Eurasian Economic Union Calls For Tax Incentives To Boost Manufacturing & Trade

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Op/Ed by Chris Devonshire-Ellis

  • Calls to create tax incentives for technical innovation
  • Credits requested for R&D expenses
  • Need to develop infrastructure highlighted   
  • VEB asked to provide project financing for Tech start-ups   

The Eurasian Economic Commission (EEC), the governing body for the Eurasian Economic Union (EAEU) trade bloc, has proposed fiscal reform to enhance economic growth rates, following on from the commission’s final report on the macroeconomic situation in the EAEU for 2020.

The EAEU, which includes Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia saw trade between members decline by 42% in 2020 as a direct consequence of the Covid-19 pandemic. The EAEU also has free trade agreements with Iran, Serbia, Singapore and Vietnam, and trade with these countries too has declined.

Proposals being considered to get the EAEU back on track and trading again include exempting R&D costs from tax and providing tax incentives for companies involved in innovative technologies. The EEC is prepared to support this as it wishes to increase investments in advanced technologies by five times – from 1% to 5% of GDP.

At present, the EAEU is forecast to grow, post Covid at rates of about 4.5% per annum, however the EEC feels this is not sufficient. That means loosening up tax incentives, which are available but in practice are rarely used, due to bureaucratic and related problems.

To accelerate such a development will require a structural transformation of the economies of the members of the union. For this, states need to carry out fiscal reform aimed at stimulating innovation. The EEC has urged member governments to invest in infrastructure development: and especially transport and telecommunications. The commission is also keen to develop technical innovation, developing countries receive increased economic benefits from the implementation of technological innovations. Increase in the share of R&D expenditures by 1% of GDP could accelerate economic growth by 18.7%, the EEC said.

More work needs to be done, including some political in addition to far reaching tax reforms. The EEC legislation lacks clear definitions of the tax base, the qualifications of specific works, benefits for contractors, and mechanisms for transferring intellectual property rights. This would stimulate innovation by reducing expenses. The same applies to the issue of providing tax bonuses for enterprises that invest in promising industries.

Refusal to restructure the economy will lead to the EAEU lagging behind developed countries. According to the baseline forecast, the EAEU GDP in 2021–2023 is expected to average 2.93%. However, the global economy in contrast is forecast to grow during the same period at an average of 4.23%.

Russian tax legislation already contains tools to stimulate the development of R&D, it has allowed the use of a multiplying coefficient of 1.5 to the corresponding expenses if a certain number of conditions are met. However, this is not so actively used in practice, since it involves quite significant labor costs (documentation, analytical accounting, etc.) although it des gives tangible tax savings in the form by halving the pertinent costs.

This year, a new incentive measure has been introduced that also applies an investment tax deduction for R&D expenditures, allowing for lower administrative costs but on the other hand, lower savings.

Russia’s Ministry of Finance has said that mechanisms for supporting innovation such as tax deductions, are already in place in Russia, and said that they are conducting ‘the appropriate work’. A fifth ‘Innovation and Technology Center’ has recently been created to examine these matters and a mechanism for supporting start-ups with VEB.RF, Russia’s largest development investor is being worked out. VEB.RF have already financed over 300 projects.

All this is good news. However, the EEC notes that the protracted nature of the Covid pandemic may lead to a depletion of resources (both of which are potential for revenues and borrowing), which will require governments to increase the efficiency of public spending and reorient to stimulate economic growth in the medium term . Moreover, there are risks of new viruses and epidemics emerging, indicating a need to adapt to new realities.

These new realities create risks for maintaining national budget stability, meaning that changes in EEC members tax regimes are possible in the medium term. While tax increases on items such as personal income tax would be unpopular, the introduction and deepening of the current progressive scale, if implemented, could be an alternative. The increase in the rates of indirect taxes such as VAT and various types of excise taxes is more likely.

However, the pandemic has already provided the Government with incentives to increase taxes: a differentiated personal income tax rate has been introduced, the mineral extraction tax has been increased, and rules tightened for capital withdrawal. There may not be such increases in tax rates soon, but the Russian tax administration can be expected to become more demanding.  The tax authorities’ access to bank secrets of individuals has already been expanded, while improving tax payment procedures for levying excise taxes, VAT, property taxes and so on are being discussed.

In Russia, the stability of the federal budget is higher than in other states, but there is no balance in the country in the context of individual subjects. In more than 70 regions, the local treasury runs a deficit, which will require additional funds from Moscow. That means that if Russia is faced with having to cut costs, it can reduce the costs of the state apparatus and the power block. However, a reduction in investments, for example, in the construction and repair of roads, support for the real estate sector and other investments would be postponed – running contra to the economic development of the EAEU.

There could be other ways out of this struggle. China signed off a Free Trade Agreement with the EAEU at the end of 2018. The impact of this has been limited, as to date it is non-preferential and does not include tariff reductions. If that can be negotiated in a manner that prevents EAEU manufacturers being swamped with cheap Chinese goods, yet at the same time allows market access to Chinese consumers, that should provide a timely boost. Russian manufacturers may be subject to a short, sharp shock in the form of Chinese competition – but then again it may also lead some of the shoddy manufacturers out of business, and kick those that remain into a semblance of global competitiveness – leading to short term pain, but longer-term gains.  Much it seems, currently rests in the hands of economists and their appetite for reform.

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Russia Briefing is written by Dezan Shira & Associates. The firm has 28 offices throughout Eurasia, including China, Russia, India, and the ASEAN nations, assisting foreign investors into the Eurasian region. Please contact Maria Kotova at russia@dezshira.com for Russian investment advisory or assistance with market intelligence, legal, tax and compliance issues throughout Asia.

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