Russian double tax treaties. According to the TC (Articles 13, 14 and 15), there is the following tax structure in the Russian Federation: • federal taxes: value added tax (VAT), excises, individual’s income tax, unified social tax, corporate profits´ tax, tax on natural resources extraction, water tax, levies for the right to use fauna and aquatic biological resources, state duty; • regional taxes: corporate property tax, tax on the gambling business, transport tax; • local taxes: land tax, individual’s property tax. Structure of tax revenues in the consolidated budget of the Russian Federation in 2008 is shown in Chart 1. We can see from this pie chart the dominative role of direct taxes (in proportion of about 80:20) as main sources of tax receipts for the Russian Consolidated Government. As for federal budget tax incomes for 2008, the prevailing character according to the Federal Tax Service statistics9 had the tax on natural resources extraction (39.3%), the corporate profits´ tax (18.7%), and the unified social tax (12.4%).

7

See: http://www.russian-criminal-code.com/PartII/SectionVIII/Chapter22.html

8

http://www.constitution.ru/en/10003000-04.htm

9

See www.nalog.ru

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Picture 1. Structure of tax revenues of the Russian Consolidated Budget, 2008 Source: Federal Service of State Statistics (Rosstat),

d) General Issues on Tax Collection The main state authority responsible for tax collection in Russia is the Federal Tax Service (FTS) under the supervision of the Ministry of Finance of the Russian Federation (the Ministry of Finance, MF). The FTS collects taxes enumerated in the Articles 13-15 of the TC for the all levels of the national budget system. Besides FTS, there is also a separate Federal Customs Service (FCS), whose responsibility is a collection of custom duties. Among all federal budget revenues in 2008, the share of taxes administrated by FTS was 44%, share of custom duties whose levies are under the control of the FCS equaled to 38.7%. Share of taxes administrated by FTS was 52.8% among all revenues in the Consolidated Budget of the Russian Federation, while a share of customs duties were estimated as 22.4%10. The tax administration is based on the following main principles: subordination, territorial, industrial, economic, legal status of a taxpayer, and budget principle. According to the subordination and territorial principles, the Russian tax administration is structured as follows: • FTS (the supreme tax authority coordinating all processes of tax administration);

10

100

Calculations by authors based on the Federal Service of State Statistics (Rosstat) and FTS data (see www.gks.ru and www.nalog.ru).

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• interregional tax authorities and tax administrations in the federal districts of Russia; and • local (territorial) tax authorities. Seven interregional tax authorities, as well as tax administrations in the federal districts of Russia, are governed directly by the FTS. It was established for coordination and control of local tax authorities. Local (territorial) tax authorities are divided under the industrial principle (i.e. administration is based in accordance with the taxpayers’ main business activities – banking and finance, trade, insurance, etc.); and according to the taxpayer’s legal status (i.e. there are taxing authorities administrating only legal entities or individuals, or foreign companies, etc.). Generally, for tax control purposes, all legal entities and individuals in Russia are obliged to register with the territorial tax authorities. Legal entities are obliged to register at their location and at location of each of their separate divisions. Physical persons have to register with the tax authorities at their registered dwelling place (place of registration in Russia for foreign citizens). Additionally, owners of immovable property and (or) transport vehicles are obliged to register with the tax authorities at location of this property. Tax registration of foreign legal entities operating in Russia is currently regulated by the Special Decree No. AP-3-06/124 issued by the Ministry of Finance on April 7, 2000. According to it, in case a foreign company carries out or intends to carry out activities in the Russian territory through a separate division within the period over 30 calendar days during a year (constantly or as a whole), this company shall register with the tax authorities at location of its activities not later than 30 days since the beginning of operating in Russia. If a foreign legal entity plans to operate in several locations in the Russian territory, it is obliged to register with the territorial tax authorities at location of each place of activities. Within five days after registration, the tax authorities provide each taxpayer with its individual identification number (INN) applied to all taxes (including those accrued in relation to transfer of goods through the Russian boarder) paid by the certain taxpayer throughout Russia. Special tax administration is established for the largest taxpayers, which are administrated depending on (a) the total amount of accrued federal taxes (from RUR 75 million to the RUR 1 billion, and exceeding RUR 1 billion); (b) the total amount of annual profits (from RUR 1 billion to the RUR 10 billion, and exceeding RUR 10 billion); and (c) the total annual assets value (from RUR 1 billion to the RUR 10 billion, and exceeding RUR 10 billions). If the taxpayers meet the requirements mentioned above to the amounts of accrued taxes, gained profits, and owned assets, they are considered largest and administrated by the special interregional or regional tax authorities

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directly governed by the FTS or respective tax administrations. At the present time, there are 10 interregional tax authorities of the FTS in the following industries: oil, gas, construction and trade, energy, metallurgy, communications, transport, arms manufacturing, banking, and finance. As for the budget principle of tax administration, main administrators of tax collections are local tax authorities. They control the correctness and timeliness of tax payments, accrue fines and late payment fees, collect tax debts and issue decisions on offset or refund of overpaid taxes. Taxpayers are obliged to pay taxes to the respective tax authorities in accordance with the certain code of budget classification. This code is assigned to each tax (tax part) under which the tax amounts are transferred to the correspondent parts of the state budget (federal, regional or local). For example, corporate profit tax is transferred partially in percentage wise: 2% to the federal budget and the rest (maximum 18%, if not decreased by the regional authorities up to 13.5%) to the regional budget. The territorial divisions of the Russian State Treasury are factual administrators of budget collections. Their activities are regulated by the budget legislation and the Budget Code of the Russian Federation (the BC) in particular. The BC prescribes the proportions of each tax (in percentage) transferred to the certain budget items. This is a budget tax administration. For example, excises are transferred to the federal part of the state budget depending on the kind of excise (from 50% to 100%). The activity of the Russian tax administrations of all levels is evaluated quite effective during the last several years (at least during the period between1998 - 2008). Thus, according to the FTS data, the annual increase of consolidated budget tax revenues amounted to 28% in 2007 and 14.9% in 200811. Nevertheless, the current economic crises changed this favorable tendency. Tax collections for the first 5 months of 2009 (January - May) decreased one-fourth in comparison with the same period in 2008 (RUR 2.66 trillion in May, 2009, opposite RUR 3.51 trillion one year before12). The most radical tax income decrease is expected by the MF in 2009 was for collections of corporate profit tax (minus 50-60% of the previous year’s revenues). So anti-crisis tax administration in the Russian Federation should plan its activity in accordance with the general situation in the economy. However, several attempts have been already made by the Russian Government. Dynamic of the main budget income´s receipt for 2009 is shown in Table 1. The main conclusions from these data are a sufficient decrease in tax on natural resources extraction collections (-53% in the first half of the year) as well as a radical decline of customs duties and corporate profits´ tax receipts. In contrast, there is a slow growth in the VAT, unified social tax, as well as individual’s income tax collections. Concerning tax structure changes, we can see a raise inthe VAT, unified social and individual’s income taxes share; both in the federal and regional budgets reflect this tendency.

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11

http://nalog.ru/html/docs/pril_0708.xls, http://nalog.ru/html/docs/pril_2007.xls

12

http://nalog.ru/html/docs/pril_yanv_may.xls

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Table 1. Dynamic of the main budget incomes receipt in Russia in 2009 Budget incomes

January – May, RUR bill.

As a percentage to January – May 2008

Share in budget incomes, %1 2008

2009

To the Federal Budget VAT

478.3

+6

12.2

18.1

Unified social tax

203.4

+4.2

5.3

7.7

Unified social tax, including funds out the budget

327.3

+3.2

-

Tax on natural resources extraction

302.8

-52.9

17.4

11.5

Import duties

179.3

-21.5

6.2

6.8

Export duties

565.7

-48.7

27

21.4

Corporate profits´ tax

114.7

-65.2

8.9

4.3

Corporate profits´ tax

453.7

-43.5

32.6

19.6

Individual’s income tax

596.5

+1.2

24

25.8

Transfers from the Federal Budget

503.7

+53.3

13.4

21.8

To Regional Budgets

Note: For the period January – May. Sources: The Federal Treasury, Vedomosti (www.vedomosti.ru) 1

Due to the serious decrease of tax collections for 2008 and the first half of 2009, the FTS not only tightened tax control within the tax department, but also spread it on the taxpayers, strengthening the severity and quantity of tax audits. Companies, as the tax authorities started to pay attention first, are large taxpayers and companies frequently claiming a tax refund from the state budget. Loss making companies and companies pay low average salaries or use tax schemes. Nevertheless, these companies can be honest or dishonest taxpayers; they all fall into the high risk zone. These taxpayers, at the moment, suffer from numerous requests on documents and information regularly inquired by the tax authorities in which they are asked to submit to the tax authorities: information on losses and their economic reasons, business plans on future commercial activities in Russia, profits planned to receive and taxes to transfer to the state budget. Most of such requests do not have any legal ground; they indicate the tax authorities’ aim to establish control under the tax budget receipts. As a result, they involve taxpayers into numerous timeconsuming court disputes and interfere into their normal business activities up to laying off business. Nevertheless, sometimes the Ministry of Finance is an even a stronger advocate of Russian taxpayers’ interests than the whole national court system. Thus, in the latest MF’s appeal, the initiative of the Supreme Court of the Russian Federation to allow to tax authorities to levy taxes without any court’s resolution was declared as unconstitutional. The MF blocked up the entry of such amendment in the current Russian tax legislation13.

13

http://www.newsru.com/finance/27jul2009/nalogi.html

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One more solution favorable to taxpayers is concerning the impossibility for more high court instances, to which a taxpayer might address to for a solution, to aggravate the fiscal position of the physical or juridical person by levying supplement taxes in addition to taxes fixed by this low level court instance.

3. Tax System

Background14. When Russia established a tax system suitable for a market economy in 1992, the tax systems of the Western countries provided some guidance: Western Europe was the model for the tax structure, whereas tax rates were set according to the US example. Therefore, the Russian tax system has both European and American elements: An example for the former is the existence of a value-added tax, while the latter are represented best by the moderate rates of income taxation. The introduction of this tax system is a good example for what went wrong with the economic reform in Russia. After more than 80 years of command economy, a market economy was to be established fast. With the help and advice of Western experts, the Russians went about to transform the formal institutions of taxation, the tax laws. But that transformation suffered from two defects: on the one hand, the new tax laws fell short of what was necessary in that they retained many features of the old plannedeconomy tax system – such as the extremely broad base (i.e. the minimal deduction possibilities) of the profit´s tax which, in Soviet times, effectively served as a gross income tax for enterprises. Due to that feature, companies were overburdened by a corporate profit tax whose effective rates were – because of the limits on cost deductibility – considerably higher than the nominal rates. On the other hand, the new laws went too far because they were written without paying much attention to the informal institutions: the behavioral norms and the expectations formed during the decades of the command economy. The law makers did not take into account the high level of mistrust towards the Government and bureaucracy, the importance of barter transactions and, above all, the lack of experience with the tax system of a market economy on the part of both the tax payers and the fiscal authorities. The latter problem was exacerbated by a misguided fiscal federalism which led to the aforementioned multiplication of taxes. “The myriad of tax stipulations are richly contradictory, which makes them almost impossible to implement. Adding to the confusion, many regulations are changed quarterly15.”

Of course, under these circumstances, the tax administration could not but fail – especially with an organization, system and procedures which were (and still are) quite ineffective. As a consequence, tax liabilities have often been negotiated rather than determined by law. To make matters still worse, tax authorities were allowed to impose highly punitive penalties which often bear no relationship to the actual tax liability or the seriousness of the offence. Because of this administrative leeway (and the poor salaries of most tax officers), corruption flourished.

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14

The historical overview of the Russian tax system is based on materials of two articles wrote by A. Pogorletskiy in cooperation with Prof. Dr. F. Söllner: Pogorletskiy A., Söllner F. The Russian Tax Reform // Intereconomics. 2002. No 3. May/June. P. 156-161; Pogorletskiy A., Söllner F. The Russian Tax System and Its International Competitiveness // Intereconomics. 2008. No. 5. September / October. P. 288 – 297.

15

Popova T., Tekoniemi M. Challenges to Reforming Russia’s Tax System // Review of Economies in Transition, 1998, No. 1, p. 14.

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Such tax policy is harmful under the best of circumstances – much more so in a period of transformation and structural change when business investments are, at the same time, very risky and very important for the economic recovery. “According to both Russian and foreign businessmen, the instability and discrepancies within the Russian tax system are among the most important problems hindering their activities16.” Government coffers also suffered: It is estimated that, in the 1990s, only between 60% and 70% of taxes due were actually collected; in the case of the individual income tax, this percentage even drops to about 40%17. Accordingly, the general Government revenue (as a percentage of the GDP) fell from 35.5% in 1993 to 28.4% in 199818. The low tax revenue led to, on the one hand, an increase of the budget deficit and, on the other hand, to deficiencies in the provision of public goods and arrears in the payment of wages and pensions – with negative consequences for the reputation of government and the willingness of citizens to pay taxes. Serious mistakes were made not only in the field of tax policy but also in the economic policy in general. Unsurprisingly, the economic situation did not improve substantially. On the contrary, investment remained low, whereas barter transactions and the shadow economy even grew in importance and corruption. Capital flight and tax evasion rose to record levels. The Government under the first Russian President Yeltsin having been politically weak, the necessary fundamental reforms could not be carried out against the resistance of vested interests and a hostile parliament. Instead, one resorted to a patchwork of shortsighted, half-hearted and uncoordinated measures to tackle problems as they arose, and one at a time. In the field of tax policy, attempts to fundamentally reform the tax system came to nothing. Plans were made, inter alia, to abolish the sales taxes existing side by side with the VAT, to lower tax rates (especially of individual’s income tax and corporate profits´ tax) while broadening the tax bases, and to simplify the tax system and the tax administration could. However, they were not applied, although major legislative proposals going in this direction had been under consideration for some time. Instead, tax legislation became more and more complicated as more and more special regulations were introduced and the relationship between tax authorities and tax payers deteriorated even further when a repressive, arbitrary tax police was established. Due to the lack of real reforms, the economic recovery in 1996 and 1997 proved to be fragile and temporary, fueled by high oil prices and speculative capital imports. In 1998, with the onset of the Asian crisis and the fall of oil prices, the Russian economy collapsed and the Government was faced with the complete failure of its economic policy – and, in particular, of its tax policy: “The crisis had several causes, but a key one was the

16

Popova T., Tekoniemi M. Challenges to Reforming Russia’s Tax System // Review of Economies in Transition, 1998, No. 1, p. 14.

17

Egorova E., Petrov Y. A Comparative Study of Taxation in Foreign Countries and the Reform of the Russian Tax System // Economic Systems, 1997, v. 21, No. 4, p. 362; Gavrilenkov E. Permanent Crisis in Russia: Selected Problems of Macroeconomic Performance // Restructuring, Stabilizing and Modernizing the New Russia (ed. by P.J.J. Welfens, E. Gavrilenkov), Berlin (Springer) 2000, p. 459; Popova T., Tekoniemi M. Challenges to Reforming Russia’s Tax System // Review of Economies in Transition, 1998, No. 1, p. 14.

18

Ebrill L., Havrylyhyn O. Tax Reform in the Baltics, Russia, and Other Countries of the Former Soviet Union // IMF Occasional Papers, 1999, No. 182, p. 3.

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inadequacy of federal government tax policies in achieving a sustainable improvement in revenue mobilization.”19 Before December 31st, 2000, the rough outlines of the Russian tax system looked as follows: • Individual’s income was taxed progressively with (marginal) rates of 12%, 20% and 30%. • Business profits´ were subject to a tax of up to 30% (the tax rate of banks and other financial companies can reach 38%). This tax applies, in principle, to the profit of all companies registered under Russian law – not just joint-stock companies or limited liability companies, but also partnerships. The corporate profits´ tax had a fixed and a variable portion: The revenue of the former (11% of taxable profits) went to the federal budget, whereas that latter (up to 19% of taxable income; for banks and other financial companies this rate was a maximum of 27%) went to regional budgets20. Insofar, as regional authorities chose not to apply the maximum rate (19% or 27%), the total profit tax rate was below 30% (38%). There were some highly unusual restrictions for the deduction of costs from the tax base. Dividends received were excluded from the tax base and subject to a 15% withholding tax21. • The social security system was financed by four different payroll taxes whose proceeds went to the pension fund, the unemployment fund, the medical insurance fund and the social insurance fund, respectively. These taxes summed up to (at least) 38.7% of the payroll, and had to be paid by the employers (depending on occupational risk. This rate could go up to 49.2%); in addition, employees had to contribute 1% of their salaries to the pension fund22. • The Federal Government also levied a VAT with a regular rate of 20% and a reduced rate of 10%, some excise taxes and duties and the infamous “road user’s tax” (a kind of sales tax with a rate of 2.5% whose proceeds went to regional budgets). • Among regional taxes, the most important was a sales tax (with a rate of up to 5%) and a business property tax. • Finally, there were also local taxes such as a personal property tax, a gift and inheritance tax, the “municipal housing tax” (yet another sales tax!) and several special duties. It was the regional and local taxes which contributed most to the enormous number of taxes in Russia (about 200, of which about 80 are actually raised) – and thus made

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19

Ebrill L., Havrylyhyn O. Tax Reform in the Baltics, Russia, and Other Countries of the Former Soviet Union // IMF Occasional Papers, 1999, No. 182, p. 2.

20

Such distribution of the corporate profits´ tax was copied by the Russian Federation from the German experience, where there is the principle of redistribution of corporate profits´ tax incomes between the Federal State and the Länder (States of the Federation).

21

For example, advertising and insurance costs were deductible only within narrow limits, and the carry-over of losses was very restricted.

22

In order to evade these taxes, part of the wage is often reclassified, especially as interest income: employees get a (cheap) loan and they immediately deposit this sum for which they earn a high interest rate (sometimes several hundred percent). The difference between the interest they receive and the interest they pay is their unofficial wage – on which no social security taxes are paid (this method was particularly attractive when interest income was not taxed at all). The use of this stratagem is facilitated by the fact that Russian firms are, for a considerable part, organized in financial-industrial groups to which banks and other financial companies belong (see, e.g., Perotti E.C., Stanislav G. Red Barons or Robber Barons? Governance and Investment in Russian Financial-Industrial Groups // European Economic Review, 2001, v. 45, pp. 1601-1617).

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the Russian tax system one of the most complex in the world23. So, such system really needed reformation. The political situation in Russia has changed dramatically since Vladimir Putin was elected president in March 2000. Already in 1999, his supporters’ parties won a decisive victory in parliamentary elections so that he – unlike Yeltsin – could (and still can as the acting Russian Prime Minister) rely on a loyal, cooperative parliament. Putin used his political strength to reassert the power of the federal Government and to reduce the influence of both regional governors and business tycoons (the infamous “oligarchs”). Having consolidated their position, he and his allies began to push through farreaching reforms. One of the most important and most successful of these reforms is the tax reform in 2000 and 200124. The first part of this comprehensive reform was enacted in August 2000 and became effective on January 1st, 2001. Most importantly, individual’s income taxation and the social security taxes were changed substantially; in addition, also indirect taxes and the corporate profits´ tax were affected. The reform of the corporate profits´ tax presented the second wave of the reform was passed in August 2001 and became effective on January 1st, 2002. The tax reform in the beginning of the 21st Century was the first step towards building a competitive tax system for the Russian Federation. During the tax reform process, the following steps were made: • Increasing fairness and neutrality of the tax system by abolishing unjustifiable tax advantages, ineffective taxes (such as the sales tax and the road user’s tax) and collection methods, and by introducing clear rules for tax base determination and tax administration; • Reducing the overall tax burden for taxpayers by evenly distributing the tax burden, decreasing the tax burden of the wage fund and lowering individual’s income and corporate profits´ taxes (of course, it was the nominal tax burden that was reduced; the effective tax burden of some tax evaders which were targeted by a more effective tax administration may well have increased). • Tax system simplification by reducing the number of taxes and collection methods and by simplifying and rationalizing tax payment; • Bringing stability and predictability to the tax system by abandoning the chaotic, unsystematic tax legislation of the first Russian President Yeltsin era. The reform was designed to rationalize the tax system by, e.g., reducing the number of taxes and to lower the corporate and individual tax burden. Changes to the tax regime that came into effect in January 2001 included the introduction of a flat-rate individual’s income tax of 13%, instead of the previous 12-35% progressive rates and the simplification of social security taxation. The corporate tax rate was lowered 23

Götz R. Die großeSteuerreform in Russland // AktuelleAnalysen des Bundesinstitutsfürostwissenschaftliche und internationaleStudien, 1997, No. 28, p. 3; Popova T., Tekoniemi M. Challenges to Reforming Russia’s Tax System // Review of Economies in Transition, 1998, No. 1, p. 14.

24

Significantly, the US magazine “The Time”, in its “The Best and Worst of 2001” section of the double issue of December 31st, 2001 and January 7th, 2002, praises the Russian tax reform as the “best reform” in 2001 (p. 102).

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from 35% to 24% in the early 2002. The basic VAT rate was reduced from 20% to 18% in the early 2004, and a regional 5% sales tax was abolished. Furthermore, tax administration has continuously been improved since the beginning of the new Century (e.g., tax revenue in 2007 grew almost 30% year-on-year25). The reform of the Russian tax system was realized by taking into account the insights of modern public finance theory and the results of the neo-conservative tax reforms in the USA and Great Britain, as well as of the successful VAT implementation in Europe. Stimulating business by considerably reducing individual’s income and corporate profits´ taxes and shifting the tax burden to indirect taxes (the VAT and the tax on extraction of natural resources) were the specific traits of the Russian tax reform in the 2000s. It became the most coherent and effective reform among all economic transformations pursued by the second Russian president Vladimir Putin and his administration. As a result, Russia has now a quite modern, competitive tax system, which strongly contributes to making Russia attractive both for domestic and foreign individuals or corporations. The Russian tax systemcharacterizes the post-reform, according to its tax burden level (see Chart 2). First of all, we can mark that the overall tax burden in Russia is about 36.5% of its GDP (Chart 2, upper graphic) while the tax burden for non-oil and gas sector is lower than in the majority of the countries all over the world (about 29.5% of the GDP, low graphic in Chart 2). Thus, as we can assume, Russian taxes are more sufficient for oil and gas companies than for other companies, as well as for citizens. The second remark is that direct taxes play the dominative role in the modern Russian economy (at least 80% of tax receipts of the consolidated budget, and 70% of the federal budget in 200826).

Picture 2. Tax burden for non-oil and gas sector (low line) and overall tax burden (upper line) in Russia, percent of GDP Source: Federal Service of State Statistics (Rosstat)

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25

http://www.nalog.ru/html/docs/pril_2007.xls.

26

http://nalog.ru/html/docs/pril_0708.xls

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In the international context, Russia has about 70 applying treaties on double taxation with almost all major countries of the world. They make it sufficiently easy to repatriate profits´ (especially dividends, interests and royalties) from Russia to other countries, as well as to invest into the Russian economy through low-tax countries and international holding, financial, licensing and service companies and banks.

a) Income and Wealth Taxes ± Direct Taxes

The most important direct taxes in the Russian Federation are corporate profit tax (29.7% of consolidated budget tax collections and 18.7% of federal budget tax collections in 2008), tax on natural resources extraction (relatively, 20.6 and 40.1%), and individual’s income tax (19.7% of tax receipts to consolidated budget in 2008).

The corporate profits´ tax (Chapter 25 of the TC) is applied both for the Russian enterprises and foreign legal entities conducting business in the Russian Federation through permanent establishments. The TC does not contain a special term “tax resident” applied to companies while, according to its provisions, Russian legal entities are those incorporated under the Russian Law. Russian enterprises are subjected to tax in Russia on their worldwide income. On the contrary, foreign legal entities are those incorporated under the law of foreign countries, international companies, as well as their branches or representative offices in Russia. Foreign companies operating in Russia are subject to taxation on the Russian territory depending on their activities carrying out in Russia. Generally, they pay all main taxes as the Russian taxpayers provided operating through a permanent establishment (PE) in Russia (i.e. corporate profits´ tax, VAT, unified social tax, etc.). Those foreign legal entities which do not create a PE (i.e. do not carry out commercial activities regularly in the Russian territory) are only subject to withholding tax on their Russian profit. The definition of “permanent establishment” for foreign companies is similar to the definition of the same term in the OECD model tax treaty. For both Russian legal entities and foreign legal entities operating in Russia through a PE, the basic corporate profits´ tax rate consists of a 2% rate payable to the federal budget and rates ranged from 13.5 to 18% payable to the regional budgets. As a result, the basic corporate profits´ tax rate varies from 15.5% to 20%, depending on the rate set by the regional government. In most cases, the corporate profits´ tax rate is 20%. Foreign legal entities not creating a PE in Russia, and gaining profits´ from Russian sources generally pay withholding tax at rate 20% on all Russian profits, except those gained from the lease of transport vehicles in relation to international transportation and dividends received from Russian legal entities – these profits are taxed at 10% and 15 % correspondently. The tax on the Russian profits, gained by the foreign legal entities not operating in Russia through a PE, shall be withheld by the tax agents in the time of every payment made to the foreign legal entity. However, as it is stipulated in the TC, the tax agents could be only the Russian legal entities or foreign legal entities operating in Russia through a PE from which the profits´ were received. The legal mechanism of taxation of profits´ in case of sales to the foreign legal entity or a Russian physical person is not prescribed in the TCTherefore, we may

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concludethat, despite corporate profits´ tax is stated in the TC and shall be applied in all cases set forth in the TC and the Russian double tax treaties, sometimes it could not be realized in practice. The tax on natural resources extraction (TNRE) was introduced in Russia in 2002 (the TC, Chapter 26). It is imposed on the value or volume of extracted commercial minerals (mostly oil and gas) in accordance with various rates. TNRE with respect to crude oil is determined as the quantity of extracted crude oil multiplied by the tax rate with taking into account a multiplier reflecting fluctuations in world prices for Urals crude. In frames of the anti-crisis tax management of the federal Government, some measures to increase the TNRE rates (especially for gas) are discussed27. The individual’s income tax (the TC, Chapter 23) in the Russian Federation depends on a resident status of a physical person. Russian tax residents are those individuals which have been in the country for 183 days or more during any twelve consecutive months. Their incomes are subject to tax in Russia on the world-wide basis. The basic tax rate for Russian residents is 13% (flat rate). Some incomes of individuals that are Russian residents are imposed by other tax rates, such as 9% (dividend incomes) and 35% (gambling incomes, lottery prizes, some interest incomes). For physical persons – non-residents of the Russian Federation – the tax rate on incomes from Russian sources is 30%. It is necessary to make an accent that the basic rate of Russian individual’s income tax is one of the lowest all around the world, and it favors to wealthy people to legalize their incomes. The TC provides the taxpayers with exemption of individual’s income tax on several kinds of income, among which state maintenance allowances, pensions, all kinds of compensations stated by the state authorities at the federal, regional and local levels, grants, alimony and other such as kind of social payments. Additionally, Russia grants its individual tax residents various kinds of offsets. Particularly, there are so called social, property and professional offsets for the physical persons. Social offset means a deduction granted to the taxpayer in an amount that he spent on his medical treatment, education, or transferred for the charity purposes justified by the respective primary documents. This offset is granted in the amount of factual expenditures, but not exceeding the certain limit stated in the TC (e.g. not more than RUR 50,000 spent on Education). Property offset is provided in case of sales of houses, apartments, rooms, summer houses or land plots in amount of received income, but not exceeding RUR 1 million for the mentioned property owned by the taxpayer less than three years (RUR 125,000 – for the other not mentioned above property objects), and in the total amount of income gained from a realization of the property owned more than three years. The property offset is also granted for a new construction or purchase of a new house, apartment, room or other living quarters on the Russian territory in an amount of factual expenditures

27

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In particular, the Russian Government assumed to increase TNRE for gas since 2010 but decided not to introduce these measures in 2010 as it planned before (see http://www.vedomosti.ru/newspaper/article.shtml?2009/07/30/207530).

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spent on construction or purchase, but nor exceeding RUR 2 million, excluding those spent on special purpose loan repayments. Professional offsets are provided for the several categories of taxpayers, such as individual entrepreneurs, notaries, attorneys, etc., and represent factual expenditures proved by the primary documents which are allowed to be taken into consideration for calculation of the tax base. It should be noted that, in the early July, 2009, within the frame of currently conducted tax reforms (anti-crisis measures), the Russian Parliament passed the draft law substantially improving taxpayers’ position. In particular, it is suggested in the draft law additionally to grant a property offset in case of purchasing a land plot for a new construction of individual apartments; the list of incomes not subject to individual’s income tax is suggested to extend and, for example, not to impose a tax on sales of cars by individuals owning them for not less than three years before sales. Moreover, it is planned to increase property offset in case of sales of movables from RUR 125,000 to RUR 250,000. Another important direct tax in Russia is a property tax (almost 10% of consolidated budget tax receipts between January and April 2009). This tax assumes both the corporate property tax and the individual’s property tax. Corporate property tax was introduced by the Article 30 of the TC as a regional tax, i.e. it is regulated by the legislation of the relevant region. The tax base includes movable and/or immovable fixed assets owned by Russian legal entities and foreign companies operating in Russia through a PE, and is calculated based on the depreciated book value of those assets. The maximum rate of the tax is 2.2%. Foreign legal entities, owing immovable property on the Russian territory or possessing it under a consignee agreement, are also subject to corporate property tax in Russia, which is calculated on the inventory value of immovable property in accordance to the data regularly provided by the technical inventory authorities. Taxation of the property of individuals is provided for in the so named Federal Law No. 2003-1, issued on December 9, 1991. According to it, physical persons in Russia currently have to pay individual’s property tax on their houses, individual apartments, summer residences, parking houses and other buildings, rooms or constructions owned by them. The individual’s property tax rates are established by the local state authorities depending on the total inventory value within the limits stated by the named Federal Law (i.e. up to 0.1% tax rate on the property value not exceeding RUR 300,000; from 0.1% to 0.3% tax rate on the property value of RUR 300,000 to RUR 500,000; and from 0.3% to 2% tax rate on the property value exceeding RUR 500,000). The individual’s property tax is calculated by the tax authorities in accordance with the property’s inventory value annually provided by the state inventory authorities. The tax is accrued into the local budget at location of the property. According to the budget proposals of the Russian President, it was suggested to replace the individual’s property tax and land tax with the unified real estate tax for individuals. This initiative is now in implementation process, as it follows from the main

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directions of the tax policy in the Russian Federation for 2009-2011, approved by the Russian Government on May 25, 2009.

b) General Direct Taxation Issues

Relatively low level of principle income taxes (corporate profits´ tax and individual’s income tax) makes Russia one of the most favorable tax jurisdictions in Europe to produce and to live in. Indeed, the Russian Federation has quite strong positions in the international tax competition. Nevertheless, the Russian federal Government sometimes uses tax instruments (including corporate profits´ and individual’s income taxes) not only for indirect regulation of the economy, but for repressions against political opponents. Cases of Yukos company and its CEOs M. Khodorkovskiy and P. Lebedev, as well as a case of Arbat Prestige company (V. Nekrasov and S. Mogilevich) showed that tax authorities could accuse successful business in tax frauds, initialize and win the trial basing mostly on political not economical preferences. It is a worry signal both to home and foreign investors as well as for potential tax refugees to use Russia as a favorable tax destination. In most cases, the Russian tax authorities used to accuse business in receiving “unreasonable tax benefit”, i.e. no factual business activities, no really economic sense or reasoned economic purpose of business relations, etc. Moreover, they usually argue the price value of the concluded transactions referring to its invalidity in comparison to the market price. Based on these arguments, they charge taxes, fines and late payment fees upon the conducted tax audits, and debit them directly from the taxpayers’ bank accounts. Since the fact that the tax authorities in Russia have an implicit right to charge taxes from the corporate taxpayers’ bank accounts without any additional permission, the most effective way to challenge these charges and to return money back is appealing to the court. Except those cases when the court is politically biased, as it was said above, the court practice is rather positively disposed to the taxpayers in Russia; most courts resolve cases in favor of them. However, it could not but mention that court disputes are rather long: in average, it takes one or two years. Moreover, tax legislation is complicated in Russia, and officially, we do not have a judge made law. Therefore, the court has no legal opportunity to resolve cases against the current legal provisions (despite of the fact they contradict general principles of law) and the taxpayers lose the case on its face, not in substance

c) Consumption Taxes and other Indirect Taxes

The principal indirect taxes in the Russian Federation are the VAT and the excises which joint share in 2008 was 16% in consolidated budget and almost 30% in the federal budget. The VAT was originally introduced in Russia in 1992 based on the experience of the European Union. Currently, the VAT imposition is regulated by the Article 21 of the TC (the Article opens Chapter II of the TC, whichoutlines the importance of the tax). The VAT is applied to the sale of goods, work and services in the Russian Federation, as well as is imposed on goods imported into Russia. There are two main tax rates of the VAT: (1) a basic rate of 18% on the sale of most goods and (2) a lower rate of 10% for limited types of goods, such as pharmaceuticals, medical equipment, and certain food products and periodicals.

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The export of goods is free of tax (0%); however, the right to exempt exporting goods shall be justified by submitting a set of primary documents to the Russian tax authorities. As for the tax budget receipts from the VAT, they were very important because of the positive fiscal role of the VAT in the first years after its introduction (this fact made VAT a tax No.1 in Russia in the end of XX Century). Now, the VAT continues playing principal role in the Russian tax system, but it ceded its place to corporate profit tax, TNRE, and individual income tax. The VAT share in GDP was stable amounted 6-7% for the years 1992 – 2007 (see Chart3).

Picture 3. Share of VAT as a percent of GDP of Russia, 1992 – 2007 Source: Ministry of Finance (www.minfin.ru)

Excises. The order of excise implementation is regulated by the Article 22 of the TC. The main groups of commodities to be imposed by excises include alcohol (spirits and spirit contained products as well as beer), tobacco, power vehicles and motorbikes, as well as gasoline and diesel fuels. Because of the economic crises, the Russian Government has increased basic excises for alcohol and tobacco since 2010 for 30% and 44% respectively28.

d) General Indirect Taxes Issues

The VAT court disputes constitute one of the major parts of tax disputes currently being resolved in court. The main problem is that the Russian tax authorities argue the taxpayer’s right to receive the VAT refund or reimbursement from the state budget. Most large taxpayers with a big monthly turnover suffer from the tax authorities’ frequent, unreasonable demands. First, the existing situation is determined by the economic downturn period, because the state authorities’ policy is aimed at collecting money by all costs and obviously they are rather negatively disposed at refunding money from the budget, despite in most cases, it is their obligation. Therefore, the taxpayers rather

28

http://news.mail.ru/economics/2780646/

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frequently meet with missing deadlines for the VAT refund and other artificial obstacles made by the tax authorities. Second, at the moment many companies use tax schemes involving shell companies in the chain of business in order to minimize VAT payments into the budget. The tax authorities analyze the revealed schemes and, in return, develop certain criteria they use in accusing taxpayers fordishonest business activities. Thus, those companies, which business process is structured similar to these criteria, automatically fall into the high risk zone, and are more scrupulously audited by the tax authorities. Finally, in practice, there are many problems related to customs VAT. For example, under the Russian customs´ legislation, a foreign legal entity not operating in Russia through a PE cannot be an importer under the transaction between this foreign legal entity and a Russian company. Therefore, this foreign company will not have an import VAT refund. Additionally, there are many court disputes between the taxpayers and the tax authorities with regard to export VAT subject to a 0% rate. Mostly, these disputes devoted to proving whether realized works or services are subject to 0% tax rate due to their direct relation to the exported goods, or they are subject to the basic 18% VAT rate, as simply realized on the Russian territory.

e) Other Taxes (Contributions, Fees, etc.) Amongother taxes playing an important role in the modern Russian tax system, there are the unified social tax (UST), corresponding to 12.4% of the federal total tax collection in 2008, and the state duties. The UST (analog of social security tax which tax base is a wage fund, including salaries and other remuneration paid to individuals under labor and civil contracts), introduced by the tax reform in the 2000s, is now under radical revision. The UST has been planned to be abolished since January 1, 2010, as it was recently introduced and adopted by the Russian Parliament (on July 18, 2009, the passed draft law was sent for signature to the Russian President). If the new draft law is finally approved by the President, Russia will return to the practice of the 1990s, when separate security taxes, paid to the national pension, social security and medical funds existed. Regardless any attempts of the Russian Ministry of Economic Development to postpone the reform Until the end of economic crisis, in the draft law, it is planned to increase the total amount of contributions to the various funds from 26% to 34%. State duties do not play such important fiscal role for federal, regional, and local authorities as other taxes already mentioned above. It is amounted only 0.3% of all incomes of consolidated budget in 200829. Nevertheless, as a reaction of decreasing tax collections in 2009 because of crisis reasons, the Ministry of Finance is supposing to

29

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over evaluate the current level of state duties (there have beenno changes in this sphere since 2000) and to increase all types of them. It is expected that those measures could provide an at least supplemental RUR 50 billion to the budget system and to double the total state duties´ collections of the Federal Government30.

f ) Tariffs and International Trade Duties Issues associated with implementation of tariffs and international trade duties are under the competence of the FCS, and are regulated by the CC, the respective federal laws and the Russian Government’s Resolutions in this sphere. Receipts of customs duties amounted to 38.7% of all revenues of the Russian federal budget in 200831. So questions of changes the current customs regime and access to the WTO are very important for the Russian Federation, especially in the conditions of the economic crises, when the volume of international trade, hence receipts of customs duties and other taxes for international trade operations, are decreasing.

g) Taxation and Electronic Commerce In essence, questions of electronic commerce taxation did not develop perfectly in the modern Russian economy. Nevertheless, Russia, which has an observer status in the OECD (Committee for Fiscal Affairs), could use the appropriate OECD recommendations concerning treatments of the Articles 7 and 12 of double tax treaties (in cases with difficulties to identify e-commerce incomes as profit or royalties). By the way, the Russian Federation followed the EU experience to impose the VAT on e-commerce transactions and apply now the VAT to virtual sells of different commodities and services, such as trains and air tickets, books and other items.

