A SHIFT IN MODEL

Azerbaijan is embarking on the most extensive tax reform in recent years. It affects virtually all key elements of the system—from control and administration to the taxation of income, VAT, depreciation, simplified tax, and sectoral exemptions.

Despite the external diversity of changes, the logic of the reform remains quite cohesive. The state is moving away from directly increasing fiscal pressure in favour of expanding the tax base and the systemic "formalisation" of the economy.

A mental shift

One of the conceptual innovations is the introduction of the institution of horizontal monitoring into tax legislation. In essence, this is about a shift in the philosophy of control. Instead of post-factum audits, there will be constant information exchange between the tax authority and the taxpayer.

For companies admitted to horizontal monitoring, desk audits are not conducted, and field audits are performed only in rare exceptions. In return, the taxpayer assumes expanded obligations regarding information disclosure and compliance with tax discipline. The rules for selection, the subject of monitoring, grounds for exclusion, and sanctions will be enshrined in separate articles of the code.

This mechanism is already used in a number of countries worldwide and, if correctly implemented, can reduce administrative costs for businesses, increase the predictability of tax obligations, and reduce conflicts with tax authorities. There is one risk here—a limited pool of participants. If access to monitoring proves narrow, the reform's effect will be local.

Changes in the taxation of profit and depreciation deductions are directly linked to horizontal monitoring. Companies participating in it gain the right to choose between the straight-line method and the diminishing balance method when calculating depreciation. A stricter approach is maintained for other taxpayers.

A soft return

The most sensitive element of the tax reform is the phased introduction of income tax for employees in the private non-oil sector. Since 2019, this category has enjoyed significant tax and social exemptions, which had a noticeable effect on formalising employment and wages.

Starting in 2026, a careful, time-staggered exit from the preferential regime begins. Rates will increase gradually—from 3% to 7% for incomes up to ₼2,500 by 2028, while maintaining moderate progression for higher incomes.

The mechanism is as follows. Until January 1, 2027, the tax rate for income up to ₼2,500 will be 3%; for income from ₼2,500 to ₼8,000—₼75 plus 10% of the exceeding amount; for income over ₼8,000—₼625 plus 14% of the exceeding amount. From January 1, 2027, the corresponding rates will increase to 5%, ₼125 plus 10%, and ₼675 plus 14%. From January 1, 2028, the plan is to set the rate at 7% for incomes up to ₼2,500, ₼175 plus 10% for the ₼2,500-₼8,000 range, and ₼725 plus 14% for incomes above ₼8,000.

Thus, the state seeks to maintain a balance: on one hand, to reintegrate income tax into the system; on the other, not to provoke a reverse shift of wages "into the shadows." The key risk is more psychological in nature. Employers and employees, especially in the small business segment, may perceive the removal of exemptions as a signal to reconsider employment terms. This is precisely why a scenario of phased increases was chosen, not a sharp fiscal reversal.

As noted by the Head of the Main Department of Tax Policy at the State Tax Service, Nijat Imanov, the results of the previous reform stage were substantial. Compared to the beginning of 2019, the number of employment contracts in the private non-oil and gas sector increased by 89.2%, exceeding 1 million by November 1, 2025. Their share of the total number of employment contracts grew from 38.5% to 54.2%. Furthermore, in 2024 compared to 2018, the total wage fund increased 2.5 times, and 2.7 times in the private non-oil sector. Revenues from compulsory state social insurance grew 2.5 times, including a 2.6-fold increase in the non-budget sector. Simultaneously, the share of budget transfers in the revenues of the State Social Protection Fund decreased—from 35.6% to 17.5%.

"The reform has allowed for significant progress in formalising employment. The current task is to preserve the achieved results and continue supporting the 'formalisation' of labour income. For this purpose, a mechanism for the differentiated application of taxes and insurance contributions is being formed, with a phased and soft transition," emphasised Nijat Imanov.

Against the shadow economy

One of the main lines of the reform is stimulating cashless payments. For VAT and simplified tax purposes, turnovers generated through POS terminals will be accounted for with a coefficient of 0.5. In essence, this means a reduction in the tax base specifically for "formal" turnovers.

The principle can be illustrated as follows. An individual entrepreneur in retail trade generated a turnover of ₼250,000 through cashless operations via a POS terminal and ₼50,000 in cash over 12 consecutive months. With a total turnover of ₼300,000, only ₼175,000 (250,000 × 0.5 + 50,000) are considered for VAT purposes. Since this amount is below the mandatory VAT registration threshold of ₼200,000, the entrepreneur does not incur an obligation to register as a VAT payer.

Simultaneously, for retail trade and services to the population, the mandatory VAT registration threshold is increased this year—from ₼200,000 to ₼400,000—but taking into account the application of the coefficient to cashless operations.

So, for example, a company providing legal services to citizens and conducting settlements exclusively through POS terminals received a turnover of ₼400,000 over 12 months. Considering the coefficient of 0.5, the taxable turnover for VAT purposes will be ₼200,000, meaning it does not exceed the registration threshold, and the obligation to register for VAT does not arise.

