Module 1 Theoretical Fundamentals of Taxation in Ukraine

Module 1. Theoretical Fundamentals of Taxation in Ukraine Topic 1. The essence of taxation, its functions and elements 1. 1. The history of taxation

• Taxes form an element of the social existence. Human society is heterogeneous for natural and physiological reasons. Already in antiquity this made people unite their efforts and wealth for the purpose of responding to natural disasters and external enemies, as well as in order to build common towns, to support the people not able to work and to provide for many other social needs. Taxes constitute an integral attribute of the state. Taxes became a necessary element of the socio-economic relations at the formation of the state.

• Primary taxes were initially applied directly on wealth through land individual taxes. Secondary taxes appeared later, initially in the form of internal customs charges, and with the development of commodity-monetary relations, in the form of excises, which were paid by all the free individuals.

• In Ancient Rome, during peace times there were no taxes, but in times of war, citizens were subjected to taxes applied in accordance to their wealth. The tax rate (or the census) was determined once in 5 years. In the IV-III centuries B. C. the Roman state was expanding, new townscolonies were being conquered and the taxation system was changing as well. Community (local) taxes and duties were being introduced in the colonies. Rome was becoming an empire.

• The main source of income for the Roman provinces was the land tax; on average its rate constituted 1/10 of the revenue from the land area. Other taxation forms were also used, for example, the tax on fruit trees or vine plants. In addition, chargeable to taxation were real estate, live assets (horned cattle and slaves), and other valuables. In addition to direct taxes, there were indirect ones, the most important of which were: • -Transactions taxes, usually at the rate of 1% • -Special taxes on slave transactions of 4%, • -Taxes on the release of slaves at the rate of 5% of their market price.

• Already in the Roman Empire taxes played not only a fiscal role, but also had the function of stimulating economic development. At that time taxes already had a monetary form, which forced the population to generate surplus production for sale. This promoted the expansion of commodity-monetary relations, an intensification of the division of labour and of the urbanisation process.

• Many economic traditions of the Ancient Rome were adopted in the Byzantine Empire. In the early Byzantine period of up to the end of the VII century, the empire had 21 types of direct taxes, including: • Land taxes • Individual duties • Army maintenance taxes • Taxes on the purchase of horses • Recruit taxes, which released the person paying the tax from military obligations • Charges on the sale of merchandise (usually around 10 -12. 5%) • Charges for issued state documents.

• The taxation system changed its form and improved under the influence of class conflicts. Its regressive character, conditioned by the preponderance of indirect taxes started to change in the 20 th century in direct conformity with the transition to progressive income taxation. The taxation system of the 20 th century, as a result of the efforts made in the finance science and practice is distributing the taxation burden more uniformly than ever in the history of taxation.

• In general, the taxation system is a complex and effective mechanism for the regulation of economic conditions; it is a flexible instrument, which influences the profitability of various ownership forms, and the effectiveness of national economies in the conditions of the current science development and of economic globalisation. However, the taxation policy of the state (which is defined as the manoeuvring of the rates and types of taxes) is subject to the lag effect, in contrast to the banking-monetary policy, which is caused by the fact that any change of the tax rate must take the form of a legal document.

• 1. 2. Key terms of taxation: its economic content, functions, tax allowances • In general, a duty (payment, contribution) is a compulsory payment to the appropriate budget charged from payers of dues on condition they obtain special benefit, particularly as a result of the performance of actions with the legal effect to their benefit by state authorities, local self-government bodies, other authorised bodies and parties.

• Taxes are a defined as mandatory payments of the contributors to the budget and to the extra- budgetary funds in the amount determined by law and within the stipulated deadlines. Taxes represent the monetary relations of the state with corporations and individuals regards to the redistribution of the national income and the mobilisation of financial resources to the budgetary and non-budgetary funds of the state.

• Ricardo wrote “Taxes form the share of the produce and work of the country, • which is transferred to the government, and ultimately they are always paid from the capital or income of the country. ” • Sokolov wrote: “Taxes should be understood as the compulsory collection of funds charged by the state from corporations and individuals in order to provide for its costs, without offering the tax-payer a corresponding equivalent. ” Which means that the state collects with the help of taxes means for the formation of a centralised state fund necessary for the fulfilment of the state functions.

• 1). The main function of taxation is the fiscal one. It is through fiscality that taxes play their role in the formation of the state budget necessary for the realisation of national and holistic state programmes. The fiscal function provides for the achievement of the main social goal of taxation — the formation of the state’s financial resources necessary for executing the role of the latter (defence, social, environmental protection, etc. )

• 2)The allocation function of taxation expresses their essence as a special centralised instrument of allocation relations and consists of the social income redistribution among various groups of citizens: from wealthy to deprived ones, which ultimately provides for the assurance of the social stability of the population.

