ECONOMIC SHADOW

Today the shadow economy with multimillion-dollar financial flows escaping official records, control of fiscal services and state budget is an increasingly profitable business of global scale despite the strengthened counter measures. Azerbaijan is not an exception in this case. The share of existing informal relations between businesses and tax authorities in the national economy has not reached dangerous levels, but causes serious concerns.

The objective of new large-scale tax and social reforms is to ensure transparency of business operations and stimulate the growth of voluntary transfers to state budget.

Starting from scratch

Since there is no precise data, let's look at some figures to somehow show the volume of the shadow economy in Azerbaijan. In 2018, the Ministry of Taxes revealed that a number of large wholesale companies, supermarket chains and private clinics lowered the volume of their turnover in the amount of ₼1.3 billion. Most of the turnover amount hidden from taxes (₼0.9 billion) fell is the share of wholesalers. This data covers only a tiny portion of the private sector. One can add to this amount the millions of manats paid as "dirty" wages, which bypassed the social insurance system, and received from smuggling goods. Therefore, the situation requires taking immediate action.

According to the Minister of Taxes Mikayil Jabbarov, the fight against the shadow economy is the primary task for 2019. All fiscal services will work together for this. "Our intention is to build direct relations with businesses. We think to start everything from scratch. So far, we have received positive feedback. We think that we are on the right track," the minister said.

In fact, everything starts from a fair approach. If an entrepreneur sees obvious "favors" from fiscal services in relation to his competitors, it is impossible to expect a confidential and honest attitude from him. There are situations when honest working businessmen simply lose market position in favour of their shadow business rivals. This leads to a massive outflow of entrepreneurs as illegal immigrants, which feeds and stimulates the shadow economy, grows and becomes a threat to the nationwide economic development.

According to Jabbarov, the fiscal reforms started last year are developed to eliminate these negative aspects. "We gave entrepreneurs time to restore the accounting system. We had to tighten control in some sectors. First results are positive: the volume of recorded turnover and, accordingly, tax revenues, as well as the number of employees increased. If we manage to establish a robust system for formalising transactions between the key sellers and buyers in the market, we will be able to ensure transparency in the economy," Minister Jabbarov said.

In fact, the tax authorities encounter different schemes of tax evasion, such as the fragmentation of business, creation of one-day companies, etc. It is not easy to fight against all of them. It is necessary to overcome obvious discontent and resistance. There are entrepreneurs who prefer to wait and see, hoping that the process is temporary. "The times when some people engaged in obscure business schemes are over. As to ensuring the transparency of business relations, there is no turning back. Good taxpayers should be treated individually such that they can take advantage of legitimate benefits, which will prevent unfair competition and make business operations within legal framework more profitable," Jabbarov said.

Yet another amnesty

International financial institutions also support the aspiration of the Azerbaijani government to combat the shadow economy without increasing the tax burden. Thus, according to the head of the World Bank’s office, Navid Hassan Nagvi, in 2018 the share of tax revenues in Azerbaijan’s GDP was 14%, which is considered an average compared to other similar economies based on revenues from natural resources. "But if we compare this figure with countries that have passed a similar historical path and institutional structure, then there are big changes in Azerbaijan. If Azerbaijan continues its efforts to eliminate the shadow economy, the results will be even more impressive," Nagvi said.

The government announced plans to improve the protection of taxpayers through creating a separate Institute of Tax Ombudsman, which will automatically increase the responsibility of tax officials for their decisions.

At the same time, another widely popular tool for "whitewashing" the economy is tax amnesty. In 2017, Azerbaijan introduced a similar mechanism, which made it possible to write off non-payment interest and part of financial sanctions. As part of the law on partial tax amnesty, the Ministry of Taxes wrote off the interest debts of almost 72 thousand taxpayers and financial sanctions (more than ₼743 million).

However, entrepreneurs believe that this process can be continued and expanded. According to the president of the American Chamber of Commerce in Azerbaijan (AMCHAM) Nuran Kerimov, this would make a significant contribution, in particular, to the issue of registering enterprises and disclosing assets. This issue is still on the agenda of the Ministry of Taxes, but so far there is a study of foreign experience, positive and unsuccessful examples of the consequences of this step.

There are still enough tax changes for this year. Since January 1, 2019, the government has introduced 240 amendments to the Tax Code significantly changing the tax legislation. Although not all taxpayers were able to adapt to these changes, it is necessary to pay taxes and report on them. This, of course, creates some nervousness in the business-state relationship. Therefore, entrepreneurs reasonably ask the fiscal departments to continue to announce such large-scale changes in advance. "The parliament adopted the changes on November 30, 2018. They were approved on December 20, 2018 and entered into force on January 1, 2019. This is a very short time and the businesses do not have time to adapt to the changes in a timely manner," N. Kerimov said.

Investment attractiveness

By the way, one of the changes easily adopted by businesses is the elimination of income tax for employees of the private sector (with the exception of oil and gas companies). Thus, the number of concluded labour contracts in the first months of 2019 has increased significantly. According to the Minister of Labour and Social Protection, Sahil Babayev, in January 2019, approximately 20,000 new labour contracts were concluded. "This data changes daily. Every day new contracts are added and old contracts are cancelled. In general, we believe that the increase in the minimum wage, the application of benefits in the private sector, the expansion of the coverage of the employment system and the use of many other tools play an important role both in legalising the labour market and increasing the number of labour contracts," S. Babayev said.

Legalisation of labour relations is another important tool for "whitewashing" the economy. Ultimately, the goal of all reforms is to facilitate business activities in the country, to create equal and favourable conditions for all businesses. Then the results of attempts made in recent years to increase the investment attractiveness of the economy will be even more noticeable. According to the Minister of Economy, Shahin Mustafayev, thanks to the reforms implemented in 2018, the share of the private sector in GDP reached 84% with 76% of employment in the private sector. Tax reforms contribute to the growth of this indicator. "According to a recent EU survey on the assessment of the business environment in Azerbaijan, 66% of respondents answered positively to the question "Would you invest in Azerbaijan?" At the same time, 89% of the respondents announced plans to expand their activities in Azerbaijan in the next couple of years or to maintain their activities at stable level," Mustafayev said.

Any changes in tax procedures stimulate the national economy leading either to positive or negative effects. In this case, whitening of the shadow economy will undoubtedly strengthen the economic potential of Azerbaijan leading to a significant increase in both GDP and state budget potential.