22 February 2006

Tax Incentives for the IT Industry

VVP's trip to Nizhny Novgorod has really enforced the fact that he is serious about doing something to support the IT industry. This should really be entered under the "competition for teacher's pet" category but it's potentially too serious for that.

From Vedomosti (Russian only) an article entitled "The Chinovniki Rethink." (A straw poll of native Russian speakers determined that Chinovniki (bureaucrats) was being used in a (mildly) derogatory way.) The full text in machine-translated English is below the commentary.

The long and short is that the Ministry of Finance has agreed under significant political pressure to review their previous position against using tax incentives to help the export (offshoring/outsourcing/product-related) section of the IT/technology industry. Principally these relate to a simplified taxation scheme which relates to profit tax and VAT/NDS. The article also makes reference to a reduction in social taxes (employee-related taxes paid by the company.) These are significant and remain the single largest reason why IT companies stay in the black economy.

Whilst I am delighted that something is being done research in to the effectiveness of British, Irish, Israeli and US venture capital and start-up industries has shown that tax incentives play little or no role in their successful development. If this is done in alliance with a well-constructed Government venture fund-of-funds then I can only be in favor. As the piece notes this is a policy that is being enacted to be shown to do something even if something is not always beneficial.

"ministries are easy to be understood: the assignment of the privileges to separate branches generates abuses and corruption, discusses deputy director Centre of political technologies Aleksey Makarkin. - but simultaneously for officials it is necessary to carry out the commission of the President and to diversify the economy, and support IT - one of a few methods to make this ".
Here is the translation in its entirety:

Minfin - Ministry of Finance and Minekonomrazvitiya, until now, were against the tax preferences for IT- companies, are now ready to change their position. As it was stated yesterday by the Deputy Minister of finances Sergey Shatalov, the solution to transfer IT- sector to the special tax regime has more pluses, than minuses. Participants of the market are astonished by the change of officials mood, and experts explain it by the interest, which Vladimir Putin devotes to IT- sector. The Deputy Minister of finances Sergey Shatalov reported yesterday that in the next weeks Minfin - Ministry of Finance will study the possibility of the introduction of special tax regime for IT- companies. To make this department directed vice- premier Aleksandr Zhukov at the session of the commission for law making activity, explained Deputy Minister. "we see pluses and minuses of this solution, and now we are ready to say that there are more pluses, but also a lot of minuses", cites Shatalov the agency "of Prime- TASS". the Press- secretary of the minister of finances Gennadi Yezhov yesterday could not comment the attitude of Minfin toward idea in more details, and the official demand of "Vedomosti" to Shatalov remained without the answer.

The opinion of Minfin - Ministry of Finance is required in order to prepare conclusion to the bill, introduced to the government at the end of the past year by a number of parliamentarians, explained to "Vedomosti" the director of the department of strategy of the information society construction of mininformsvyazi Oleg Byakhov. The authors of bill propose to supplement tax code with the chapter, which leads special tax regime for IT- branch. "support must bear precisely branch nature", he emphasizes Byakhov, citing as an example of Russian Agricultural products producers, that are used special tax regime. "we helped deputies to prepare this bill and gave positive conclusion, he says. - it is now necessary that Minfin - Ministry of Finance and Minekonomrazvitiya to finish mechanism". At the end of 2004 the government supported the proposal o mininformsvyazi to grant the IT-companies tax and customs preferences - in particular, to simplify the procedure of the customs formulation of the programs, which go for the export, and to decrease the rate of unified social tax. But as a result these eased regime was decided to grant not to separate branch, but to special economic zones (SEZ), law about which developed Minekonomrazvitiya. At the end of 2005 this ministry totaled of competition to the title SEZ, and from numerous IT- projects it supported only four.