• 3) The regulatory function of taxation was initiated as soon as the state started to take active part in the economic set-up of the society. This function is aimed at achieving specific goals of the taxation policy through the taxation mechanism. Taxation regulation entails three sub-functions: • a)The stimulating subfunction is aimed at the development of special socio-economic processes, and is implemented through a system of allowances, exemptions and preference arrangements. The legislation in force stipulates the stimulation of a number of taxpayer categories such as the owners of small enterprises, the agricultural producers, capital investors, or charities.

• The destimulating sub-function inhibits some socioeconomic processes through the conscious exaggeration of the taxation burden. As a rule, the effect of this subfunction is related to the introduction of excessive tax rates. These are, for example, the protectionist measures of the state, aimed at supporting local producers through prohibitive import custom duties. It is important to keep in mind, nevertheless, that taxation relations, as any other relations, must replicate continuously. Taxes must be collected today, tomorrow and always. This is why the utilization of the destimulating sub-function should not lead to the weakening of the taxation basis, to suppression, or even to liquidation of the tax source. Such an exaggeration may result in a situation where there will be no income/processes to be taxed.

• 4) The controlling function of taxation— through taxation, the state controls the financial-economic activity of persons. This also contributes to controlling the sources of income and the directions of spending. • 5). The incentive function stipulates special taxation arrangements for a certain group of citizens, who are social achievers (participants in wars, etc. ). This function of taxation has a social facet.

• The unifying basis of all taxes in Ukraine and other countries are the taxation elements. One of the main elements, typical for the taxation instrument as a whole, is the notion of payer, i. e. , the notion of the taxation subject.

• The taxation subject is the individual or company, fulfilling taxation obligations in accordance to the ownership of the taxation object. Every citizen of a state is a taxation subject. If the state has the right to deduct a part of the income, this relates to the obligation of each citizen to offer a part of his/her wealth to the state. In this context, one should not forget about the distinction between the taxpayer and the taxcarrier. The former is the entity that initially pays the tax; the latter is the entity carrying the tax as a result of economic processes and transfers. This takes place primarily at the deduction of secondary taxes. For example, taxation subjects are responsible for paying the VAT, yet the real carriers of the tax are the consumers.

• The taxation object is the object or phenomenon, which, according to the law, is being taxed. Taxation objects can be classified in the following way: income (income tax), wealth (real estate, land), wealth transfers (inheritance and gift tax), consumption (excises and VAT), or the import and export of goods (customs duties). Income taxation is divided into the taxation of earned and unearned income. Earned income tax relates to salaries, fees of people engaged in freelance occupations, the income of individual juridical persons. Taxation of unearned but legal income refers to dividends, interest revenue, capital expansion, land real estate rents. The taxation object materializes as a result of legal events (actions, events, conditions), which affect the obligation of the subject to pay the tax: the sale of goods, works and services; the transit of goods though a customs territory, ownership of wealth, the receipt of inheritance rights, the receipt of revenue in one or another form.

• A tax allowance is a full or partial reduction of the taxation burden in correspondence with the legislation in force. In the international practice, the system of allowances and reliefs has been formed along time ago. Individual income is taxed only after it reaches a certain level (which is the non-taxable income). Additional sums for the maintenance of each dependant, expenditures for the support of infants and elderly, for medical services that cost over a certain amount, for charitable donations and for education expenses are subtracted from the taxed income. It is possible to develop a certain systematisation of tax allowances. These can be classified into permanent and temporary allowances.

• Temporary allowances are granted to adolescents, re fugees, foreigners, and people without a permane nt residence in the given state but who are • there only temporarily. • Permanent tax allowances are granted to people, who are fulfilling other obligations or who have earned special merits with the state.

• Tax allowances provide for the financialeconomic stimulation of the economic activity of the taxpayer through the reduction of the taxation burden obligations. Tax allowances form an important element of the taxation policy and entail social and economic goals. For example, in the sphere of international economic relations, tax allowances are widely used as an incentive for exporters and foreign investors. Tax allowances are usually implemented through the taxation obligation of the payer, but sometimes this is done through the extension of the payment deadline, which is also a reduction in the taxation obligation. Tax allowances include the following types:

• 1) The untaxed minimum • 2) Exempting from taxation certain elements of the object • 3) Exempting from the payment of taxes certain natural persons or categories of payers • 4) The reduction of the tax rate • 5) Full tax relief, and others.

• The tax amount can be reduced either partially or entirely, for a limited or unlimited period of time. The exemption from tax for a certain period of time is called a tax break. The process of appropriation removes certain objects from being covered by taxation. Appropriation can be relevant permanently or temporarily, for all taxpayers and for certain categories. Tax discounts are aimed at the reduction of the taxation basis. Depending on the influence on the results of taxation, discounts can be divided into limited discounts (the size of the discount is limited directly or indirectly) and unlimited discounts (the taxation basis can be reduced up to the full amount of the payer’s expenditure).

• Tax credits are allowances aimed at the reduction of the tax amount and of the taxed sum. The tax credit takes the form of accounting for previously paid taxes and is used in order to avoid double taxation (a credit foreign tax).