4. Economic Development a) Background The statistical data for 2008 indicates that the Russian Federation was present in the list of Top-10 leading economies of the world according to the total GDP evaluation (both the market exchange rate and the PPP estimation - Table No. 2). It also shows strong Russian annual GDP growth positions in 2008 (+5.6%), as well as a leadership among the BRIC countries in terms of GDI per capita figures.

30

http://vedomosti.ru/newspaper/print.shtml?2009/06/18/200750

31

http://gks.ru/bgd/regl/b09_06/IssWWW.exe/Stg/1/13-02.htm

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Table 2. Russia in comparison with the 12 world’s biggest economies Total GDP ranking (2008)

Country

1

USA

2

Population* Total GDP GDP (millions (billions of growth of people, USD, 2008) (%, 2008) 2008)

PPP GDP in USD* (billions of USD, 2008)

GNI per capita* (USD, 2008) Atlas method

PPS

304.1 (3)

14,204.3

1,1

14,204.1 (1)

47,580 (14)

46,970 (11)

Japan

127.7 (10)

4,909.3

-0,7

4,354.6 (3)

38,210 (30)

35,220 (32)

3

China

1,325.6 (1)

3,860.0

9,0

7,903.2 (2)

2,770 (130)

6,020 (122)

4

Germany

82.1 (14)

2,668.1

1,3

2,925.7 (5)

42,440 (22)

35,940 (29)

5

France

62.0 (21)

2,853.1

0,3

2,112.4 (8)

42,250 (23)

35,660 (34)

6

UK

61.4 (22)

2,645.6

0,7

2,176.3 (7)

45,390 (18)

36,130 (28)

7

Italy

59.9 (23)

2,293.0

-1,0

1,841.0 (10)

35,240 (32)

30,250 (39)

8

Brazil

192.0 (5)

1,612.5

5,1

1,976.6 (9)

7,350 (82)

10,070 (95)

9

Russia

141.8 (9)

1,607.8

5,6

2,288.4 (6)

9,620 (75)

15,630 (71)

10

Spain

45.6 (28)

1,604.2

1,2

1,456.1 (12)

31,960 (37)

31,130 (37)

11

Canada

33.3 (36)

1,400.1

0,4

1,214.0 (14)

41,730 (25)

36,220 (27)

12

India

1,140.0 (2)

1,217.5

7,3

3,388.5 (4)

1,070 (163)

2,960 (155)

* In brackets – ranking in the world. Sources: World Bank, IMF

The overall economic indicators for the Russian Federation in 2001 – 2009 (see Table No. 3) determine a relatively high level of economic dynamic of the country in the beginning of the 21stCentury. Thus, the GDP nominated in the national currency grew almost five times between 2001 and 2008, as well as the sufficient increase of investments, exports and imports activity, and foreign reserves are observed in this period. Moreover, Russia sharply decreased its external government debt and accumulated huge assets in the Stabilization Fund (divided later for the Reserve Fund and the National Welfare Fund). Of course, the country was continuing to force with some problems such as a high level of inflation (close to the annual rate of 13% in average for the period of 2001 – 2008). However, the national currency stability, the sufficient increase of wages until 2008 (5.5 times in terms of the average wage), and the stabilization on the labor market were definitely among the most visible achievements of the Russian economy in this historical period.

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Table 3. Key economic indicators for the Russian Federation, 2001 – 2009 Macroeconomic indicators 2001

2002

2003

2004

2005

2006

2007

2008

2009

as of

GDP, %-change

5.1

4.7

7.3

7.2

6.4

7.7

8.1

5.6

-9.8

Q1/09

GDP, RUR billion

8944

10831 13243 17048 21625 26904 33111 41668 8482.8

Q1/09

Industrial production, % -change1

2.9

3.1

8.9

7.3

4.0

3.9

6.3

2.1

-15.4

1-5/09

Fixed investments, %-change

10.0

2.8

12.5

13.7

10.9

16.7

21.1

9.1

-17.7

1-5/09

Exports, $ billion

101.9

107.3

135.9

183.2

243.6

304.5

355.2

471.8

101.4

1-5/09

Imports, $ billion

53.8

61.0

76.1

97.4

125.3

163.9

223.1

292.0

66.8

1-5/09

Current account, $ billion

33.9

29.1

35.4

59.5

84.4

94.3

76.2

102.3

17.22

H1/09

Unemployment, % (end of a period)

8.7

9.0

8.7

7.6

7.7

6.9

6.1

7.7

8.5

5/09

Fiscal indicators for federal government (% of GDP, unless otherwise indicated; end-year figures for debt) 2001

2002

2003

2004

2005

2006

2007

2008

2009

as of

Revenues2

17.8

20.3

19.5

20.1

23.7

23.4

23.6

22.3

18.622

1-5/09

Expenditures3

14.8

19.0

17.8

15.8

16.3

16.0

18.1

18.2

22.22

1-5/09

Balance

3.0

1.4

1.7

4.4

7.5

7.4

5.4

4.1

-3.62

1-5/09

External debt

33.3

27.7

22.4

16.1

9.2

4.4

2.7

1.8

2.3

Q1/09

External debt, $ bn

102.0

95.7

96.9

95.5

69.9

43.2

35.8

28.2

26.42

H1/09

18.9

43.0

89.1

156.8

225.1

184.5

6/09

2007

2008

2009

Stabilization fund, $ bn4

Monetary indicators 2003 2004 2005 2006

2001

2002

18.6

15.1

12.0

11.7

10.9

9.0

11.9

13.3

11.9

6/09

39.7 111 4.9 17.9 36.6

32.4 142 5.0 15.7 47.8

50.5 180 4.5 13.0 76.9

35.8 237 3.8 11.4 124.5

36.8 301 4.0 10.7 168.4

48.8 408 4.0 10.5 303.0

47.5 550 5.2 10.8 476.4

1.7 608 7.0 15.5 427.1

-6.3 569 8.9 16.0 412.6

5/09 5/09 4/09 4/09 6/09

RUB/USD exchange rate6

30.14

31.78

29.45

27.75

28.78

26.33

24.55

29.38

31.29

6/09

RUB/EUR exchange rate6

26.49

33.11

36.82

37.81

33.94

34.70

35.93

41.44

43.82

6/09

Inflation (CPI), 12-month, %5 M2, 12-month growth, %5 Average wage, $ 6 Deposit interest rate, %5 Lending interest rate, %5 Forex reserves, $ bn (incl. gold)

as of

Notes: 1 New methodology from 1.1.2005, figures for 2001-2004 revised, not comparable with previous years. 2 Preliminary figure. 3 Since 2002 parts of the unified social tax is included in the federal budget. 4 In 2008 the Stabilization Fund was split into the Reserve Fund and the National Welfare Fund. 5 Ends of a period. 6 Period average. Sources: Federal Service of State Statistics (Rosstat), Central Bank, Ministry of Finance, IMF, BOFIT

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What are the main causes of the good economic performance of the Russian Federation in the pre-crisis period of the 2000s? We try to understand the situation. The recent long-term period of economic growth in the Russian Federation commenced soon after the financial crisis in August 199832.Pursuant to qualified anti-crisis policy in1998, the Russian economy was liberalized with extension of entrepreneurs’ freedoms and with an accent on indirect methods of government involvement in the business activity (including a more neutral role of taxation for business). The weak ruble helped the Russian producers in their competitiveness both at domestic and international markets. Due to a poor tax policy in the 1990s (i.e. inability of fiscal authorities to collect taxes because of high level tax evasions of individuals and organizations mostly caused by the low profit level of the majority of the Russian taxpayers) named by the IMF as one of the main causes of the crisis. The Russian Government decided to initialize the radical tax reforms starting from 1999. The new tax code of the Russian Federation introduced a quite modern tax structure and favorable methods of tax base calculation, as well as moderate tax rates. The radical reform in Russian taxation had to be one of the most important parts of the national economic transformation on the boundary of the 20th and 21st Centuries. The reform used the best world tax theories and practice and had to provide a sufficient level of economic growth in the beginning of the 21st Century. Definitely, one of the main senses of the Russian tax reform in the 2000s was to use stimulated role of taxation on the national economy based on a supply-side theory. One of the explanations of this well-made tax policy was also a well-trained guidance of the fiscal division of the Russian Government under the supervision of liberal Ministry of Finance Alexei Kudrin, and his supply-side theory follower, Deputy Minister of Finance Sergey Shatalov. Their authority in tax issues was absolute and still stays untouched. Nevertheless, reason of a stable economic development of the Russian Federation in the 2000s, which was even more important than liberalization and good tax administration, was a favorable situation on the world’s raw materials´ markets. Since the main exports´ commodities for Russia are minerals (primary oil and gas), as well as metals,33 the sufficient price increase which lasted until summer 2008 was the driving factor No. 1 for the national economy. Indeed, the unprecedented growth rate of the Russian economy in 2006 (+7.7% of the GDP), 2007 (+8.1% of the GDP), as well as in the first half of 2008, can be explained by the same unprecedented oil price increase (see graphic on Chart4 illustrating price of Urals barrel between 2005 – 2009). As soon as oil prices radically down turned from its maximum level in July 2009, the growth rate of the Russian economy became negative.

32 Events of August 1998 consisted in the State debt default and sufficient national currency devaluation (two times between August and September 1998, about four times between August 1998 and August 1999). 33

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According to the Federal Service of State Statistics data, fuel and energy commodities (including oil share of 32% and natural gas share of 14%) amounted two third of the total Russian exports of goods between January – May 2009, as well as the share of metals in the same period, which was 12.4% (see http://www.gks.ru/bgd/free/b04_03/IssWWW.exe/Stg/d02/132.htm).

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Picture 4. Price of Urals oil, dollars per barrel

Source: Center of economic analyses and short-term forecasting (http://www.forecast.ru/mainframe.asp)

b) Important issues

While theseveral years (at least, the period between 1999 – 2008) were, in general, very favorable to the development of the Russian economy34, soon the country’s dependence on the oil and gas prices vulnerability became evident. Windfall effect of the period lasted until the summer of 2008 when oil prices reached their historical peak. Nevertheless, without a windfall factor, annual rates of GDP growth in Russia were steady negative since 2004, when the “Holland disease” effect, as well as deteriorations of the quality of Government regulations, became more evident. Chart 5 shows evaluated losses in the potential GDP growth rate due to poor quality of policies and institutions in the Russian Federation (it reflects the calculations of the Institute of Economic Analysis, whose director Andrei Illarionov is one of the most critical opponents of the Russian authorities35). In such circumstances, the Russian tax policy was more and more shifting from the initial growth-oriented objects to just fiscal-oriented policy basing on taxes for extraction, different transactions and export of natural recourses. Current economic crisis, which heated Russia in the Fall of 2008, had to revise the previous Government approach to economic growth based on windfall oil and gas factors, and caused a serious problem in public finance. Indeed, after the favorable period of economic growth between1999 – 2008, with huge positive fiscal balance of the State (which reached more than 7% of the GDP between 2005-2006, and about 4.1% in 2008 for the federal budget), the situation in 2009 and forecasts for 2010 ofsufficient negative fiscal balances are seemed as a sharp contrast from these propitious years of the beginning of the 21st century.

34

Rates of GDP growth averaged 7% annually since the financial crisis of 1998.

35

While A.Illarionov, who was the advisor of Mr. Putin on economic affairs, is constantly seriously criticizing the economic policy of the Russian President and his government, he has no critical remarks concerning the modern Russian tax policy which is, according Illarionov, one of the very few positive achievements of Putin during his entire presidency in 2000 – 2008.

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Picture 5. Real GDP growth in Russia adjusted for windfall profits received (GDP real growth minus windfall profits, percent of GDP) Source: the Institute of Economic Analysis (www.iea.ru).

c) Economic Growth The inter-crisis period between 1999 – 2008 is characterized by a relatively high level of economic growth in the Russian Federation, which started from 6.4% of the GDP in 1999 and finished with 5.6% of the GDP in 2008. In peak years, the Russian GDP was growing even more than 8% annually (by 10.0% in 2000 – the first year of the Russian tax reform realization, by 7.7% in 2006, and by 8.1% in 2006). The main drivers of this growth changed from year to year: in the beginning of the 2000s, it was the positive effect of the national currency devaluation, as well as a different stimulus, including the new tax system created by the Russian government for business; whereas in the middle of 2000s, it finally became the windfall effect of the price increase for the principal Russian export commodities, such as minerals and metals. Definitely, just in this period, the Russian economy was infected by the “Holland disease”, and the Russian Government was incapable of developing the innovation growth model. Nevertheless, in the years of the favorable situation on international raw materials markets, the Russian Government used fiscal instruments, such as export duties and the tax on natural resources extraction, to create a “safety pillow” in the form of official reserves in a foreign currency (about RUR 600 billion in August 2008, and more than RUR 400 billion in July 2009) as well as assets of the Reserve Fund and the National Wealth Fund (about RUR 190 billion in total in July 2009). Chart6 presents statistical data of the Russian annual GDP growth in the period between 1999 - 2008 with some estimation for 2009. Unfortunately, global economic

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crises deteriorated growth outlooks for Russia in 2009 until minus 6.5% of the GDP according to IMF data and even less (-8.5% of the GDP) according to evaluations of the Russian Ministry of Economic Development (MED).

Picture 6. Annual GDP growth (in percents), 1999 – 2009 Source: the Federal Service of State Statistics (Rosstat)

Thus, negative prospects for Russia in 2009 and quite modest improvements forecasting by 2010 (weak GDP growth, with a 0.1-1.0%rate) are making the Russian tax policy for 20092012 strongly dependent on these problems. At that time, the Russian Government was aimed at solving the issue of negative budget balance (according to recent evaluations, the expected federal budget deficit will reach 6.5% of the GDP in 2009, 4% in 2010, and 3% in 201236; it was stability positive during all time before the crisis period), but a continuation of tax reforms. Nevertheless, the State authorities declared official denial of increasing a nominal tax burden of basic income taxes to support post-crisis economic growth. Evaluating prospects for the Russian economy for 2009 and 2010 made both national experts and international institutions rather pessimistic. Indeed, all estimations predict the decline in the GDP and production growths, as well as a negative consolidated budget balance for the post-crises period (see Table No. 4). Hence, the national tax policy for 2009 – 2010 has to react at these circumstances, meaning the sufficient decrease in tax collections.

36

http://www.rbc.ru/rbcfreenews/20090713184305.shtml

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Table 4. Development Prospects of the Russian Federation Indicator

Annual GDP growth, %

Institute

2009

2010

IMF (July 2009)

-6.5

+1.5

World Bank

-7.9

+3.5

OECD (June 2009)

-6.8

+3.7

BOFIT

-9.8

…

-8/-8.5

+0.1/+1.0

-12.5

+0.8

OECD (June 2009)

-6.0

-4.0

Ministry of Finance (July 2009)

-9.4

-7.5

Adjusted Budget Law 2009

+7.4

Russian government (July 2009) Annual production growth, % Russian government (July 2009) Consolidated Budget balance, % of GDP

Sources: IMF, World Bank, OECD, BOFIT, Government of the Russian Federation.

d) How Taxation affects the Development Process In general, the tax system of the Russian Federation is pointed rather for simulative than dissimulative function. Moreover, the Russian tax reform in the 2000s was commenced just to influence on the development process by the effective way. However, like any national tax system, it has both positive and negative peculiarities.

d.1) Impairing The most negative traits of the Russian tax system are connected with its dissimulative character for oil and gas producing companies. Indeed, tax burden in Russia is higher for the oil and gas sector (see Chart 2), due to the existence of a special tax for natural recourse extraction, which is important also for forming the National Reserve Fund and the National Welfare Fund. It is one of the modern Russian paradoxes, but such system does not provide a real development of flag man and the most important industries of national economy. So, since 2003, a tendency to decrease the Russian oil and gas production has existed. It definitely could be risky for mineral resources depended economy under circumstances of oil and gas prices decline. Indeed, Russian oil and gas companies do not have sufficient investment capital to develop new fields or to renovate their equipment and basic infrastructure, since they should pay extra taxes in comparison with other sectors of the Russian economy. Other impairing of the Russian taxation is a preconceived character of tax administration, which is expressed in real tax repressions for private companies and wealthy individuals. It forces a business to transfer capitals abroad and to re-invest in Russia using recently safer tax jurisdictions, such as Cyprus, Luxembourg, Netherlands, the United Kingdom, etc. Such process distorts the real investments picture in the Russian economy.

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d.2) Enhancing Nevertheless, advantages of the Russian tax system outweigh disadvantages. First of all, Russia poses very strong positions in the international tax competition, both as an attractive destination for capital and investments (basic profits´ tax rate of 20% is one of the lowest in Europe) and as a favorable jurisdiction to establish a tax residency for individuals (basic individual tax income rate of 13% is rather an exclusion in the modern world). Second attractiveness of the Russian tax climate for development is connected with good long-run tax strategy of the Government. Indeed, a national tax policy is not criticized in the Russian Federation even by the most radical opponents of “the Putin – Medvedev’s regime”. According to the opinions of different experts in economics, taxation is the only sphere in Russia with competent governance37, excellent adaptation to influence of external environment, and fast positive results of transformations in the 1990s and the 2000s. Even under the impact of the world economic crisis, the Russian Government adopted a new wise tax strategy pointed at development, including guarantees of moderate taxes for companies and individuals as well as prevention of tax frauds (whose part is a new antioffshore legislation).

e) External Investment Flow Issues Because of the moderate character of basic Russian income taxes, the Russian Federation became a preferable jurisdiction for foreign investments just before a downturn in 2008, when the capital inflow to Russia overweighed the outflow. Nevertheless, the volume of outwards investments from Russia prevailed over inward investments into the Russian economy during all the 1990s and the 2000s. Table No. 5 presents the net capital flow to/ from Russia between 1994 – 2009. Only between2005 – 2007, the capital flow balance was positive for the Russian Federation. In the other years, Russian residents preferred to export capital abroad. It is fully true also for foreign direct investments (FDI): according to statistical data of the Central Bank of Russia (CBR)38, a positive FDI flow balance was registered only between 2004 – 2007 (see Table No. 6). After the beginning of the world economic crisis, Russia lost sufficient foreign Investments, and the FDI stock in the country was reduced 2.3 times. Of course, tax issues were the not primary explanations of such process, and one of the aims of the Russian modern tax policy is to continue to stimulate the investment´s inflow in the national economy.

37

Sergey Shatalov, Deputy Minister of Finance and “father” of all modern Russian tax reforms, and his well-educated, experienced team, had a key role in the modern Russian tax policy.

38

Statistical data of CBR are different from the indicators of investments movement of the leading international organizations. Sometimes (concerning, for example, FDI flow) differences are reaching even more than four times. Thus, according to UNCTAD data (see http:// stats.unctad.org/fdi/), in 2007 the Russian federation received USD 52,5 billion of inward FDI and FDI stock for the year was evaluated as USD 324,1 billion. The simplest explanation of that is the different statistical methodology of the Russian institutions which estimate all transactions (including M&A ones) could be treated as FDI even without real cross-boarder components (such as Russian residents invest to the national economy using sophisticated offshore schemes of purchasing or buying companies belong to Russian residents).

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Table 5. Net capital flow to/from Russia, 1994 – 2009 Years

Capital flow, billion of USD

Years

Capital flow, billion of USD

1994

-14,4

2002

-8,1

1995

-3,9

2003

-1,9

1996

-23,8

2004

-8,9

1997

-18,2

2005

0,1

1998

-21,7

2006

42,0

1999

-20,8

2007

82,3

2000

-24,8

2008

-132.8

2001

-15,0

2009, January - June

-25.6 (est.)

Source: Central Bank of Russia (http://www.cbr.ru/statistics/credit_statistics/print.asp?file=capital.htm).

Table 6. FDI dynamic to/from Russia, 2001 – 2008 (billion of USD) 2001

2002

2003

2004

2005

2006

2007

2008

FDI inflow in Russia

20.7

18.0

25.8

25.6

57.9

85.6

225.4

-277.5

FDI stock in Russia

52.9

70.9

96.7

122.3

180.2

265.9

491.2

213.7

Russian FDI abroad, outflow

24.1

18.2

72.7

16.4

39.4

69.8

153.7

-164.7

Russian FDI abroad, stock

44.2

62.4

90.9

107.3

146.7

216.5

370.2

202.8

Net FDI flow to/ from Russia

-3.4

-0.2

-46.9

+9.2

+18.5

+15.8

+71.7

-112.8

Source: Central Bank of Russia (http://www.cbr.ru/statistics/credit_statistics/print.asp?file=iip_rf.htm).

As for the principal investors to the Russian economy, it is not a top secret that there are mostly low tax jurisdictions, such as Netherlands, Cyprus, Luxembourg, Ireland, British Virgin Islands (see Table No. 7). All these countries are also primary destinations for the Russian investments abroad. So, the main explanations of this fact are taxing reasons (favorable double tax treaties with a big number of such low tax jurisdictions), as well as a protection of the Russian capital accumulated abroad from possible nationalization by the Russian authorities (it became more evident after Yuko´s case in the middle of the 2000s).

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Table 7. Top 10 investors in Russian economy (April 2009) Rank Country

Share in all accumulated foreign investments in Russia, %

Share in total Share in accumulated FDI in total Russian Russia, % investments abroad

1

Netherlands

19.6

36.8

21.4

2

Cyprus

16.0

23.5

29.5

3

Luxembourg

14.4

1.0

…

4

United Kingdom

12.2

3.6

4.0

5

Germany

6.7

6.4

4.2

6

Ireland

3.9

0.4

…

7

France

3.8

1.9

…

8

USA

3.4

3.1

10.7

9

British Virgin Islands

2.7

3.7

6.3

10

Japan

2.5

0.7

…

Source: http://www.gks.ru/bgd/free/b04_03/IssWWW.exe/Stg/d02/91inv21.htm

f ) Tax Reforms Shaping Economic Development According to the official positions of the Russian authorities, the tax reform in the 2000s has been all but completed, and there are no plans for reforms that would affect the structure of the tax system39. Instead, current tax policy in the Russian Federation aims at improving the present system of taxation by, in particular, removing any remaining inconsistencies. Thus, it is intended to: • improve the quality of the national tax administration (including improvement of relations between taxpayers and tax authorities; control over application of transfer pricing rules between domestic and foreign companies supervised by the Russian residents; determination of a tax residency for legal entities); • increase the effectiveness and neutrality of the main taxes (including correction of taxable income for inflation, decrease of basic tax rates, change of the unified social security tax, introduction of a real estate tax); • integrate the Russian tax system into the global tax system (signing of new double tax treaties, fighting against an international tax evasion and tax avoidance). We will consider the most important changes in the Russian taxation planned for the nearest future. All of them are quite progressive, and reflect the best international practice of taxation. No doubt, these modifications of the Russian tax legislation will strengthen the country’s position in the international tax competition, if they are realized as intended. 39

See Main directions of the tax policy in Russian Federation for 2008-2010 (Approved by the session of the Government of Russian Federation on March 2, 2007, in Russian) // www.sovtex.ru/Generators/STDocGenerator.aspx?ID=c1fb0d8e-fb5a-44f1-b3ab-e476a19f3227

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Tax Residency of Legal Entities The Russian current tax legislation (the TC) does not include the category “tax residency of legal entities”40. Due to this defect of the TC, it is uncertain under what circumstance tax treaties preventing double taxation could be applied to a “Russian legal entity” having headquarters (place of effective management), e.g., in Switzerland or in Cyprus. Also, it allows Russian businessmen to use different possibilities of international tax planning to transfer incomes from Russia to low tax jurisdictions, because the real “residence” of a Russian business unit, de jure, managed from abroad, is often inconsequential. To prevent this abuse, the Russian authorities are about to introduce the category “legal entity – tax resident of the Russian Federation”. It is supposed to rely on such criteria of company residence as a place of effective management and place of residence of controlling owners. This is supposed to help Russian tax authorities to tax the global profit of companies registered outside the Russian Federation, but managed from Russia and belonging to which are taxing residents of the country. For example, the new Protocol to the DTT between Russia and Cyprus, dated April, 2009, has already stated that “whether the place of effective management of a person other than an individual cannot be determined, the competent authorities of the contracting States shall endeavor, having regard to all factors they consider relevant, to determine by agreement the place of effective management in everyone case”. The latter means that, currently, even at the international level, the state tax authorities are endued to determine the place of effective management for the tax purposes, and this right is farmed out to the respective tax authorities (very nearly local tax authorities) of the contracting states.

Transfer Pricing Control

The Articles 20 and 40 of the TC already contain measures to prevent abuses of transfer pricing rules to avoid Russian taxes. Nevertheless, Russian authorities intend to restrict transfer pricing in the tax planning activities of related companies by abolishing the Articles 20 and 40, which are to be replaced by a new Section V1 of to the TC (Interdependent persons. General provisions on prices for purposes of taxation. Controlling transactions)41. First of all, the method of determination of related business units will be changed (taking into account the real relations between participants of transactions instead of the current practice, according to the Article 20). It is also intended to introduce the categories “identical” and “homogeneously good” in the existing Article 38 in order to make the determination of the objects of taxation easier. In addition, methods of calculation of arm’s length price corresponding to the Western practice (comparable price method, re-sale price method, cost-plus method) will be

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40

The Russian tax code contains such categories as “taxpayers”, “tax agents”, “tax authorities” (TC, Article 9), “physical persons – tax residents of the Russian Federation” (TC, Article 207), “Russian organizations” and “foreign organizations conducting business in Russia” (TC, Article 246), but does not apply the term “tax resident” to Russian organizations which actually are paying corporate profit tax according to the principle of global income taxation (principle of residence). The actual residency of “Russian organizations” is determined in the tax code according to the criteria of incorporation (TC, Article 11).

41

http://www1.minfin.ru/common/img/uploaded/library/2007/11/pfzink.doc; see also http://www1.minfin.ru/ru/ tax_relations/policy/ use_regulation/government_docs/

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mandated. Moreover, the interval of the permissible deviation of transfer prices from market prices will be changed. Instead of the current interval of ±20% (according to the Article 40), new formulas for the determination of minimal and maximal prices for transactions between related companies are introduced as follows: Min. transfer price

Max. transfer price

3a + b 4

a + 3b 4

a – minimal, b – maximal price in transactions with identical goods between non-dependent business units in comparable economic conditions

Finally, one more innovation of the Russian transfer pricing regulation is the possibility to conclude advanced price agreements (APAs) between taxpayers and tax authorities. This practice exists, in particular, in the USA, allowing taxpayers to minimize risks due to an evaluation (and possible modification) of transfer price transactions by the tax service, even if these transactions completely respect the letter of the law. APA is a quite radical proposal for the Russian authorities, who reflect their interest to strike a compromise and understanding with taxpayers.

Introduction of CFC Rule The CFC (controlled foreign company) rule is also one of the innovations in Russia. Many Russian businessmen are controlling shareholders or owners of foreign companies, and many of them are incorporated in low tax jurisdictions (e.g. Cyprus, British Virgin Islands, Switzerland, etc.) exclusively for tax purposes. To prevent this practice, harmful to the national budget, Russian authorities intend to introduce a CFC rule42 soon, which is equivalent to that already in use in about 30 major countries, including the USA, the United Kingdom, Germany, France, and Japan. After the implementation of the CFC rule, Russia will begin to tax the profits of a number of offshore companies belonging to national residents. Good example of implementation of this policy at the international level is the already mentioned Protocol to the DTT between Russia and Cyprus. The tax authorities of the contracting States would like to state the so called “limitation benefits”, according to which “it is understood that a resident of a contracting State shall not be entitled to any reduction of, or exemption from taxes provided for in this agreement on income derived from the other contracting State if, as a result of consultations between the competent authorities of both contracting States, it is established that the main purpose or one of the main purposes of the creation or existence of such a resident was obtaining the benefits under this Agreement that would not otherwise be available”. The latter means obvious States’ intention to forbid the existed practice of the DTTs’ application only for decreasing of tax burden (not real business purposes), stating this both at international and national levels. The said rule does not have retrospective effect.

42

Main directions of the tax policy in Russian Federation between 2008–2010 (approved by the session of the Government of the Russian Federation on March 2, 2007, in Russian). P. 42 // www.sovtex.ru/Generators/STDocGenerator.aspx?ID=c1fb0d8e-fb5a-44f1-b3abe476a19f3227.

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Taxation of dividends Since the beginning of 2008, the regime of dividend taxation has become more favorable both for the Russian and foreign investors. Instead of the previous withholding rate of 9%, dividends paid to Russian corporations controlling at least 50% of the dividend paying company are now fully except from tax. The 9% rate continues to be applied to the dividend income of Russian individuals or corporations holding less than 50% of the dividend paying company. For dividends distributed to foreign individuals, the withholding tax rate is lowered from 30% to 15% - the same rate foreign corporations already have had to pay43. These measures stimulate the investment in Russian equity both by domestic and foreign investors. Moreover, the withholding tax on dividends for foreign individuals can be reduced from 15% to 5% or 10%, according to various treaties on double taxation. Concerning the situation between 2008 – 2009, we may conclude that the Russian Federation had to react immediately on the challenges of the external factors. Economic downturn, which “affected” the whole world at the end of 2008, obviously, could not have touched Russia. Tax payments to the state budget decreased many times, which predetermined the significant changes made to items of the state budget at the end of the last year and the objective necessity to make changes in Russian tax policy and tax legislation for the next several years. Major “anti-crisis” amendments which were already realized in Russia concerned the VAT and the corporate profits´ tax. VAT: planned tax rate decrease (from 18% to 12%) was postponed for the economic downturn period. H, however, starting from 2009, the tax period for VAT payments was changed from one month to one quarter (the so called “VAT installment”), and the existed obligation to pay the VAT separately in case of barter, swap deals, and securities operations were abolished, as well. Also, a new mechanism of double-quick VAT refund was introduced since in 200944. Corporate profits´ tax: the tax rate was reduced from 24% to 20% (using reduction of that part of tax, which is enrolled to the federal state budget45). Moreover, it should be mentioned that the Russian Government is now in the process of consideration of various tax initiatives from the respective governmental agencies. The most “aggressive” initiatives proceeded from the Ministry of Finance of the Russian Federation and the Federal Tax Service, which were intended on gaining more than a RUR 1 billion (i.e. approx. USD 33 billion);and most of them were already rejected by the Russian Government: • Temporary (for the period of the economic downturn) implementation of 0.5% turnover tax; Since the beginning of 2008 the regime of dividend taxation has

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43

Main directions of the tax policy in Russian Federation for 2008–2010 (approved by the session of the Government of Russian Federation on March 2, 2007, in Russian). P. 41 // www.sovtex.ru/Generators/STDocGenerator.aspx?ID=c1fb0d8e-fb5a-44f1-b3ab-e476a19f3227

44

Starting from 2009, a seller of goods (works or services) is obliged to issue invoices (the so called Russian “stchet-factura”) on down payments to a buyer. Then a buyer, in its turn, obtains a right to refund the named VAT (previously, a buyer could have claimed a VAT refund only when he performed a full payment under the respective invoice).

45

Thus, starting from 2009, taxpayers pay fewer profit taxes to the federal state budget at 4%, and they may expect up to a 4% tax rate reduction at the regional level, as it was before.

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become more favorable both for the Russian and foreign investors. Instead of the previous withholding rate of 9%, dividends paid to Russian corporations controlling at least 50% of the dividend paying company are now fully except from tax. The 9% rate continues to be applied to the dividend income of Russian individuals or corporations holding less than 50% of the dividend paying company. For dividends distributed to foreign individuals the withholding tax rate is lowered from 30% to 15% - the same rate foreign corporations already have had to pay.45 These measures stimulate the investment in Russian equity both by domestic and foreign investors. Moreover, the withholding tax on dividends for foreign individuals can be reduced from 15% to 5% or 10% according to various treaties on double taxation. Concerning the situation of 2008 – 2009, we may conclude that the Russian Federation had to react immediately on the challenges of the external factors. Economic downturn, which “affected” the whole world at the end of 2008, obviously, could not have touched Russia. Tax payments to the state budget decreased many times which predetermined the significant changes made to items of the state budget at the end of the last year and the objective necessity to make changes in Russian tax policy and tax legislation for the next several years. Major “anti crisis” amendments which were already realized in Russia concerned VAT and corporate profits´ tax. VAT: planned tax rate decrease (from 18% to 12%) was postponed for the economic downturn period, however, starting from 2009 the tax period for VAT payments was changed from one month to one quarter (the so called “VAT installment”), and the existed obligation to pay VAT separately in case of barter, swap deals and securities operations were abolished, as well new mechanism of double-quick VAT refund was introduced since 200946. Corporate profits´ tax: the tax rate was reduced from 24% to 20% (using reduction of that part of tax, which is enrolled to the federal state budget47). Moreover, it should be mentioned that the Russian Government is now in the process of consideration of various tax initiatives from the respective governmental agencies. The most “aggressive” initiatives proceeded from the Ministry of Finance of the Russian Federation and the Federal Tax Service, which were intended on gaining more than a RUR 1 billion (i.e. approx. USD 33 billion ) and most of them were already rejected by the Russian Government: • Ttemporary (for the period of the economic downturn) implementation of 0.5% turnover tax; • limitation of cash flow and allowing Russian tax authorities access to the databases • of the Central Bank of Russia and Federal Financing Monitoring Service concerning all financial operations and interbank payments as an obligatory term for the implementation of a turnover taxable; • abolishment of limited terms on collecting tax debts and double-quick VAT reimbursement, etc.;

46

A Russian application to join the GATT, then its successor, the WTO, was presented in July, 1993.

47

http://online.wsj.com/article/SB124777633269153521.html

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• contrary to the fiscal authorities’ tax plans, the Russian Ministry of Economic Development suggested a progressive tax burden decrease, particularly: • postponement of the Unified Social Tax reform for 2010; • implementation of a 0% VAT rate on advance payments; and • simplification of the procedure of granting tax grace (installment), as well as allowing constituent units of Russia to implement 0% or reduced tax rates for the small businesses, etc. Some of the tax initiatives have already been discussed in the State Duma (Lower Chamber of the Russian Parliament) and are going to be realized. Among them, there are the new transfer pricing rules and the implementation of a new concept on “consolidated taxpayer” for the corporate profits´ tax purposes. New transfer pricing rules suppose clarification of the definition “related parties”; implementation of a term “transaction under control”, and a special procedure of filing primary documents to tax authorities proving the transaction price, as well as a procedure of issuing tax authorities’ decision, proving that a certain transaction price contradicts a market price; and many other related rules, which are going to help tax authorities to prevent businesses from minimizing their tax obligations by using illegal transfer pricing methods. It is necessary to mention that now, in lack of the well-defined categories and terms on transfer pricing, Russian tax authorities, as a rule, fail to prove the contradiction of a certain price to a market price in most particular court disputes. Implementation of a new concept on “consolidated taxpayer” for the profits´ tax purposes. We assume that, in general, the new concept ofon “consolidated taxpayer” is aimed at unification and simplification of tax administration procedures, which is expected to decrease tax authorities’ expenses. Nevertheless, as it is stated in the initiative of the Russian Ministry of Finance, it was introduced in order to endue Russian related taxpayers with a right to join their profits´ and losses, and to exempt them from tax authorities’ control on transfer pricing. However, the concept of a “consolidated taxpayer”, as it is now stated in the Draft Law, does not seem to be realized in practice, because it contains rather inapplicable terms to comply with even by the large taxpayers (e.g. consolidated taxpayer may be constituted by one main company or its several parent companies only provided direct interest of the main company in each of its parent companies is not less than 90%; the concept is applied only for the profits´ tax purposes, and does not expand at several groups of taxpayers, such as banks, insurance companies, non-state pension funds, etc.). As to the new reporting rules for consolidated taxpayers, similar procedures have already been applied in Russia before for the separate divisions of Russian companies, although, in this case, it will be aimed at holding companies. Finally, we could not but mention “anti-crisis” amendments recently introduced by the Russian Government in the Draft Law on amendments to the bBudget cCode of Russia. It is suggested to allow the Russian Sstate authorities (at federal, regional and local levels) to change tax rules and to introduce or abolish new taxes together with respective budget items (not by amending the Russian tTax cCode, as it was before). Such procedure of passing tax rules is planned for the rest of 2009. At that Those changes, which will be passed in 2009 and will become effective since on January 1, 2010. Such initiative has not been discussed before in the public and was already called sensational.