The project of the law, which promises to IT- association tax relaxations, appeared in the summer of 2005, but then it was rejected in Minekonomrazvitiya, resembles the President of holding IBS Anatoliy Karachinskiy. But now government decided to examine this idea anew. "We propose to support first of all companies, which work on the export", described to "Vedomosti" one of the authors of bill - chairman of the committee of the Dumas on credit organizations and financial markets Vladislav Reznik. According to him, the discussion deals with the introduction of the single tax, which will lower tax burden on IT- company from present 36% to 6-9% of their gain. Byakhov confirms that this support must obtain only companies, "the predominant portion of its revenue is connected with deliveries of IT- products and services for the global market", in this case not less than their 50% expenditures must be connected with the payment of wage to employees.
"Volume of the world market IT-autsorsinga - $60 billion, and in portion of Russian companies is only $1 billion", laments Karachinskiy. If government approves bill, then many small companies will leave the shadow and they can raise money from investors. "Law will contribute to development of IT- sector, although its present version still must be corrected - for example, tax preferences must not concern small enterprises, which fall under the simplified taxation", notes the President of the association of "russoft" Valentina Makarov.

Representative Minekonomrazvitiya promised that his department will examine the initiative of deputies, after recalling that earlier it spoke against the support of business according to the branch principle. Yes even in Minfin this idea half a year ago was criticized. "ministries are easy to be understood: the assignment of the privileges to separate branches generates abuses and corruption, discusses deputy director Centre of political technologies Aleksey Makarkin. - but simultaneously for officials it is necessary to carry out the commission of the President and to diversify the economy, and support IT - one of a few methods to make this ". Year ago in Novosibirsk Vladimir Putin issued a call government to support innovation projects, and he last week criticized by several officials for sluggishness. Now Minfin and Minekonomrazvitiya completely can support the idea to create tax preserve for IT, although this solution will be political, sums up Makarkin.

2 comments:

Daniel Nerezov said...

Very interesting points on the relationship between tax reform and IT contribution to GDP. I think the short term measures discussed here are great, except that longer term measures are also important.

From one point of view, whilst things like grants, R&D tax breaks and capital gains concessions have been used in countries like Australia - my personal experience has been that these measures haven't been effective - because they haven't worked to institutionalise a national entrepreneurial culture.

So, the culture for risk taking is important, it's unquantifiable, it doesn't happen over night - and it's starts in the classrooms rather than in the corridors of duma.

That said, Russia has an incredibly entrepreneurial culture which is largely underground. The Global Entrepreneurship monitor is testament that Russians want to do startups, they are doing startups, they've always been doing startups except that no one wants to go legit for the tax reasons you mentioned.

This underground approach to private enterprise has been going for 80 odd years, it even used to have its own name (and criminal code section) for it, and I think these legislative changes may well prove to be a great experiment to see how many founders decide to turns their backs on the old way of doing business, declare income and go legal.

From my personal point of view however, the fin ministry has a lot of work cut out for them. Venture capital starts with availability of LPs, and Russia's pension system just doesn't have the compulsory contributions regime that's necessary to create large pools of risk capital.

I think in the future that will change with Russia developing a proper three tiered system for retirement savings, and it will take some time for Russian mutual funds to multiply, capitalise and allocate money to private equity, but when this does happen, I think this would be the most effective structural change to support Russian innovation in IT.

Retirement savings - that's the overwhelming problem facing Russia - solve that and the country will have a shot at resurrection.

The Poster said...

Daniel,

I think that you have to create a separate definition of entrepreneurialism for what happens in Russia versus the Silicon Valley model (for example). The term that I have heard and used a number of times is "zhiguli" entrepreneurialism - it generally does not work therefore you need to be clever to keep it on the road and identifying where to find the spare parts. The definition is slightly dated (mid-90's) but the concept is right. Being willing to take risk is a necessary but not sufficient condition for an entrepreneurial culture. To create meaningful businesses knowledge of sales and marketing techniques is probably more important - a good management team can rescue a bad technology......

As the government addresses one area of the "ecosystem," as broadly defined, it becomes very clear that other areas are still barely nascent. The biggest change I would like to see has nothing to do with the technology sector per se - a simplification of running small business.

But in general positive steps.

