NEW ORDERS

The Azerbaijani government has changed its tax exemption policy on interest paid to bank account holders, a policy which had been in effect since 1999. In the final days of last year, the Milli Maclis [parliament] adopted a number of amendments to the Tax Code. 

Exemptions for the majority of depositors will remain in effect, with some conditions.

How is it calculated?

And just like that, the "depositors'" moratorium was lifted. Up until now, the moratorium on taxing interest earned from bank deposits was in effect three years at a time, but now, according to the amendments, that time-frame has been done away with. Instead, limits have been put in place on the dividend amounts exempt from taxation.

Accordingly, interest income that amounts to less than 500 manats will not be subject to a 10 per cent earnings tax. Considering that the average annual interest rate on deposits is 10 per cent, depositors can still keep up to 5,000 manats in their savings accounts without any dent to their interest earnings.

Let's say though that a depositor has 20,000 manats in the bank and receives 2,000 manats per year in interest. Now, according to the changes in the Tax Code, 500 manats of those earnings are tax exempt, meaning that our depositor is taxed for the amount of 1,500 manat, which comes out to 150 manats (10 per cent taxation rate). As a result, the depositor will earn in a year not 2,000 manats, but 1850 manats.

By distributing funds among different banks, however, one can avoid the tax altogether. If our investor were to divide his 20,000 manats and make deposits of 5,000 manats into four separate banks, he would receive interest from each account in the amount of 500 manats and not have to pay any tax.

This is to say that if so desired, a depositor could distribute even a large sum of money in such a way to avoid taxation. For example, at the time these amendments were adopted, 43 banks in Azerbaijan were available to accept deposits. Hypothetically then, a single depositor could enjoy tax free interest earnings on up to 215,000 manats that are distributed in 5,000 manat deposits. 

It should be noted that the new taxation policy will apply not only to accounts with rates fixed in 2015, but to existing accounts as well. In this case, taxes will only be withheld from a portion of interest earnings that accumulate during the current year and the one following that, since tax exemptions were in effect until the end of 2014. It is possible that the banks themselves will process the payment of taxes on account earnings and that they will not require citizens to obtain a taxpayer identification number.

What can we expect?

The partial suspension of tax breaks was news not just for the public, but for bankers too who were caught by surprise. Bankers requested that they be given two to three months in order to adapt to the new law, change the software and perform other work. The introduction of a new policy for calculating interest earnings has generated a lot of questions. In particular for depositors who have entered into long-term fixed-interest deposit agreements whose dividends will be paid in full at the end of the contract period and in accordance with its terms. In addition, there are various kinds of savings accounts whose dividends accrue on a daily or monthly basis. How the taxation of these and other types of accounts will be carried out is anyone's guess.

Some people in the banking community consider a personal income tax in the form of interest earned from savings accounts a natural development.

"These taxes are collected in all countries. Azerbaijan is actively working to improve the tax system. These amendments to the tax code again show that the country is on a path of integration into the global financial system," said VTB (Azerbaijan) Board Chairman Yuri Yakovlev.

The deputy chairman of the parliamentary committee on economic policy, Cingiz Asadullayev, who is  also head of the board of directors of AGBank, suggested during a discussion of the amendments to the Tax Code that banks increase interest rates on savings accounts in order not to lose depositors.

"We are currently seeing a downward trend in the number of insured deposits. People prefer to earn more rather than insure their deposits, that is, they prefer bank deposit products at a rate higher than 9 per cent. Banks will do what they can to prevent the loss of depositors who form their resource base, and will raise rates so that depositors, as a result of earning additional interest, do not feel the loss of incurred tax payments," said Asadullayev.

He noted that the Azerbaijani Deposit Insurance Fund (ADIF) was currently debating an option in which the restriction on the interest rate for insured accounts (currently at 9 per cent) would be lifted altogether. According to this option, the only condition for insuring deposits is that they not exceed 30,000 manats.

A possible increase in interest rates on savings accounts could lead to more expensive credit, which is inconsistent with the Central Bank's policy of lowering interest rates.

Yuri Yakovlev doubts that the introduction of the tax would have any major impact on interest rates on deposits. "In some cases, individual banks will raise rates as part of a special campaign. But given the general trend and policy of the Central Bank to lower lending rates, the tax will not result in an increase of the rate," he said. Moreover, he added, a possible increase in interest rates on savings accounts would not affect the interest rates on loans.

"We are not expecting changes of this sort in the market. Lending rates will continue to fall as part of the current general trend in the Azerbaijani banking sector," he said.

Nonetheless, some experts have expressed concern that once the tax is in effect, depositors will see a reduction in their dividends while interest rates remain flat or even fall. As a result, some people may simply take their money out of the bank and put it in other investment instruments or choose to deposit their money abroad.

Yuri Yakovlev rejects this concern. "Changes to the Tax Code do not result in the public withdrawing their savings, simply because the tax rate of 10 per cent is not critical. This is a small loss for the depositor and the bank. Of course, some customers may find that it is better to withdraw their deposits, but most will leave their savings untouched, will continue to make deposits, and will grow accustomed to this tax as an integral part of the business," he said.

Banks have reported that for the time being, there is no sign of a strong response from depositors.

Economic Effect

Currently, the average bank account interest rate is approximately 9.6 per cent, which, according to Central Bank of Azerbaijan (CBA) head Elman Rustamov, is quite high. According to his comments made during a recent debate in Parliament concerning the law "On the 2015 State Budget", this year, the general population stands to earn a total of 500m manats in interest from deposits. "This is a significant fi-gure, and it plays an important role in improving the social welfare of the population," he said. It should be note that between January and November 2014, the general population earned a total of 450m manats on their deposits. Out of 1,000 Azerbaijanis, 473 are deposit account holders.  The average deposit is valued at 745 manats and there are upwards of 6.4m total bank accounts belonging to private individuals.

Meanwhile, the Tax Ministry says that the decision to change the policy on taxing interest while preserving some breaks was made  in order to protect citizens and banks from risks.

According to Deputy Tax Minister Natiq Amirov, the new tax policy will yield 5m-6m manats per year in additional revenue for the Azerbaijani state budget.  "If the government were to simply cancel the tax breaks without putting a new policy in their place, then the state would receive around 60m manats in additional revenue," Amirov said.

Azerbaijan's state budget reve-nues for 2015 are projected to be 19.438bn manats. This means that the additional income generated by the new policy will increase the budget by only 0.03 per cent. Therefore this tax is more likely associated with efforts to reform the country's economy according to international standards than with desires to fill the budget.

WORLD EXPERIENCE

Taxes on interest earned from deposits exist in many countries. In Russia, the tax applies to deposits with high interest income (calculated using a special formula that looks at the difference between the deposit rate and the lending rate set by the CBR) at a rate of 35 per cent. In Ukraine, the tax rate is 20 per cent of interest earned.

Interest income is taxed in the UK, USA, Canada, Germany and many other countries, and in most of them, the rate varies according to the region of the country, the deposit amount and other factors. Taxes are not levied in Switzerland, but the country is no longer a tax haven for investors due to  agreements with countries to provide information on depositors from other countries.