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We assume that realization of these new rules contradicts all stated principles of law and Russian tax legislation, in particular, and as a temporary extra measure, may cause tax voluntarism at the local level, as well as a decrease of tax discipline and tax collectability in general. If such “aggressive” initiatives are passed, in fact, the Russian Government admits that aneconomic situation is unstable and absolutely unpredictable. However, it should be concluded that, at the time being, no longer any of such “sensational” reforms have been accepted.

5. International Trade of Goods and Services a) The WTO and other international trade treaties ± history and development The Russian external trade in the 2000s was characterized by the high level of annual growth, with average rates of 21-26% for export and import of goods and services (see Table No. 8). According to the WTO’s report, the total value of commodities and services achieved, in 2008, RUR 522 billion for the export, and RUR 367 billion for import.

Table 8. Russian external trade Exports Value 20081

Imports2

Annual percentage changes 20002008

2006

2007

2008

Value 2008, $ bill.1

Annual percentage changes 20002008

2006

2007

2008

Goods

$472 bill. (2.9%)

21

25

17

33

$292 bill. (1.3%)

26

31

36

31

Services

$50 bill. (1.3%)

23

25

27

29

$75 bill. (2.2%)

21

16

32

29

Notes: 1 In brackets – share in total world exports/imports. 2 Imports are valued f.o.b. Source: WTO

The Russian Federation is not a member of the WTO, while it is in the process of accessing trade negotiations with WTO during the last 16 years. It makes Russia the only big country all around the world which is not integrated in the international trade system created by the WTO and its predecessor, the GATT. In the Summer of 2009, some controversial steps on the way to join the WTO were made by the Russian politicians,just after the public declaration that Russia enters into the WTO in 2010, made by Minister of Economic Development Elvira Nabiulina during the St. Petersburg Economic Forum. It isunexpected, and fully contrasts a statement of Russiarecalling its WTO application,followed from the side of Russian Prime Minister Vladimir Putin. Few weeks after this demarche, Russian President Dmitry Medvedev confirmed that Russia would like to have an access to the WTO

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as soon as possible. According to last public speeches of Russian politicians (in particular, by Vice-Prime Minister Igor Shuvalov), Russia resumes its WTO access negotiations and planes to join the organization in 2010. Such different metamorphoses would happen on the way of Russian entering to the WTO in the nearest future. Nevertheless, Russia concluded bilateral trade treaties with the majority of the WTO members, preparing to the access to the organization. Also, Russia has strong positions in the international trade in the post-soviet space, where it is a member of a triple Customs Union between Russia, Belarus and Kazakhstan. The controversial Russian position related to the WTO activity could be explained from the tax point of view, particularly by the fact that custom duties play a very important role for the federal budget, constituting about 40% of revenues. In the current crisis times, when revenues of the Russian federal budget decreased very sharp, the idea to freeze the process of entering to the WTO is not so bad. Russian Minister of Finance Alexei Kudrin strongly follows the conservative position because his subordinate Ministry really needs custom duties collections currently charged under the Russian trade tariffs (about 13% in average48).

b) Tariff policy and regimes IIn this section, we consider basic laws on State regulation of foreign trade activity, peculiarities of the Russian customs´ tariff, as well as the Russian tariff policy and special requirements. We also present a brief overview of the existed customs´ regimes. Basic laws on state regulation of foreign trade activity. The Constitution declares basic principles of economic regulation, including principles of united economic space, free circulation of goods, services, and financial assets in Russia. The customs code of the Russian Federation determines procedure and rules for transfer of all types of goods through the customs´ border of Russia; it sets out customs clearance procedures and regimes, rights and obligations of persons involved into the customs´ procedures, the procedure for custom tariff payment, custom control, etc. The State regulation of foreign trade activity in the Russian Federation is based on the principle of equality and non-discrimination of the parties,stipulated in the Federal Law “On the State Regulation of Foreign Trade Activity” No. 164-FZ, issued on December 8, 2003. Under this Law, all Russian and foreign entities are permitted to engage in foreign trade activity, except for special cases mentioned in international treaties and federal laws of the Russian Federation. This rule is further developed in the CC, stating that all entities have equal rights to transfer goods through the customs´ border of the Russian 48

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Federation, subject to exceptions stated in international treaties, the CC, and other federal laws of the Russian Federation. Customs regimes. The CC determines various types of custom regimes: main, economic, finalizing, and special custom regimes; export, international customs transit, and realize for internal use constitute main custom regimes. Among special customs regimes, there are the temporary import, duty free sale and other special regimes. Economic custom regimes are processing on the customs territory or for internal use, out of customs territory processing and temporary export, customs warehouse and free customs zone (free warehouse). The latter are usually granted to the foreign investors operating on the Russian territory provided, they comply with the certain requirements of the Russian Government prescribed in the respective investment agreements. The CC means re-export, re-import, destruction, and refusal in favor of the State as the so called finalizing customs regimes. Goods transfer under the certain customs regime is in the declarant’s discretion. However, it should be done only upon the customs authorities’ allowance. The Customs Tariff. The Law “On Customs Tariff” No. 5003-1, issued on May 21, 1993 (Customs Tariff) provides for the rules of customs tariff establishment, contains provisions on seasonal tariffs, customs value evaluation, determination of country of origin and tariff preferences. The Customs Tariff is one of the main laws regulating export and import of goods within the system of tariff and non-tariff regulation. Export custom duties play a very important fiscal role for the Russian public finance because its receipts are sufficient for the revenue part of the Government budget. The size of export duties is more for oil and gas producing companies than for other sectors of the national economy. In August 1st, 2009, the Russian Government fixed the following export duty rates for oil and oil products: • USD 222 per one ton of oil; • USD 161.9 per one ton of bright oil products; and • USD 87.2 per one ton of dark oil products. In conditions of the current Russian economic crises, it means the oil export duties increase from its previous level in July 2009 (USD 212.6, 155.5, and 83.8 per ton respectively)49. Import of goods is generally subject to import customs duties and customs processing fees. The amount of customs tariffs (fees) applicable to all types of imported goods is set 49

http://www.rbc.ru/rbcfreenews/20090729110422.shtml

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forth by the Foreign Trade Nomenclature of Goods of Russia (TN VED), and is calculated based on the customs value of imported goods. The Customs Tariff offers six methods for determining the customs value of imported goods: • Method 1 - based on the value of the transaction (contract amount); • Method 2 - based on the value of transactions with identical goods; • Method 3 - based on the value of transactions with similar goods; • Method 4 - based on value subtraction; • Method 5 - based on value addition; or • Method 6 - reserve method. The methods are set forth in order of preference. Thus, if Method 1 can be applied, it will be applied in preference to all the other methods. The Russian tariff policy. In the implementation of the respective Russian Government Resolutions, the Federal Customs Service adopted a list of countries enjoying tariff preferences (i.e. decreased custom duties, refund of previously paid custom duties, preference quotas for import or export of goods, or full exemption). At the moment, the goods which are fully exempt from import custom duties while importing them into Russia shall originate from the following countries: Azerbaijan, Armenia, Belorussia, Georgia, Kazakhstan, Kirgizia, Moldova, Tadzhikistan, Turkmenistan, Uzbekistan or Ukraine. Other countries from the list are granted special tariff preferences on the respective goods. Currently, Russia confirmed a list of 135 countries enjoying the most favored treatment (China, the USA, etc.), 104 developing countries (Argentina, Brazil, etc.) and least developed countries (Angola, Sudan, Ethiopia, etc.). Special requirements. The Russian legislation provides for special requirements applicable to an importer. The CC does not contain the word “importer”, but uses the word “declarant” ,defined as a person responsible for the undertaking of customs clearance procedures. There is a general requirement that only Russian legal entities can act as importers of record before the Russian customs authorities if one of the parties under the foreign trade contract is a Russian party. Under the CC, a foreign entity may act as an importer of record in the following exceptional Cases: (a) when it imports goods into Russia through its duly registered (accredited) representative office or branch under the “temporary importation”, “reexport”, and “transit” customs regimes or the customs regime of “free circulation”

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only with respect to goods imported for own needs of such representative offices or branches; and (b) when there is no cross-border transaction to which a Russian entity is a party and pursuant to which the foreign entity is entitled to dispose of the goods in the Russian territory. The importer of record (whether Russian or foreign legal entity) may retain a specialized custom broker (a representative of the importer of record) for customs clearance purposes or customs clear the goods itself. When a foreign entity act as an importer of record under the Russian law, it is certainly practically advisable that it retains a local specialized custom broker to represent it before the Russian customs.

c) International trade treaties and internal taxation: effects and limitations The main internal taxes influence on the international trade activity, and international trade treaties are the VAT (like customs VAT), excises, and customs processing fees. The customs VAT. Import of goods is subject to Russian customs VAT levied at the same rates as the Russian sales VAT (i.e. 18%, 10%, and 0%). Pursuant to some initiatives of the Russian Government, the 18% VAT rate could be potentially decreased down to 16% or 15% in the next several years, while the 10% VAT rate might be abolished. However, no firm decision has been made in this regard so far. The VAT is imposed on all goods imported into Russia, and also applies to the sale of goods, works, and services in Russia. The general VAT rate is 18%, and applies to most goods, works and services. The 10% VAT rate applies to limited categories of goods, e.g. medicine, children products, some food products, while some other medical equipment and medical goods, art and cultural goods, etc., may be subject to a 0% VAT rate. Excises. Excise taxes apply to imports of limited categories of products, like tobacco products, spirit and alcohol, beer, cars, petroleum products, diesel, and motor oil. Food products, other than alcohol products, generally do not fall under this category and, thus, are not subject to excise taxes under the Russian law. The Customs processing fees. The CC also provides for custom processing fees, which are levied as a percentage of customs values of imported goods, but are capped at RUR 100,000 (approximately USD 3,000 at the current exchange rate).

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d) International tax treaty issues The Russian Federation has about 70 tax treaties on avoidance of double taxation and information on fiscal affairs (DTT) which are currently effective50, as well as almost 20 tax treaties waiting for the ratification or exchange of ratification documents51. So, the Russian tax treaty network will consist soon of about 90 DTTs, and this fact allows Russia to be active in international economic relations with the principal trade and investments partners. DTTs’ regulations prevail over provisions of the national tax legislation. That is set forth in the Vienna Convention on the Law of Treaties (1969), and guaranteed by the Article 15 of the Constitution: The universally-recognized norms of international law and international treaties and agreements of the Russian Federation shall be a component part of its legal system. If an international treaty or agreement of the Russian Federation fixes other rules than those envisaged by law, the rules of the international agreement shall be applied. Russian tax treaties signed with the OECD countries are based on the OECD Model Tax Convention, while treaties with developing countries use the UN Model Tax Convention. In some cases, Russia implies its own Model Tax Convention to put it in the basis of a concrete double tax treaty. The Russian tax treaty network allows foreign companies and individuals to invest in the national economy, as well as allows Russian residents to invest abroad by using the more favorable tax regime for repatriation of dividends, interest, and royalties. Thus, instead of the Russian standard withholding tax on dividends at a15% rate, it is possible to apply reduced rates of 5 or 10% by implementing appropriate tax treaty provisions. Analogically, withholding tax rate on gained interest of 15% or 20% in case of royalties can be totally reduced, i.e. up to 0%. It is another reason to use Cyprus, Luxembourg, Netherlands, Ireland, and Switzerland as principal countries to reinvestment into Russia: favorable tax regime for passive income repatriation based on DTT provisions makes those jurisdictions preferable for holding, financial and intellectual property operations with the Russian Federation.

e) Tax Reforms Shaping International Trade Performance A priority for the Russian tax policy in the international area is fighting against tax havens because of the wide-spread practice of tax evasions and tax avoidance of Russian

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50

The Russian Federation has such treaties with Albania, Armenia, Australia, Austria, Azerbaijan, Belarus, Belgium, Bulgaria, Canada, China, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Finland, France, Germany, Greece, Hungary, Iceland, India, Indonesia, Iran, Ireland, Israel, Italy, Japan, Kazakhstan, North Korea, Republic of Korea, Kuwait, Kyrgyzstan, Lebanon, Lithuanian Republic, Luxembourg, Macedonia, Malaysia, Mali, Mexico, Morocco, Moldova, Mongolia, Namibia, Netherlands, New Zealand, Norway, Philippines, Poland, Portugal, Qatar, Romania, Serbia and Montenegro, Slovakia, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Syria, Tajikistan, Turkey, Turkmenistan, Ukraine, United Kingdom, United States, Uzbekistan, Vietnam.

51

Among them there are signed tax treaties with Algeria, Argentina, Botswana, Brazil, Chile, Cuba, Estonia, Ethiopia, Georgia, Laos, Malta, Mauritius, Oman, Saudi Arabia, Singapore, Thailand, Venezuela.

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companies and individuals basing on the use of offshore jurisdictions. In this area, the Russian Federation supports joint attempts of the G8 and the G20 to impact the tax havens activity approved on the summits of these organizations in 2009. Russia also tries to realize its own measures pointed to the offshore operations of Russian residents. Thus, in December 2007, the Russian Ministry of Justice approved a list of offshore jurisdictions prepared by the Russian Ministry of Finance. It was enlarged in 200952. The main criterium for a country or a territory to be classified as an offshore jurisdiction is the absence of information exchange with Russia on fiscal affairs or a low level of corporate profit taxation (less than 2/3 of the basic Russian tax rate of 20%). Russian residents doing business with or in countries from that “black list” incur the risk to be audited by tax authorities with regard to the CFC rule or transfer pricing. Also, Russia has the intention to conclude double taxation treaties with those jurisdictions on the list for which no such agreements exist at this point (such as United Arab Emirates; Russia already has treaties withCyprus and Malaysia, for example). As for the existing DTTs with those countries with favorable taxation, such as Cyprus, at the moment, they are in process of signing additional protocols to the DDTs with Russia. The main purpose for Cyprus and comparable jurisdictions to sign additional clarifications to the DTTs is to be excluded from the “black list” of offshore jurisdictions. At the same time, such additional documents which are being prepared by the contracting States dramatically change the terms of the DTTs for Russia. In particular, these supplementary documents not only stipulate such clarifications that reword the Russian national tax legislation and impose additional tax burden, i.e. stipulate tax objects not subject to taxation previously under the treaty (e.g. sale of shares constituting of more than 50% of Russian immovable property is planned to be taxed in Russia), but also introduce new detailed regulations concerning cooperation between the tax authorities of the contracting States (e.g. on exchange of fiscal information, including bank information previously undisclosed, etc.),which make using DTTs with these jurisdictions unfavorable.

6. Conclusions In conclusion, it is necessary to point out the following main features characterizing Russia at the moment. First, the Russian tax system is established under the general principles of the international law, and structured in accordance with a Constitution and a national legislation, with the tax code of Russia in the lead. It establishes the main principles of taxation and stipulates taxes collected on the federal, regional and local 52

The complete list of low tax countries and non-cooperative jurisdictions according 2007 provisions includes Andorra, Anjouan (Comoros), Anguilla, Antigua and Barbuda, Aruba, the Bahamas, Bahrain, Belize, Bermudas, British Virgin Islands, Brunei-Darussalam, Cayman Islands, Cook Islands, Dominica, Gibraltar, Grenada, Hong Kong (China), Isle of Man, Labuan (Malaysia), Liberia, Lichtenstein, Macao (China), Maldives, Malta, Marshall Islands, Mauritius, Montserrat, Nauru, Netherlands Antilles, Niue, Norman Isles (Guernsey, Jersey, Sark, Alderney), Palau, Panama, Republic of Cyprus, Samoa, San Marino, St. Vincent and Grenadines, St. Kitts and Nevis, St. Lucia, Turks and Caicos Islands, United Arab Emirates, Vanuatu (http://www1.minfin.ru/ru/tax_relations/policy/use_regulation/government_docs/ index. php?id4=2766). In 2009 it was enlarges by Seychelles.

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levels, among which the federal corporate profits tax and individual income tax bringing the vast majority of tax collections for the state budget. Second, Russia differs from the other developed and developing countries by its moderate tax burden, including one of the lowest corporate profits´ and individual’s income tax rates in Europe. Relatively low level of principal income taxes, developed legislation on foreign investments, and regional tax incentives make Russia one of the most favorable tax jurisdictions in Europe to produce and to live in. Third, Russia is not a member of the WTO yet; however, its tariff policy is aimed at granting tariff preferences to 290 countries worldwide, among which 135 developed countries enjoying the most favored nation treatment. Goods imported from neighbor countries (Azerbaijan, Armenia, Belorussia, Georgia, Kazakhstan, Kirgizia, Moldova, Tadzhikistan, Turkmenistan, Uzbekistan and Ukraine) are fully exempt from import custom duties. Finally, the economic downturn worked out in serious turnaround in the Russian State tax policy: important changes were made in the tax legislation, tightening of State tax control, and serious amendments to the double tax treaties with offshore jurisdictions currently being prepared by the contracting states. Nevertheless, not any of sensational tax reforms violating taxpayers’ rights or infringing foreign investors’ interests have been accepted, which indicates that the Russian Government is succeeding in controlling the situation in the country, and prevent its economy from unreasonable up-to-the-minute exposures.

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3.2. Lessons from Russian Tax Reform Arnaldo Sampaio de Moraes Godoy *

One of the strange paradoxes that marked the transition from a communist Soviet Union to an integrated Russia in a market economy was the fact that they spent hours in line, at temperatures below zero, to the payment of taxes. They went through a painful transition, much less prosaic than what is suggested by the opening of the first McDonald’s in Moscow, much less heroic than what seems to be the memory of Boris Yeltsin atop a tank, reading a statement in favor of the return to a new constitutional order that was intended to be implemented during the counter-revolution happening in the midst of hard-line of people affected by the reforms of Gorbachev. The shape of a market economy in Russia demanded extensive tax reform, from which the Brazilian people can take some lessons. The transformation from a system of socialist planning to a market economy has meant the agony of a tax model that had a very little number of contributors, and in which the Sstate was the owner of both companies and tax collector agent, translated into quotas of collaboration. Tax administration was no longer passive; it has become proactive. One totalitarian tradition has quietly guided the formation of a Fiscal Police in a permanent fight against tax avoidance and evasion. A revolution in attitudes has accompanied the changes. Before 1993, the Soviets did not tax transactions, were not aware of returns, and did not understand rebates of tax credits. The private accounting was a language understood by few curious. Not all the technology that martyrizes the bureaucratic Western culture of the West was known. It was driven by retention formulas, reflected by statistics that explained the reality, as evidenced throughout the 1990s. The Sstate monopoly of the banks intimidated any more aggressive attitude of tax collection fixed on the results of banking activities. The introduction of new technologies accompanied the proliferation of sources of credit, concomitant with the creation of a decentralized collection apparatus in a huge territory, explaining an impressive business and tax capillarity. In the first decade of transition to market regime, the Russian Ggovernment found that it did not collect the amount it needed. Furthermore, it spent with the soaring costs of the implementation of the model. On the other hand, the taxpayer, which has become manager or employee, has faced soaring costs of compliance, directly and indirectly. It needed to hire some guidance, and ended up paying the bill for the organization of the new tax administration. In addition, because the quality of institutions and public policies is area secure indicator of economic welfare, the later, in Russia and anywhere in the world, depends on the first. In Russia, in the early years of the new Ggovernment, a number of tax amnesties marked a culture of negative induction: the good taxpayer was motivated to pay little, the bad taxpayer bet on favoritism that would benefit them. Although intended to expand * Ex-General Coordinator for Tax Affairs of the National Treasury Attorney General in Brasília. PhD Researcher and Professor of the Masters in Law at the Catholic University of Brasília

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the universe of taxpayers, Russian tax amnesties in the 1990s resulted in a culture of low trust in the tax collector agent. And Also,as totalizing culture, it historically undermined the control of Government spending. It was not known what the destination of the money raised was. There was no incentive for voluntary payment of taxes. The tax authorities did not know how much they could charge, nor even predicted effectively how much it could realistically be charged. Reportedly, the advance of democratic institutions and the control of public spending would have contributed to the awareness of the need for collecting due to taxes. By the tax authorities, the exact determination of the amount to be charged, and the approximate presumption of how much it could be collected at a lower cost, guided an aggressive collecting policy; an effectively factor of facing tax avoidance and evasion. These are the great lessons of the Russian tax reform: controlling public spending, by the person who pays taxes; the lack of interest in collecting an unreal tax credit, since it is objectively impossible to be collected; the concentration of power against tax avoidance and evasion through the use of a Fiscal Police; and the distrust of amnesties, which just fuel the negative induction. This is how Russians and Brazilians can improve the so-called “moral tax”. That is, the general attitude of the taxpayer in relation to tax payments: knowing where the money goes, charging only what is realistically collectible, fighting fraud, and taking precautions to the regime of amnesties.

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4. India 4.1. Tax system and reform in India: An analysis from the perspective of Economic Development and International Trade

1

Vishwa Nath Alok*

CONTENTS 1. Introduction 2. Constitution and Tax Structure in India 2.1. The Legislative Framework 2.2. Tax Structure in India 2.3. Tax Jurisdiction and Apportionment 2.3.1. Sharing of Central Taxes: 2.4. Intergovernmental Fiscal Transfer: The Mechanism 3. Tax System in India 3.1. Direct Taxes 3.2. Indirect Taxes: A Move towards Goods and Service Tax 3.2.1. Excise Duty/Central VAT 3.2.2 Service Tax 3.2.3. State-VAT 3.2.4. Harmonization of Interstate Tax 3.2.5. A Way towards GST * Indian Institute of Public Administration, New Delhi, [email protected] 1

I’m grateful to Rajkumar for excellent research assistance in producing statistical tables. I’m also grateful to Himanshu Gupta, S K Mohanty, and Mahesh Purohit for helpful discussions. S P Sharma and M.S. Bisht provided excellent secretarial support. Usual disclaimer applies.

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3.3. Customs Duty 3.3.1. High Tariff 3.3.2. Low Tariff 3.3.3. Single Rate 3.4. Taxation and E-commerce 4. Economic Development 4.1. Macroeconomic Developments 4.2. Total Factor Productivity 4.3. The Human Development Index 4.4. Infrastructure Development 4.5. Foreign Investment Flows 4.6. Double Taxation Avoidance 5. Conclusions 6. References Annexes Annex 1 - Legal Structure of Major Taxes in India Annex 2 - Items with above “Peak” Basic Customs Duty Rates Annex 3 - India’s commitments under various trade agreements till 2009 Annex 4 - List of Regional Trade Agreements Annex 5 - Double Taxation Agreement Treaties Annex table.1 - Selected macroeconomic indicators, 2000-09 Annex table.2 - Basic economic and social indicators, 2000-09 Annex Table.3 - Revenue Power of Rural Local Governments in Indian States at Each Tier

1. Introduction

The BRIC Nations viz, Brazil, Russia, India and China together account for 40 percent of the world’s population and 40 percent of global gross domestic product (Table-1.1). In recent times, the cooperation among BRIC is gradually gaining more substance with the growth in trade and investment. On June 16, 2009, the leaders of the BRIC countries held their first summit in Yekaterinburg, Russia, and issued a declaration calling for the establishment of a multipolar world order. India is among the fastest growing BRIC economies, and plays the part in coordinating international efforts to overcome the ongoing financial and economic slowdown. In the recent past, India has witnessed high economic growth with rapid expansion in trade and outbound investment to developing countries including Brazil, Russia and China (BRC). The trend has attracted attention to international forums also. The analysis emanating from such forum emphasizes the need for long standing partnership between India and BRC. While the India-BRC economic relationship is picking up steadily in this decade, a scenario of business uncertainty is being created after the emergence of global meltdown, which surfaced in October 2008. The symptoms of global recession are predicted to

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be disastrous for the global economy. After a prolonged phase of recession, the world economy just revived, and buoyancy continued until 2007 before plunging into another episode of recession in 2008. According to IMF projections in 2008, the global output growth is likely to decline in near the future. In such a critical situation, developed countries and emerging economies are capable of taking the heat of the recession in terms of emerging global economy to create conditions for the early recovery so that tenure of the recessionary phase for the global economy can be shortened. Less developed countries, which suffered severely during the so-called ‘lost decades of growth’, are likely to face the severity of the global meltdown if the present economic impasse continues for a longer period of time. This would adversely affect growth prospects of less developed economies because many of these countries resort to depend high on exports. In many such cases, export becomes a major driver to maintain high growth in the economy. Decline in the demand for global absorption may have a dampening effect on the export prospects of these economies. Considering the high propensity of imports in developed countries, it is expected that these countries can become major part of global imports to absorb exports originating from less developed countries. Industrialized countries, however, are already in deep crisis before the eruption of full-fledged recession in the world economy. Average real growth rate of industrialized countries has already started declining much before October 2008. The developed countries have registered sharp fall in real growth rate of GDP in 2007, and it is likely to be negative in the near future. In this situation, emerging countries such as BRIC are expected to perform better than the global average, although the fact that these economies are likely to face downturn during this episode of global recession. India, as an emerging country, is no exception to this trend. It may be noted that India posted a robust average growth rate of more than 9% during 2005-07. But growth performance is likely to go down in the near future. Despite the decline in India’s growth prospects as projected by various domestic and multilateral agencies, the achievable targets for real GDP growth can project India as the fastest growing market-driven emerging economy in the world. India’s major driver of growth during the period of crisis would be domestic demand as projected by IMF2. In this context, relevance of BRIC economic cooperation is important in terms of mitigating the severity of anticipated impact of global meltdown. It is believed that India is likely to grow fast during the period of crisis, over two and a half times higher than the rate of growth of global output. Since the expansion of the economy is mostly driven by the surging domestic demand, India can offer a larger market access to BRC countries. The domestic demand for India could range from high-technology intensive products to primary products. As we can see from Table 1.2 and 1.3, India’s trade with BRC has increased about ten times between 2000 and 2008. 2

Mohanty, S.K. and Sachin Chaturvedi 2009.

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Table 1.1. Global Rankings of the BRIC Categories

Brazil

Russia

India

China

Area

5th

1st

7th

3rd or 4th

Population

5th

9th

2nd

1st

GDP (nominal)

10th

8th

12th

3rd

GDP (PPP)

9th

6th

4th

2nd

Exports

21st

11th

23rd

2nd

Imports

27th

17th

16th

3rd

Current account balance

47th

5th

169th

1st

Received FDI

16th

12th

29th

5th

Foreign exchange reserves

7th

3rd

4th

1st

External debt

24th

20th

27th

19th

Public debt

47th

117th

29th

98th

Electricity consumption

10th

3rd

7th

2nd

Number of mobile phones

5th

4th

2nd

1st

Number of internet users

5th

11th

4th

1st

Source: Wikipedia

Table 1.2. Contribution of India’s Export to the World and BRC (Rs. Billion) Year

World

Brazil

China

Russia

BRC Total

BRC % to total of world

2000-01

2013.6

10.2

37.9

39.7

87.7

4.4

2001-02

2090.2

10.4

45.4

38.1

93.9

4.5

2002-03

2551.4

23.2

95.6

34.1

152.9

6.0

2003-04

2933.7

12.7

135.8

32.8

181.3

6.2

2004-05

3753.4

30.5

252.3

28.4

311.2

8.3

2005-06

4564.2

48.3

299.2

32.5

380.0

8.3

2006-07

5717.8

65.8

375.3

40.9

481.9

8.4

2007-08

6558.6

90.8

434.1

37.8

562.7

8.6

Source: Centre for Monitoring India Economy (India Trade)

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Table 1.3. Import to India from the World and BRC (Rs. Billion) Year

World

Brazil

China

Russia

BRC total

BRC % to total of world

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

2283.1 2452.0 2972.1 3591.1 5010.6 6604.1 8380.5 10123.1

6.5 14.7 15.3 14.4 35.6 39.5 44.9 38.2

68.2 97.1 135.1 186.3 318.9 481.2 790.1 1090.3

23.6 25.5 28.7 44.1 59.4 89.5 109.0 99.6

98.3 137.4 179.1 244.8 414.0 610.2 944.0 1228.1

4.3 5.6 6.0 6.8 8.3 9.2 11.3 12.1

Source: Centre for Monitoring India Economy (India Trade)

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The share of India’s export to BRC in total India’s export has also increased from 4% to 9% from 2000-01 to 2007-08 (Table-1.2). Moreover, India’s import from BRC as a share of India’s total import has increased threefold from 4% to 12% in the corresponding period. It can be seen from above graph that trade relation among BRC countries is expanding. India’s imports from BRC are increasing at a faster rate in comparison to exports to BRC. Table 1.4. Top Four Commodities of India’s Export to BRC

Year/Unit

Transport equipment

Machinery & instruments

Tea

Drugs, pharmaceuticals & fine chemicals

Russia Machinery & instruments

Man made yarn fabrics made ups

Drugs, pharmaceuticals & fine chemicals

Petroleum & crude products

Non-ferrous metals

Brazil

Other ores & minerals

Cotton raw including waste

China

Iron ore

Commodity

Importer

1000 1000 Rs. 1000 1000 Rs. Rs. Rs. Rs. 1000 Rs. Rs. Tonnes Tonnes Billion Kgs Tonnes Billion Billion Billion Billion Kgs Billion Billion

1999-00

35.2

0.0

2.8

0.0

0.0

1.9

0.3

0.3

5.3

70.1

1.1

0.2

2000-01

59.4

1.5

3.3

8.2

0.7

3.7

0.4

0.4

5.0

47.9

0.6

0.1

2001-02

98.7

0.0

5.4

1.4

2.6

3.5

0.5

0.8

4.8

40.3

0.8

0.3

2002-03

197.6

0.1

7.4

10.2

123.9

3.7

0.8

0.8

5.2

28.7

0.6

0.7

2003-04

378.4

16.3

5.9

19.9

10.5

4.0

0.7

0.8

6.4

26.0

0.7

0.3

2004-05

1206.1

9.1

16.1

29.4

132.6

4.9

2.0

1.5

7.7

23.4

1.0

0.6

2005-06

1449.0

183.7

14.1

53.5

248.9

6.2

1.9

2.0

10.8

23.8

1.3

1.1

2006-07

1508.3

297.0

30.3

267.5

353.8

7.8

4.0

2.4

13.2

27.9

2.0

1.0

2007-08

2148.5

404.0

37.4

164.4

442.3

7.5

6.6

6.1

12.0

28.5

2.4

1.9

Source: Centre for Monitoring India Economy (India Trade)

Wilson and Puroshothaman (2003) in their paper “Dreaming with BRICs: The Path to 2050” recognize that Brazil, Russia and China have changed their political systems to adopt globalization and liberalization. The paper predicts that China and India would be the dominant global suppliers of manufactured goods and services while Brazil and Russia would become dominant as suppliers of raw materials. Economic cooperation is seen to be logical among the BRICs because Brazil and Russia together are significant commodity suppliers to India and China. Investment linkages between the two countries have also increased significantly in recent years.

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Table 1.5. Import from BRC Countries to India

Non-electrical machinery

Sugar

Vegetable oils (edible)

& metal scrap

Metaliferrous ores

Brazil Fertiliser manufactured

Wheat

Non-ferrous metal

Iron & steel

Russia

Organic chemicals

Iron & steel

Non-electrical machinery

China

Electronic goods

Commodity

Exporter

Rs. Rs. 1000 Rs. 1000 Rs. 1000 1000 Rs. 1000 1000 Rs. Year/Unit billion billion Tonnes billion Tonnes billion Tonnes Tonnes billion Tonnes Tonnes billion 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

7.7 11.2 18.3 39.2 63.4 95.3 154.6 226.7 307.3

2.3 2.8 3.4 5.1 8.5 20.5 44.9 83.3 130.6

13.3 3.4 6.9 4.5 14.5 63.5 147.2 672.3 770.3

7.7 8.3 11.5 15.8 21.7 28.4 43.0 58.3 68.8

26.4 46.2 24.4 49.5 86.8 152.1 250.3 184.0 163.0

2.6 2.8 2.8 3.3 6.7 7.0 10.8 12.4 15.4

n.a. n.a. n.a. n.a. n.a. n.a. n.a. 203.3 115.1

87.0 39.4 65.5 46.7 64.6 104.0 214.7 142.4 110.4

0.3 0.2 0.3 0.5 1.1 2.9 3.0 12.0 9.2

38.6 10.0 59.1 66.6 56.7 75.1 85.1 32.5 58.2

51.5 0.8 0.0 3.2 0.0 86.8 52.6 0.0 0.0

0.8 0.8 1.4 1.3 1.3 2.0 3.8 4.5 3.8

Source: Centre for Monitoring India Economy (India Trade)

However, much more needs to be done to facilitate capacity building in BRIC countries so that developing countries in general trade directly with each other rather than through trans-national corporations, which results in increased transaction costs. There is a need for a mutual commitment to fight for larger gains in the global trading system in the developing world. The process must address, not perpetuate or aggravate, existing inequalities. BRIC Summit is a testimony that all the four nations stand for strengthening cooperation and coordination among themselves. In the Summit, the leaders of BRIC countries “agreed upon steps to promote dialogue and cooperation among four countries in an incremental, proactive, pragmatic, open and transparent way.”3 The paper is an attempt towards that direction. This paper presents an analysis of the Indian tax system relating to its structure and constitutional provisions. It also presents the summary of recent economic development and issues related to international trade in India. This work is presented in the five sections. Section II presents the broad analysis of the provisions in Indian constitution related to taxation and its distribution. Section III discusses several issues related to major taxes in India. The issues related to the transition from cascading type indirect taxes to comprehensive value added system or goods and service tax has also been discussed. The section also critically analyses the structure of custom and tariff in India. Section IV presents the account of India’s development under several parameters. The last section concludes this paper. 3

Joint Statement of BRIC countries’ Leaders, on June 16, 2009 at Yekaterinburg, Russia.

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2. Constitution and Tax Structure in India 2.1. The Legislative Framework

4

IIn India, the executive power at the federal level is vested in the President, who is assisted by the Cabinet5, while legislative power is held by the Parliament. The head of the Executive, the President, is elected for five years by an electoral college comprising elected members of both the upper and lower houses of the Parliament and the state legislatures. The Vice President is elected also for a period of five years by an electoral college made up of members of both houses of Parliament. The President is aided by the Council of Ministers, which is headed by the Prime Minister. The Prime Minister is appointed by the President, who also appoints the remaining Cabinet members on the advice of the Prime Minister6. Members of the Cabinet must be members of the Parliament; any Cabinet member which is a Member of the Parliament for six consecutive months can continue to be a member of the Cabinet7.

The Parliament, comprising the President, the Council of the States (Rajya Sabha) or upper house, and the House of the People (Lok Sabha) or lower house, hold legislative power. The Council of States may have a maximum of 250 members (of which 12 are nominated by the President);8 It may not be dissolved but one third of its members are subject to retirement every two years9. The House of the People, which sits for five years, may have a maximum of 550 members, of which 530 are elected from the states and 20 from the Union Territories10. Except for money bill, all bills may be introduced in each house; money bills, under Article 109 of the Constitution, may only be introduced in the House of the People. All bills, except bills amending the Constitution, must be passed by a simple majority in both houses of Parliament and be signed by the President in order to become law. The President may request amendments to the bill and withhold assent; however, if the bill is passed again in its original form, the President may not withhold assent. Money bills, once approved by the House of the People, must either be approved or returned to the House of the People with recommendations by the Council of States within 14 days. If the House of the People accepts the recommendations, the bill is deemed to be passed by both houses; if it does not accept the recommendations, the bill is deemed to have been passed by both Houses in the form in which it was passed by the House of the People. If

4

Initial part of this section is drawn from WTO, 2007.

5

Articles 52 and 53 of Chapter 1, Part V of the Constitution. Neither the President nor the Vice President can be members of Parliament.

6

Article 75.

7

Article 75.

8

Members of the Council of States include not more than 238 representatives of the states, who are elected by the legislative assembly members (elected) of each state, as well as 12 members nominated by the President (Article 80)

9

Each member is elected for a term of six years. Every two years, one third of these members complete their six-year term resulting in the election of one third of the membership of the Council at the beginning of every third year.

10

148

In addition, under Article 331 of the Constitution, the President may, if he believes that the Anglo-Indian community is not adequately represented in the House of the People, nominate not more than two members of that community to the House of the People.