22 February 2006

Tax Incentives for the IT Industry

VVP's trip to Nizhny Novgorod has really enforced the fact that he is serious about doing something to support the IT industry. This should really be entered under the "competition for teacher's pet" category but it's potentially too serious for that.

From Vedomosti (Russian only) an article entitled "The Chinovniki Rethink." (A straw poll of native Russian speakers determined that Chinovniki (bureaucrats) was being used in a (mildly) derogatory way.) The full text in machine-translated English is below the commentary.

The long and short is that the Ministry of Finance has agreed under significant political pressure to review their previous position against using tax incentives to help the export (offshoring/outsourcing/product-related) section of the IT/technology industry. Principally these relate to a simplified taxation scheme which relates to profit tax and VAT/NDS. The article also makes reference to a reduction in social taxes (employee-related taxes paid by the company.) These are significant and remain the single largest reason why IT companies stay in the black economy.

Whilst I am delighted that something is being done research in to the effectiveness of British, Irish, Israeli and US venture capital and start-up industries has shown that tax incentives play little or no role in their successful development. If this is done in alliance with a well-constructed Government venture fund-of-funds then I can only be in favor. As the piece notes this is a policy that is being enacted to be shown to do something even if something is not always beneficial.

"ministries are easy to be understood: the assignment of the privileges to separate branches generates abuses and corruption, discusses deputy director Centre of political technologies Aleksey Makarkin. - but simultaneously for officials it is necessary to carry out the commission of the President and to diversify the economy, and support IT - one of a few methods to make this ".
Here is the translation in its entirety:

Minfin - Ministry of Finance and Minekonomrazvitiya, until now, were against the tax preferences for IT- companies, are now ready to change their position. As it was stated yesterday by the Deputy Minister of finances Sergey Shatalov, the solution to transfer IT- sector to the special tax regime has more pluses, than minuses. Participants of the market are astonished by the change of officials mood, and experts explain it by the interest, which Vladimir Putin devotes to IT- sector. The Deputy Minister of finances Sergey Shatalov reported yesterday that in the next weeks Minfin - Ministry of Finance will study the possibility of the introduction of special tax regime for IT- companies. To make this department directed vice- premier Aleksandr Zhukov at the session of the commission for law making activity, explained Deputy Minister. "we see pluses and minuses of this solution, and now we are ready to say that there are more pluses, but also a lot of minuses", cites Shatalov the agency "of Prime- TASS". the Press- secretary of the minister of finances Gennadi Yezhov yesterday could not comment the attitude of Minfin toward idea in more details, and the official demand of "Vedomosti" to Shatalov remained without the answer.

The opinion of Minfin - Ministry of Finance is required in order to prepare conclusion to the bill, introduced to the government at the end of the past year by a number of parliamentarians, explained to "Vedomosti" the director of the department of strategy of the information society construction of mininformsvyazi Oleg Byakhov. The authors of bill propose to supplement tax code with the chapter, which leads special tax regime for IT- branch. "support must bear precisely branch nature", he emphasizes Byakhov, citing as an example of Russian Agricultural products producers, that are used special tax regime. "we helped deputies to prepare this bill and gave positive conclusion, he says. - it is now necessary that Minfin - Ministry of Finance and Minekonomrazvitiya to finish mechanism". At the end of 2004 the government supported the proposal o mininformsvyazi to grant the IT-companies tax and customs preferences - in particular, to simplify the procedure of the customs formulation of the programs, which go for the export, and to decrease the rate of unified social tax. But as a result these eased regime was decided to grant not to separate branch, but to special economic zones (SEZ), law about which developed Minekonomrazvitiya. At the end of 2005 this ministry totaled of competition to the title SEZ, and from numerous IT- projects it supported only four.