• The tax rate is the size of the tax set per unity levied. There are fixed and percentage rates. Percentage rates are classified can be proportional, progressive or regressive. It is important to emphasize the notion of base (main) rate, i. e. the rate that does not take into account the specific characteristics of the subject or the type of activity.

• Progressive rates increase with the increase in the taxation object, in accordance with a tax rates ladder. Progressive taxation is related to the notion of discretionary, or free income. Discretionary income isdefined as the difference between the total amount of income obtained by the payer and the untaxed minimum income. Progressive taxation is defined through an increase in the tax rate in conformity with simple and complex progression.

• With the simple progression method, an increase in income leads to an increased taxation rate of the entire income. • With the complex progression method, a specific ladder taxation is applied, where the size of the rate is determined in accordance with the rate of income increase, yet the increased rate does not apply to the entire income, but only to the sum that exceeded a certain level (income tax for natural persons).

• Complex progression is opportune for payers with high incomes; this is why it became very popular. • A mixed taxation method is used in practice. This method implies using the progressive method for one part of the object and the proportional method for the rest of the object. • Regressive taxation is the method where an increase in income (the taxation object) leads to a decrease in the taxation burden.

• There is also the reduced rate, which takes account of the specific traits of the payer and applies a reduced taxation burden, and the increased rate, which again takes into consideration the specific activity type that leads to income creation and applies an increased rate. • Tax rates can also be classified as follows: • * Value added rates — expressed in percentages (income tax) • * Specific rates — expressed in a monetary form in conformity with the physical features of the objects levied (ex. the land tax). • In terms of content, there are marginal, factual and economic rates. A marginal rate is indicated directly in the taxation legislation (ex. income tax for a company).

• The factual rate is defined as the relation between the paid tax amount and the total amount of income received. The comparison of economic rates most adequately represents the consequences of taxation.

• The taxation basis is the part of the taxation object expressed in levied units, to which a tax rate is applied in correspondence with the law. For example, when income is taxed, not all of it will serve as the taxation basis, but only a part of it — the taxable income. In a number of cases the taxation basis is factually a part of the object levied, to which the tax rate is applied.

• But this is relevant only in the cases where the taxation object is directly conducive to and allows for a calculation measure. Thus, the taxable profit can be expressed directly in monetary units. In contrast, the majority of the taxation objects cannot be expressed directly in taxation units. In order to measure the object, it is necessary to first select some physical feature, i. e. to determine the measuring unit of taxation. For example, the taxation object for car owners is the car itself. Different countries have various parameters of levying: in France it is the power of the engine, in Holland—the weight of the car, in Germany—the volume of the operating cylinders of the engine. In these cases, the taxation basis cannot be determined as the part of the taxation object.

• Tax payment deadlines are dates indicated in the law, when payments have to be made to the state or local budgets, as well as to extrabudget ary funds. Missing the deadline automatica lly leads to penalties, irrespective of the identity of the taxpayer who missed the deadline.

• The source of tax payment is a resource used for paying the tax. The source is different from the object and does not always correspond to the latter. Irrespective of the taxation object, the source of the tax payment can only be the net income (profit) or the capital of the taxpayer. Thus, the object of the land tax is land ownership and the taxed item is the specific piece of land.

• Tax Classification • Principles of Tax Classification • The existing taxation system includes various types of taxes, which defer from one another in form andc ontent. In practice, tax classification is done according to various criteria: • In accordance with the collection method: • 1. Direct taxes which are determined directly for the income or wealth (income tax, land, individual tax, real estate tax, and others) • 2. Indirect taxes which are applied to goods and services in the form of an addition to the price or tariff (VAT, excises and the customs duty).

• In accordance with the taxation object • 1. Income tax (profit tax, income tax for natural pers ons) • 2. Taxes on wealth (individual tax, real estate tax, inheritance and gift tax) • 3. Consumption tax (VAT, excises, customs duties) • In accordance with the objective asset: • 1. Fiscal, aimed at the formation of the state budget • 2. Limiting (excises and customs duties) • In accordance with the taxation subject — individual and corporate taxes

• In accordance with the entity, which deducts the tax and disposes of it: • 1. State taxes, determined by state legislation, transferred into the state budget and applied in the same way for the entire territory: income tax, VAT, excises, customs duties, individual tax • 2. Local taxes collected by the local authorities of the corresponding territory and transferred to the local budget: real estate tax, land tax, natural resources charges and local charges.

• In accordance to the purpose of utilization: • General taxes are amalgamated and transferred to a single state account; they are directed for general state programmes. General taxes encompass the majority of the taxes in any taxation system. • Special (purpose) taxes have a strictly defined p urpose and are aimed at a certain type of expen ditures (land tax, road tax, natural resources charges). As a rule, special extrabudgetary funds are created for the special purpose taxes and a special article for this type of tax is introduced in the budget law itself.