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the bill is not returned to the House of the People within 14 days, it is also deemed to be passed by both houses. Under Article 123 of the Constitution, if the President sees the need to enact legislation during Parliament’s recess, an ordinance may be promulgated. The ordinance has the same force as an Act of Parliament. However, it will expire six weeks after the reassembly of Parliament, unless it is enacted into law by both houses. The Constitution also provides for a division of jurisdiction between the Parliament and the legislative assemblies of states and union territories11. The Supreme Court, head of the judiciary, consists of a Chief Justice and not more than 25 other judges. There is a High Court in each state and district and session courts happen at the district level. The Supreme Court has jurisdiction over all disputes between the Union and the states or between the states12. It is also the final court of appeal on civil and criminal proceedings of a High Court. The Supreme Court may also, at its own discretion, grant special leave to appeal to any judgment taken by a national court or tribunal. Its decision is binding on all courts. India’s legal system is based on written law. The judiciary is independent and there is a separation of the judiciary from the executive. The system suffers from a shortage of staff, infrastructural constraints, and procedural delays. Recent efforts to address this problem include the establishment of fast-track courts to resolve criminal cases and more funding to the judicial system13. Other steps include a project on Information and Communication Technology Enablement of the Indian Judiciary, established in October 2005, and a National Legal Literacy Mission, in March 2005. The lower courts, however, remain weak and apparently also prone to corruption14. In addition, to reduce the burden on the legal system and to enable quicker disposal of claims in some cases, tribunals such as Consumer Forums have been set up. An alternative form of dispute resolution, the Lok Adalat (courts of the people) has also helped to settle a large number of cases out of court, thereby reducing the pressure on the already overburdened legal system15.

11

There are currently 28 states, 5 union territories and 2 union territories with legislature.

12

As India is a union of states, the Constitution specifies certain responsibilities as being the jurisdiction of state governments, while others are in the jurisdiction of the Union government (the Union list) and remaining are shared. For example, issues related to international trade and international agreements are in the Union`s list of the Seventh Schedule; public health and sanitation, agriculture, water and land are stating subjects; and economic and social planning, criminal and civil procedures, electricity and price controls are on the “Concurrent list”.

13

According to Government of India 2006, some Rs 2.8 billion has been released by the Union to the state governments since 1993-94 for the development of infrastructural facilities for the judicial system (Department of Justice, Ministry of Home Affairs. Online source.

14

A study on corruption in India by Transparency International found in 2005 that, among public services, the lower courts were seen by the population to be among the most corrupt (Transparency International, 2005). India was ranked 88th out of 158 in the 2005 Corruption Perceptions Index (Transparency International, 2005). Corruption is closely related to lack of transparency and consequent scope for administrative discretion. In this regard, India ranks among the most opaque (42nd out of 48) countries based on the 2004 Opacity Index, which measures the degree to which countries lack clear, accurate, easily discernible and widely accepted practices governing the relationships among governments, businesses, and investors.

15

By 31 December 2005 almost 500,000 such lok adalats had been set up and around 18.6 million cases settled out of court.

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2.2. Tax Structure in India

The Constitution makes elaborate and complex arrangements related to the distribution of taxes between the Union16 and the states, and power of borrowing and provision for grants-in-aid by the Union to the states. The underlying philosophy of these arrangements is to place adequate financial resources at the disposal of the two tiers of government to enable them to discharge their respective responsibilities under the Constitution. Seventh Schedule of the Constitution specifies the powers between the Union and states. List I in the Seventh Schedule refer to the taxation powers of the Union government (Table 2.1). List II, in the same Schedule, specifies the taxation powers of the state governments (Table 2.2). List III, which is a concurrent list, does not contain any item related to taxation, except one related to stamp duty. In other words, the tax assignment follows the principles of separation.

Table 2.1. Taxes within the Jurisdiction of the Union as Enumerated in the seventh schedule of the Constitution of India S. Nº

Entry Nº Description of the tax/ duty in List I

1. 2. 3.

82 83 84

4. 5.

85 86

6. 7. 8.

87 88 89

9. 10.

90 91

11. 12.

92 92A*

13.

92B**

14. 15.

92C*** 97

Taxes on income other than agricultural income Duties of customs, including export duties Duties of excise on goods manufactured or produced in India except alcoholic liquors for human consumption and narcotics but including medicinal and toilet preparations containing alcohol Corporation tax Taxes on the capital value of assets, exclusive of agricultural land, of individuals and companies; taxes on the capital of companies Estate duty in respect of property other than agricultural land Duties in respect of succession to property other than agricultural land Terminal taxes on goods or passengers, carried by railway, sea or air; taxes on railway fares and freights Taxes other than stamp duties on transactions in stock exchanges and future markets Rates of stamp duty in respect of bills of exchange, bank checks, promissory notes, bills of lading, letters of credit, policies of insurance, transfer of shares, debentures, proxies, and receipts Taxes on the sale or purchase of newspapers and on advertisements published therein Taxes on the sale or purchase of goods other than newspapers, where such sale or purchase takes place during inter-State trade or commerce Taxes on the consignment of goods (whether the consignment is to the person making it or to any other person), where such consignment takes place throughout inter-State trade or commerce Taxes on services Any tax not enumerated in List II or List III of the Seventh Schedule

* Inserted by the Constitution (Sixth Amendment) Act, 1956 (w.e.f. 11-6-1956) ** Inserted by the Constitution (Forty-sixth Amendment) Act, 1982. (w.e.f. 2-2-1983) *** Inserted by the Constitution (Eighty-eighth Amendment) Act, 2003. Source: Government of India (2005)

16

150

The term “Union” and “Center” has been used interchangeably in this paper.

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Service tax has been placed, after Constitution Act (Eighty-eighth Amendment), 2003, under the Union List in the Seventh Schedule under Article 268A, which reads as follows: 1)

Taxes on services shall be levied by the Government of India and such tax shall be collected and appropriated by the Government of India and the states in the manner provided in clause (2). 2) The proceedings in any financial year of any such tax levied in accordance with the provisions of clause (1) shall be: a) collected by the Government of India and the States; b) appropriated by the Government of India and the States. In accordance with such principles of collection and appropriation may be formulated by Parliament by law. Table 2.2. Taxes within the Jurisdiction of States as Enumerated in the seventh schedule of the Constitution of India

S. Nº

Entry Nº in List II

1. 2. 3. 4. 5. 6.

45 46 47 48 49 50

7.

51

8. 9. 10.

52 53 54*

11.

55**

12. 13.

56 57

14. 15. 16. 17. 18.

58 59 60*** 61 62

19.

63

Description of the tax/ duty Land revenue Taxes on agricultural income Duties in respect of succession to agricultural land Estate duty in respect of agricultural land Taxes on lands and buildings Taxes on mineral rights subject to any limitations imposed by Parliament by law relating to mineral development Duties of excise on alcoholic liquor and narcotics manufactured or produced in the State but not including medicinal and toilet preparations containing alcohol Taxes on the entry of goods into a local area for consumption, use or sale therein Taxes on the consumption or sale of electricity Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I Taxes on advertisements other than advertisements published in the newspapers (and advertisements broadcast by radio or television) Taxes on goods and passengers carried by road or on inland waterways Taxes on vehicles, whether mechanically propelled or not, suitable for use on roads, including tram-cars subject to the provisions of Entry 35 of List III Taxes on animals and boats Tolls Taxes on professions, trades, callings and employment Capitation taxes Taxes on luxuries, including taxes on entertainment, amusements, betting and gambling Rates of stamp duty in respect of documents other than those specified in the provision of List I with regard to rates of stamp duty

* Substituted by the Constitution (Sixth Amendment) Act, 1956: ** The words ‘and advertisements broadcast by radio or television’ inserted by the Constitution (Forty-second Amendment), Act, 1976: *** The scope of these taxes is spelt out in Article 276, the clause (2) of which fixes the amount payable by a person on account of these taxes. Source: Government of India (2005)

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The property of the Union is exempt from state taxation under Article 285(1). Likewise, the property and income of the states are exempt from Union taxes, except that Parliament may, by law, provide Central taxation of any trading activities of a state which is not incidental to the ordinary functions of state government - Article 89(2). As regards Union Territories, the Parliament has the power to impose any tax included in the state List. Constitution also imposes certain restrictions on the taxation powers of the states. Although a State legislature enjoys the power to levy any of the taxes mentioned in List II, in the case of certain taxes, this power is subject to restrictions imposed by substantive provisions of the Constitution. Some examples of these restrictions are as follows. The powers to impose taxes on the sale or purchase of goods, other than newspapers, belong to the state (see entry 54 of List II). However, Article 286 ensures that sales taxes imposed by the states do not interfere in imports and exports or inter-state trade and commerce, which are matters of national importance. In view of this, Article 286 places the following restrictions on the power of the states to enact sales tax legislation. No law of a State shall impose a tax on the sale or purchase of goods where such sale or purchase takes place (i) outside the state; or (ii) during import into or export out of the territory of India; With regard to inter-state trade, there are two restrictions: (i) the power to tax sales taking place in the course of inter-state trade and commerce belongs to the Union (vide entry 92A of List I in the Seventh Schedule), and (ii) the sales tax on intrastate sales of ‘declared goods’ (i.e. goods of special importance in inter-state trade) are subject to certain restrictions in terms of the nature of the levy and the rate of tax. A State legislature is empowered to levy a tax on professions, trade, calling or employment (see entry 60 of List II). However, the total amount payable in respect of any person to the state by way of such tax is not to exceed Rs. 2,500 per year [Article 276(2)]. A State legislature is empowered to levy a tax on professions, trade, calling or employment vide entry 60 of List II. However, the total amount payable in respect of any one person to the state by way of such tax is not to exceed Rs. 2,500 per annum [Article 276(2)].

2.3. Tax Jurisdiction and Apportionment

Like most federations, the tax powers in India are specified by law between the Union and the constituent units, namely the states17. The powers and functions of the respective levels of government are enumerated in the Seventh Schedule to the Indian Constitution. The concurrent list has no item that has any direct bearing on taxation except one. This relates to ‘stamp duties other than duties or fees collected by means of judicial stamps, but not including rates of stamp duty’. Recovery of taxes, like any other public demands, also occurs in the concurrent list. The residual powers of taxation, as in general legislation, belong to the Union (see entry 97 of List I in the Seventh Schedule). The Union, therefore,

17

152

An exception is the USA, where the Constitution is silent on the assignment of indirect taxes, except tariffs (McLure, 1983).

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can enter tax fields not charted in the Constitution. For example, the Union government, under such power, imposed gift tax in the past, which was abolished in 1998. Similarly, service tax was also imposed in the beginning of this millennium under such power. Contrary to the practice in several other federations where taxes can be levied concurrently at two levels, the right to levy a given tax, in the Indian Constitution, belongs exclusively to the tier to which it is assigned. In practice, the tax arrangements of Union taxes can be classified into the following categories. • Service Tax levied by the Union and collected and appropriated by the Union and the states (Article 268A), but does not form part of the divisible pool. • Duties levied by the Union but administered and appropriated by the states (Article 268): e.g duties of excise on medicine and toilet preparations containing alcohol, and stamp duties on bills of exchange, etc. as mentioned in the entries 84 and 91 of the Union List respectively, and taxes on the sale or purchase of goods where such sale or purchase takes place during inter-State trade or commerce, and taxes on the consignment of goods where such consignment takes place throughout inter-State trade or commerce as per the entries 92A and 92B in the Union List. • Taxes levied and shared between the Union and the states (Article 277): All taxes referred to in the Union list, except the one mentioned above, are levied and collected by the Government of India and from a divisible pool that is shared between the Union and the states. Moreover, there are taxes mentioned under entries 87, 88 and 92 B in the Union List that is not being levied. These entries pertain to estate duty, and succession duty in respect of property other than agricultural land and taxes on the consignment of goods where such consignment takes place during inter-state trade or commerce. The incidence of both estate duty and succession duty is on the same object, viz. property being inherited after the death of the owner. In the case of the estate duty, the value of the whole estate, even if situated in more than one state, is the base for tax. The succession duty is related to the value of individual shares (i.e. parts of an estate) being inherited by the successors. The Estate Duty was imposed in India in 1953 and abolished in 1985. Local governments, both rural and urban, have been recognized in the book of the statute after 1992. They have no exclusive power of taxation under the Constitution18. They derive their taxing authority from the state governments. The states on their own may assign any of the taxes in the State List to the local governments. The taxes generally assigned to local governments are property taxes, octroi, and taxes on vehicles, taxes on the professions, trades, calling license fees, etc. Seemingly, the tax assignment in the Indian Constitution is in conformity with the theories of tax assignment in federations, “the basic scheme of the Constitution dividing the field of taxation between the Union and the states and incorporating adequate arrangements for sharing of resources between them is sound and no 18

See Alok (2006) for more details

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major modifications in it are called for” observed by the Commission on CenterState Relations in 1988. From the equity and efficiency criteria, progressive income and expenditure taxes should be with the federal government. Destination-based consumption taxes like sales tax should be with the sub-national government. Local government should levy property taxes, and all three levels of government should have the authorities to collect user charges (McLure, 1983, Shah, 1994). Tax assignments mentioned in the Indian Constitution are consistent with the theoretical literature. The exception related to the power of the states to tax natural resources, such as minerals, was corrected subsequently by giving dominant power to the Union to levy or regulate the tax on minerals19. Although the Indian constitutional scheme on tax assignment seems good on paper, its actual working has revealed many shortcomings, including the following: Vertical imbalance: The substantial number of taxes has been assigned to the states, but the most buoyant taxes, i.e. customs, union excise, corporate income tax and personal income tax are with the Union. As a result, the Union government collects two third of the total revenue. The states together with local governments20 collect the rest. Since sub national governments are assigned about two third expenditure responsibilities, it needs large fiscal transfers from the Union to state governments. Vertical imbalance is considered desirable in a federation to ensure the redistribution of income and the constitution makers deliberately made this provision but not to this degree. Initially, when governments’ budgets used to have revenue surplus and capital investments were funded through borrowings, vertical imbalance of small magnitude was justified. In the eighties, both levels of governments started showing revenue deficit and huge fiscal deficit. “The accountability suffers when revenue and expenditure decisions are declined21.” It erodes fiscal discipline and creates a widening vertical fiscal gap; Tax Exportation: The Union has the power to tax central sales tax on interstate sales. It delegates the power to the state to administer the tax and retain the revenue. Under the scheme, the exporting state collects the revenue by levying central sales tax on the sale of goods from the state. The consumer of the importing state has to bear the tax. Thus, the central sales tax is the major vehicle of tax exportation and distorts the common market that the union of states in India offers. Tax Competition: The power of sales taxation is with the States. In the past, in the absence of coordination among them, the states engaged in tax war by lowering tax rates on automobiles and electronics items to lure consumers, providing tax incentives, exemption and deferment of different kinds to encourage trade and industry in their jurisdictions. All of them led to revenue loss and distortion in the location of industries.

19

154

Mines and Minerals (Regulation and Development) Act of 1957.

20

Local governments collects very little (Alok, 2009).

21

Bagchi, 1998 p 324.

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2.3.1. Sharing of Central Taxes Exclusive powers have been assigned to both, the Union and the states, but the Union cannot appropriate all the proceeds of the taxes collected by them. As per the design of the Constitution, revenue from Union taxes is required to be shared with the states to fulfill their needs. Before 2003, only personal income tax and the Union excise duties were shared with the States. The sharing of the income tax was mandatory under Article 270 while that of the Union excise duties was discretionary under Article 272. Under tax rental arrangements with the States, the Union government collected the tax on behalf of the states and then distributed the proceeds among the states based on criteria recommended by the successive finance commissions. These were (a) additional excise duty in lieu of the sales tax on textiles, tobacco and sugar22 and (b) grant in lieu of tax on railway passenger fares. Following the Constitution (Eightieth Amendment) Act, 2000, all central taxes have been brought into a divisible pool, and a certain percentage is shared with the states. The article 270 is amended and provide for the sharing of all central taxes, except taxes under Articles 268 and 269 and chesses, and surcharges under Article 271. Only net revenues are shared after deducting a cost of collections. Prior to 1988`s Amendment to the Constitution, Union government levied the service tax under its residual powers (see entry 97 of List I in the Seventh Schedule), and was part of the divisible pool. It is now excluded. In the 80th amendment, the objective was to construct a pool of all central taxes for sharing so that a holistic view could be taken, and both sides could share in the aggregate buoyancy of the central tax revenues. With service taxes being excluded from the ambit of the recommendations of the finance commission, the idea of the overall shareable pool of central taxes appears to be in the process of being reversed. While service taxes are likely to prove highly buoyant soon, these will not be subjected to share with the states under the Constitution, although other statutory arrangements can be made, which can include sharing as well as assignment. It may be noted that hitherto items under articles 268 and 269 were subjects that were generally of interstate nature, with limited revenue importance. These were wholly assigned to the States. In this context, it needs to be stressed that any legislation passed by Parliament with respect to appropriation of service tax proceeds must ensure that the revenue accrue to the states through any proposed changes should not be less than the share that would accrue to them, had the entire service tax proceeds been part of the shareable pool23.

22

These commodities were considered to be of national importance, and the states do not levy a sales tax on these items as per the agreement, in 1956, between the Union and states,

23

Government of India 2004, p.15-16.

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2.4. Intergovernmental Fiscal Transfer: The Mechanism

“The Constitution clearly divides powers and responsibilities between two levels of governments with some amount of flexibility. “Exact correspondence of resources and functions is impossible to secure in any federal situation, but in India the balance is titled rather heavily in favor of the Center and the outstanding feature of the financial relationship between the Center and the states. Consequently, the former is always the giver and the latter are the receivers. The favorable position given to the Center in regard to financial resources reflects the strong-Center theme running through the Constitution and many feel that this has been an important factor in keeping the country united24.” Vertical imbalances between the revenue powers and functional responsibilities of different tiers of government are a characteristic feature of all federations, whose economies are large. Therefore, vertical imbalance calls for transfer of resources from federal government to the sub-national governments. In India, wide variations can be seen in the capacity and resources across states. Thus, intergovernmental fiscal transfers are an integral part of the system. Such transfers were envisaged in the Constitution for vertical and horizontal redistribution of income. The Constitution has a simple provision. But, in practice, the fiscal transfer system in India has become quite complex and the money flows from multiple channels, including the following: • Non-plan statutory transfers through the Finance Commission. • Plan transfer through the Planning Commission. • Discretionary transfer under central and centrally sponsored schemes. In addition to these transfers, funds also flow to the States through the establishment of Central public sector enterprises, subsidized lending by financial institutions and subsidized loans to the states from the central government and the banks. Finance Commission Transfers: It is perceived that the Indian Constitution is not a static document since it provides continuity with change. The provision of Finance Commission under article 280 illustrates this point. The Constitution does provide for central transfers, but it neither indicates the share of the sates in the divisible taxes nor prescribes any principles for the distribution of taxes among the states. Thus, the percentage and manner of sharing taxes and the actual determination of grants is left to the Finance Commission. The President of India, in every fifth year or earlier as deemed necessary, appoints the Finance Commission, composed by a chairman and four members. The Commission recommends to the President, inter alia, the principles of distribution between the Union and the states of the proceeds of taxes and the allocation among the states of the shares of such proceeds. The Finance Commission makes a detailed assessment of the financial position of the finances of the Central and state governments. Both Union and state governments submit their memoranda to the Commission. The Finance Commission transfers a share of certain central taxes and grants-in-aid

24

156

Administrative Reforms Commission 1968, p. 15.

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of revenues to the states. In other words, although the exclusive taxation powers are assigned to both the Center and the states, yet all the taxes and duties levied by the Center cannot be appropriated by the Center. Certain taxes and duties collected by the Center are shared with the States to supplement the revenues of the states in accordance with their fiscal need and capacity. In addition, the Finance Commission also recommends grants-in-aid under article 275(1) to such states, which still need financial assistance even after the provision of shared taxes from the Union. At present, the 13th Finance Commission is set to give its recommendation before the end of the year 2009. Planning Commission Transfers: After India gained independence, a formal model of planning was adopted. For the purpose, the planning commission, with Prime Minister of India as chairperson, was established. It was set up on 15 March, 1950, with Prime Minister Jawaharlal Nehru as the chairman. The Planning Commission has to make a periodic assessment of all resources in the country and formulate plans for the optimum utilization of resources. Below are the functions of the Planning Commission: • To make an assessment of the resources of the country and to see which resources are deficient. • To formulate plans for the most effective and balanced utilization of country’s resources. • To indicate the factors which are hampering economic development. • To determine the machinery that would be necessary for the successful implementation of each stage of the plan. • Periodical assessment of the progress of the plan. • With the changing times, the Planning Commission is preparing itself for long term vision for the future. The commission is looking forward to maximizing the output with minimum resources. • For being a centralized planning system, the Indian economy is slowly progressing towards indicative planning wherein the Planning Commission has set the goal of constructing a long term strategic vision for the future. • It sets sectorial targets and provides the catalyst to the economy to grow in the right direction. • The Planning Commission plays an integrative role in the development of a holistic approach to the formulation of policies in critical areas of human and economic development.

The financial assistance of the Planning Commission comprises grants and loans. The assistance in allocation based on a formula devised by the Planning Commission and approved by the National Development Council of which the Prime Minister is the Chairperson and the Chief Ministers of States and Cabinet Ministers are members.

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Out of the total funds transferred to states, 30 percent is earmarked to special category states25. These states spend the money on their own plan projects. The remaining 70 percent of the funds are distributed among 17 general category states based on a formula with weights assigned to population, per capita income, fiscal management and special problems. Previously, 30 percent of the assistance was given as grant and the remaining 70 percent was given as loans. As per the recommendation of the Twelfth Finance Commission, central loans to states have been discontinued from 2005. States are now encouraged to raise resources from the market. At present, 11th Five Year Plan is in operation. In addition to the finance commission transfers and planning commission transfers, financial assistance is given to states for identified purposes through central schemes. Despite sharp criticism of these schemes, a large amount of funds flows through about 200 schemes. The relative importance of these transfers can be seen from Table-2.3. Table 2.3. Fiscal Transfers from Centre to States as % of Gross Revenue Receipts of the Union Finance Commission Period Average (percent)

1 VII FC VIII FC IX FC X FC XI FC (first two yrs)

2 22.39 20.25 21.37 21.4 20.93

3 1.96 2.52 3.42 2.34 5.20

4 24.35 22.77 24.79 23.75 26.13

5 12.11 13.56 14.48 10.57 10.39

6 1.66 1.54 1.06 0.63 0.82

(5+6)

Transfers

Total Other

statutory)

Grants (non-

Non-plan

Commission

Planning

through

Other Transfers

Grants

(2+3)

Commission

through Finance

Total Transfers

Grants

Central Taxes

Year

Share in

Finance Commission Transfers

7 13.77 15.10 15.54 11.19 11.21

Total Transfers (4+7) 8 38.11 37.86 40.33 35.79 37.20

Source: Government of India, 2004

3. Tax System in India As mentioned in the previous section, the power to levy taxes in India is clearly demarcated between the Union government and the state governments. The Union government levies both direct taxes such as corporate income tax and personal income tax and indirect taxes such as customs and excise duties/CENVAT and a service tax. States levy a VAT/state sales taxes (in State where VAT is not yet in force), stamp duty, state excise, land revenue and tax on professions. State can also levy a tax on agricultural income. Local governments both rural and urban are empowered by their respective State governments to levy a tax on properties, octroi and collect user charges for utilities like water supply, drainage, etc.

25

158

Out of 28 states in India, eleven are special category states. These states have difficult geographical terrain and considerable international borders.

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Table 3.1. Fiscal Trends in India (% of GDP) Revenue Deficit Fiscal Deficit (Centre) (Centre)

Year

Primary Deficit

Tax Ratio (Centre)

Tax Ratio (States)

Tax Ratio (Total)

1990-91

4.2

9.3

4.9

7.6

5.3

12.8

1995-96

3.2

6.5

1.6

6.9

5.4

12.2

1996-97

3.6

6.3

1.1

6.8

5.2

12.0

1997-98

4.2

7.2

2

6.3

5.3

11.6

1998-99

6.4

9

3.6

6.0

5.1

11.1

1999-00

6.3

9.5

3.8

6.6

5.3

11.8

2000-01

6.5

9.2

3.3

6.5

6.0

12.5

2001-02

6.9

9.6

3.4

5.9

6.6

12.5

2002-03

6.6

9.3

3.0

6.5

6.7

13.2

2003-04

5.7

8.4

2.0

6.8

7.0

13.8

2004-05

3.6

7.3

1.2

7.1

7.3

14.5

2005-06

2.6

6.6

0.8

7.5

7.6

15.1

2006-07(RE)

2.1

6.5

0.9

8.4

8.1

16.5

2007-08(BE)

1.2

5.7

0.3

8.6

8.2

16.8

Source: Indian Public Finance Statistics and CMIE. RE: Revised Estimates BE: Budget Estimates

3.1. Direct Taxes

In the beginning, after independence in India, the direct taxes were highly influenced by the ‘socialist pattern of society’. The taxes were levied to finance planned economic development. The Report of Taxation Enquiry Commission in 1954 recommended raising revenues through high rates of taxes in a progressive structure. Later, in 1956, Kaldor Committee prescribed a host of other direct taxes, i.e., expenditure taxes, a wealth tax and a gift tax to be integrated with the taxes on income, capital gains and estates. As a result, the personal income tax, in 1973-74, had eleven tax slabs with the highest rate of 85 percent above the income of Rs. 2,000,00. With 15% surcharge, the effective rate was 97.5 percent. In a way, the system encouraged people to evade taxes and generate black money. In the following two decades, there were sporadic efforts to reduce the tax rates. Finally, Manmohan Singhinitiated a structural adjustment program when he became Finance Minister in 1991 and tax reform was its integral part. The Tax Reform Committee, under the chairmanship of Raja Chelliah, was constituted. As per the recommendations of the Committee, the personal income tax rates were considerably simplified with only three slabs rates of 20-30-40 percent. This was reduced further to 10-20-30 percent in 1997-98.

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Table 3.2. Combined Revenue Receipts of Union and States in India (R$ billion) (RE) 2006-07

(BE) 2007-08

35867

41292

47234

3053

5877

7355

8548

358

718

1676

2310

2688

53

165

357

1013

1465

1684

b) Personal income tax (PIT)

54

156

318

608

782

936

c) Other direct taxes*

15

37

43

56

63

67

Indirect taxes

755

1395

2336

4201

5045

5860

a) Customs

206

358

475

651

818

988

b) Union excise duties

245

402

685

1112

1173

1302

0

9

26

231

382

502

d) State excise duty

50

87

159

264

308

331

e) General sales tax

182

357

729

1365

1665

1928

71

183

261

578

699

810

Year

1990-91

1995-96

2000-01

2005-06

GDP

5696

11918

21023

Tax Revenue

877

1753

Direct taxes

123

a) Corporation income tax (CIT)

c) Service tax

f) Other indirect taxes**

Source: Union Budgets , Indian Public Finance Statistics, and CMIE. Note: * Other Direct Taxes includes Estate duty, Interest tax, Wealth tax, Gift Tax, Land Revenue, Hotel receipts tax, and expenditure tax. ** Other Indirect Taxes includes Stamp & registration fees, Sales tax, Taxes on vehicles, Tax on goods & passengers, Tax & duty on electricity and Other.

Table 3.3. Contribution of Each Major Tax of Centre and States in GDP (%) Year

1995-96

2000-01

2005-06

(RE) 2006-07

(BE) 2007-08

Tax Revenue

15.4

14.7

14.5

16.4

17.8

18.1

Direct taxes

2.2

3.0

3.4

4.7

5.6

5.7

a) Corporation income tax (CIT)

0.9

1.4

1.7

2.8

3.5

3.6

b) Personal income tax (PIT)

0.9

1.3

1.5

1.7

1.9

2.0

c) Other direct taxes

0.3

0.3

0.2

0.2

0.2

0.1

13.2

11.7

11.1

11.7

12.2

12.4

a) Customs

3.6

3.0

2.3

1.8

2.0

2.1

b) Union excise duties

4.3

3.4

3.3

3.1

2.8

2.8

c) Service tax

0.0

0.1

0.1

0.6

0.9

1.1

d)State excise duty

0.9

0.7

0.8

0.7

0.7

0.7

e) General sales tax

3.2

3.0

3.5

3.8

4.0

4.1

f) Other indirect taxes

1.2

1.5

1.2

1.6

1.7

1.7

Indirect taxes

Source: Same as table 3.2

160

1990-91

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The Corporate Income Tax rate was also reduced in a phased manner to 40 percent in 1993-94. It reduced further to 35 percent in 1997-98. Minimum Alternate Tax (MAT) was introduced to discourage zero tax companies avoiding taxes by taking full advantages of concessions and tax incentives in the tax structure. The prevailing rates and the provision of personal income tax, corporate income tax, capital gain tax and withholding tax are given in Annex 1. The fiscal importance of taxes can be seen in tables 3.1 to 3.8. Table 3.4. Contribution of Each Major Tax in the Total Tax Revenue of the Union and States (%) 1990-91

1995-96

2000-01

2005-06

(RE) 2006-07

(BE) 2007-08

14.0

20.4

23.5

28.5

31.4

31.4

a) Corporation income tax (CIT)

6.1

9.4

11.7

17.2

19.9

19.7

b) Personal income tax (PIT)

6.1

8.9

10.4

10.3

10.6

11.0

c) Other direct taxes

1.8

2.1

1.4

1.0

0.9

0.8

Indirect taxes

86.0

79.6

76.5

71.5

68.6

68.6

a) Customs

23.5

20.4

15.6

11.1

11.1

11.6

b) Union excise duties

27.9

22.9

22.4

18.9

15.9

15.2

d) Service tax

0.0

0.5

0.9

3.9

5.2

5.9

e) State excise duty

5.7

4.9

5.2

4.5

4.2

3.9

e) General sales tax

20.8

20.4

23.9

23.2

22.6

22.6

8.1

10.5

8.5

9.8

9.5

9.5

100.0

100.0

100.0

100.0

100.0

100.0

Year Direct taxes

f) Other indirect taxes Total Tax Revenue Source: Same as table 3.2

Table 3.5. Gross Revenue Receipts of the Centre (R$ billion) Year

1990-91

1995-96

2000-01

2005-06

2007-08

2008-09

2009-10

GDP

5696

11918

21023

35867

47234

53218

n.a.

Total Revenue

550

1100

1927

3480

5419

5622

6145

Gross Tax Revenue

430

819

1369

3662

5931

6279

6411

Direct taxes, of which

69

223

497

1623

2959

3450

3700

a) Corporation tax (CIT)

53

165

252

1013

1929

2220

2567

b) Personal income tax (PIT)

13

43

238

608

1026

1226

1129

3

15

7

3

3

4

4

Indirect taxes, of which

361

596

873

2038

2972

2829

2711

a) Customs

206

358

342

651

1041

1080

980

b) Union excise duties

141

222

498

1112

1234

1084

1065

0

9

20

231

513

650

650

14

9

14

45

79

16

16

c) Other direct taxes*

c) Service tax d) Other indirect taxes Source: Same as table 3.2

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Table 3.6. Share of Each Major Tax in Gross Tax Revenue of the Centre (%) Year

1990-91 1995-96 2000-01 2005-06 2007-08 2008-09 2009-10

Direct taxes, of which a) Corporation income tax (CIT) b) Personal income tax (PIT) c) Other direct taxes Indirect taxes, of which a) Customs b) Union excise duties c) Service tax d) Other indirect taxes Gross Tax Revenue

16.1 12.4 2.9 0.7 83.9 48.0 32.8 0.0 3.2 100.0

27.2 20.1 5.3 1.8 72.8 43.6 27.1 1.1 1.0 100.0

36.3 18.4 17.4 0.5 63.7 25.0 36.3 1.4 1.0 100.0

44.3 27.7 16.6 0.1 55.7 17.8 30.4 6.3 1.2 100.0

49.9 32.5 17.3 0.1 50.1 17.6 20.8 8.6 1.3 100.0

54.9 35.4 19.5 0.1 45.1 17.2 17.3 10.4 0.3 100.0

57.7 40.0 17.6 0.1 42.3 15.3 16.6 10.1 0.2 100.0

Source: Same as table 3.2

3.2. Indirect Taxes: a Move towards Goods and Service Tax

26

At present, the move in India is towards comprehensive goods and service tax by integrating primarily Union Excise Duty, State Sales Tax and Service Tax. As mentioned earlier, the Indian Constitution assigns Union Government to impose a broad spectrum of union excise duties (UEDs) on production or manufacture of goods and the state governments the power to levy a tax on sale of goods. The authority to levy a tax on services has been assigned to the Union List. However, the states are empowered to levy a tax on some services through entertainment tax, electricity duty, motor vehicles tax, passengers and goods tax, entry tax, octroi etc.

3.2.1. Excise Duty/Central VAT Excise Duty/CenVAT is levied by the Union Government at the manufacturing level on almost all manufactured goods except hydrocarbon and tobacco. The Union government initially levied Union Excise Duty (UED) on about a dozen articles at a very low rate of tax. However, as the time passed by, the rates were revised and the tax base was enlarged to bring more items into the tax net. It was levied mainly on finished goods but also covered raw materials, intermediate goods and capital goods. The first reform in the UED regime was undertaken in 1986 through the introduction of modified value added tax (Modvat), which was based on the Report of the Jha Committee27. This scheme provided a set-off for the taxes paid on inputs used in about a dozen articles. In 1987, the scheme was extended to cover some additional commodities. The processes of reform in indirect taxes got strengthened in post 1991 when structural adjustment program was initiated to revive the Indian economy. To

162

26

This section has been drawn liberally from Purohit 2009.

27

Government of India 1978.

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begin with, based on the recommendations of the Report of the Tax Reforms Committee (TRC), the Modvat was further extended to encompass a large number of commodities28. The procedures of Modvat have been overhauled since then, converting the existing UEDs into Central VAT or CenVAT, which covers almost all items, except high-speed diesel (HSD), motor spirit (gasoline) and matchboxes. The Union Budget 2006-2007 converted the CenVAT into a two-rate duty structure of 16 percent and 8 percent. However, now the rate of CenVAT has been reduced to 14%. CenVAT allows instant credit for all the taxes paid on inputs in the form of UEDs (i.e. Modvat/CenVAT) or additional duties of excise (ADE). Input credit is also given for additional duty of customs, which is known as countervailing duty (CVD) 29 and is collected at the time of the imports. For capital goods, however, only 50 percent of the duty can be claimed as input credit in a financial year; the remaining credit can be claimed in the next financial year, provided the goods are still in use (except for spares and components). A manufacturer producing only tax-exempt final products is not allowed to claim this credit. However, it is permissible for a manufacturer who produces both dutiable and exempted final products in the same factory30. Along with CenVAT, the Union government also levies the additional excise duty in lieu of the sales tax31; additional duty of excise on textiles and textile articles; and cess on specified commodities.

3.2.2. Service Tax The Constitution was amended to include service tax in the Union List by inserting item 92(C) into the Seventh Schedule. This enables the Union to assign this tax to the states, solely or concurrently, whenever it so desires. It is to be noted that the services´ sector contributes the largest share in GDP. Since 1994-95, when it was introduced under residuary entry in the Union List, the number of services has increased over the years and the leviable rate of service tax was also revised (Table 3.7). Initially, only three services were taxed, viz. general insurance, stock broking and telephone. The coverage of the tax was gradually expanded and presently service tax is levied on 106 services. At present, the standard tax rate is 10% with effect from February 24th, 2008. The service tax is now integrated with CenVAT.

28

Government of India 1993

29

This has been discussed in the Annex 1 and subsequent part of this section.

30

This is subject to certain conditions, viz. maintenance of separate records in respect of inputs used to manufacture exempted products or payment of 8 percent of the total price (excluding taxes) of the exempted final products or in the case of a few specified items, on reversal of the credit availed.

31

Additional excise duty in lieu of the sales tax has been levied since 1956 on tobacco, textiles and sugar under a tax rental arrangement between the Union and the States. According to this arrangement, the Union government was levying the additional excise duty on these items and the States refrained from levying sales tax on them. The net proceeds of this duty have been distributed among the States based on consumption. With the efforts of the country to move towards VAT, the proceeds of this tax is now included in the divisible pool, and the states have also been allowed to levy VAT on these items.