The project of the law, which promises to IT- association tax relaxations, appeared in the summer of 2005, but then it was rejected in Minekonomrazvitiya, resembles the President of holding IBS Anatoliy Karachinskiy. But now government decided to examine this idea anew. "We propose to support first of all companies, which work on the export", described to "Vedomosti" one of the authors of bill - chairman of the committee of the Dumas on credit organizations and financial markets Vladislav Reznik. According to him, the discussion deals with the introduction of the single tax, which will lower tax burden on IT- company from present 36% to 6-9% of their gain. Byakhov confirms that this support must obtain only companies, "the predominant portion of its revenue is connected with deliveries of IT- products and services for the global market", in this case not less than their 50% expenditures must be connected with the payment of wage to employees.
"Volume of the world market IT-autsorsinga - $60 billion, and in portion of Russian companies is only $1 billion", laments Karachinskiy. If government approves bill, then many small companies will leave the shadow and they can raise money from investors. "Law will contribute to development of IT- sector, although its present version still must be corrected - for example, tax preferences must not concern small enterprises, which fall under the simplified taxation", notes the President of the association of "russoft" Valentina Makarov.

Representative Minekonomrazvitiya promised that his department will examine the initiative of deputies, after recalling that earlier it spoke against the support of business according to the branch principle. Yes even in Minfin this idea half a year ago was criticized. "ministries are easy to be understood: the assignment of the privileges to separate branches generates abuses and corruption, discusses deputy director Centre of political technologies Aleksey Makarkin. - but simultaneously for officials it is necessary to carry out the commission of the President and to diversify the economy, and support IT - one of a few methods to make this ". Year ago in Novosibirsk Vladimir Putin issued a call government to support innovation projects, and he last week criticized by several officials for sluggishness. Now Minfin and Minekonomrazvitiya completely can support the idea to create tax preserve for IT, although this solution will be political, sums up Makarkin.

2 comments:

Daniel Nerezov said...

Very interesting points on the relationship between tax reform and IT contribution to GDP. I think the short term measures discussed here are great, except that longer term measures are also important.

From one point of view, whilst things like grants, R&D tax breaks and capital gains concessions have been used in countries like Australia - my personal experience has been that these measures haven't been effective - because they haven't worked to institutionalise a national entrepreneurial culture.

So, the culture for risk taking is important, it's unquantifiable, it doesn't happen over night - and it's starts in the classrooms rather than in the corridors of duma.

That said, Russia has an incredibly entrepreneurial culture which is largely underground. The Global Entrepreneurship monitor is testament that Russians want to do startups, they are doing startups, they've always been doing startups except that no one wants to go legit for the tax reasons you mentioned.

This underground approach to private enterprise has been going for 80 odd years, it even used to have its own name (and criminal code section) for it, and I think these legislative changes may well prove to be a great experiment to see how many founders decide to turns their backs on the old way of doing business, declare income and go legal.

From my personal point of view however, the fin ministry has a lot of work cut out for them. Venture capital starts with availability of LPs, and Russia's pension system just doesn't have the compulsory contributions regime that's necessary to create large pools of risk capital.

I think in the future that will change with Russia developing a proper three tiered system for retirement savings, and it will take some time for Russian mutual funds to multiply, capitalise and allocate money to private equity, but when this does happen, I think this would be the most effective structural change to support Russian innovation in IT.

Retirement savings - that's the overwhelming problem facing Russia - solve that and the country will have a shot at resurrection.

The Poster said...

Daniel,

I think that you have to create a separate definition of entrepreneurialism for what happens in Russia versus the Silicon Valley model (for example). The term that I have heard and used a number of times is "zhiguli" entrepreneurialism - it generally does not work therefore you need to be clever to keep it on the road and identifying where to find the spare parts. The definition is slightly dated (mid-90's) but the concept is right. Being willing to take risk is a necessary but not sufficient condition for an entrepreneurial culture. To create meaningful businesses knowledge of sales and marketing techniques is probably more important - a good management team can rescue a bad technology......

As the government addresses one area of the "ecosystem," as broadly defined, it becomes very clear that other areas are still barely nascent. The biggest change I would like to see has nothing to do with the technology sector per se - a simplification of running small business.

But in general positive steps.