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The Fiscal Code – new provisions for 2005
by Alex Milcev
November 2004
The Fiscal Code has now been in place for more than ten months,
since its enforcement on 1st January 2004. During this period both taxpayers
and the tax authorities have had time to test and assess its strengths and
weaknesses, check its practical applicability and analyse the potential for
improvement.
Since the enforcement of the Code, the Ministry of Finance has been considering
ways to improve the Fiscal Code and to reduce the number of unclear or controversial
provisions, which resulted in the amendments to the Code published on 27 August
by means of Ordinance 83/2004. The amendments to the Code will be in effect
as of 1 January 2005 (such advance notice is an important step towards better
transparency of the legislative process, as it allows taxpayers more time
for reaction and adjustment, even though it is shorter than the recommended
term of six months prescribed by the Code for any change to take effect).
There are several key changes introduced by the Ordinance, which are presented
below.
Definitions
There is an amendment to the definition of related parties, which reduces
the threshold of control beyond which two parties shall be deemed as related,
from 33 per cent to 25 per cent. This will increase the pool of businesses
that will be subject to transfer pricing provisions.
The real estate property definition has been reduced in scope by elimination
of any reference to harvests, natural resources and agricultural equipment.
This could relax the tax regime of such properties transacted by non-residents,
though not for natural resources, where the existing profits taxation regime
would not be affected by the change.
Tax rates
Important changes will occur in respect of tax rates. Profits tax will be
cut to 19 per cent from the current 25 per cent, while for individuals the
top marginal rate of 40 per cent will be reduced to 38 per cent together with
an increase in the income threshold over which the top rate will apply. At
the same time, dividend tax for individual shareholders will increase to 10
per cent from the current 5 per cent.
Deductibility of expenses
Deductibility of marketing and promotion expenses will not be restricted any
more for loss-making companies. Also, bad debt write-off will be allowed for
deduction in more cases than at present (for example, in the case when a debtor
is in major financial distress and cannot pay, even if there is no bankruptcy
procedure open on him); the deduction can be taken to start from 2005, and
not from 2007 as the law currently prescribes. Separately, rules for deductible
provisions will change. Provisions for pre-2004 bad debts will be deductible
in a manner similar to those incurred after 2004, in proportion of 25 per
cent of the debt value in 2005 and 30 per cent in 2006 (in 2004 such provisions
apparently are not deductible at all).
An important change will apply to branches of foreign companies operating
in Romania: the government has removed the deductibility limitation on management
and administration costs that may be allocated to a branch. Currently, the
costs are deductible in the limit of 10 per cent of salaries of branch employees.
Thin cap rules
The thin capitalisation rule will be stricter in the sense that net interest
expense and net forex loss may be non-deductible for companies having an unfavourable
debt-equity ratio, even if the costs do not exceed 10 per cent of turnover
(in 2004, only the excess portion is affected). However, at the same time,
many types of debt will be excluded from the thin capitalisation restrictions,
which would confine the (anyway temporary) tax exposure mainly to Romanian
companies using related party financing.
Capital gains tax
Another change will allow taxpayers using the special capital gains tax of
10 per cent (instead of the regular 19 per cent tax) for transactions with
real estate and shares acquired before 2004 (currently only the 2004 acquisitions
qualify); however the two-year holding condition will be kept.
Tax holidays
Tax holidays granted to the Dacia car plant and to certain companies in free
trade zones will be cut short to 31 December 2006 from 1 October 2007 and
30 June 2007, respectively.
Withholding tax
For withholding tax of non-residents’ incomes, the intermediation services
will be taxable in Romania only if they are performed in Romania; currently
the taxation occurs irrespective of the place of supply.
VAT
The Ordinance will allow VAT payers to settle their VAT liabilities from sales/purchases
of real estate via a reverse-charge mechanism, without an effective payment
of VAT. By eliminating considerable cashflow costs associated with VAT payments
in such transactions, this measure should be expected to make the real estate
market more dynamic. The new provisions will also allow more flexibility in
issuing fiscal invoices. VAT payers providing supplies exempt from VAT without
deduction rights or outside the VAT scope may choose not to issue fiscal invoices,
but other documents, depending on the case.
Excise duty
Excise duty on coffee will be reduced, as will that of beer produced by small
manufacturers. On cigarettes a minimum excise of 11 euros per 1,000 pieces
will apply (this is to cap at the bottom the current excise duty formula of
5.73 euros per 1,000 pieces plus 31 per cent of value). The changes have introduced
extensive clarification and requirements referring to organising and operating
a fiscal warehouse, including a 5-year ban from operating a fiscal warehouse
on people whose fiscal warehouse authorisation is cancelled.
In our view the amendments to the Fiscal Code represent an improvement of
the initial version, both in terms of clarification and details of the existing
framework, as well as in the fundamental issues of tax policy, such as stimulation
of businesses via tax cuts and a more relaxed regime of business costs. Still,
there is much room for improvement, especially in such a significant area
as transfer pricing taxation of multinationals. Moreover, the approach to
personal taxation policies requires rethinking and simplifying, for instance,
via reduced tax rates and minimising the number of brackets, which would stimulate
disclosure of income and eventually result in higher tax revenues.
Alex Milcev is a Senior Tax Manager at Ernst & Young Romania