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Table 3.7 Service Tax: Growing Revenue Source Year

Number of services

Number of assesses

2002-03

52

232048

5

41.2

24.8

2003-04

60

403856

8

78.9

91.4

2004-05

75

740267

10

142.0

80

2005-06

84

806585

10

230.6

62.4

2006-07

99

918746

12

376.0

63.1

2007-08

106

NA

12

513.0

36.4

NA

12*

650.0

26.7

P

2008-09(RE)

Tax rate (per Revenue (Rs. cent) billion)

Growth (per cent)

P provisional Source: Government of India 2009

3.2.3. State-VAT While the Union government at a central level levies a Cen-VAT on all manufactured goods and a service tax (integrated with CenVAT), all the states levy a state-VAT on goods sold within the state. Previously, different models of the single-point, doublepoint and multi-point sales tax were adopted in different States. However, the models adopted initially were replaced by a first-point sale tax and gradually, almost all the States switched over to this system. In addition to first-point sale tax, the States also imposed some other levies related to sale tax. These were in the form of additional sale tax, turnover tax or surcharge on sale tax. Considerable variations existed in these levies among the States. The first-point sale tax, as well as the other supplementary taxes, suffered from many weaknesses such as cascading and uncontrolled incidence, multiplicity of rates, vertical integration of firms, non-neutrality and lack of efficiency in the tax system. Given these deficiencies in the prevailing structure of a sale tax, efforts were made to replace it with a system of sub-national VATs. Under a sale tax regime, all the States gave huge concessions and sales tax incentives to attract new industries. The Government of India took the initiative to design an acceptable structure for VAT. This was accomplished by a study report titled Reform of Domestic Trade Taxes in India in 199432. Finally, the following consensus emerged. The report was discussed in a number of forums involving Chief Ministers and Finance Ministers of all states so that differences among states could be resolved. Finally, the following consensus emerged: • The number of rates prevailing under the sales tax would be reduced to a four-rate structure; • The number of exemptions under the sales tax would be curtailed considerably;

32

164

NIPFP 1994

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• No new tax exemptions (known as incentives) would be given to the industries and the existing incentives converted into deferment; and • VAT should replace the existing sales tax system. It was felt that prior to introduction of VAT, some preparations were essential. The States had attempted to rationalize their existing sale tax system by adopting two major reforms. The first reform related to the adoption of a four-rate structure (i.e. zero, 4, 8 and 12.5 percent) in the existing sale tax. These rates were in addition to two special rates of 1 percent and 20 percent for a few specified items. The recommended rates were flooring rates – the States had the freedom to adopt a higher rate on any of the commodities from the list. This had checked the rate war and diversion of trade among the states. However, when the states started implementing the four-rate categories many of them found it difficult to impose it on some commodities. Either the classification faced some problem or there were administrative difficulties in implementing the floor rates. Hence, a few changes were made in the items falling under the exempt list and in other categories. The second reform pertains to the abolition of incentives related to sale tax as all the states granted various incentives to new industries in the form of exemption from tax on the purchase of inputs/sale of finished goods as well as sales tax loans and/or tax deferral. Various studies and committee reports33 have already argued against such incentives and pointed out that these incentives take the form of tax competition (war) or harmful tax practices in a federation. The VAT was finally introduced in most of the states from 1st April 2005. Haryana (a northern state) was the first State to introduce VAT on April 1st, 2003. Eventually, the rest of the states implemented the same. As of now, all the states have a system of VAT, known as state-VAT. The coverage of tax includes a sale of all goods, except diesel, petrol (gasoline), aviation turbine fuel, natural gas and liquor. It has two basic rate categories of 4% and 12.5% (standard rate) with some tax-exempt items and two special categories: 1% on gold, silver, and ornaments and 20% on petroleum products.

3.2.4. Harmonization of Interstate Tax

As stated earlier, taxation of inter-state transactions is in of the Union List of the Constitution. However, while the authority to levy the tax remains under the jurisdiction of the Union Government, section 9 of the Central Sales Tax Act entrusts the task of administering the tax to the states. The states are also allowed to retain this revenue. In effect, the tax has been assigned to the states. Thus, the tax is administered, collected and retained by the exporting state, based on ‘origin’. Although the CST serves the purpose of regulating the flow of interstate movement of goods, it’s not compatible with the concept of a unified market in a federal country like India. It is contrary to inter-jurisdictional equity, causes cascading, discriminates against the consuming states, hinders the formation of common Indian market and causes the levy of tax on exports to other states. Also, its procedural requirement causes corruption in the tax administration.

33

Government of India 1998 and 1999.

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Keeping in view the above stated weaknesses and the demands of the open and liberalized economy, it was felt that an ‘origin base’ tax hampers the inter-state trade and puts Indian industry and business at a considerable disadvantage in comparison to producers abroad, whose products are now being imported on an increasing scale. In addition, India has made a commitment in the SAARC that all the SAARC countries should move towards free trade. Hence, breaking barriers across states has become necessary. There is an increasing realization that the tax on inter state sale is distortion and breaks the chain of transactions in the Indian common market. Thus, it becomes imperative to abolish CST. It has, however, now been decided to phase CST out by 1% point every year, to as to reduce it to zero by March 31, 201034. In doing so, the Union Government has announced some compensatory measures for the States, which are as follows: Table 3.8. Contribution of each Major Tax of States in GDP (% of GDP) Year Tax revenue# Direct taxes^ a) Land revenue b) Corporation income tax (CIT) c) Wealth tax d) Others* Indirect Taxes^ a) State excise duties b) General sales tax c) Stamp & registration fees d) Tax on vehicles e) Custom duties f) Service tax g) Others** Non-tax revenue

1990-91

1995-96

2000-01

2005-06

5.29 0.22 0.11 n.a. n.a. 0.11 5.08 0.84 2.89 0.37 0.27 n.a. n.a. 0.71 0.97

5.37 0.19 0.11 n.a. n.a. 0.07 5.19 0.72 2.84 0.50 0.31 n.a. n.a. 0.82 1.50

6.00 0.37 0.07 0.21 neg. 0.10 5.63 0.75 3.25 0.44 0.31 0.23 0.01 0.63 0.96

7.60 0.87 0.08 0.72 neg. 0.07 6.73 0.73 3.70 0.72 0.34 0.51 0.19 0.54 0.96

(RE) 2006- (BE) 200707 08 8.09 0.96 0.07 0.81 0.01 0.07 7.13 0.74 3.75 0.77 0.34 0.55 0.25 0.74 0.99

8.20 1.00 0.07 0.85 0.01 0.07 7.20 0.70 3.83 0.81 0.33 0.57 0.28 0.69 0.90

Source: Indian Public Finance Statistics, and CMIE. Note: * Hotel receipts tax, Share of estate duty, Agriculture tax, and others ** Motor spirit sales tax, Tax on goods & passengers, Tax & duty on electricity, Entertainment tax, Tax on purchase of sugarcane (incl. cess on sugarcane), and Others ^ Direct and Indirect taxes minus share of income tax, share of union excise duties # Gross tax revenue minus share of income tax, share of union excise duties neg.: negligible

• Withdrawal of the benefit of concessional CST rate on inter-state sale to government departments. • Enabling states to levy VAT on tobacco @ 12.5%. • Transferring to the States the revenue from 33 services currently subject to Service Tax and assigning 44 new services to them (as and when taxed). • Filling any gap through budgetary support in the years of transition in case the measures indicated at (a), (b) and (c) do not fully cover the revenue loss.

34

166

It has already been reduced to 2 percent from April 1st, 2008.

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3.2.5. A Way towards GST After successful implementation of state-level Value Added Tax (VAT) in all the states, further reforms involving the introduction of a goods and service tax (GST) are under their way. It is planned that GST will be introduced with effect from the 1st April 2010. The basic objective for transition to GST is to have an efficient, effective and taxpayer friendly system of taxation of goods and services in line with the best international practices. Also, there is a need for preserving the sovereign powers of the union and state governments in taxation matters. Furthermore, the need is to propose a model that is easy to implement and is also acceptable to all the stakeholders. However, there are significant structural, procedural and administrative issues involved in designing an effective GST model in a federal system, given the main objective of having a unified market. Keeping this in view, the Empowered Committee of State Finance Ministers (EC) constituted a Joint Working Group to give recommendations regarding a detailed framework to be adopted for GST. The Joint Working Group recommended a dual GST as it felt that a single harmonized GST is impossible, given the prevailing Center-state relationship as well as the federal character of the economy. The Working Group has recommended that the GST should subsume all the indirect taxes on supply of goods or services, as given below: • Central Excise duties and the Additional Excise duties levied on pan masala, petroleum and tobacco products, and those levied under Additional Duties of Excise (Goods of Special importance) Act, 1957; • Additional customs duty in the nature of countervailing duties; special Additional Duty; • Special Additional Duty and other domestic taxes imposed on imports to achieve a level playing field between domestic and imported goods (which are currently classified under a customs duty); • Cesses levied by the Union, viz. cess on manufactured biris; rubber; tea; coffee; and cess on unmanufactured tobacco; and • Surcharges levied by the Union, viz. national calamity contingent duty, education cess, special additional duty of excise on motor spirit and high speed diesel. It is to be noted that some of the above cess and surcharges are earmarked for predetermined purposes, viz. education or uplift of the workers engaged in a particular industry, development of technology, etc. These do not currently form part of the CenVAT chain and are levied under independent Acts, legislated by different Ministries. These levies, therefore, could be out of the purview of GST. The Working Group further recommends that the state-GST should include in its purview purchase tax, state excise duty35, entertainment tax, luxury tax, octroi, entry tax in lieu of octroi, taxes on lottery, betting and gambling, tax on consumption or sale of electricity.

35

However, the idea of subjugation of state excise duty requires reconsideration. Firstly, it is an important source of revenue in many of

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With the above central and state taxes being subsumed under GST, the proposed GST will have two components – Central GST (levied by the Center) and State GST (levied by the states). The rates of these two components will be prescribed separately keeping in view the revenue considerations, total tax burden and the acceptability of the tax. The effective rate of state-VAT is currently 12.5 percent, while the rate of CenVAT is 16 percent. Hence, the combined tax rate is 28.5 percent. This has to be reduced to approximately 15 to 20 percent, given the rate structure around the world.

3.3. Customs Duty

In the initial years after independence, India’s dependence on custom duty was lower compared to other low income countries that had significant reliance on taxes on international trade due to India’s efforts to restrict imports36 to save scarce foreign exchange. Duties of customs are levied on goods imported or exported from India at the rate specified under the customs´ Tariff Act, 1975, and administered by Central Board of Excise and Customs in the Ministry of Finance, Government of India. For the purpose of exercising proper surveillance over imports and exports, the Union government has the power to notify the ports and airports for the unloading of the imported goods and loading of the exported goods, the places for clearance of goods imported or to be exported, the routes by which above goods may pass by land or inland water into or out of India and the ports. Rates of customs duty for goods imported from countries with whom India has entered into free trade agreements such as Thailand, Sri Lanka, BIMSTEC, south Asian countries and MERCOSUR countries are different (Annex 4 lists the countries under various groups evolved in recent time).

Custom duty consists of basic tariff, which is the protecting element, and the Additional Duty of Customs (AD), that is a counterpart of excise duties paid by Indian manufacturers on a like product produced in India. If a like product is not manufactured or produced in India, the excise duty that would be leviable on that product had it been manufactured or produced in India is the duty payable. If the product is leviable at different rates, the highest rate among those rates is the rate applicable. Such duty is leviable on the value of goods plus basic custom duty payable. It is also called as countervailing duty (CVD). In addition, Special Additional duty (SAD) is levied to counter taxes imposed on raw materials, components and other inputs similar to those used in the production of such goods37. The basic duty is levied under the Customs Act. The rate varies for different items. The Additional Duty (Countervailing Duty) is levied under section 3 (1) of the Custom Tariff Act and is equal to excise duty levied.

the states. Secondly, it fails in the category of sumptuary excises. Also, the Indian Constitution assigns a special role to the states for prohibition through this tax.

168

36

Chelliah, 1986.

37

Furthermore, states may also impose taxes on the sale of imported goods after they move from the port or out of the State in which it is located.

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Special Additional Duty (SAD) is levied under section 3(3) of the Customs Act. It can be charged on all goods by the Union government. Further, in order to safeguard the interest of domestic manufacturers, as per the situation, the Union government may also impose anti-dumping duty, protective duty and duty on bounty fed articles (see Annex 1). On the other hand, Export Duty is levied on export of goods on few articles such as skins and leather. The main objective of this duty is to restrict exports of certain goods. Thus, the import duty is collected essentially under four sub heads, i.e., basic custom duty, Additional Duty of Custom (AD) or Countervailing Duty (CVD), Special Additional Duty (SAD) and Education Cess. One may notice wide variations between a nominal basic tariff and the effective rate. Some commodities like, alcohol and automobiles have a basic rate higher than the peak rate. Please see Annex 2 for the list of these commodities. Until the Long Term Fiscal Policy introduced in 1985, the custom tariff rates were very high with complex structure in highly protected and inward looking economy. Attempts were made to rationalize the structure. As a result, the tariff rates have been declining since 1991. The peak rate has come down from 150 percent in 1991-92 to 40 percent in 1997-98, 30 percent in 2002-03, 25 percent in 2003-04, 15 percent in 2005-06 and finally 10 percent in 2007-08. The peak rate of basic customs duty on non agricultural products, which was 20 percent in 2003-04 was successively reduced in subsequent budgets to reach a level of 10%. In 2007-08, the Budget for 2008-09, however, did not carry this forward as the appreciation of the rupee vis-à-vis US$ by 9.8 percent in 200738 itself resulted in lower protection to domestic industry38. With the decline of the average tariff rate over the last two decades, the reliance on custom duty in the tax structure has also declined (tables 3.2 to 3.8). Though, average tariff remains among the highest in the world. All finance ministers in the past had made the statements to bring India’s custom tariff to the level of ASEAN (Annex 4). Even if India’s peak rate is brought down to 10%, it still has to reach the tariff levels of East Asia. On the other hand, most ASEAN rates have been reduced further under the ASEAN free trade (AFTA) agreement. At the same time, the neighboring countries in South Asia, such as Bangladesh, Nepal and Sri Lanka, also have lower average tariffs than that of India. This creates another problem of import diversion and smuggling as India has some kind of free trade agreement with some of its neighbours. Hence, it is profitable to import items first in the neighboring countries and export them from there to India. As described above, there have been continuous changes in the customs´ tariff structure since 1991. It is close to the ASEAN level. Still, India’s tariff structure is one of the highest in the world. Simultaneously, the custom duty structure is complex as it contains 1150 pages with 4000 devoted to its examples. Secondly, nonagricultural tariff needs to be reviewed concerning its classification and administration.

38

Government of India 2009, p. 40.

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3.3.1. High Tariff

39

One can argue to impose a high tax on certain consumer goods to discourage their consumption. This does not, however, translate easily into an argument for imposing higher import tariffs on the “undesirable goods.” Thus, for example, if the Government of India wants to discourage the consumption of alcohol, the best way to do this is to have higher excise taxes and an equivalent additional custom duty. This is indeed what the Government already does. Imposition of a high import tariff, on the other hand, cuts off competition from better quality alcohol, and removes the incentive for upgrading the quality. It also provides an incentive for smuggling. Items such as automobiles, air conditioners, furniture and fixtures are used both by consumers and producers. Higher tariff protection in such cases will have adverse effects on the effective protection provided to all industries because they constitute a part of the costing structure. There is one argument in the trade literature, i.e., the “Infant Industry Argument” that has often been used to justify “protection” of both “pure” consumer goods and dual use items such as cars. Even in this case, however, the (so called) first best or efficient solution is a direct subsidy to producers. Direct subsidies have the additional benefit of transparency in that the cost of protection of each protected item is measured by the known subsidy. It is very important to note that an industry cannot be an “infant” forever; it may be an “infant” for five years or at the outer limit 10 years. Twenty and thirty year old industries cannot be called “infant industries.” As time passes by, the efficiency of the industry diminishes due to complacency. Thus, any such protection must be limited in both scope and time. Moreover, the OECD countries, researchers dealing with infant industry argument have not been able to identify specific industries that would clearly and unambiguously benefit from such temporary protection. It has proven even more difficult to demonstrate that such specific interventions would be welfare improving.

3.3.2. Low Tariff There can also be a valid social argument for lower taxes on certain (pure) consumer goods like life saving drugs, medical devices and equipment and knowledge related goods. As in the previous case this is really an argument for reducing domestic consumption taxes like CENVAT and Sales tax along with the corresponding additional duty or special additional duty (SAD). Reduction of domestic taxes and SAD is an economically efficient way of ‘subsidising’ the use of these items. Once this stand is taken, the classical, efficient, economic solution is quite clear40. A direct subsidy on consumption is the best means of facilitating consumption. When there are a large number of suppliers (producers or traders) the administrative costs of such subsidy can be very high41. Therefore under exceptional situation of high administrative

170

39

Drawn from Virmani 2002.

40

Prof. Bhagwati and Srinivasan demonstrated in a number of papers that the best way of dealing with domestic distortions is through domestic policy changes to offset them, not through trade distorting measures. Please see for example Srinivasan and Vani 2009.

41

As demonstrated in the case of food and petroleum subsidies.

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cost and high standard tariff rate it may be socially desirable to reduce the customs tariff below this rate. The reduction should be considered an interim measure till the standard rate is bought down to a reasonable level.

3.3.3. Single Rate The phased reduction in the “peak” rate of basic customs duty is going on. Simultaneously, exemption and anomalies in the structure should be removed except for those arising from international agreements and higher temporary protection of agricultural raw materials. A single uniform rate of basic (protective) customs duty on all imports has many attractive features, including the following: a) b) c) d) e)

f) g)

h)

i)

“It ensures that the nominal protection for all imports is the same, thus, eliminating all classification problems and disputes, resulting in substantial savings in administrative and legal costs. It makes it much easier to administer the duty free import regime for exporters. As a single rate applies to all imports, only a total value of imports needs to be specified. Most imports can, in principle, be on self-declaration basis and customs staff can focus their time and energy on checking smuggling (through mis-declaration of quantity or concealment of an item) and chronic misstatements of price. If the uniform rate is reasonably low, the incentive for smuggling will be minimized and make the administrative problem of checking it manageable. With a single, uniform, nominal duty, the effective protection rate is also identically equal to this rate. The rate of effective protection is, therefore, neutral and equal to all value added by domestic producers. This will increase the efficiency and competitiveness of the entire economy. Uniform effective protection on all producers’ goods is more equitable in that it removes the discrimination against other producers. Higher protection for one set of producers inevitably results in lower protection for some other producer. In the case of final finished consumer goods, there is much greater economic justification for a single uniform basic customs duty equal to that on producer goods (with AD/SAD – domestic taxes on consumer goods) then, there is for a single uniform rate VAT or CENVAT (applying equally to domestically produce and imported goods). A low uniform rate duty will have the additional benefit of reducing India’s weighted average tariff rates below those prevailing in neighboring countries. Economic interests of India will then become much more closely aligned with neighbors. Indian industry and agriculture will have much less to fear from special free trade arrangements with India’s neighbors than is the case today. A low uniform duty that is close to the average for ASEAN countries will enhance India’s case for closer economic integration with ASEAN. India can then take the lead in the formation of an Asian Common Market, instead of being treated as a highly protected economy.

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j)

Such a regime will eliminate the continuous lobbying that now takes place and the special benefits to large industry and powerful interest groups and losses to the small and unorganized that inevitably result from such lobbying42.

3.4. Taxation and E-commerce

In general, e-commerce, which refers to conducting trade via the Internet, has a much larger scope than just conducting merchandise transactions electronically. It not only includes all forms of trade in goods, but also encompasses services such as banking, insurance and trading in shares. E-commerce creates diverse functions and revenue streams. Also, it reduces costs of transactions significantly. It is believed that procurement costs will be reduced by 90 percent through buying online. It is estimated, for example, that online banking costs one rupee against Rs. 27 by cash machine and Rs. 114 by bank teller43.

In view of the reduced costs and increased efficiency of e-commerce as compared to the traditional system of trade and commerce, growth of e-commerce is likely to be highest in India among the Asian nations. Estimates show that it will grow at the rate of 246 percent in India against 84 percent in Australia, 110 percent in Hong Kong, 145 percent in South Korea and 243 percent in China44. With the industry and trade rapidly picking up computer culture, its full potential will be reality in India in the near future. The opening up of the economy and globalization will stimulate its use and have a deep effect on the system of tax governance in the country. With a view to encourage e-commerce, most countries initially adopted the policy of exempting e-commerce from taxation. The ‘infant industry’ argument was the justification for such a policy. It is, however, important to note that the European Union has now started taxing e-commerce. The argument for taxation of e-commerce is based on the premise that such an exemption might induce other dealers/taxpayers to enter transactions that save them some tax. It is, therefore, important to evolve the principles that should govern taxation of e-commerce. In this context, the Government of India constituted a high powered committee on Electronic Commerce and taxation on December 16th, 199945. The objective of the Committee was to examine the projected growth of E-Commerce business and whether it should be subject to tax, etc. Some of the observations made by the committee are as follows. • No reliable data exists as to the estimate of E-Commerce business either in India or elsewhere. • There has to be uniformity in the taxation of traditional commerce and E-Commerce and to that extent, there is no case for exemption of E-Commerce from Direct Tax.

172

42

Virmani 2002, p.13-14

43

Purohit and Purohit 2006 Ibid.

44

Virmani 2002, p.13-14

45

Government of India 2001b.

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• There is no issue regarding domestic E-Commerce taxation, except for the need to avoid evasion because of the lack of records. In respect to cross border E-Commerce, however, there is a need to examine the incidence of tax and a mechanism to levy and collect the same. Significantly, the Committee has come to the view that applying the existing principles and rules to E-Commerce is impractical and the concept of “PE” (permanent place of establishment) adopted by few countries and backed up by article 5 of the OECD model tax convention should be rejected. The Committee feels that the “Base Erosion” approach in the form of a low “Withholding tax” for any payment to a foreign enterprise with the option of being offset by tax on net income by the receiver in his country is a workable option. It has been recommended that Central Board of Direct Taxes (CBDT) should examine this option and the implementation mechanism. The approach of the Committee is considered pragmatic. The CBDT is suggested by experts to initiate necessary dialogue with the International community to generate consensus on the approach and establish a suitable mechanism. In the interregnum, status quo can continue46. Presently, the revenue from E-commerce is too low to hold the attention of tax authorities.

4. Economic Development 4.1. Macroeconomic Developments In the late eighties, Prime Minister Economic Advisory Council headed by Sukhmoy Chakravarty drew pointed attention of the Government of India towards two fundamental imbalances, i.e. trade imbalance and the fiscal imbalance. The growth rate was also low. Though, India had slow growth during 1950-80, what is called “Hindu growth rate” of 3.5 percent for GDP.47 In the early nineties, the Narasimha Rao government of which Manmohan Singh was the finance minister initiated the structural adjustment program. The program comprised 10 broad policy prescriptions (Table 4.1) including fiscal discipline and tax reform. Under the program, as mentioned in the previous section, many measures were taken to reform major taxes with an underlying direction towards broader bases with moderate rates and fewer exemptions. A conducive environment for trade and industry was created. As a result, the growth rate picked up.

46

The debate on international taxation of e-commerce is inconclusive. Azam 2007 argues that the debate is oriented and ignores cyber space law and this separation is unjustified and harmful to the development of e-commerce taxation law.

47

Even growth rate of 3.5 per cent of GDP was more than four times higher than the growth rate of 0.8 per cent per year estimated for the last five decades of British rule (Sivasubramoniam 2000).

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Table 4.1. The Washington Consensus 1 Fiscal discipline 2 Reordering public expenditure in favor of education, health and economic infrastructure 3 Tax reform (towards broader bases with moderate rates) 4 Financial liberalization 5 Competitive exchange rate 6 Trade liberalization 7 Liberalisation of foreign direct investment 8 Privatisation (of public enterprises) 9 Deregulation (of barriers to entry and exit) 10 Property rights Source: Williamson (1990)

The optimism about Indian economic development continued during the period. As a corollary, the economy grew between 1960-79, 1980-91, 1992-2002 and 2002-05 periods at an annual average rate of 3.5, 5.5, 6.0 and 8.1 percent respectively. The pace of economic growth, which is regarded as the primary indicator of macroeconomic health, was unprecedented over 2003-04 to 2007-08 with an average growth rate of 8.8 percent per year. The growth decelerated in 2008-09 to 6.7 percent. This represented a decline of 2.1 percent from the average growth rate of 8.8 percent in the previous five years. However, during the preceding five-year period, from 1998-99 to 2002-03, the average growth rate was only 5.5 percent due to several reasons, including political uncertainties of coalitional government and a high fiscal deficit due to large public pay increases. Table 4.2. Growth of Real GDP (Percent per year) 1992/93- 1997/98- 2002/031996/97 2001/02 2006/07

2002/ 03

2003/ 04

2004/ 05

2005/ 06

2006/ 07

2007/ 08

GDP(factor Cost)

6.6

5.5

7.8

3.8

8.5

7.5

9.4

9.6

9.0

Agriculture

4.8

2.5

2.5

-7.2

10.0

0.0

5.9

3.8

4.5

Industry

7.3

4.3

9.2

7.1

7.4

10.3

10.1

11.0

8.5

Services

7.3

7.9

9.3

7.5

8.5

9.1

10.3

11.1

10.8

Per capita GDP

4.4

3.5

6.1

2.3

6.9

5.8

7.7

8.1

7.5

Source: Acharya, 2008 (Basic Data –CSO). Note: Agriculture comprise of agriculture proper, forestry & logging, and fishing. Industry includes mining & quarrying, manufacturing, electricity, gas & water supply, and construction. Services includes trade, hotel, transport & communication, finance, insurance, real estate and business services, and social & personal services

This includes the enhancement of total factor productivity (TFP)48, buoyant international economic environment and an extraordinary growth of a modern service 48

174

TFP may be defined as the ratio of output to a weighted combination of inputs. It reflects the efficiency with which factors of production are used, and is thus a key determinant of an economy’s performance, especially its international competitiveness. One of the most important sources of TFP growth in the long run is technological progress.

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sector, including communications, information technology and finance. The expansion of the service sector has been unprecedented. Today, its share in GDP is about 55 percent compared to one fifth share of the agriculture and one fourth shares of industry (table-4.3). Agriculture growth remains low during the period as the sector depends substantially on weather conditions. However, during 2005-08, its contribution to the GDP was noteworthy as it registered the annual growth rate between 4 to 6 percent, whereas the GDP growth rate hovers between 9 to 10 percent in the corresponding period. It is to be noted that despite low growth in agricultural it employs over half of India’s labor force. Table 4.3. Sectoral Composition of Growth Share in real GDP (%) Average of 1994-97

Average of 200407

Agriculture

28.2

19.4

Industry

26.4

Services GDP (Factor Cost)

Contribution to GDP Growth (% ) 1991/92 to 1996/97

1996/97 to 2001/02

2001/02 to 2007/08

21.1

11.5

7.0

26.5

29.0

20.2

29.3

45.4

54.1

49.8

68.3

63.6

100.0

100.0

100.0

100.0

100.0

Source: same as table 4.2.

On the other hand, Table 4.4 shows the composition of GDP growth from the expenditure side. Share of aggregate investment expenditure in GDP is showing considerable rise, whereas government and private sector consumption grew from 1996-97 to 2001-02, but declined thereafter. Table 4.4. Expenditure Composition of Growth Share in real GDP (%) Average of 1994-97

Average of 2004-07

Contribution to GDP Growth (% ) 1991/92 to 1996/97

1996/97 to 2001/02 to 2001/02 2007/08

Investment (GDCF)

23.9

32.6

29.2

20.4

57.3

Government Final Consumption

11.1

10.2

8.2

16.7

5.3

Private Final Consumption

65.7

59.6

54.3

60.2

47.9

Net Exports of Goods and Services (including Discrepancies)

-0.7

-2.4

8.4

2.7

-10.5

100.0

100.0

100.0

100.0

100.0

GDP ( Factor Cost) Source: same as table 4.2.

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4.2. Total Factor Productivity

Many things contributed to the unprecedented economic growth that India witnessed in the last two decades. Total factor productivity (TFP)49 is certainly an important element. India registered two percent increase in average annual output growth between pre reform period of 1978-93 and post reform period of 1993-04. Of this two percentage point increase, 1.2 points were attributable to improved TFP, which more than doubled from an average annual growth of 1.1% during 1978-93 and 2.3% during the period 1993-04 (Bosworth and Collins 2007). The rest of the rise was largely due to increased investment. Improved TFP contributed to roughly half of the increase in labor productivity, which almost doubled between the two periods; the rest of the increase was mainly due to higher investment. Improved TFP was also largely responsible for the substantial increase in the rate of growth of capital productivity.

Table 4.5. Total factor productivity in India, 1978-04 (Percent change per year) Overall

Agriculture

Industry

Services

1978-93

1993-04

1978-93

1993-04

1978-93

1993-04

1978-93

1993-04

Output

4.5

6.5

2.7

2.2

5.4

6.7

5.9

9.1

Employment

2.1

1.9

1.4

0.7

3.3

3.6

3.8

3.7

Capital

1.0

1.8

0.2

0.7

1.4

1.7

0.3

1.1

Land

-0.1

0.0

-0.1

-0.1

n.a.

n.a.

n.a.

n.a.

Education

0.3

0.4

0.2

0.3

0.4

0.3

0.4

0.4

TFP

1.1

2.3

1.0

0.5

0.3

1.1

1.4

3.9

Labour productivity

2.4

4.6

1.3

1.5

2.1

3.1

2.1

5.4

Capital productivity

1.8

2.4

1.7

0.5

1.4

2.2

3.5

5.5

n.a. Not applicable. Source: Bosworth B. and Collins S. 2007 as presented in WTO, 2007

Growth in both output and TFP has been much faster in the services´ sector than in industry (where performance has seemingly been hampered by, inter-alia, rigid labor laws and inadequate infrastructure). By contrast, growth in output and TFP in agriculture has slowed (possibly due to weather and other natural factors). It follows that the shifting of resources, especially labor from agriculture (where more than half of the labor force is employed) to the more productive industry and tertiary sectors would contribute to faster overall growth in output and TFP in the economy as a whole49.

49

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4.3. The Human Development Index

Since 1990, performance has been measured beyond income growth to a broader definition of well-being through the Human Development Index (HDI)50. As per the UNDP’s Global Human Development Report (HDR) 2007, the HDI for India improved from 0.577 in 2000 to 0.611 in 2004 and further to 0.619 in 2005. Although it has gone down to 0.609 in 2006, the relative ranking of India has not changed much. India is ranked at 132 among the countries with medium human development out of 179 countries of the world.

4.4. Infrastructure Development

Infrastructure is the crucial sector that plays the key role in the development process of India. For the purpose, special attention is paid to this sector by combining the efforts of public and private sectors. Hence, physical infrastructure, especially electric power, telecom, railways and roads and ports have been funded with adequate investment. Total investment in infrastructure has been estimated to be around 5% of GDP. It is viewed that the gross capital formation (GCF) in infrastructure should rise as a share of GDP from 5% in 2006–07 to 9% by the end of 2011-12 (Table 4.6).

Table 4.6. Gross Capital Formation in Infrastructure Based on Growth Targets (Top-down Estimates at 2006–07 price) Year

2006-07

2007-08

2008-09

2009-10

41458.1

45189.3

49256.4

53689.4

58521.5

63788.4

Rate of growth of GDP (%)

9.0

9.0

9.0

9.0

9.0

9.0

GCF in infrastructure as % of GDP

5.0

5.8

6.5

7.3

8.0

9.0

2072.9

2598.4

3201.7

3892.5

4681.7

5741.0

51.8

65.0

80.0

97.3

117.0

143.5

GDP Market Price (Rs. billion)

GCF in infrastructure (Rs. billion) GCF in infrastructure (US$ billion) Total GCF in Eleventh Plan

2010-11 2011-12

Rs 20115 billon or US$ 502.88 billion

Source: Eleventh Five Year Plan Report

A comparative picture of the sector-specific allocations in the two Plan periods is given in table 4.7. Compared with investment levels achieved in the Tenth Plan period, the expected infrastructure investment in the Eleventh Plan is 2.36 times the amount of US$ 217.86 billion at constant 2006–07 price. The telecom, transportation (comprising ports and airports), and storage improves their share in the total investment in the Eleventh Plan as compared to their share in the Tenth Plan. Irrigation, electricity and the transportation sectors comprising roads and railways are expected to invest more than double the actual absolute investment in the Eleventh Plan, but would register some decline as a proportion in the overall pie. The need for investment in the electricity 50 HDI provides a composite measure of three dimensions of human development: living a long and healthy life (measured by life expectancy), being educated (measured by adult literacy and enrolment at the primary, secondary and tertiary level) and having a decent standard of living (measured by purchasing power parity, PPP, income). The index is not in any sense a comprehensive measure of human development. It does not, for example, include important indicators such as gender or income inequality and more difficult to measure indicators like respect for human rights and political freedoms. It only provides a broader prism for viewing human progress and complex relationship between income and wellbeing.

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sector is greater than what has been projected. However, a realistic assessment suggests that even the projections made so far would pose serious policy and implementation challenges. If these challenges can be overcome in time, actual investments could exceed these projections51.

4.5. Foreign Investment Flows

Until recently, international investors were not seeing India as an attractive investment destination due to a number of factors including sub optimal infrastructure, industry unfriendly tax policies, political instability, etc. In any case, India on its own had acquired restrictive attitude towards foreign investment. In the nineties as mentioned earlier, India began to open up its economy. As mentioned earlier, many measures were taken to reform the tax system at the level of Center and states. Foreign investment flows started to pick up in the 1990s and have gathered further momentum in the past few years. Foreign investment comprising foreign direct investment (FDI) and portfolio investment on a net basis was US$ 14.8 billion in 2006-07 and US$ 45.0 billion in 2007-08 (204.7 percent growth), before slowing down to US$ 4.0 billion during 2008-09 (April-December). As a proportion of total capital flows, net foreign investment stood at 41.6 percent in 2007-08 (32.6 percent in 2006-07). However, its share declined to 26.4 percent during 2008-09 (April-December) on account of FII outflows pursuant to the global financial crisis52.

Table 4.8. Source wise Distribution of India’s Inward FDI Stock 1991-2009 (Rs. Million) (1991-1999 Aug-Dec) (Jan.2000 to March 2009) Country Value Per cent Value Per cent Mauritius U.S.A. Netherlands

124659 83542 21743

21.611 14.483 3.770

1619734 285606 159290

40.906 7.213 4.023

Japan U.K. Germany France Singapore Korea(South) Switzerland Others* Brazil China Russia BRC** Grand Total

29694 22279 23511 9638 12393 20921 7951 131253 23 19 1749 1791 576821

5.148 3.862 4.076 1.671 2.149 3.627 1.378 22.755 0.004 0.003 0.303 0.310 100.000

115690 229621 95335 55203 338565 20405 38838 740237 69 507 19345 19920 3959647

2.922 5.799 2.408 1.394 8.550 0.515 0.981 18.695 0.002 0.013 0.489 0.503 100.000

* Includes other countries, advance of inflow, stock swapped, and nri-rbi schemes. ** BRC refers to Brazil, China, and Russia. Source: Ministry of Commerce & Industry, Department of Industrial Policy & Promotion http://siadipp.nic.in/publicat/pub_mn.htm

178

51

Eleventh Five Year Plan Report Inclusive growth 11th_vol l, p 256

52

Government of India 2009.

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Out of both foreign investments, FDI is perceived to be the most coveted type of capital flow for an emerging economy as it brings modern technology and enhances production capabilities. During 2005-06 to 2008-09, FDI flows assumed greater significance. High inflows indicate India as an attractive investment destination as a result of its liberalized investment climate, stable and sound economic and political base, opportunities for economic growth, while capital investment abroad reflects the growing global competitiveness of the Indian corporate sector. The two-way flow of FDI, therefore, means that while the world is taking note of India’s market potential, Indian companies are also constantly looking for synergistic acquisitions abroad. With the reforms in the policies, better infrastructure and vibrant financial sector, FDI inflows into India have accelerated since 2006-07. On a gross basis, FDI inflows into India increased from US$ 8.9 billion in 2005-06 to US$ 22.8 billion in 2006-07 and further to US$ 34.4 billion in 2007-08. In the fiscal year 2008-09 (April-December), gross FDI into India was US$ 27.5 billion. FDI inflows are spread across a range of economic activities like financial services, including banking, manufacturing, information technology services and construction. FDI has grown significantly on a net basis. The year-to-year growth in FDI (net) was 153.6 percent in 2006-07 and 100.2 percent during 2007-08. Even as FDI flows into India grew substantially, a simultaneous pickup in outward investment moderated the overall net inflows. Outward investment by India increased from less than US$ 2.4 billion during 2003-04 and 2004-05 to US$ 15.8 billion in 2006-07 and US$ 21.3 billion in 2007-08. During fiscal 2008-09 (April-December), FDI into India (net) remained buoyant at US$ 27.4 billion (US$ 20.0 billion in April-December 2007) reflecting relatively better investment climate in India and the continuing liberalization measures to attract FDI. Outward FDI (net) continued to remain high at US$ 12.0 billion during April-December 2008 even in the current economic situation, though it was marginally lower than its previous year’s level of US$ 13.1 billion. Due to large inward flows, the net FDI (inward minus outward FDI) was higher at US$ 15.4 billion in April- December 2008, as compared with US$ 6.9 billion in April-December 2007. As per the UNCTAD 2008, India achieved a growth of 85.1 percent in FDI inflows, which was the highest globally53. The total flows increased from US$ 25.1 billion in 2007 to US$ 46.5 billion in 2008. This is despite 14.5 percent decline in global FDI inflows from US$ 1,940.9 billion in 2007 to US$ 1,658.5 billion in 2008. India also ranked 9th in global FDI inflows in 200854 followed by Brazil. On the other hand, China is ranked 5th followed by Russia (Table 4.9). It is considered that robust economic growth, an improved investment environment and opening up of critical sectors like telecommunications, civil aviation, refineries, construction, etc., facilitated FDI inflows into India.