A different situation arises if the turnover structure is less transparent. For instance, an entrepreneur providing translation services received ₼250,000 through cashless operations and 100,000 in cash over 12 months. The total turnover was ₼350,000, but for VAT purposes, it will be calculated as ₼225,000 (₼250,000 × 0.5 + ₼100,000). In this case, the ₼200,000 threshold is exceeded, and VAT registration becomes mandatory.

These examples clearly demonstrate the reform's logic: the system incentivises not the growth of turnover itself, but its transparency and cashless form.

A separate set of measures concerns the catering sector—one of the most vulnerable to shadow practices. Here, a temporary, three-year reduction in the tax burden on cashless turnover is provided: the rate is reduced from 8% to 6%.

In practice, this looks like this. A catering enterprise provided services worth ₼50,000 in a month, of which ₼10,000 were paid in cash and ₼40,000 through a POS terminal. The amount of input VAT subject to reimbursement was ₼3,000. Before the change, the amount of VAT payable to the budget was ₼6,000; after—it is reduced to ₼2,400.

A similar effect is observed for simplified tax payers. With the same volume of services provided (₼50,000, of which ₼40,000 are cashless), the amount of tax payable decreases from ₼4,000 down to ₼3,200.

Collectively, these measures send a clear signal to the market: the transition to cashless payments and the "formalisation" of turnover ceases to be merely a regulator's demand and becomes a financially justified decision for business.

Another "grey" segment of the economy remains the residential rental market. In 2025, the first step towards its formalisation was taken with the introduction of the institution of a tax agent, which allowed landlords to declare income without independently registering for tax.

The next stage is reducing the income tax rate from 14% to 10% for individuals renting out housing to other individuals, creating an incentive for the voluntary declaration of income.

Redistribution or growth?

The increase in the road tax on petrol, diesel fuel, and liquefied gas is also often perceived as a fiscal tightening. However, in reality, it concerns the redistribution of an existing burden.

Thus, the current rate includes a component of ₼0.02 directed to the Compulsory Health Insurance Fund. The amendments envisage reducing this component and including it in the road tax, with proceeds going to the state budget. An additional factor is the creation of the "Public Transport" Targeted Budget Fund, which will be sourced from part of the fuel road tax.

Also, one of the most resonant elements of the tax reform has been the introduction of VAT on electric and hybrid cars.

Since 2019—at the import stage, and since 2022—both the import and sale of electric cars (including hybrids) enjoyed significant tax exemptions. This produced the expected effect: renewal of the vehicle fleet and growing interest in "green" transport.

However, the market structure has changed in recent years. Local automobile manufacturing has begun to form in the country, including plans to produce electric and hybrid models from 2026. Against this backdrop, since 2023, the sale of passenger cars, including electric and hybrid ones, produced in Azerbaijan, has been exempt from VAT for 10 years.

From 2026, incompletely assembled imported electric buses intended for subsequent assembly within the country are also exempt from VAT.

The social element

One of the most socially oriented elements of the reform is changes to the system of social contributions for individual entrepreneurs. A transition is proposed from fixed payments tied to the minimum wage and regional coefficients to a single rate of 2% of turnover with established minimum and maximum limits.

The minimum insurance contribution amount will be 15% of the minimum wage (₼60), the maximum—one minimum wage (₼400). This model makes the system more flexible and fair, as the burden directly depends on real income.

Thus, for a micro-entrepreneur in trade with a monthly income of ₼5,000, the contribution under the new model will be ₼100 (2% of turnover), meaning it will remain at the current level. For an entrepreneur with an income of ₼3,500, the contribution will decrease from ₼100 to ₼70, and in the services sector with an income of ₼3,000—to the minimum ₼60. In the regions, the new model prevents a sharp increase in burden: with an income of ₼1,500, the contribution will be ₼60 instead of a more than threefold increase under the current system.

Importantly, the reform affects precisely the segment with the lowest incomes. Around 80% of individual entrepreneurs—micro-entrepreneurs—have an annual turnover of up to ₼60,000, and it is precisely for them that the burden either decreases or stabilises.

Contributions for compulsory state social insurance paid by the entrepreneur for themselves are not a tax in the classical sense. These funds form personal pension capital and directly influence future pension payments.

A reform without illusions

Commenting on the changes to tax legislation, the Chairman of the parliamentary Committee on Economic Policy, Azer Amiraslanov, emphasised that "if the goal of the reform were to increase the tax burden, the volume of tax and customs exemptions in 2026 would not reach 17% of budget revenues—₼6.6 billion. This directly points to a different logic at play: not extraction, but redistribution and expansion of the tax base."

The forecast for State Tax Service revenues in 2026—₼16.91 billion, or 43.8% of budget revenues—in itself reflects the architecture of the reform. The growth is ensured not through a mass increase in rates, but through expanding coverage and formalising economic operations.

The new model also carries certain risks, primarily behavioural ones. Its effectiveness will depend not only on the norms of the Tax Code but also on the quality of administration, the effectiveness of dialogue with business, and the state's ability to maintain trust. In a strategic sense, however, the reform appears as an attempt to transition from fiscal pressure to managed transparency—a rare, complex, but essentially inevitable choice.