53

In terms of UNCTAD Survey 2008-10, China is the most preferred investment destination, followed by India, the United States, the Russian federation and Brazil. Similarly, AT Kearney’s 2007 FDI Confidence Index shows China, India and USA as the most preferred locations in that order. For long-term prospects, JBIC survey of Japanese manufacturing Transnational Corporations (TNCs) showed India replacing China as the most promising country for business operations of Japanese TNCs.( Government of India 2009)

54

Government of India 2009.

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Table 4.9. Foreign Direct Investment in Top 11 Countries (US$ billion) Rank in 2008

Countries

2007

2008*

Growth rate (%)

1

USA

232.8

320.9

37.8

2

France

158.0

126.1

-20.2

3

UK

196.4

96.8

-50.7

4

Belgium

70.0

94.2

34.6

5

China

83.5

92.4

10.6

6

Russia

52.5

70.3

34.0

7

Spain

68.8

65.5

-4.8

8

Hong Kong China

59.9

63.0

5.2

9

India

25.1

46.5

85.1

10

Brazil

34.6

45.1

30.3

11

Sweden

22.1

40.4

83.1

1940.9

1658.5

-14.5

World * Preliminary Estimates Source: Government of India 2009

Portfolio investment55: Net portfolio inflows into India were US$ 7.0 billion in 2006-07 and US$ 29.4 billion in 2007-08. Portfolio investment by FIIs, however, witnessed large net outflows of US$ 12.4 billion during April-December 2008 (as against net inflows of US$ 24.5 billion in the corresponding period of 2007) due to large scale sale of equities by FIIs in the Indian stock market. FII outflows for the year 2008-09 amounted to US$ 15 billion vis-à-vis net inflow of US$ 20.3 billion during the year 2007-0856.

4.6. Double Taxation Avoidance

The Double Taxation Avoidance Agreements (DTAA) came into being when a resident of one jurisdiction has income source in another jurisdiction. In such cases, the normal rule says that the jurisdiction in which the concerned person is a resident has the right to tax his income. However, the source jurisdiction also has the authority to tax the income. Such taxation by the latter may be subject to a maximum permissible rate. A Double Taxation Avoidance Agreement may effectively provide for avoidance of tax or for relief against double taxation by providing grant of credit by the jurisdiction of residence of the tax paid in the source jurisdiction. Tax Avoidance Agreements may be confined to a particular type of income. The first concrete step for relieving against double taxation, in so far as India is concerned, was taken in 1939 with the enforcement of the Income tax – Double Taxation Relief – Indian States Rules. Since then, India has comprehensive DTAA with 79 countries. Under Income Tax Act 1961 of India, there are two provisions – section 90 and section 91 – which provide specific relief to tax payers to save them from

180

55

Portfolio investment includes foreign institutional investors (Flls) investment, issue of global depository receipts (GDRs)/American depository receipts (ADRs) and offshore funds.

56

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DTAA. Section 90 is for tax payers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax to a country with which India has not signed DTAA. Thus, India gives relief to both kinds of tax payers57. Annex 5 contains DTAA treaties that India had signed before. A large number of Foreign Institutional Investors who trade on the Indian stock markets operate from Mauritius. According to the tax treaty between India and Mauritius, Capital Gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the Company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether.

5. Conclusions

Wilson and Puroshothaman 2003, from Goldman Sachs, invented the acronym BRIC to describe Brazillian, Russian, Indian and Chinese economies. It is now widely used and “BRIC funds are an important part of the emerging-markets universe”58. The Goldman Sachs predicted that the four economies would comprise more than 10 percent of the global output by the end of the decade; the four economies reached 15 percent in 2008. Leaders of the four BRIC nations participated in the first BRIC Summit in Yekaterinburg, Russia on June 16, 2009. All of them agreed for strengthening cooperation and coordination among themselves to promote dialogue in an open and transparent way. Many feel that this group can play a vital role in international politics as the world’s largest growing economies are getting together on the same platform and discussing a common concern. During the current economic meltdown, it is also felt that the emerging countries such as BRIC are expected to perform better than the global average. India as an emerging country is no exception to this trend. For the last few years, India’s economic performance has been impressive averaging over 7% between 2001-02 and 2006-07. It posted a robust average growth rate of more than 9% during 2005-07. Rapid economic growth has translated into an improvement in social indicators, including a decline in infant mortality, a reduction in the percentage of the population living below the poverty line and improvements in literacy, sanitation and access to clean water. This impressive performance is largely due to unilateral trade and structural reforms, which have been continued during the period. Growth has been led by the services´ sector, where liberalization has been most rapid. Manufacturing has also performed well, although further growth may be impeded by infrastructure and other constraints. In contrast, agricultural growth continues to be slow and erratic and dependent on the weather, causing considerable distress, especially among small and marginal farmers59.

57

en.wikipedia.org/wiki/Double_taxation

58

Economist, April 21, 2008.

59

WTO, 2007

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The Government is aiming to sustain growth in the longer run. Recognizing the importance of continuing its economic reform and especially its trade aspects, India has pushed ahead with further reductions in the tariff: There has also been simplification of the tariff, although it remains complex. The Government is targeting higher export growth in order to sustain India’s high levels of economic growth and has put in place a set of schemes to reduce the anti-export bias of the trade regime for exporters. Despite a gradual increase in total tax revenue India’s tax to GDP ratio is relatively low and seemingly insufficient to meet its developmental needs. Further public spending on infrastructure and social services is constrained by the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, which requires India to reduce its fiscal and revenue deficits and to eliminate the revenue deficit by 31stMarch 2009. However, the government deviated from these targets in the election year. At present, there is no credible signal from the government for moving towards fiscal consolidation. The Central government uses the excuse of the global recession to justify the high public expenditure that is being called fiscal stimulus. India has a Parliamentary system. The Lower House is elected directly and sits for five years, while the Council of States includes representatives elected by the legislative assemblies of the states. Executive power is vested in the President, who appoints the Prime Minister and other members of the Cabinet. The Cabinet must be composed of Members of Parliament. India’s legal system is based on written law. The judiciary is headed by the Supreme Court, which has jurisdiction over all disputes between the Central Government and states or between the states. The Supreme Court is also the court of final appeal for cases heard by the High Court in each state, and by district and session courts at the local level. The legal system is burdened by insufficient resources and procedural delays, resulting in a large and apparently growing backlog of cases before the high courts and the lower courts. Measures are being taken to address the backlog of cases. India is a federal country. Powers of taxation have been divided between the Center and the states. The local governments, both rural and urban, are also part of the federal ensemble in India, although their actual powers are decided by the respective state government. As per the constitutional arrangements, the Central government has a buoyant source of revenue, i.e. corporate income tax, personal income tax, central excise/ CenVAT and customs, whereas State government relies on sales tax/state VAT. In the Indian Constitution, most responsibilities have been decentralized to the sub national government. The provision is largely consistent with provisions mentioned in the theoretical literature of public finance. However, the mismatch between the revenue power and expenditure responsibility gives rise to vertical imbalance that is corrected through the mechanism of intergovernmental fiscal transfers from Center to states. The money flows through various institutional arrangements. Finance Commission, a constitutional body, and Planning Commission, created through an order of the Executive, are the two most important institutions in this regard. Finance Commission constituted

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in every five years recommends the formula for vertical and horizontal distribution of the taxes that the Central government collects. These transfers are generally for revenue expenditure, e.g. salary to government employees, expenditure on operation and maintenance. The Planning Commission transfers the plan fund. In addition, it funds also flows through various central schemes. In short, intergovernmental fiscal transfer mechanism in India is quite complicated and creates dissatisfactions at all levels across the states. Before 1991, the tax system in India was archaic, irrational and complex. It interfered with the free play of market forces and competition, caused economic distortions and entailed a high cost of compliance and administration. In the earlier socialist pattern of development, the extraordinary high rate of income taxes was compelling tax payers to evade taxes. The manner in which the commodity taxes were levied and administered caused: • “Loss of output growth and welfare; • Inefficiency and high cost in industry and trade; • Impediments to the free flow of trade with the country and growth of the common market that the Indian Union offers; • Inter-jurisdictional conflicts; • Handicap for exports; and • High costs of compliance and enforcement”60 Measures have been taken to simplify the tax structure, especially for indirect taxes, resulting in a substantial increase in a revenue collection. Tax reforms have also been pursued to meet the fiscal deficit and an introduction of a value-added tax regime covering both the governments, i.e. the Center and the states and an increase in the number of services subject to a service tax. The introduction of the VAT by almost all states has paved the way for goods and service tax. Excise duty (CENVAT), which is a tax on manufacturing, but has the elements of a value-added tax, provides around 20% of total tax revenue. The CENVAT remains the largest source of indirect tax revenue. In the longer run, further streamlining of India’s various indirect taxes is planned so that the VAT, the CENVAT and the service tax will be replaced by a broad-based goods and service tax. As a corollary, complex custom duty structure would also be simplified. As mentioned in section II, the custom duty is an important source of Union government tax revenue and contributes about 17 percent in total tax revenue and its ratio to GDP is 2 percent. It is also the main trade instrument of India. The government has taken a number of measures to reform trade related matters. Applied MFN tariffs, especially for non-agricultural products, have continued to fall steadily. The overall trend in tariff rates continues to be downward. The “peak rate” is reduced to 10%. Despite gradual reform over the years, the tariff remains complex: tariff changes are announced throughout the year and with numerous exemptions, a number of, which are based on industrial use. India also offers tariff preferences under its regional trade agreements. However, apart from the agreement with Sri Lanka and preferences to LDC members of SAFTA, the preferences do not appear to be significant. 60

NIPFP, 1994

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India is a major user of anti-dumping measures, although the numbers of investigations and measures in force have been on decline. Steps are being taken to align national standards increasingly with international norms; currently, some 73% of national standards, for which corresponding international standards exist, are aligned with these international norms. In general, national standards are subject to review every five years to ensure that they keep up with international trends. India is not a member of the WTO Agreement on government procurement. Its procurement policies have undergone reform, especially at the Central government level, although preferences continue to be extended to certain items from the small-scale industry and from state-owned enterprises. While import barriers have been falling, India’s export regime continues to be complex. Export prohibitions and restrictions are large in numbers. However, in order to reduce the anti-export bias inherent in India’s import and indirect tax regime, a number of duty remission and exemption schemes are in place to facilitate exports. While a number of these schemes are open to all exporters who use imported inputs, several schemes are targeted at sectors such as electronics (hardware and software), agricultural products and services. Export processing zones, export-oriented units that are now called special economic zones (SEZs) also offer tax holidays to investors. According to Ministry of Finance estimates, revenue forgone from such schemes is in the range of five to eight hundred billion rupees in recent years. India also provides export assistance through export insurance and financing schemes by the Export-Import Bank of India. In addition, internal reforms have concentrated on increasing competition and efficiency in the economy. Industrial policy reforms have concentrated on simplifying and reducing restrictions. The number of items reserved for production only by the small-scale sector has declined from 799 in 2001 to 326 in May, 2006. The high growth in India stems from the structural adjustment program initiated in 1991 of which tax reform and trade liberalization are the integral components. In order to sustain the high growth, India needs to give pace to its existing reforms and initiate further reforms to eradicate, inter alia, poverty and infant mortality. As the world expected in the beginning of this decade, India’s future looks bright despite uncertainties that Indian democracy has learnt to manage over time. Mahatma Gandhi said, “Democracy is the art and science of mobilizing the entire physical, economic and spiritual resources of various sections of the people in the service of the common good at all61. This is precisely what we will have to do.

6. References

ACHARYA, Shankar 2005, “Thirty Years of Tax Reform in India”, Economic and Political Weekly, Volume 40, No. 20, May 14. ________. 2006, “Economic Growth: Some Reflections”, Economic and Political Weekly, November 4. ________. 2009, India’s Macroeconomic Performance and Policies since 2000, ICRIER Working Paper No. 225, October

61

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Quoted in Government of India, 2009, Budget, 2009-10, Speech of Minister of Finance, July 6.

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Administrative Reforms Commission 1968, Report of the Study Team on Centre-State Relationship, v. I, New Delhi, Government of India AHMAD, Ehtisham and Nicholas Stern 1991, Theory and Practice of Tax Reform in Developing Countries, Cambridge, Cambridge University Press AKYUZ, Yilmaz, 2005, The WTO Negotiations on Industrial Tariffs, What Is At Stake for Developing Countries, Third World Network, Penang. ALOK, V N 2006, “Rural Local Government: Organization and Finance”, in Anwar Shah (ed) Local Governance in Developing Countries, Washington, DC., The World Bank ________. 2009, “Share of Local Governments in the Union Divisible Pool: An Option before the 13th Finance Commission”, The Indian Journal of Public Administration, Vol. LV, Jan-Mar, No. 1. ANDERSON, Robert D. 2006, “Meeting the challenges of good governance, the complementary roles of trade liberalization and competition rules in addressing anti-competitive barriers and practices in national procurement markets”. Paper prepared for an International Conference on Public Procurement, Global Revolution III, Session on Combating Collusion in Public Procurement University of Nottingham, 1-20 June. AZAM, Rifat, E-commerce 2007, Taxation and Cyberspace Law: The Integrative Adaptation Model, Virginia Journal of Law and Technology, vol 12, No. 5, Summer. BAGCHI, Amaresh, 1998, Tax Assignment in Indian Federation: A Critique, in Isher Judge Ahluwalia and IMD Little (eds.) India’s Economic Reforms and Development. Essays for Manmohan Singh, OUP, Delhi. BAGCHI, A. and Pulin Nayak 1994, “A Survey of Public Finance and the Planning Process, The Indian Experience”, in Bagchi,-Amaresh and Stern,-Nicholas, (eds). Tax Policy and Planning in Developing Countries. Delhi, Oxford University Press. BHATTACHARJEA, Aditya 2006, “Amending India’s Competition Act,” Economic and Political Weekly, 14 October. BIRD, Richard, 1989, “The Administrative Dimension of Tax Reform in Developing Countries” in Gills, Malcolm (ed) The Theory and Practice of Tax Reform in Developing Countries, Duke University Press London , 1989, pp. 315-345. BOSWORTH B. and Collins S. 2007, “Accounting for Growth: Comparing China and India”, Economics of Developing Countries Papers CASANEGRA de Jantscher, Milka 1990, “Administering VAT” in Gillis,-Malcolm; Shoup,-Carl-S.; Sicat,-Gerardo-P.,(eds). Value Added Taxation in Developing Countries, A World Bank Symposium, Washington, D.C., The World Bank. CHADHA, R. 2000. ‘GATS and Developing countries, A Case Study of India’, Paper commissioned by the World Bank. ________. 2002. Globalization of Services, India’s Opportunities and Constraints. New Delhi, Oxford University Press. ________. 2005. ‘India’s Stake in the WTO Services Negotiations’, in Bibek Debroy and Mahammed Saqib (eds), WTO at Ten, Looking Back to Look Beyond, Vol II, Issues at Stake, pp. 21-74. Konark Publishers, New Delhi. CHAKRAVARTHY, S. 2005, “India”, in Douglas H. Brooks and Simon J. Evenett, (eds), Competition Policy and Development in Asia, New York, Asian Development Bank and Palgrave MacMillan. CHANG, Ha Joon 2005 ‘Developing Countries Need to Wake Up to the Realities of the NAMA Negotiations’, TWN Briefing Paper 26. CHATURVEDI, Sachin and S K Mohanty 2008, The WTO and Trade in Electronically Delivered Software: Emerging Challenges and Policy Options – An Indian Perspective, Journal of World Trade 42 (5) October, Wolters Kluwer. CHELLIAH, Raja J.1986 “Change in the Tax Structure: A Case Study of India”, Paper Presented at the 42nd Congress of International Institute of Public Finance, Athens, Greece. CMIE, I-Cube service, Centre for Monitoring the India Economy Pvt Ltd. DAS-GUPTA, Arindam and Dilip Mookherjee 1997, Design and Enforcement of Personal Income Tax in India’, in Sudipto Mundle (ed.) Public Finance, Policy Issues for India, Themes in Economics, Oxford in India Readings, Oxford University Press DAS-GUPTA, Arindam 2002 “Central Tax and Administration Reform in the 1990s, An assessment” in M. Govinda Rao (ed.) Development, Poverty and Fiscal Policy, Decentralisation of Institutions, Oxford India Paperbacks, Oxford University Press, New Delhi.

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions ________. 2004, “The Income Tax Compliance Cost of Corporations in India , 2000-2001” NIPFP Working Paper No. 8, March ________. 2004a, “The Compliance Cost of the Personal Income Tax in India, 2000-2001, Preliminary Estimates” NIPFP Working Paper No. 9, March 2004. Government of India 1953, Report of the Taxation Enquiry Commission, Ministry of Finance, New Delhi, India. ________. 1956. Indian Tax Reform, Ministry of Finance, New Delhi. ________. 1971. Direct Taxes Enquiry Committee, Final Report, Ministry of Finance, New Delhi, India. ________. 1978. Report of the Indirect Taxation Enquiry Committee, Ministry of Finance, New Delhi. ________. 1991. Tax Reforms Committee, Interim Report, Ministry of Finance, New Delhi, ________. 1993. Report of the Tax Reforms Committee, Vol. II and III, Ministry of Finance, New Delhi ________. 1998. Report of the Finance Ministers Committee to Chart a Time Path for the Introduction of VAT, August ________. 1999. Report of the Committee of Finance Secretaries for Identification of Backward Areas, November ________. 2001. Report of the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan, Planning Commission, May. ________. 2001a. Report of the Expert Group on Taxation of Services, Ministry of Finance, New Delhi, ________. 2001b. Report of the High Powered Committee on Electronic Commerce and Taxation, Central Board of Direct Taxes, New Delhi ________. 2002. Report of the Taskforce on Indirect Taxes, Ministry of Finance, New Delhi, India, December. ________. 2002a. Report of the Taskforce on Indirect Tax, 24 December, New Delhi. ________. 2003. Report of the Task Force on Implementation of the Fiscal Responsibility and Budget Management Act, Ministry of Finance, New Delhi, ________. 2004. Report of the Twelfth Finance Commission, New Delhi ________. 2005. Ministry of Law and Justice, The Constitution of India, ________. 2006. Export Promotion of Consultancy and Management Services from India, Consultancy Development Centre, March, Ministry of Commerce and Industry. ________. 2006. Foreign Trade Policy 2004-2009, Handbook of Procedures, v. 1, Chapter II, April, Ministry of Commerce and Industry New Delhi. ________. 2006. Foreign Trade Policy, 1 September 2004-31 March 2009, Ministry of Commerce and Industry, Viewed at, http http, //dgft.delhi.nic.in. ________. 2006. Department of Justice, http://mha.nic.in/justi.htm ________. 2009., Economic Survey 2008-09, Ministry of Finance, New Delhi. ________. 2009a. Union Budget 2009-10, Ministry of Finance New Delhi. HAUSMANN, Ricardo, Dani Rodrik and Andes, Velasco 2005, ‘Growth Diagnostics’, John F Kennedy School of Government, Harvard University, Cambridge, Massachusetts, March HAUSMANN, Ricardo, Lant Pritechett and Dani Rodrik 2005, ‘Growth Accelerations’, Journal of Economic Growth, 10(4), December, pp 303-29. KHOR, Martin and Goh Chien Yen 2006, The WTO Negotiations on Non-Agricultural Market Access, A Development Perspective, Third World Network, Penang. KUMAR, S. 2005. Trade in Service: Advantage India, New Delhi, Bookwell. MCLURE Jr., Charles 1983, Tax Assignment in Federal Countries, Canberra, Australian National University. MOHANTY, S K 2008, Rise of BICS and the World Economy Implications of India’s Recent Expansion on Developing Countries, New Delhi, RIS, (RIS Discussion Paper 138). MOHANTY, S.K. and Sachin Chaturvedi (2009) Emerging Trade and Investment, Linkages between India and Africa, Challenges and Prospects (processed). MUKHERJEE, A. and N. Patel, 2005. FDI in Retail Sector, India, New Delhi, Academic Foundation. MUKHOPADHYAY, S. 2006, “Which way for indirect taxes”, Economic and Political Weekly, April. MUSGRAVE, Richard 1983 “Who should Tax Where and What’ in Mclure (ed.) NIPFP 1994, Reform of Domestic Trade taxes in India, Issues and Options, National Institute of Public Finance and Policy, New Delhi NIPFP 1996, Report of the Committee of State Finance Ministers on Stamp Duty Reform, NIPFP.

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PODDAR, Tushar 2004, ‘Domestic Competition Spurs Exports, The Indian Example’, Working Paper No. 04/173, IMF, Washington, DC. PODDAR, Tushar and Eva Yi 2007, ‘India’s Rising Growth Potential’, Goldman Sachs Global Economic Paper No. 152, January. POIRSON, H. 2006. “The Tax System in India, Could Reform Spur Growth?”, IMF Working Paper WP/06/93, April, Washington, D.C. PUROHIT, Mahesh C. 2001, Sales Tax and Value Added Tax in India, Delhi, Gayatri Publications. ________. 2009. A Road Map for GST, Foundation for Public Economics and Policy Research (Working Paper). PUROHIT, Mahesh C. and Vishu Kanta Purohit 2006, E-commerce and Economic Development, EPEPR, Delhi, Gayatri Publication PURUSHOTHAMAN, Roopa 2004, ‘India, Realizing BRICs Potential’, Goldman Sachs Global Economic Paper No. 109. RAO, M.G. 2005, “Tax System Reform in India, Achievements and Challenges Ahead”. International Symposium on Tax Policy and Reform in Asian Countries, 1-2 July, Tokyo. RBI 2008, Annual Policy Statement for the Year 2008-09, Mumbai. RODRIC, Dani and Arvind Subermanian, 2004. ‘Why India can Grow at 7 percent a Year or More, Projections and Reflections’, Working Paper No. 04/118, IMF, Washington, DC. RODRIK, Dani. ‘Goodbye Washington Consensus, Hello Washington Confusion?’, Journal of Economic Literature. SHAH, Anwar 1994, The Reform of Intergovernmental Fiscal Relations in Developing and Emerging Market Economies, Washington, DC, World Bank Research Series. SHIVA Rao, B 1968, The Framing of India’s Constitution, New Delhi, Indian Institute of Public Administration SIVASUBRAMONIAN, S 2000, The National Income of India in the Twentieth Century, Oxford University Press, New Delhi. SRINIVASAN, T.N. and Vani Archana 2009, India in Global and Regional Trade: Determinants of Aggregates and Bilateral Trade Flows and Firms’ Decision to Export, ICRIER Working Paper No. 232, February. SOLOW, Robert M 1956, ‘A Contribution to the Theory of Economic Growth’, Quarterly Journal of Economics 70, pp 65-94. SURY, M.M. 2008, Centre State Financial Relations in India, 1870 to 2010, New Delhi, Indian Tax Foundation. TANEJA, Nisha, 2004. Trade Facilitation in the WTO, Implications for India, ICRTER, UNCTAD, 2001 ‘Best Practices for Enhancing the Competitiveness of Developing Countries’. Report of the Expert Meeting on Electronic Commerce and International Transport Services. Transparency International 2005, Corruption Perceptions Index. Viewed at, http, //www. transparency. org/policy_research/surveys_indices/cpi/2005 ________. 2005a. India Corruption Study, 2005. Viewed at, http, //www. tiindia.in/data/files/India%20 Corruption%20Study-2005.pdf. and viewed at: http://www.opacityindex.com/opacity_index.pdf ________. 2009. Global Corruption Report, viewed at, http, //www. transparency.org/publication [ 23 July 2009]. UNCTAD 2008. “Assessing the Impact of the Current Financial and Economic Crisis on Global FDI Flows” Virmani, Arvind, B.N. Goldar, C. Veeramani and Vipul Bhat 2004, “Impact of tariff reforms on Indian industry, Assessment based on a mutli-sector econometric model”, ICRIER Working Paper No. 135. VIRMANI, Arvind. 2002. Towards a Competitive Economy: VAT and Customs Duty Reform (working paper no. 4/2002-PC), Planning Commission. WILSON, Dominic, ROOPA Purushothaman. 2003, ‘Dreaming with BRICs, The Path to 2050’, Goldman Sachs Global Economic Paper No. 99. WILLIAMSON, John. 1990. ‘What Washing Tax Means by Policy Reform’ in Williamson (ed.) Latin American Adjustment: How Much Has Happended? Institute for International Economics, Washington, DC. WTO 2002, Trade Policy Review, India, Geneva. ________. 2005. “International Trade in Air Transport, Recent Developments and Policy Issues”, World Trade Report, Geneva. ________. 2007. Trade Policy Review, India, Geneva

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7. ANNEXES Annex 1 ± Legal Structure of Major Taxes in India

62

Tax on Corporate Income Companies residents in India are taxed on their worldwide income arising from all sources in accordance with the provisions of the Income Tax Act. Non-resident corporations are essentially taxed on the income earned from a business connection in India or from other Indian sources. A corporation is deemed to be resident in India if it is incorporated in India or if it’s control and management are situated entirely in India. A company has been defined as a juristic person having an independent and a separate legal entity from its shareholders. Income of the company is computed and assessed separately in the hands of the company. However, the income of the company, which is distributed to its shareholders as dividend, is assessed in their individual hands. Such distribution of income is not treated as expenditure in the hands of the company. The income so distributed is an appropriation of the profits of the company. Domestic corporations are subject to tax at a rate of 33.9% (including education surcharge and education cess). Foreign corporations have a tax rate of 42.33% (including education surcharge and education cess). Corporations are subject to wealth tax at the rate of 1%, if the net wealth exceeds Rs. 1.5 million (US$ 31,000 approx.). Domestic corporations have to pay dividend distribution tax at the rate of 12.5%. It is proposed to be increased to 15% in the Union Budget presented on July 6, 2009. However, such dividends received are exempt in the hands of the recipients. Corporations have to pay for Minimum Alternative Tax at 10% (plus surcharge and education cess) of book profit as tax if the tax payable as per regular tax provisions is less than 10% of its book profits. It is proposed to be increased to 15% in the Union Budget presented on July 6th, 2009.

Capital Gains Tax

63

A capital gain is income derived from the sale of an investment. A capital investment can be a home, a farm, a ranch, a family business, or a work of art, for instance. In most years, slightly less than half of taxable capital gains is realized on the sale of corporate stock. The capital gain is the difference between the money received from selling the asset and the price paid for it. Tax is payable on capital gains on sale of assets. Long-term Capital Gains

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62

Drawn from http://finance.indiamart.com/taxation/corporate_tax/index.html

63

“Capital gains” tax is a misnomer. It is more appropriate to call it the “capital formation” tax. It is a tax penalty imposed on productivity, investment, and capital accumulation. The capital gains tax is different from almost all other forms of taxation in that it is a voluntary tax. Since the tax is paid only when an asset is sold, taxpayers can legally avoid payment by holding on to their assets--a phenomenon known as the “lock-in effect.” There is unfairness imbedded in the current tax treatment of capital gains. One is that capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power, but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income. In fact, most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary economy. Another unfairness of the tax is that individuals are permitted to deduct only a portion of the capital losses that they incur, whereas they must pay taxes on all of the gains. That introduces an unfriendly bias in the tax code against risk taking. When taxpayers undertake risky investments, the government taxes fully on gain that they realize from positive return of the investment. But the government allows only partial tax deduction if the venture goes sour and results in a loss.

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Tax is charged if capital assets are held for more than three years and. In the case of shares, securities listed on a recognized stock exchange in India, units of specified mutual funds, the period for holding is one year. Long-term capital gains are taxed at a basic rate of 20%. However, long-term capital gain from a sale of equity shares or units of mutual funds is exempt from tax. Short-term capital gains are taxed at the normal corporate income tax rates. Short-term capital gains arising on the transfer of equity shares or units of mutual funds are taxed at a rate of 10%. Long-term and short-term capital losses are allowed to be carried forward for eight consecutive years. Long-term capital losses may be offsetting against taxable long-term capital gains and short-term capital losses may be offset against both long term and short-term taxable capital gains.

Personal Income Tax Personal income tax is levied by Union Government and is administered by Central Board of Direct Taxes under Ministry of Finance in accordance with the provisions of the Income Tax Act. The rates for personal income tax after the revision in the Union budget 2009-10 are as follows: Taxable Income Slab (Rs)

Rate (%)

Upto 1,60,000

Nil

Upto 1,90,000 (for woman)

Nil

Upto 2,40,000 (for senior citizen)

Nil

1,60,000 – 3,00,000

10

3,00,000 – 5,00,000

20

5,00,000 upwards

30

Withholding Tax The Union government, under Section 90 of the Income Tax Act, has been authorized to enter Double Tax Avoidance Agreements (tax treaties) with other countries. The object of such agreements are to evolve an equitable basis for the allocation of the right to tax different types of income between the ‘source’ and ‘resident’ states, ensuring in that process tax neutrality in transactions between residents and non-residents. Domestic corporations are granted credit on foreign tax paid by them, while calculating tax liability in India. A non-resident, under the scheme of income taxation, becomes liable to tax in India in respect to income arising here by virtue of its being the country of source and then again, in his own country in respect to the same income by virtue of the inclusion of such income in the ‘total world income’ which is the tax base in the country of residence. Tax incidence, therefore, becomes an important factor influencing the non-residents in deciding about the location of their investment, services, technology, etc. Tax treaties serve the purpose of providing protection to tax payers against double taxation and thus preventing the discouragement which taxation may provide in the free flow of international trade, international investment and international transfer of

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technology. These treaties also aim at preventing discrimination between the tax payers in the international field and providing a reasonable element of legal and fiscal certainty within a legal framework. In addition, such treaties contain provisions for mutual exchange of information and for reducing litigation by providing for mutual assistance procedure. India has signed Double Taxation Avoidance Agreement with BRC at a different point of time – Brazil in 1994-95, Russia in 2000-01 and China in 1996-97 (Annex 5). Current rates for withholding tax for payment to non-residents are: • • • • • • •

Interest 20%; Dividends paid by domestic company Nil; Royalties 10%; Technical Services 10%; Any other services; Individuals: 30% of the income; and Companies: 40% of the net income.

The above rates are general and are applicable in respect of countries with which India does not have a Double Taxation Avoidance Agreement.

Tax Incentives Government of India provides tax incentives for: • Corporate profit; • Accelerated depreciation allowance; • Deductibility of certain expenses subject to certain conditions. These tax incentives are subject to specified conditions, available for new investment in: • Infrastructure; • Power distribution; • Certain telecom services; • Undertakings developing or operating industrial parks or special economic zones; • Production or refining of mineral oil; • Companies carrying on R&D; • Developing housing projects, • Undertakings in certain hill states; • Handling of food grains; • Food processing; • Rural hospitals, etc; and • Excise Duty/CENVAT. Central excise revenue is the single largest contributor to gross revenue for the Government of India. Section 3 of the Central Excises and Salt Act, 1944, provides that there shall be levied and collected in such a manner as may be prescribed duties of excise on all excisable goods other than salt, which are produced or manufactured in India at the rates set forth in the schedule to the Central Excise Tariff Act, 1985. It is, therefore, clear that as soon as the goods in question are produced or manufactured, they will be liable to payment of excise duty. However, for convenience, duty is collected at the time of removal

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of the goods. While Section 3 of the Central Excises and salt Act, 1944 lays down the taxable event, Rules 9 and 49 of the Central excise Rules, 1944 provides for the collection of duty. Manufacture of goods in India attracts Excise Duty under the Central Excise Act 1944 and the Central Excise Tariff Act 1985. The term manufacture means bringing into existence a new article having a distinct name, character, use and marketability including packing, labeling, etc. Most of the products attract excise duties at the rate of 16%. Some products also attract special excise duty/and an additional duty of excise at the rate of 8% above the 16% excise duty. Two percent education cess is also applicable on the aggregate of the duties of excise. Excise duty is levied on a ad valorem basis or based on the maximum retail price in some cases.

Service Tax Service tax is levied at the rate of 10% (plus 2% education cess) on certain identified taxable services provided in India by specified service providers. Service tax on taxable services rendered in India is exempt, if payment for such services is received in convertible foreign exchange in India, and the same is not repatriated outside India. The Cenvat Credit Rules allow a service provider to avail and utilize the credit of additional duty of customs/excise duty for payment of service tax. Credit is also provided on payment of service tax on input services for the discharge of output service tax liability.

Customs Duty Duties of customs are levied on goods imported or exported from India at the rate specified under the customs´ Tariff Act, 1975, and administered by Central Board of Excise and Customs in the Ministry of Finance, Government of India. The rate varies for different items. The Additional Duty (Countervailing Duty) is levied under section 3 (1) of the Custom Tariff Act and is equal to excise duty levied. Special Additional Duty is levied under section 3(3) of the Customs Act. One may notice a wide variation between a nominal basic tariff and the effective rate. Some commodities like alcohol and automobiles have a basic rate higher than the peak rate (Please see Annex 2). The other details and analysis of the custom duties are given in the text. Anti-dumping Duty: In order to capture Indian markets, when foreign sellers abroad export goods into India at the price below the price applicable in their domestic markets, the practice known as dumping is considered detriment of Indian industry. In order to prevent dumping, the Union government may levy additional duty equal to the margin of dumping on such articles if the goods have been sold at less than a normal value. Pending determination of margin of dumping, such duty may be provisionally imposed. After the exact rate of dumping duty is finally determined, the Union government may vary the provisional rate of dumping duty. Dumping duty can be imposed even when goods are imported indirectly or after changing the condition of goods. There are, however, certain restrictions on imposing dumping duties in case of countries which are signatories to the GATT or on countries given “Most Favored Nation Status” under the agreement. Dumping duty can be levied on imports

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on such countries only if the Union government proves that import of such goods in India at such low prices cause material injury to Indian industry. Protective Duty: If the Tariff Commission set up by law recommends that in order to protect the interests of Indian industry, the Union government may levy protective antidumping duties at the rate recommended on specified goods. The notification for levy of such duties must be introduced in the Parliament in the next session by way of a bill or in the same session if Parliament is in session. If the bill does not pass within six months of introduction in Parliament, the notification ceases to have a force but the action already undertaken under the notification remains valid. Such duty will be payable up to the date specified in the notification. Protective duty may be canceled or changed by notification. Such notification must also be placed before Parliament for approval as above. Duty on Bounty Fed Articles: In case foreign country subsidizes its exporters for exporting goods to India, the Union government may charge additional import duty equal to the amount of such subsidies or bounty. If the amount of subsidies or bounty cannot be clearly determined immediately, additional duty may be collected on a provisional basis and after final determination, the difference may be collected or refunded, as the case may be.

Sales Tax/ State VAT Sales tax is levied on the sale of movable goods. Most of the Indian States have replaced Sales tax with a new Value Added Tax (VAT) from April 01, 2005. VAT is imposed on goods only and not on services, and it has replaced the sales tax. There are four slabs of VAT: • • • •

0% for essential commodities; 1% on bullion and precious stones; 4% on industrial inputs and capital goods and items of mass consumption; All other items 12.5%; and

Petroleum products, tobacco, liquor, etc., attract higher VAT rates that vary from State to State. A Central Sales Tax at the rate of 4% is also levied on inter-State sales and is being phased out. In addition, State levies other taxes, like Stamp duty on transfer of assets, agriculture income tax on income from plantations and Luxury tax levied on specified goods.

Taxes Levied by Rural and Urban Local Governments The Annex Table 3 shows that a variety of taxes have been devolved to different levels of rural local governments (panchayats). The similar case is there for the urban local governments (municipalities). The relative importance of these taxes varies from state to state. The intermediate and district panchayats are endowed with powers to collect very few taxes, whereas village panchayats are given substantial taxing powers. In a number of cases, under the tax rental arrangement, the village panchayats collect taxes and pass them on to the higher level of panchayats. Property tax, cess on land revenue, surcharge on additional stamp duty, tolls, tax on professions, tax on advertisements, non-motor

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vehicle tax, octroi, user charges and the like contribute the maximum to the small kitty of own-source revenue, which contributes only 6 to 7 percent of the total expenditure of panchayats. In most states, the property tax contributes the maximum revenue to the local governments both panchayats and municipalities. However, this tax remains inelastic because of inefficient administration in its collection. Its assessment is based on the annual rental value of taxation and its associated evil: under a declaration of rentals. However, some progressive states have reformed the tax structure and use the unit area method in determining the tax base.

Annex 2 Items with above “Peak” Basic Customs Duty Rates Chap. N. 2. 4. 8. 8. 8. 8. 9. 9. 9. 10. 10. 10. 12. 15. 15. 15. 15. 16. o

17. 22. 22. 22. 33. 40. 87. 87. 98.

Description of Goods Agriculture & Allied Poultry meat (Chicken leg) Other Milk powder (0402,10, 0401.21) Coconuts (0801.11, 0801.19) Areca nuts, others (0802.90) Dried grapes (0806.20) Apples (0808.10) Coffee (09.01) Tea (09.02) Pepper, cloves, cardamom (09.04, 09.06, 0908.30) Rice in the husk (paddy) & husked (brown) rice (10.0630.40) Semi-milled or wholly milled rice and broken rice (10.0630/40) Wheat, maize/corn, spelt, sorghum, millet (10.01/05/07/0820) Copra (12.03) Soya bean oil, crude or refined (15.07) Rapeseed/colza/mustard oil (crude or refined: 15.14) Palm/groundnut/sunflower/safflower/coconut/other oils: crude Palm/groundnut/sunflower/safflower/coconut/other oils: refined Sausages/meat prods of meat offal/blood (16.01), other prepared meat/offal/blood of fowls of species´ Gallus domesticus (16.0232) Sugar (17.01) Beer, grape must, wine, vermouth, other fermented beverages (22.03-06) Un-denatured ethyl alcohol (2207.10) Whiskies, rum, gin, vodka, liqueurs & cordials, etc. (22.08) Alcoholic preparations used to manufacture beverages (3302.10) Natural raw rubber latex (4001.01) Automobiles Motor cars and two wheelers, used (87.03, 87.11) Complete (CBUs of) Motor cars and two wheelers, new (87.03, 87.11) Other Baggage articles, other than on transfer of residence, above Rs. 12,000 (98.03)

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Annex 3 India’s commitments under various trade agreements until 2009 Agreement

Trade in goods

SAFTA

Non-LDC members, including India, are to reduce tariffs to 20% within two years, followed by a reduction of 0-5% in five years (six years for Sri Lanka) and three years for imports from LDC members. India has a negative list of 744 imports from LDCs and 865 items from non-LDC members who are excluded from tariff reduction commitments.a The first tariff reductions came into effect on 1st July 2006.

n.a.

n.a.

Asia Pacific Trade Agreement (Bangkok Agreement)

Tariff preferences for 570 HS six-digit tariff lines and an additional 48 tariff bank line for LDC members with margin of preference ranging from 5% to 100%. Special concession on some items has also been extended to the LDCs.

n.a.

n.a.

BIMST-EC

Framework Agreement signed in February 2004 to form a free-trade area by 2012 with an additional five year given to the LDC members. Negotiations on trade in goods were to be completed by the end of 2005, but are yet to conclude. Negotiations on services and investment have commenced and must be concluded by 2007.

n.a.

n.a.

GSTP

Tariff concessions of 10%-50% on 53 tariff lines at the HS six-digit level. Tariff concessions of 50% apply to three tariff lines and are available only to Bangladesh, Benin, Guinea, Haiti, Mozambique, Sudan, and Tanzania.

n.a.

n.a.

Special preferential areas

Tariff preferences for certain imports from Mauritius, Seychelles, and Tonga.

n.a.

n.a.

Afghanistan

Tariff reductions on 38 HS six-digit tariff lines, with margins of preferences of 50% or 100% of the MFN tariff in force from 13 May 2003.

n.a.

n.a.

Nepal

Tariff exemptions for all goods subject to rules of origin. Imports of certain goods (vanaspati, copper products, acrylic yarn and zinc oxide) are subject to annual quotas.

n.a.

n.a.

Continues

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Trade in services

Other areas

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Continued Singapore (CECA)

Zero duties as of 1 August 2005 for 506 HS eight digit products covered by the early harvest program. Phased reduction and elimination of duty by 1 April 2009 for 2,202 HS eight-digit products and phased reduction of duty by 50% by 1 April 2009 for 2,407 HS eight-digit products. Some 6,500 HS eight-digit products are excluded from duty reductions.

Business services, communication, construction, distribution, financial (banking), health, tourism, recreational and transport (maritime) services.

Investment, standards, SPS, intellectual property rights, science and technology, education and dispute settlement.

Sri Lanka

Zero duties as of 1 March 2000 for over 1,000 tariff lines and a 50% margin of preference for all other items except 429 items on a negative list. Tariff concessions on textiles are 25% below the MFN rate. Tariff quotas apply to tea and garments and vanaspati. Total quantum of import restricted to 250,000 tonnes per annum.

n.a.

n.a.

Thailand

Early harvest scheme for 82 products at the HS six-digit level; tariffs to be reduced in phases from 1st September 2004 and to be eliminated by 1st September 2006.

n.a.

n.a.

Bhutan

Non-tariff restrictions on the goods entry into respective territories. Trade will be transacted in Indian Rupees and Bhutanese Ngultrums.

n.a.

n.a.

MERCOSUR PTA

From 1st, June 2009 there is a tariff concession on 452 Indian products in MERCOSUR while a concession on MERCOSUR’s 450 products in India.

n.a.

n.a.

PTA & Framework with Chile

Joint Study Group Fixed tariff preferences ranging from 10% to 50% on 178 tariff lines at the eight digit level has been provided to Chile while Chile has offered tariff preferences on 296 tariff lines at the 8 digit level with margin of preference ranging from 10% to 100%.

Framework Agreement with ASEAN

Progressive elimination of tariffs and nontariff barriers in substantially all trade in goods, Common products on which the new ASEAN states agree to exchange tariff concessions are 105 while products on which India´s accord concessions to the New ASEAN Member States are 111.

Progressive liberalization of trade in services with substantial sectoral coverage

It agrees to cooperate in customs, plant and animal health, technical standards and regulations, food safety, mutual recognition of sanitary and hytosanitary measures, including through equivalence agreements in accordance with relevant international criteria. Establishment of a liberal and competitive investment regime that facilitates and promotes investment within the India-ASEAN RTIA Regional Trade and Investment Area, Areas of Economic Corporation, Early Harvest Programme.

n.a. Not applicable. a) India has offered Bangladesh market access for 8 million pieces of garments, of which 3 million using fabrics of Indian origin, three million using fabrics either of Indian or Bangladesh origin and two million unconditionally. This is part of India’s sensitive list. Source: Ministry of Commerce and Industry online information. http://commerce.nic.in

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Annex 4 List of Regional Trade Agreements

196

SACU

GCC

BIMSTEC

Bangkok

EFTA

South Africa

Bahrain

Bangladesh

Bangladesh

Norway

Lesotho

Kuwait

Bhutan

Laos

Switzerland

Swaziland

Oman

Nepal

Republic of Korea

Iceland

Botswana

Qatar

Sri Lanka

Sri Lanka

Liechtenstein

Namibia

UAE

Thailand

Philippines

Myanmar

Thailand

India

India

ASEAN

SAFTA

MERCOSUR

CIS

NAFTA

EU

Indonesia Malaysia Philippines Singapore Thailand Brunei Vietnam Lao PDR Myanmar Cambodia

India Bangladesh Bhutan Nepal Sri Lanka Pakistan Maldives

Spain Portugal Brazil Argentina Uruguay Paraguay Bolivia Chile Columbia Ecuador Peru

Azerbaijan Armenia Belarus Georgia Kazakhstan Kyrgyz Moldova Russia Tajikistan Uzbekistan Ukraine

Canada USA Mexico

Austria Belgium Bulgaria Cyprus Czech Denmark Estonia Finland France Germany Greece Hungry Ireland Italy Latvia Lithonia Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom

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Annex 5 Double Taxation Agreement Treaties S.No.

Name of the Country

Effective from Assessment Year

1

Australia

1993-94

2

Austria

1963-64

3

Bangladesh

1993-94

4

Belgium

5

Brazil

6

Belarus

1999-2000

7

Bulgaria

1997-98

8

Canada

1987-88; 1999-2000

9

China

1996-97

10

Cyprus

1994-95

11

Czechoslovakia

12

Denmark

13

Finland

1985-86; 2000-2001

Amending protocol

14

France

1996-97

(Revised)

15

F.R.G

1958-59

(Original)

F.R.G.

1984-85

(Protocol)

D.G.R.

1985-86

F.R.G.

1998-99

16

Greece

1964-65

17

Hungary

1989-90

18

Indonesia

1989-90

19

Israel

1995-96

20

Italy

1997-98

(Revised)

21

Japan

1991-92

(Revised)

22

Jordan

2001-2002

23

Kazakistan

1999-2000

24

Kenya

1985-86

25

Libya

1983-84

26

Malta

1997-98

27

Malaysia

1973-74

28

Muritius

1983-84

29

Mongolia

1995-96

30

Namibia

2000-2001

31

Nepal

1989-90; 1999-2000

(Revised)

1994-95

1986-87; 2001-2002

(Revised)

(Revised)

1991-92

(Revised)

1990-91

Continua

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Continuação 32

Netherlands

1990-91

33

New Zealand

1988-89

(1999-2000 amending notification) (2001-2002 Supp. Protocal)

198

34

Norway

1988-89

35

Oman

36

Philippines

1996-97

37

Poland

1991-92

38

Qatar

2001-2002

39

Romania

1989-90

40

Singapore

1995-96

41

South Africa

1999-2000

42

South Korea

1985-86

43

Spain

1997-98

44

Sri Lanka

1981-82

45

Sweden

1990-91; 1999-2000

46

Switzerland

1996-97

47

Syria

1983-84

48

Tanzania

1983-84

49

Thailand

1988-89

50

Trinidad & Tobago

2001-2002

51

Turkmenistan

1999-2000

52

Turkey

1995-96

53

U.A.E.

1995-96

54

U.A.R.

1970-71

55

U.K.

1995-96

56

U.S.A.

1992-93

57

Russian Federation

58

Uzbekistan

1994-95

59

Vietnam

1997-98

60

Zambia

1979-80

1999-2000

2000-2001

(Revised)

(Revised)

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Tax system structures and the effects on development and foreign trade performance - lessons and solutions

Annex Table 1 Selected Macroeconomic Indicators, 2000-09 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 200801 02 03 04 05 06 07 08 09 National accounts

(Percentage change)

Real GDP (at 1999/00 factor cost)

4.4

5.8

3.8

8.5

7.5

9.0

9.2

9.0

6.7

Consumption

1.8

5.4

1.2

7.0

6.9

..

..

..

..

Private consumption

2.1

6.2

1.6

7.8

6.5

..

..

..

..

Government consumption

0.3

1.7

-0.6

2.4

9.2

..

..

..

..

Gross fixed capital formation

0.0

5.0

9.9

11.3

9.5

..

..

..

..

Exports of goods and non-factor services

15.9

0.2

20.5

25.0

37.9

29.7

..

..

..

Imports of goods and non-factor services

8.1

-3.3

16.4

18.6

51.7

32.6

..

..

..

Unemployment rate (%)

7.3

..

..

..

8.3

..

..

..

..

Prices and interest rates

(Per cent)

Inflation (%age change) WPI

7.2

3.6

3.4

5.4

6.4

4.4

5.4

4.7

8.4

CPI – industrial workers

3.7

4.3

4.0

3.9

3.8

4.4

6.7

6.2

..

Deposit rate

8.59.0

7.58.5

4.256.0

4.05.25

5.255.5

6-6.5

..

..

..

Nominal prime lending rate (period average)c

11.5

11.5

10.8

10.3

10.3

10.3

..

..

..

b

Money credit (end period) Broad money supply (M3)

(Percentage change) 16.8

14.1

14.7

16.7

12.3

21.2

21.5

21.2

18.6

15.8

11.8

18.3

13.0

26.0

32.1

25.8

21.0

16.9

Rupee/US$ (financial year - annual average)

45.7

47.7

48.4

46.0

44.9

44.3

45.3

40.2

45.9

Really effective exchange ratee (%age change)

5.3

-0.1

-4.9

1.5

2.5

5.4

-1.6

8.1

-8.3

Nominal effective exchange ratee (% age change)

0.3

-1.8

-6.3

-1.9

-0.7

3.9

-3.9

6.7

-13.0

d

Credit to a private sector Exchange rate

(Per cent of GDP, unless otherwise indicated) Central government balance Current balance

-4.1

-4.4

-4.4

-3.6

-2.5

-2.6

-2.0

..

..

Current revenue

9.2

8.8

9.4

9.5

9.8

9.7

10.3

..

..

Tax revenue

6.5

5.9

6.4

6.8

7.2

7.6

8.4

9.3

8.8

Current expenditure

13.2

13.2

13.8

13.1

12.3

12.3

12.4

Continues

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Continued Capital receipts

6.3

7.1

7.4

7.5

6.1

4.4

3.9

4.2

5.8

Capital expenditure

2.3

2.7

3.0

3.9

3.6

1.9

1.8

2.5

1.8

Gross fiscal balance

-5.7

-6.2

-5.9

-4.5

-4.0

-4.1

-3.7

..

..

..

59.9

63.4

62.8

63.8

61.5

62.6

..

..

52.8

56.8

61.0

61.1

61.8

59.6

60.6

..

..

Gross domestic savings

23.4

23.5

26.4

29.7

31.7

34.2

35.7

37.7

Public sector

-1.9

-2.0

-0.6

1.1

2.2

2.4

3.3

4.5

Gross domestic investment

24.0

22.9

25.2

28.0

31.5

33.8

..

..

..

Public sector

6.9

6.9

6.1

6.3

7.1

7.4

..

..

..

Current account balance

-0.6

0.7

1.2

2.3

-0.4

-1.2

-1.1

-1.5

-2.5

Net merchandise trade

-2.7

-2.4

-2.1

-2.3

-4.8

-6.4

-6.9

-7.7

..

Merchandise exports

9.9

9.4

10.6

11.0

12.1

13.0

14.0

13.5

..

Merchandise imports

12.6

11.8

12.7

13.3

16.9

19.4

21.0

21.2

..

Services balance

0.4

0.7

0.7

1.7

2.2

3.0

..

Capital account

1.9

1.8

2.1

2.8

4.0

3.1

5.0

9.2

..

Direct investment

0.9

1.3

1.0

0.7

0.9

1.1

2.4

2.8

..

Balance-of-payments

1.3

2.5

3.3

5.1

3.6

1.9

3.9

7.7

..

Terms of trade (1978/79=100)

128.1

125.4

113.6

123.4

110.0

135.0

142.0

163.0

..

Merchandise exports (%age change)

27.7

2.6

21.9

16.9

25.6

22.0

24.3

10.0

..

Merchandise imports (%age change)

10.2

1.4

16.2

17.8

45.3

30.3

24.4

15.5

..

Service exports (%age change)

9.4

9.6

22.9

22.7

57.3

40.5

..

..

..

Service imports (%age change)

32.1

-1.2

25.7

-7.2

62.6

33.4

..

..

..

Foreign exchange reserves (US$ billion, end-period)

39.6

51.0

72.6

108.8

137.0

145.9

192.4

299.6

..

in months of imports

8.2

10.9

13.4

16.1

13.7

11.1

..

Total external debt (US$ billion; as at end-March)

101.3

98.8

104.9

111.6

133.0

138.1

169.7

221.2

..

Debt service ratioh

16.2

13.6

16.0

15.9

6.1

10.2

4.8

..

..

f

Central government total debt Domestic debt Saving and investment

External sector

g

.. a b c

..

..

Not available. Provisional. Refers to the deposit rates of five major public sector banks of maturity of one to three years, as at end-March. Relates to States’ bank prime lending rate, which is the benchmark interest rate for the various categories and classes of advances granted by the bank. d Including currency with the public, other deposits with the RBI, demand deposits and time deposits. e Six-currency trade based weight (including the EURO, Japan, United States, United Kingdom, Hong Kong and China). f Revenue receipts plus capital receipts (not including borrowing and other liabilities) minus total expenditure. g Excluding gold, SDRs (Special Drawing Rights) and Reserve Tranche Position in IMF. h Including debt-servicing on non-civilian credits Source: WTO. 2007, Government of India 2009 and Government of India 2009a;

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Annex Table 2 Basic economic and social indicators, 2000-09 200001

200102

200203

200304

200405

200506

200607

200708

200809

Real GDP at factor cost (Rs billion, 1999/00 prices)

18,647.7

19,729.1

20,477.3

22,225.9

23,896.6

26,045.3

28,711.2

31,297.2

33,393.8

Real GDP at market prices (Rs billion, 1999/00 prices)

20,308.7

21,366.3

22,162.6

24,022.5

26,022.3

28,424.8

31,200.3

34,027.2

36,094.3

Current GDP at factor cost (Rs billion)

19,254.2

21,001.9

22,653.0

25,494.2

28,559.3

32,509.3

37,793.9

43,208.9

49,331.8

Current GDP at market price (Rs billion)

21,023.8

22,810.6

24,580.8

27,654.9

31,266.0

35,671.8

41,291.7

47,234.0

53,217.5

Current GDP at factor cost (US$ billion)

421.5

440.4

468.1

554.8

635.6

734.3

834.6

1,073.8

1,074.4

Current GDP at market price (US$ billion)

460.2

478.3

507.9

601.8

695.9

805.7

911.8

1,173.8

1,159.0

GDP per capita at current market price (Rs)

20,631.7

21,975.5

23,299.4

25,773.4

28,684.4

32,223.8

36,950.2

41,416.1

..

GDP per capita at current market price (US$)

451.6

460.8

481.4

560.9

638.4

727.8

815.9

1,029.2

..

Annual percentage change GDP by economic activity at constant 1999/00 prices Agriculture, forestry, and fishing

-0.2

6.3

-7.2

10.0

0.0

6.0

4.0

4.9

1.6

Mining and quarrying

2.4

1.8

8.8

3.1

7.5

3.6

8.8

3.3

3.6

Manufacturing

7.7

2.5

6.8

6.6

8.7

9.1

11.8

8.2

2.4

Electricity, gas, and water

2.1

1.7

4.7

4.8

7.5

5.3

5.3

5.3

3.4

Construction

6.2

4.0

7.9

12.0

14.1

14.2

11.8

10.1

7.2

Services

5.7

7.2

7.4

8.5

9.6

9.8

11.2

10.9

9.7

Trade, hotels, transport and communication

7.3

9.1

9.2

12.1

10.9

10.4

12.8

12.4

9.1

Financing, insurance, real estate, and business services

4.1

7.3

8.0

5.6

8.7

10.9

13.8

11.8

7.8

Community, social, and personal services

4.8

4.1

3.9

5.4

7.9

7.7

5.7

6.8

13.1

Per cent Share of main sectors in current GDP Agriculture, forestry, and fishing

23.4

23.2

20.9

20.9

18.8

18.3

18.2

18.1

17.5

Mining and quarrying

2.4

2.3

2.8

2.5

3.0

2.8

2.8

2.7

2.5

Continues

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Continued Manufacturing

15.6

15.0

15.3

15.2

15.9

16.0

16.3

16.3

15.8

Electricity, gas, and water

2.4

2.3

2.4

2.2

2.1

2.0

1.9

1.8

1.6

Construction

5.8

5.8

6.0

6.2

6.5

6.8

8.4

8.7

8.9

Services

50.5

51.5

52.7

52.9

53.7

54.1

52.4

52.4

53.7

Trade, hotels, transport, and communication

22.3

22.8

23.3

23.9

25.0

25.4

25.1

25.2

25.3

Financing, insurance, real estate, and business services

13.2

14.0

14.7

14.7

14.5

14.3

13.9

13.7

14.0

Community, social, and personal services

15.0

14.8

14.8

14.3

14.3

14.4

13.5

13.4

14.4

Agriculture, hunting, and fishery

5.1

5.2

4.9

5.2

5.3

5.6

5.5

..

..

Mining and quarrying

3.6

3.4

3.4

3.4

4.1

4.1

4.6

..

..

Manufacturing

23.7

23.2

22.9

22.2

21.5

21.2

20.9

..

..

Electricity, gas, and water

3.5

3.6

3.5

3.6

3.5

3.4

3.3

..

..

Construction

4.1

4.1

4.0

3.7

3.7

3.6

3.5

..

..

Services

60.0

60.6

61.3

62.0

61.9

62.0

60.9

..

..

Wholesale and retail trade

1.8

1.8

1.8

2.0

2.0

2.1

2.1

..

..

Transport, storage, and communication

11.3

11.2

11.3

11.2

11.0

10.7

10.2

..

..

Financing, insurance, real estate, etc.

5.9

5.9

6.0

6.7

7.1

7.3

7.6

..

..

Public administration and defense and other services

41.1

41.6

42.2

42.1

41.9

41.8

41.0

..

..

Birth rate (per 1,000)

26.1

25.4

25.0

24.8

24.1

23.8

23.5

23.1

..

Life expectancy at birth

63.3

63.3

63.7

63.3

64.0

64.0

..

..

..

Infant mortality rate (per 1,000 live births)

69.0

67.0

67.0

63.0

..

58.0

57.0

..

..

Adult illiteracy rate

42.8

42.0

38.7

39.0

..

..

..

..

..

Share of a sector in total employmenta

Memorandumb

.. Not available. a Organized sector employment only. b Based on calendar year: 2000/01 should read 2000. Source: WTO. 2007, Government of India 2009 and Government of India 2009a;

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4.2. Introduction to the Constitutional Law

of India

Arnaldo Sampaio de Moraes Godoy*

The Indian right moves between tradition and modernity, bringing closer Vedic concepts, transcendent concepts of dharma, any references of significant population of the Islamic faith, any influences of a common law of England, starting a lively pluralism of sources1. A democratic constitution was written, which should live and be applied to ancient idiosyncrasies, even indicative of the caste system, which enabled pariahs, untouchables and excluded. It is about a character made up over the centuries, though shaken and stimulated in the movement of opposition to England2. The clash between ancient culture and political engineering is so new that gives the contours of the Indian constitutional law. The constitution of India begins with the preamble which proclaims that the people of India solemnly decided to constitute the country into a Sovereign Socialist Secular Democratic Republic, in order to ensure to all citizens justice, liberty, equality and fraternity. This is a solemn declaration of 1949, the year of the constitution’s promulgation. It refers to the justice in its social, economic and political dimensions. It remembered the freedom in its thought, expression, belief and religion perceptions. The equality was conceived in terms of social status and opportunities. The fraternity was forearmed as a mechanism to ensure the dignity of individuals with the unity and the integrity of the nation in the consecrated expressions in the text to the comments coming, read in its English version. India is organized as a union of states. The territorial composition of the country can be modified by legislation of the Parliament. States may have their territory increased or decreased, in addition to the changes in limits and even the name of the units. The Indian nationality is defined in a constitutional provision. Indians are those who were born in the territory of India, the children born in the territory of India, in addition to those who have resided in India in the five years preceding the making of the constitution previously mentioned. There are specific constitutional provisions, which reach Indians, who migrated to Pakistan. Indians living abroad has their Indian nationality, since they are registered at the competent diplomatic or consular department. It is excluded those who voluntarily acquired citizenship of another State, which consequently lose their Indian nationality by virtue of the constitutional provision. The Parliament has the jurisdiction to regulate other matters of nationality. The constitution of India formally acclaimed isonomy. It has been written that the state may not deny to any person equality before the law as well as equal protection to * Ex-General Coordinator for Tax Affairs of the National Treasury Attorney General in Brasília. PhD Researcher and Professor of the Masters in Law at the Catholic University of Brasília 1

Cf. MENSKI, Werner F. Hindu Law- Beyond Tradition and Modernity. New York: Oxford University Press, 2005.

2

METCALF, Bárbara D. e METCALF, Thomas R. A Concise History of India. Cambridge: Cambrigde University Press, 2003, p. 260.

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everyone within the territory of India. It has been determined that the State could not be discriminated against anyone based on religion, race, caste, gender or place of birth. Access to stores, public restaurants, hotels and entertainment venues cannot be denied based on discriminatory practices. The same rule applies to the use of tanks, bathing sites, roads or any other items kept partly or entirely with State resources, and intended for the use of all the population. This conception of equity is also projected by the constitution of India on employment relations, maintained by the State. The caste of untouchables was abolished, determining that untouchable is abolished and its practice in any form is forbidden. The use of this immemorial custom is a crime to be punished according to the law. The Constitution of India has abolished the use of noble titles, also forbidding the citizens of India from receiving securities from other States. Military and academic titles are an exception. It is applied the freedom of expression, the right of peaceful assembly, the participation in unions and associations, the movement in the Indian territory, the choice of place of residence. India adheres to the legal reserve in criminal matters. It has also been explained that nobody will be compelled to testify against themselves. The human trafficking and the forced labor are forbidden and condemned. It is permitted, however, that the State imposes the law enforcement. There is an express provision in Indian constitution, which prohibits the employment of children under the age of 14 in factories or mines of the country, and in any other occupation that is harmful. In terms of religion, it has been determined that subject to public order, morality and health, all religious denominations are entitled to keep their institutions for purposes of religion or charity, to conduct their own problems in matters of religion, to own and acquire movable and immovable property and to manage their properties in accordance to the law. It is forbidden the collection of taxes in favor of religious denominations. There is an article that protects the interests of minorities, with special attention to the admission in educational institutions maintained by the State. The right of maintenance of distinct languages, writing and cultures is validated. Public policies should be targeted in order to equally ensure the citizens, men and women, the right to earn adequate livelihoods. It has been an objective that the ownership and the control of material resources of the community are distributed in order to better ensure the common good. The intention is to prevent the economic system to raise the concentration of wealth to the detriment of the common good. The wages are aimed to be the equal to men and women. Health and the strength of workers of both genders are pursued. Children are given opportunities and facilities for a healthy development, with conditions of freedom and dignity, ensuring childhood and youth against exploitation and moral and material abandonment. It has been determined equality in the administration of justice and free legal advice for those who cannot afford lawyers’ fees and court costs. The Indian Constitution provides brief requirements on labor protection, maternity, participation of workers in the decisions of the factories, the making of a civil code and the guarantee of free and compulsory education for children. It has been determined that it is a duty of the State to improve the level of nutrition and living conditions, as well as to improve public health.

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It is also an obligation of the Indian State, under the constitution of that country, to organize national agriculture and livestock, to protect the environment by taking care of forests and wildlife, to protect monuments and sites of national importance, to effectively separate the judicial and executive powers and to promote international peace and security, among other determinations. There is an article that states the basic obligations of Indian citizens. Every Indian must obey the constitution and laws, welcome and follow the noble ideals which inspire the struggle for national freedom, support and protect the sovereignty, unity and integrity of India, defend the country and provide services when asked, promote harmony and spirit of common brotherhood among all people of India, transcending barriers of religion and language, renounce to all forms of women’s dignity denial, value and preserve the values of cultural heritage, protect the environment, including forests, lakes, rivers and wildlife, have compassion for living creatures, develop a scientific spirit, humanism, the spirit of research and reform, fight for the safeguard of public property, renounce violence, in addition to fighting for the excellence in all spheres of individual and collective activity, so that the Indian nation constantly reaches higher levels of effort and achievements. The judiciary is headed by the President. The president is the one who also heads the armed forces. The President is elected by an electoral college which consists of members chosen by both houses of the legislature and the state legislative assemblies. The presidential mandate lasts five years. Impeachment is expected when the president violates the constitution and the Indian constitutional text explicit every step of the procedure for removal. Re-election is allowed. It is required of a presidential candidate, among others, Indian citizenship and 35 year-old minimum age. The Indian constitutional text specifies the terms of the president’s oath of office, namely: “I, [name of president], swear by God and solemnly affirm that I will faithfully serve in the position of President of India and make the best of my ability to preserve, protect and defend the Constitution and the laws and I will devote myself in service to the welfare of the people of India” The constitution also states a vice president, whose occupant heads a council of Indian states. There is special election for the post of the vice president, whose mandate, like the president, also lasts five years. A council of ministers assists and advises the president. This council is headed by a Prime Minister. The prime minister is appointed by the president and other ministers are also appointed by the president, with advice of the prime minister. The Minister shall hold Office during the pleasure of the President. The Indian constitution provides an Attorney General, since the person appointed by the president holds the right conditions to assume the judiciary in the Supreme Court. This person has the competence to advise the Indian government in all legal matters. The Parliament is bicameral; it consists of a Council of States and a House of the People. The Council of States has 12 members appointed by the president and with no more than 238 representatives of states and of the Union. The House of the People consists of no more than 530 members directly elected and no more than 20 members representing the Union territories, chosen in a manner provided by Law. It was determined that the parliamentary debates should be rendered into Hindi and English. The parliamentarian is

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allowed to use his/her mother tongue, which, therefore, will be translated into Hindi and English. The judiciary is, at the top the Supreme Court, headed by the chief judge, accompanied by seven other magistrates, unless the Parliament prescribes the greater number of judges. It is the president who appoints the judge of the Supreme Court. The magistrate cannot hold office after completing 65 years. Indian citizenship is required to hold the office of judge in the Supreme Court of India. The Supreme Court has jurisdiction to hear and adjudicate a conflict between the central government and other Indian states and between two states. The Supreme Court exercises judicial review and evaluates the process on final appeal.

1. References

GLENN, H. Patrick. Legal Traditions of the World. New York: Oxford University Press, 2000. GODOY, Arnaldo Sampaio de Moraes. Direito Constitucional Comparado. Porto Alegre: Sergio Antonio Fabris, 2006. MENSKI, Werner F. Hindu Law- Beyond Tradition and Modernity. New York: Oxford University Press, 2005. METCALF, Bárbara D. e METCALF, Thomas R. A Concise History of India. Cambridge: Cambrigde University Press, 2003. UNGER, Roberto Mangabeira. Law in modern society. New York: The Free Press, 1977. ZOLO, Danilo. Cosmopolis- Prospects for World Government. Cambridge : Polity Press, 1997. ZWEIGERT, Konrad e KOTZ, Hein. Introduction to Comparative Law. Oxford: Clarendon Press, 1998.

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4.3. The Influence of India on Global

Issues and its Relations with Brazil (Pronouncement) Leila Bijos*

The last years have presented extraordinary results in terms of bilateral relations between Brazil and India, particularly in terms of scientific projects. Brazil has demanded efforts to expand its international relations with India, focusing on the growth of trade, exchanges in scientific projects, educational exchanges, among others. The focus on new forms of economic integration makes clear that economic globalization is a new and fruitful frontier for the collective welfare, development and material progress. In this sense, the Minister of Trade and Industry, Kamal Nath, and Minister of Foreign Relations, Celso Amorim, met outside the Annual Meeting of World Economic Forum held in Davos, on January 30th, 2009, in order to identify possibilities for the resumption of trade negotiations of the Doha Round, and find joint solutions to the global economic situation. The representatives of Brazil and India argue that it is necessary to prioritize the basic democratic values of dignity, freedom, respect for life and integrity of the human beings so that we can achieve qualitative parameters in the context of international relations, which have the human being as the primary purpose of democracy. It is undisputed the participation of Brazil and India on issues of science, technology, environment, human rights, rights of women and children, housing and welfare for the population. The issues on the agenda illustrate the active participation of Brazil and India in a world of universal integration. Both countries have continental dimensions, with large populations, and face the common challenge of development. The objectives are ambitious in order to decrease the rates of endemic poverty, income disparities and the gaps in education with processes of institutional reform and economic opening, which will lead them to the establishment of continuous and dynamic developmental structures. It is also worth noticing the importance of environmental conservation, another prominent topic in discussions between the two countries. Both countries share the unusual privilege of having abundant natural resources, with projects for the preservation of the environment that strive for conservation of tropical forests, fauna and flora, water resources, coupled with the material issue, the development of societies and quality of life of our nations1.

*Leila Bijos holds a PhD in Sociology from the Universidade de Brasília (UNB), is a Professor of the Master course in International Economic and Tax Law from the Universidade Católica de Brasilia, an expert on International Policy, a visiting researcher at the University of California in San Diego, USA, and at the University of Tsukuba, Japan. 1

Marco Maciel, opening words at the Brazil-India Seminar, conducted on the 11th and 12th of January, 1996, in Rio de Janeiro.

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Concerning the economic reform, India has overcome the challenge of terrorist violence and has delimited a controlled economic reform, according to the words of President Smt. Pratibha Devisingh Patil during a joint session of the Parliament in New Delhi, on February 12th, 20092. The Indian Government’s diplomatic effort underlines the commitment of an articulated inclusive development in the National Common Minimum Program (NCMP), which was turned into laws, policies and programs. Among the most relevant actions, it is emphasized the right of labor for the population in rural areas, which was guaranteed by the National Rural Employment Guarantee Act and the Law of Social Security for Informal Sector Workers, 2008, which aims at facilitating the provision of social security for 430 million informal workers. Through the Law related to the Right to Information, the government has advanced toward community action, with a transparent public management, rendering the accounts to citizens. The National Rural Employment Guarantee Act, which has already covered the entire country, is the first intervention of this type anywhere in the world, through which a country provides employment for a specific number of days for any category of citizen. According to official figures, in 2007-2008, about 34 million rural families got a job under this program3. The program has the double objective of giving to the poor consumer spending and improving rural productivity and incomes. In the sixtieth year of the republic, the National Rural Employment Guarantee Act makes India a Republic of Labor. The perspective that emerges in terms of radical changes in India shows that there is a new configuration of forces in international politics. Brazil, India, Russia and China, in a global sense, are considered as “new influential,” and tend to exert increasing influence on global events contributing effectively to enforce law and order, ensuring international stability. These coordinated efforts have significantly contributed to the resurgence of a new international order centered on common sense, on the perception of the interests of all countries, and on a perception of responsible and cooperative diplomacy. Gradually, India, like Brazil, has been actively imposing itself as a prominent member of the international community of “new influential,” showing a serious work in the area of public and social policies.

2

Official speech published by the newspaper Notícias da Índia, Vol. 3, Number 4, published by the Embassy of India, 02/15/2009, p.1.

3

Idem, p. 1.

5. China 5.1. The Chinese Tax System and its Effects

in the Development and in International Trade Relations of China: A Juridical and Economic Approach Zhu Weiqun*

CONTENTS 1. Introduction 2. Constitution and Tax System in China 2.1. Constitutional Structure 2.2. Tax Constitution 2.3. Tax Jurisdiction and Apportionment 2.4. General Issues on Tax Collection and Management 3. Chinese Tax System 3.1. Income Taxes 3.2 Property Taxes 3.3. The Reform Issues of Direct Taxation 3.4. Consumption Taxes and other Indirect Taxes * Professor Zhu Weiqun has been working at Shanghai University of Finance and Economics(SUFE) for 20 years. His academic interests are Public Finance and Taxation. He is an author or co-author of more than 20 academic articles and about 15 books in his research fields. He got his MA in1989 and Ph.D in2000 at SUFE. He was a former vice dean of School of a Public Economy and Administration and deputy directors of Graduate Administration in his University. He was awarded the Second Prize of The Fifth National Outstanding Research Achievement on Public Finance by China Society for Public Finance.

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3.5. General Indirect Taxation Issues 3.6. Other Taxes Contributions, Fees, etc. 3.7 Taxation and electronic commerce 4. Economic Development in China 4.1. Background 4.2. Important Issues 4.3. Economic Growth 4.4. How Taxation Affects the Development Process 5. External Investment Flow Issues in China 5.1. Background Knowledge 5.2. The Analyses on Total Volume of External Investment Flow 5.3. The Analyses on Structures of FDI into China 6. International Trade of Goods and Services in China 6.1. WTO – History and Developments 6.2. Tariff Policy and Regimes 6.3. International Free Trade Agreements (FTAs) 6.4. International Tax Treaty Issues 6.5. Export Tax Rebate System 7. Conclusions

1. Introduction Tax system has been an important instrument of the Chinese government. The government not only relies on taxation as its main source of revenue, but also a “leverage” in “regulating” economic and social activities. To Chinese senior decision makers, taxation is often viewed as a powerful policy means to promote economic development and improve international trade relations. This Chapter introduces the Chinese tax system and assesses its effects in the development and in international trade relations of China from juridical and economic views. Part II discusses some issues related to taxation in the context of Chinese´s constitution and introduces basic system arrangement about Chinese tax jurisdiction and tax revenue sharing, as well as some general issues on Chinese tax collection and management. Part III outlines the current Chinese tax system and describes related issues for tax reforms. Part IV discusses the role of tax policy in China’s economic development by discussing some important issues in the process of economic development. Part V gives a detailed quantitative analysis on external investment flow in China. Part VI introduces the history and development of WTO entry of China, the reforming process of the Chinese tariff regimes and the Chinese international free trade agreements already signed, under negotiation or under research. It also discusses the tax treaty and export tax rebate system in China.

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2. Constitution and Tax System in China 2.1. Constitutional Structure

The current “Constitution of The People’s Republic of China” was adopted at the 5th Session of the 5th National People’s Congress and promulgated to become effective by the proclamation of the National People’s Congress on December 4th, 1982. Thirty-one amendments have been made in the years 1988, 1993, 1999 and 2004. The current version of the Chinese constitution is divided into the following parts: • • • • •

the Preamble; Chapter I – General Principles; Chapter II – the Fundamental Rights and Duties of Citizens; Chapter III – the Structure of the State; and Chapter IV – the National Flag, the National Anthem, the National Emblem and the Capital. Under the current constitution, the provision directly related to taxation is only the 56th article, i.e. “It is the duty of citizens of the People’s Republic of China to pay taxes in accordance with the law.” The legislative intent of this provision is clearly to emphasize the tax liability of citizens, rather than to establish legitimate principles of taxation and to protect the rights of taxpayers. In addition, there are two articles used as a logical base for providing guidance with respect to protecting the property rights and human rights of citizens. These two articles are paragraph 1 in article13, i.e. “The state protects the right of citizens to own lawfully earned income, savings, houses and other lawful property.”, and paragraph 3 in article 33 , i.e. “The state respects and preserves human rights.” As the constitution is the fundamental law in a country, confirming the principles relating to taxation in the constitution must be the starting point to legalize tax law. Nevertheless, there is no clear response in the Chinese current constitution about the basic taxation principles, the basic system arrangement for public finance and taxation, the legislative division among different governmental levels and the division of the central and local tax authority. These constitutional failures are undoubtedly disadvantageous to establish principles of taxing legitimately, to protect the rights of taxpayers, as well as to push forward the process of construction of tax legislative in China.

2.2. Tax constitution

The Basic Tax Law is an extension of the spirit of the constitution in the fields of tax law. It can standardize tax legislation; tax administration and tax judicature to some extent, and thus improve the overall effect of the tax legal system and promote the achievement on the democratization and legalization of taxation. However, because of the constitutional failures mentioned above and a little possibility to amend the constitution immediately, it is expected by the academics and the tax administrator to formulate a Basic Tax Law, so as to partly solve the problem. Currently, there are two proposals concerning the legislative framework of the Basic Tax Law. One is drafted by the State Administration of Taxation; the other is

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drawn by experts who were commissioned by the National People’s Congress Financial and Economic Committee. Both of them covered the contents of tax legislation, tax administration, tax judicature and tax law interpretation, and considered the Basic Tax Law as a fundamental and comprehensive law. The difference between these two drafts is that, the former focuses on the maintenance of the effective implementation of taxing power; the latter emphasizes the relief and protection of the rights of the taxpayer.1 As a matter of fact, in the “Law of the People’s Republic of China on the Tax Collection and management” (hereinafter referred to as “Tax Collection and Management Law”), amended and implemented in 2001, there are dozens of rights for taxpayers, such as the right to be informed, to be kept private, to defense and to apply for tax refund. However, lots of scholars hope to make the relevant regulations on the rights of taxpayers in the Basic Tax Law, for the purpose of clarifying and protecting those rights in the higher level of law. In the researches and discussions regarding the Basic Tax Law, there is a plenty of different views in terms of the scope of application, the basic principles of taxation, the division of the legislative power and other major aspects. Therefore, the requirements for the Basic Tax Law to enter the legislative process are not yet fully met. This is the reason why the Basic Tax Law was not included in the legislation plan conducted on the 11th Standing Committee of the National People’s Congress in 2009.

2.3. Tax Jurisdiction and Apportionment

At present, the tax revenues in China are collected by three government agencies: the tax authorities, customs authorities and finance authorities, just as shown in Table 1. Among them, the tax authorities include the State Administration of Taxation set up by the central government, as well as two tax collection systems established at the provincial level and at the lower level, i.e. the national tax authorities and the local tax authorities. The national tax authorities are responsible for collecting central taxes and central-local shared taxes; the local tax authorities, by contrast, focus on the collection of the local taxes. The customs´ authorities mainly collect a tariff, VAT and consumption tax occurred when importing. The finance authorities are responsible for the collection of farm land occupation tax and deed tax; these taxes, however, have been collected by tax authorities in some regions after the year 2000.

Table 1. The government agencies for collecting tax and their responsibilities Government agencies

Responsibilities

Tax authorities

National tax authorities

Taxes belonging to central government (central taxes), Taxes shared by central and local government (shared taxes)

Local tax authorities

Taxes belonging to local government (local taxes)

Customs authorities

Tariff Value added tax occurred when importing Consumption tax occurred when importing

Finance authorities

Farm Land Occupation Tax, Deed Tax (After the year 2000, these taxes have been collected by tax authorities in some regions.)

1

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Tang Gongliang, Liu Shuang: “Review and outlook of the Basic Tax law”, Taxation Research, 2008 (1).

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The fiscal decentralization was being made During the period that started with the opening-up reform to the tax-sharing system in 1994.. This led to an advantageous situation for the local governments in the distribution of national income. During this period, the fiscal revenue of central governments accounted for roughly 20% to 30% of the total fiscal revenue; the fiscal revenue of the local governments, whereas, took up as high as 70% to 80% of the total2. As a result, both the ratio of the fiscal revenue to GDP and the ratio of central government’s fiscal revenue to the national fiscal revenue (referred to as “the two ratios”) declined. In order to raise “the two ratios” and improve the fiscal capacity of central government, an important reform of the tax system occurred in 1994. As the largest-scale, the most extensive and the most profound reform since the founding of New China, it divided all taxes as central taxes, local taxes and central-local shared taxes between central government and local governments (including provinces, autonomous regions, municipalities and the cities of a single plan). After the reform, the decline of “the two ratios” was stopped; the macrocontrol capacity of central government was accordingly strengthened. Currently, the division of all kinds of taxes in China is as follows: 1)

Central taxes

• • • • • 2)

Consumption tax Vehicle Acquisition Tax Tariff Ship Tons of Tax imposed by customs Value Added Tax imposed by customs Local taxes

• • • • • • • • • • 3)

City Maintenance and Construction Tax Resource Tax Stamp Tax House Tax Urban and Township Land Use Tax Land Value Added Tax Vehicle and Vessel tax Deed Tax Farm Land Occupation Tax Tobacco Leaf Tax Shared taxes

• Shared tax and the specific share between central government and the local government are displayed in Table 2.

2

Shang Tieli, Wang Na: “The Situation, embodiment and countermeasures about the vertical competition on taxation”, Taxation Research, 2008 (10).

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Table 2. Tax shared between central government and local government Tax

Share of central government

Share of local government

Individual Income Tax

60%

40%

VAT

75%

25%

Enterprise Income Tax

60%

40%

Stamp tax(part of stock exchange)

97%

3%

Business tax

Business tax imposed on the Ministry of Railways, the bank’s head office, head office of the insurance companies

The rest

Since 1994, there were several adjustments on the division of all types of taxes between central and local governments, and on the ratio of shared taxes as well. The effects of those adjustments show that there are mainly three problems of the taxsharing system: 1)

2)

3)

An imbalance between financial powers and responsibilities. In the tax-sharing system, there is no corresponding division on rights of handling administrative affairs between local and central governments; the pattern of the division concerning routine power, thus, has not been changed. This leads to the fact that most of the financial resources has been obtained by central government (about 50% to 60% of the total fiscal revenues).By contrast, the responsibility of local governments on routine expenditures is much too heavy (nearly 70% of public expenditure, taking place at or below the provincial level, of which more than 55% expenditures occurred in the cities, counties or villages). A deterioration of fiscal difficulties at the level of grass-roots government. The concentration of public finance at the provincial and city level has seen an increase, meanwhile the financial difficulties of counties and villages are aggravated. In some regions, the transfer payments from higher levels of government have become the main source of the local governments’ revenue. Nevertheless, the transfer payment system still has many problems, such as overmuch special subsidy and overmuch counterpart funds, which weaken the function of a transfer payment system to narrow the financial gap among regions. Extra-budgetary fund has been regarded as the most important incremental revenues of local governments. The land remise income is a main but informal source of the revenue of local governments. This leads to the short-term behaviors of the government, corruption and the ineffective supervision on the budget.

2.4. General Issues on Tax Collection and Management 2.4.1. The Legislative Process on Tax Collection and Management For a long time, since the founding of New China, the highly centralized and planned economic system was implemented; the fiscal revenue and expenditure are therefore

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centralized, so the government paid little attention to the building of the tax laws and regulations. The regulations of tax collection and management scattered among the separate laws and there was no uniform law and regulation on tax collection and management. In April 1986, in order to change the fact that the system of the tax collection and management was scattered, isolated and relatively conflicting, the State Council promulgated the “Provisional Regulations on Tax Collection and Management”. This is the initial realization on the separation of the tax substantive law from procedural law in China; in addition, the prototype of the uniform legislation on tax collection and management was taking shape. In September 1992, in order to resolve the problems that separate administration system from domestic and foreign-related tax, weak enforcement powers of the tax authorities and inadequate protection on the rights of taxpayers, the Seventh National People’s Congress Standing Committee adopted the “Tax Collection and Management Law”, according to the legislative principles that “strengthen tax collection and management, safeguard tax revenue and protect the legitimate rights and interests of taxpayers”. Afterwards, there were two amendments in 1995 and 2001 respectively; it has become the basic law and regulation of tax authorities in respect of tax collection procedures.

2.4.2. Tax Registration According to the regulations, the main targets of tax registration are the units and individually-owned business engaged in production and operation. The individuals (natural persons), state organs and the small traders in rural areas who have no fixed places for production and operation do not need to be tax-registered. According to the time and the content of registration, tax registration is divided into three types: the registration for establishing, the registration for changing and the registration for cancelling. The tax registration code is composed jointly and enforced uniformly by the state and local tax authorities. Therefore, although the tax collection is divided into two authorities, there is no duplicate registration. In practice, according to “Tax Collection and Management Law”, industrial and commercial administrative organs should inform tax authorities about the situation of tax registrations and issuances of a business license. However, there is inadequate communication between these two departments, leading to the problem that the number of industrial and commercial registration is greater than the number of tax registrations.

2.4.3. Management on Books, Vouchers and Invoices According to the regulations, the tax authorities are responsible for administering invoice, which involves management and supervision of its printing, receiving and buying, issuing, keeping and cancelling. In China, because VAT is a major source of tax revenue, in order to ensure the effective implementation of the VAT credit system, whose key factor is the invoices, the security control network has been carried out with respect to the forgery of invoices and fraud of tax credits.

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2.4.4. Methods on Tax Collection In the case of having a sound financial accounting system and the ability of calculating tax payable accurately, a “checking accounting book” method can be used. That means that the taxpayer declares the amount of taxes payable by himself, fill in a special form after the verification of tax authorities and then pay the tax to the designated banks. However, in the case of small enterprises with an inadequate financial system, a “specified amount” method is implemented. In addition to these two, other approaches, including “self-check, self-pay”, “withhold and pay” and “commissioned to levy a tax” are available. As a result of overmuch emphasis on the guidance of tax plan to the work of the tax collection, some local tax authorities impose the more tax than it should be to achieve the tax plan. This kind of tax collection is no longer in accordance with the law. Currently, the analysis and evaluation on tax revenue, as well as the monitoring of tax source, is used to ensure the rationality of the tax plan.

2.4.5. Tax Relief According to the regulations, if there is a dispute between tax authorities and taxpayers, withholding agent or tax guarantors in the process of tax collecting, the tax payable must be paid according to the decision of the tax authorities, or the tax as well as the fines must be transferred, or the related guarantee must be provided. Afterwards, the taxpayers, withholding agent or tax guarantors have to apply for the administrative reconsideration and then appeal to an administrative litigation if they are still unconvinced. Such a procedure will not only hinder the taxpayers to get the relief by legal means, but also increase the relief costs of the taxpayers. Due to the shortcomings in the design of such system and the long-term existence of the “authoritative” image of tax authorities, the taxpayers dare not to challenge the tax authorities in person and thus few cases happened, in reality, that the taxpayers tried to get relief by legal means.

2.4.6. Protection of the Rights of Taxpayers For the purpose of setting up an administrative system with a public service-oriented government in China, the tax authorities, as a public service department in government, are gradually changing their thoughts from the past that the government is an absolute “authority” and everything is firstly considered from the viewpoint of the government. The conception of providing services to taxpayers is actively being established in China. A lot of specific performances of tax authorities to provide services for taxpayers are as follows: establishing Tax Service Office to provide a “one-stop” service to taxpayers; offering a variety of ways to declare tax, e.g. by door-to-door visit, mail, telephone, the internet etc.; setting up a national unified free hotline, i.e. 12/366, which means 366 days or 12 month in a year, and websites specialized for tax service; newly founding a “tax-service division” in the State Administration of Taxation this year as well as special departments supplying full-time services for the taxpayers in the local tax bureaus.

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In the stage of tax paying and collecting, it has become common habit that the tax authorities serve and protect the rights of taxpayers.

2.4.7. Measures to Safeguard Tax Collection “Tax Collection and Management Law” and its detailed rules for implementation provide a series of measures to safeguard the tax collection, including: tax preservation, mandatory enforcement, tax subrogation rights and revocation rights, restrictions on the departure abroad, etc. Tax preservation is implemented by tax authorities; mandatory enforcement could be carried out by both tax authorities and courts and mainly by business organizations; tax subrogation rights and revocation rights are exercised through the court proceedings; restrictions on the departure abroad generally should be decided by tax authorities and implemented by public security organs. In addition, the living housing and daily needs of taxpayers and their dependent family members are out of the scope of tax preservation and mandatory enforcement, which embodies the respect for basic human rights.

2.4.8. Penalties Penalties can be divided into administrative penalties and criminal penalties. According to “Tax Collection and Management Law”, if taxpayers break the tax law, they will be punished based on administrative penalties, by paying fine and forfeit or even being confiscated upon illegally income, etc. The procedure of tax administrative penalty includes a simple and a general one. The “Criminal Law” in China provides a number of tax-related crimes, mainly including two types of criminal acts: one is harmful to the tax collection; the other is jeopardized by the invoice management. The former includes several types, such as cheating the tax rebates on export, refusing to pay taxes, escaping paying tax arrears; the latter involves forging VAT invoices, faking VAT invoices, purchasing counterfeit VAT invoices, etc. In February 2009, the Standing Committee of National People’s Congress decided in the “Criminal Law Amendment” to change the original “tax dodging crime” to “evading tax payment crime” and amended the specific provisions of the crime. Among them, the name of “tax dodging crime” seems to be inappropriate and is not in conformity with international practice, while, after the change, the qualitative crime is more accurate. As for standards to convict, the original specific standard on the tax amount evaded is deleted, however the proportion which should be paid is reserved. This change adapts to the current economic and social development in China.

2.4.9. Informatization of Tax Collection and Management Since the late 1980s, the computer technology was first applied to the main fields of tax collection and management and then in the local area network (LAN).Finally to all aspects of administration of the tax authorities. Currently, the tax collection and management in China have changed from the traditional manual operation into a relatively advanced modern management based upon the informatization.

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It is worth mentioning that the “Golden Tax Project” (GTP), promoted by the State Administration of Taxation started in 1994,which is also called Chinese Tax Management Information System (CTAS), is the key work in the informatization construction of tax administration. At present, both the first phase of GTP, called the Trail of VAT Computer Cross Audit System, and the second phase, which consists of Anti-counterfeiting Tax-Controlled Invoicing System, Anti-counterfeiting Tax-Controlled Authentication System, VAT Computer Cross Audit System and Invoice Investigation System, have been completed. The third phase started in 2007 and its target is to build a platform for the unified and standardized national application system, two levels centralized processing information of both state and provincial administration of taxation, three aspects covering all taxes, the important segments of tax work, both the national and regional tax authorities and relevant departments, four systems consisting of a collection and management system, the administrative management system, the decision supporting system and external information exchange system. The third phase of the “Golden Tax Project” will have an important effect on full integration and extensive using of information resources, strengthening tax collection and management, optimization the tax service, improving the administrative efficiency, reducing the cost of taxation, promoting governance according to tax law and ensuring tax revenue.

2.4.10. Improvement and Outlook on the “Tax Collection and Management Law” The current “Tax Collection and Management Law” gradually exposes some problems incompatible with economic and social development, which need to be improved.

2.4.10.1. Further Confirming Notions that the Rights and Obligations of Both Sides are Equal and Protecting the Rights of Taxpayers The main purpose of the current “Tax Collection and Management Law” tends to intensify tax authority and to ensure the realization of tax revenue. In order to meet the needs of safeguarding the rights and interests of taxpayers and establishing new relationships between tax authorities and taxpayers, the concept that both parties in taxation are equally important in tax law must be established. The exercise of administrative power by tax authorities must be under the restriction of taxpayer’s rights.

2.4.10.2. Improving the Law Articles Concerning the Protection the Rights of Taxpayers Although at present there are nearly 30 articles, which involve protecting the taxpayers’ legal rights and offering service for taxpayers, they are dispersive and lack wholeness. Therefore, it is hard for taxpayers to understand and grasp them. So, these provisions need to be adjusted and integrated for taxpayer to complete understanding and mastering.

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2.4.10.3. Coordinating with Other Laws Currently, there are some inconsistencies in “Tax Collection and Management Law” with the “Administrative Punishment Law”, the “Administrative Reconsideration Law” and the “Administrative Procedure Law” of China. As an example, there is a difference of 75 days about the time limit on the decision to enforce for punishment between the “Tax Collection and Management Law” and the “Administrative Punishment Law”. In addition, after the amendments of the “Criminal Law” on the crime of tax evasion, the relevant content of the “Collection and Management Law” must also be revised accordingly.

2.4.10.4. Restricting the Discretion of Tax Authority There are some provisions in the “Tax Collection and Management Law” which authorize large discretion to the tax authorities and likely cause power abuse, corruption, are unjustly enforced, or impinge on taxpayers’ rights. For example, the 60th article of this law stated: “The taxpayer with one of the following conducts shall be ordered to make corrections within a time limit, by the tax authority, may be imposed a fine of not more than RMB 2000 Yuan; in the case of serious violation, be imposed a fine not less than RMB 2000 Yuan, but not more than RMB 10,000 Yuan.” The word “may” in the article means that the tax authorities have the power to decide to impose a fine or not, and the chosen amount of the fine is over wide. Other similar provisions in the law need to be adjusted to limiting the discretion of the tax authorities. At present, the revision of the “Tax Collection and Management Law” has been included in the 5-year legislation plan conducted the 11th Standing Committee of the National People’s Congress.

3. Chinese Tax System The current Chinese tax system was formed in 1994 and can be divided in direct tax, indirect tax and other taxes. Figure1 shows the increase trend of total tax revenue, Figure 2 shows the proportion of each part according to total data from 1994 to 2007 and the Figure 3 shows the proportion of each part according to annual data.3 3

Direct tax includes enterprise income taxes, individual income tax, house tax, city and town land use tax, land value added tax and deed tax; indirect tax includes value added tax, consumption tax, business tax and resource tax.

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Figure 1. The increase trend of total tax revenue in China, 1994-2007

Figure 2. The proportion of tax revenue in China, 1994-2007 Source: the Federal Service of State Statistics (Rosstat)

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3.1. Income Taxes

The income tax accounts for about 26.2% and 27.5% of total tax revenue in 2007 and 2008 respectively. The current Chinese income tax includes enterprise income tax and individual income tax.

3.1.1. Enterprise Income Tax The establishment and improvement of the Chinese enterprise income tax system can be divided into two aspects. Firstly, foreign enterprise income tax systems were established in the early 1980s and consolidated in 1991. In 1980 and 1981, the income tax on Chinese-foreign equity joint ventures and the income tax on foreign enterprises were implemented respectively. These two income taxes were merged into a consolidate income tax for enterprises with foreign investment and foreign enterprises in 1991. For another aspect, domestic enterprise income tax system had been established and developed gradually. Since 1983, according to the nature of the enterprises’ ownership, the Chinese Government promulgated and implemented the state-owned enterprise income tax, the collective enterprise income tax, the private enterprise income tax and the state-owned enterprise profit regulation tax. Meanwhile, based on the employees’ bonus paid by enterprises and public institutions, the Chinese Government imposed three kinds of bonus tax respectively on the state-owned enterprises, the collective enterprises, and the institutions. This fragmented structure of the enterprise income tax system ended by the integrated domestic enterprise income tax in 1994. From then to 2008, China has had two kinds of “domestic” and “foreign” enterprise income tax system. On January 1, 2008, the “Enterprise Income Tax Law” became into effect, which achieved completed unification in the income tax rate, methods and standards of tax deduction, tax preference, and tax collection for both foreign-funded and domestic enterprises. The enterprise income tax in China is collected yearly, but received in advance every quarter. The tax year is from January 1stto December 31st, any kinds of production or business income and other income shall be taxed. Although the principle of the tax is approximately the same as other countries, it has also its characteristic. First, the taxpayer of enterprise income tax includes all the enterprises and other profit organizations in China. But individual proprietorship enterprise and partnership enterprise are not taxpayers of enterprise income tax. They are taxpayers of individual income tax. Second, taxpayers are divided by register place, and actually manage the organization place into a resident taxpayer and non-resident taxpayer. If resident taxpayers’ burden is unlimited obligation of the tax, all the income of resident

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taxpayers, not only domestic income, but also overseas, should be imposed on the tax. If nonresident taxpayers’ burden is limited obligation of tax, only domestic income should be imposed on the tax. Third, the rate of enterprise income tax is 25%, but some enterprises enjoy preferential tax rates. Such small-scale, low-profit enterprise enjoys 20% of a tax rate. Enterprises which advanced in technology and science, supported by the State, enjoy 15% of a tax rate. Fourth, the type of preferential treatments in enterprise income tax has been changed from region-oriented to be industry-oriented in order to encourage technology innovation and investment, to sustain environment protection and to promote employment rate, etc.

3.1.2. Individual Income Tax The individual income tax in China was established in 1980 and revised in 1993. The taxpayers include Chinese citizens, foreigners and compatriots from Hong Kong, Macao and Taiwan, countries with income in China (including people who have no nationalities). The most remarkable characteristic of the Chinese individual income tax is that it is a classified income tax, not a comprehensive income tax. Under this kind of Chinese individual income tax system, all the taxable income is classified into 11 tax items. Each has its tax rate and calculating method. The tax items and their tax rates can be seen from table below. Table 4. Individual Income tax rates (Applicable to wages or salaries) Grade

Taxable income of the month

Tax rate (%)

1

Less than 500

5

2

The portion of income in excess of 500 to 2,000 Yuan

10

3

The portion of income in excess of 2,000 to 5,000 Yuan

15

4

The portion of income in excess of 5,000 to 20,000 Yuan

20

5

The portion of income in excess of 20,000 to 40,000 Yuan

25

6

The portion of income in excess of 40,000 to 60,000 Yuan

30

7

The portion of income in excess of 60,000 to 80000 Yuan

35

8

The portion of income in excess of 80,000 to 100,000 Yuan

40

9

The portion of income in excess of 100,000 Yuan

45

Note: “The taxable income of the month” in this table refers to the amount of a monthly income after deduction of 2000 Yuan for living expenses or additional living expense deductions which is 2800 Yuan at present for foreigner who work in China – Chinese people who work aboard and people come from Taiwan – Hong Kong and Macao.

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Table 5. Individual Income tax rates (Applicable to production or business income of individual industrial and commercial households, and business Income from contracted or leased enterprises)

Grade

Taxable income of the year

Rate(%)

1 2 3 4 5

Not exceeding 5,000 Yuan The portion of income in excess of 5,000 to 10,000 Yuan The portion of income in excess of 10,000 to 30,000 Yuan The portion of income in excess of 30,000 to 50,000 Yuan The portion of income in excess of 50,000 Yuan

5 10 20 30 35

Note: The “taxable income of the year” in the table refers to the taxable income based on the gross income of a tax year after the deductions for costs, expenses and losses in accordance with the provisions of Article 6 of this Law.

Table 6. Individual income tax rates (Applicable to independent labor income) Grade

Taxable income of once

1 2 3

Rate(%)

Not exceeding 20000 Yuan The portion of income in excess of 20,000 to 50,000 Yuan The portion of income in excess of 50,000

20 30 40

3.2. Property Taxes

Property tax now in China is all local taxes which include house tax, land value-added tax, deed tax, urban and township land use tax, and farm land occupation tax. Table 7. The current property taxes in China Date of taking effect

Tax

Tax object

Tax rate

House tax

Business house in cities, county towns, administrative towns, industry and mining districts

For self use: 1.2 For rent: 12

01/10/1986

Urban and Township Land Use Tax

Sate-owned land in the areas same as the above

See table 9

01/11/1988 01/01/2007 revised

Deed tax

Land and house acquisition of ownership 3-5

03/31/1950 1954 revised 1/10/1997 revised

Land value added tax

Transfer of real estate

30-60

01/01/1994

Farmland occupation tax

Occupation farm land to build a house and engage in non-agricultural construction

5-50 Yuan/m2

01/04/1987 01/01/2008 revised

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3.2.1. House Tax House tax in China is not collected in the countryside. It shall be collected in cities, county towns, administrative towns, and industrial and mining districts. The taxpayer is the owner of the house used in business. House tax has two kinds of method of calculating. When the house is used in self production or business, the tax rate is 1.2% annually, the taxable value is the original house value reduced by 10~30% (determined by local governments). When the house is for rent, the tax rate is 12%, collected with the rent, but if an individual rents it, the tax rate is 4%.

3.2.2. Land Value Added Tax IInstitutions and individuals with returns from the transfer of use right of Stateowned land, buildings and other attachments thereon (hereinafter referred to as “realty transfer”) shall be payers of land value added tax. The amount of land value added shall be the balance of the income of a taxpayer from a realty transfer after deductions of items provided. For a real estate development enterprise, the deduction of an item includes the payment obtained the right to use land, development cost, development expenses, transfer taxes and fees, and an additional deduction which is 20% of the sum of the payment obtained the right to use land and the development cost. The land value added tax shall be levied at progressive rates based on the rate of value added. which is a quotient obtained from value added divided by the total deduction amounts. Table 8. Progressive rates of land value added tax Grade the rate of value added

Rate

1

not exceeding by 50%

30%

2

exceeding from 50% to 100%

40%

3

exceeding from 100% to 200%

50%

4

exceeding 200%

60%

3.2.3. Deed Tax An organization or person who obtains the right to use land or house in any legal means within the territory of the PRC shall pay the deed tax. The tax object does not include the transfer of operation right of the rural collective land. Rate of the deed tax is from 3% to 5%. Basis for calculating deed tax is on transacted prices. The deed tax in nature is a real estate acquisition tax and a turn over tax. The real estate must be taxed when it is turned over and may be taxed repeatedly.

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3.2.4. Urban and Township Land Use Tax An organization or individual using land for production or business in cities, county towns, administrative towns, and industrial and mining districts shall be a payer of urban and township land use tax. This tax shall be assessed on a yearly basis and paid in installments, and determined by the provincial level governments. The annual tax amount of each square meter of land used shall be as follows: Table 9. Rate of urban and township land use tax Districts

Annual tax amount Yuan/m2)

Big cities

1.5-30

Medium-sized cities

1.2-24

Small cities

0.9-18

County towns, administrative towns and industrial and mining districts.

0.6-12

NOTE: The land use tax shall be levied according to the tax amount assessed on the basis of the actual area of the land used by a taxpayer in accordance with relevant regulations.

The people’s Governments of the provinces, autonomous regions, and municipalities directly under the State Council shall determine a suitable tax amount range within the range of tax the amount prescribed in the previous article and in light of the local urban construction and degree of economic development in the areas under their jurisdiction.

3.2.5. Farmland Occupation Tax The farmland occupation tax applies to all State-owned and collectively-owned farmlands. Farmland used for building house or engaging in non-agricultural construction shall be the object of this tax. The average tax amount per square meter for each province, autonomous region and municipality was determined by the State Council. Each province, autonomous region and municipality shall set the applicable tax amount differentially for each county (city) and suburb, but the average tax amount shall not be lower than the average tax amount specified regulations. This tax is a one-time tax, not a periodical tax.

3.3. The Reform Issues of Direct Taxation 3.3.1. The Reform of Individual Income Tax The reform of individual income tax is a pop topic in China now. In developed countries, individual income tax is a powerful tool in income redistribution. In China, however, the revenue of individual income tax only is 7% of total tax revenue. Individual income tax in China is a classified income tax, 11 items of individual income tax adopt different deduction and exemption amounts, different tax rates, different preferential measures. Only labor income and business income adopt a progressive tax rate. Others adopt a proportion tax rate.

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Even though income from wages and salaries and income from labor service are all labor recompense, they have different methods of calculating. Besides, individual income tax doesn’t consider family status of taxpayers (number of family members, health of family members, debt of family, and so on). There is a reform trend that the individual income tax system will be changed from its original classified system to a more comprehensive one.

3.3.2. The Real Estate Tax Reform At present, the Chinese Government will focus reconstruction of the real estate tax system on real estate maintenance. They will integrate current real estate taxes to levy a new real estate tax. The assumed real estate tax has some characteristics as follows:(a) the taxpayers shall be the units and individuals which owned or possessed real estate;(b) the tax basis is the value of taxable real estate in its maintenance phase, and(c) the tax is calculated according to a certain percentage rate. The main purposes of introducing the new real estate tax are as follows: (a) to reform and improve the existing real estate tax; (b) to adjust the income gap; (c) to promote the local tax reform and (d) to regulate the real estate market. Since 2003, the State Administration of Taxation has carried out the assumed new real estate’s assessment experiments´ simulation in 10 provinces and cities. From the decision-making level, it is imperative to introduce the tax. The matter is when to levy it. However, the introduction of this tax still has more difficulties, such as: (a) It is a great challenge for tax authority to assess a value of the real estate, that is, how to realize the objective to control collection cost fairly and effectively;(b) the property tax reform will involve many kinds of tax, and the coverage of integration will be involved widely, so it is necessary to take it into full consideration;(c) whether merging the revenue of transferred land into the tax base is not yet been in consensus; (d) if levy is done on non-operating real estate of the individual, how to determine the scope and standards of collection is a problem. If the taxable scope is too broad and the taxable start point is too low, people will oppose it.

3.3.3. Inheritance Tax (Gift Tax) Issues Inheritance tax is no stranger to China. After the PRC was founded, the central Government enacted the Principles for Implementation of the National Tax Policy in 1950, which include the Article of Inheritance tax. However, because of subsequent public-private partnerships and the implementation of the planned economy, there is nearly no private property to private citizens, so the inheritance tax was not introduced. The tax reform listed inheritance tax as one of the taxes preparing for introduction in 1994. In 1996, the National People’s Congress (NPC) of the PRC approved “The Ninth Five-Year Plan about national economic and social development and Long-Term Goals for 2010”, in which, it said China will gradually introduce inheritance tax and gift tax.” In recent years, with China’s economic development, personal wealth increase, and income gap, the issue of inheritance tax once led to a hot discussion. Currently, to avoid excessive concentration of wealth and to regulate the gap between the rich and the poor in China, the introduction of inheritance tax as an effective means is an

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inevitable trend under the background of building a harmonious society. In some sense, the introduction of inheritance tax has an economic basis but is still facing some disadvantages, such as the concealment of property distributed of the high-income earners, the weak administration abilities of the tax authorities, the difficulties of the heritage assessment, and so on. Therefore, some relevance systems to support this tax must be established in advance, such as creating a personal asset document management and the a value evaluation system, designing a system to prevent the transfer of personal property to the foreign effectively, avoiding capital flight after an introduction of inheritance tax, etc. Even with the introduction of an inheritance tax at the early stage, tax authorities should also apply the way of narrow the tax basis and low tax rates, then spread and improve them gradually.

3.4. Consumption Taxes and other Indirect Taxes

Tax system in China is primarily based on indirect taxes. The first three main indirect taxes in China are the value added tax, the consumption tax, and the business tax. Besides these, the resource tax, the city maintenance and construction tax, and the education fee supplement also have character of indirect tax.

3.4.1. Value added tax The Value added tax is the largest tax in China; the revenue of the tax exceeded 1.5 thousand billion yuan in 2007, approximately 31% of the whole tax revenue of the year. China began to gradually put the VAT in force in 1984 and revised t in 1994 and 2008. An institution or individual engaged in selling and/or importing goods, providing processing, repair and/or replacement services within the territory of the PRC shall pay the value added tax. Besides processing, repair and/or replacement, other legal services are subject to the business tax. The prescribed time limit for paying the VAT shall be one month, one quarter, or even one day. Though the principle of the tax is approximately the same as other countries, it also has its characteristic. First, taxpayers are divided to general taxpayers and small-scale taxpayers. To a general taxpayer, the computer formula shall be: tax payable = amount of tax on sales (tax is not included in the sales) -amount of tax on purchases (tax is not included in the purchases, generally the amount has been written in a VAT special invoice). A general taxpayer should have a good accountant system, and its scale should exceed the standard. A simplified system of computation of tax payable shall be applied to small-scale taxpayers engaged in selling goods or taxable services. The VAT rate for small-scale taxpayers engaged in selling goods or taxable services shall be 3%. The amount of taxes payable shall be computed by the following formula: the amount of taxes payable = amount of sales (tax is not included in the sales) × tax rate. Second, there are only two preferential rates for the VAT. Besides 17% as the basic rate, the low rates subject to some goods are 13% and 0 % (see Table 10). Third, only general taxpayers can apply and purchase the VAT special invoice. When applying for deducting the input tax from the output tax, a taxpayer should go to a tax authority for examining the VAT special invoice ahead of time limit. The production-type VAT has been implemented for more than 10 years. In 2004, the Chinese Government made the experiment on implementing

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the consumption-type VAT from old industrial districts in the northeast of China to the central region of China. In 2009, the consumption-type VAT has been introduced all over the nation. The type transition of the VAT eased the cash-flow pressure of the enterprises in the international financial crisis, which will benefit the enterprises to get rid of the crisis. Table 10. The Value Added Tax Rate in China Taxpayer

Tax rate

Sphere of application

General taxpayers

Basic tax rate 17%

Goods’ Selling or importing other than those listed below, and services of processing, repairs and replacement.

Lower tax rate 13%

1. Agriculture, forestry, products of animal husbandry, aquatic products; 2. Edible vegetable oil and food grains duplicates; 3.Tap water, heating, cooling, hot air supplying, hot water, coal gas, liquefied petroleum gas, natural gas, methane gas, coal/ charcoal products for household use; 4.Books, newspapers, magazines (excluding the newspapers and magazines distributed by the post department); 5.Feeds, chemical fertilizers, agricultural chemicals, Agricultural machinery and plastic covering film for farming; Etc.

Zero tax rate

Exportation of goods (except otherwise stipulated by the State)

Small-scale taxpayers

3%

3.4.2. Consumption Tax The consumption tax in China is different from other countries. In China, the consumption tax is a tax category and covers the 14 kinds of consumer goods. Some of the object of consumption tax is unwholesome consumption goods, such as cigarettes, wine and alcohol; some are luxury consumption goods, such as valuable jewelry, gem and jade; some are excessive energy consumption goods, such as cars and motorcycles; others are reproduced, reused, or replaceable consumption goods, such as oil. The collection scope of the consumption tax depends on the changes of consumption structure. On December 13, 1993, 11 specific items were covered by this tax. On April 1, 2006, the collection scope of consumption tax changed greatly. Some goods were added, such as golf and golf tools, one-off wooden chopsticks; some goods were canceled, such as skin and hair care products; some were adjusted. The consumption tax is a single stage tax which is collected only in one stage such as production, importation, subcontracting, processing, and retail sale (only for diamond and its gold and silver jeweler). This is different from the value added tax and the business tax, in which the tax is collected in every stage when the transaction is turnover. The rate of consumption tax has three forms: proportion tax rate, fixed amount tax rate, and compound tax rate. Every taxable item, the even different subdirectory in one item, has a different tax rate.

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Table 11 Items and rates of consumption tax in China Taxable items 1. Tobacco (1) Cigarettes - Fixed tax amount - Proportional tax rate Grade A Cigarettes (price of a piece of cigarette ≥ 70 Yuan) Grade B Cigarettes (price of a piece of cigarette < 70 Yuan) (2) Cigars (3) Cut tobacco 2. Alcoholic drinks and alcohol (1) Chinese liquor made from grain and potatoes - Fixed tax amount - Proportional tax rate (2) Yellow wine (3) Beer - (Factory price/ton) > 3000 Yuan - (Factory price/ton) < 3000 Yuan Self-made by entertainment industry and catering (4) Other alcoholic drinks (5) Alcohol 3. Cosmetics 4. Valuable jewelry, gem and jade 5. Firecrackers and fireworks 6. Refined oil - Unleaded gasoline - Leaded gasoline - Diesel oil, fuel oil, aviation kerosene Naphtha, solvent oil, lubricating oil 7. Golf and instruments played golf 8. Top-grade watches (The price of a watch≥10000 Yuan) 9. Barge 10. One-off wooden chopsticks 11. Solid wood flooring 12. Automobile tyre 13. Motor vehicle (1) The cylinder capacity < 250ml (2) The cylinder capacity>250ml 14. Car (1) Sedan car and Off-road vehicle - The cylinder capacity≤1500ml - 1500ml