Tax Incentives and Harmonization of the Bulgarian Tax Legislation

Georgi Ranchev[1]

Analysis of the completeness of the harmonization process to date and comments on the advantages and disadvantages of tax incentives

1. Harmonization of the Bulgarian tax legislation

“Bulgarian tax legislation should be harmonized”, “Bulgarian tax legislation should be further harmonized”, “Bulgaria will be able to meet the criteria for EU membership by the year 2000”, etc. These are but a small number of the titles and catchwords that have lately been pouring out from the radio, television and the press. And in the general rush to thump their own chests with everybody professing that they have greatly contributed to this or that and met with someone or other and agreed on this or that item within the global process, there’s one thing that remains undone, no one attempts to estimate how far have we got, what is in store and how could Bulgaria come to terms with the all-pervasive Pan-European concept.

It is obvious that the tax and business environment within the European Union keeps changing faster and more drastically than in any other period of modern European history. The new Bulgarian government of the Union of Democratic Forces has articulately voiced Bulgaria’s intention to join the European Union. In view of that steps have been taken to harmonize Bulgarian tax legislation with EU legislation. In the meantime the social and political aspects of this multi-dimensional process  had to be estimated.

As a result of the amendments to the tax legislation, in effect since 1999, provisionally labeled “tax reform part 2”, certain amendments in the sphere of indirect taxation were introduced, which brought Bulgarian legislation closer to the requirements set by the EU more than ever before.

The amendments to the Excise Act are in line with the respective EU directives concerning the structure of taxation of alcoholic drinks, beer, tobacco, tobacco products and liquid fuels.

The new VAT Act could also be regarded as a significant move in the right direction. Yet it should be noted that the inadequate administrative capacity of the tax administration has lead to the devising of a number of “odd” provisions, most of which have their background in purely practical problems. The registration threshold requirement, the terms for VAT reimbursement, the right for registration on the grounds of basic funds, the specific regimes for granting of tax credits prior to the date of registration and due to previous deregistration are but a minor part of the regulations, which are not compliant with the ubiquitous Sixth Directive of the EU and in their present shape could only be regarded as a singular contribution to the European VAT culture. Yet another new concept in Bulgarian VAT legislation is contained in chapter 19 of the VAT Act on supplies of second-hand goods, works of art, collector’s items and antiques. Without any doubt this part of the VAT Act is closest to EC  directives, but, unfortunately, it is of little practical consequence at this date.

In the sphere of direct taxation the harmonization of Bulgarian legislation is still in its initial stage. The principles of neither of the three fundamental Directives have been adopted - the EC Directive for Mutual Assistance in Direct Tax Matters, the EU Directive on the Common System of Taxation Applicable to Mergers, Divisions, Transfer of Assets and Exchange of Shares and the Parent-Subsidiary Directive. Certain general concepts have been partially adopted, such as permanent establishment, the concept of a  local person subject to taxation in Bulgaria and the concept of taxation at source.

Despite that it should be noted that the process of harmonization in direct tax matters has not been completed yet even by EU member countries. In fact, between the EU member countries there exists severe undercover competition in the sphere of direct taxation, particularly in respect of existing or newly introduced tax incentives. The kingdom of Luxembourg was warned more than once to modify its tax treatment of holding companies registered on its territory. The Netherlands is the country attracting the biggest share of foreign investment since the dividends received by established holding companies operating all over Europe are not taxable. In Belgium there are structures called “coordination centers”, which are entitled to a tax holiday for a period of 10 years and their activity is subject to a lump-sum taxation on the basis of a certain percentage from the operating expenses. In Denmark a regime was introduced in 1999 that could only be termed as “too good to be true”. These, of course, are but a small number of the examples that could be rendered of existing tax incentives in the EU. Quite apart from that a tendency for cutting down of tax rates can be observed in Europe and globally.

2. Advantages and disadvantages of tax incentives

By virtue of a series of amendments to the Corporation Tax Act and the Foreign Investments Act, practically no tax relief is granted to Bulgarian and foreign investors in the country. Foreign experts involved in the process of harmonization of the Bulgarian legislation have stressed more than once that Bulgaria needs no such incentives as far as investors are only interested in factors like political risk, currency risk and working salary. This is undoubtedly so, Bulgaria has never seemed more stable over the last ten years but did that help to attract more foreign investments and are they in any way dependent on the existence of tax incentives. This is also an undisputed fact. As soon as foreign investors realize that the above factors are available their next question would be: “and do you give any tax incentives?”, to which the answer would be “not for the moment”. A prominent example in that respect is Hungary, which probably operates with the most aggressive tax legislation compared with other Central and East European countries, offering all types of tax incentives and even offshore regime. At the same time according to information published by the Financial Times Hungary has attracted about ten times more investments than Bulgaria. It is arguable whether that is only due to the existence of tax incentives but this factor should be overlooked under no circumstances.

The Kossovo crisis has not subdued yet, funds for recovery of the region have to be raised and allocated, and Bulgaria looks like the most stable country in the Balkans for the moment, excepting Greece, which is a member of the European Union anyway. As soon as the conflict is left behind more and more investors will start seeking suitable bases for investment on the Balkans and Bulgaria will invariably figure as a possible scenario in their plans. Whether tax incentives similar to those existing in the Netherlands granted for setting up of headquarters on the territory of the country or any other of the mentioned European models could prove crucial in that process? Yes, that is quite possible. Apart from such incentives investors would invariably appreciate the favorable geographic location of Bulgaria at the center of the Balkans, the political and currency stability, our satisfactory infrastructure and banking system, the existence of a network of Double Tax Treaties concluded with neighboring states and with almost all of the EU countries, factors that have been pointed out more than once by our leading politicians.

Incentives granted at different periods over the last 10 years have always been politically motivated. A number of the tax incentives no longer effective sought to preserve the profits of already privatized companies. As the privatization process is coming to its end the issue of attracting fresh funds from abroad will be ever more topical - one of the major objectives of the Council of Ministers. We will have to compete with Romania, Macedonia, Yugoslavia and Albania for these funds. The Romanian government has shown more than once that it is flexible in respect of major investment projects and Macedonia levies 15% corporate tax and does not impose taxes on dividends distributed to foreign persons. For understandable reasons Yugoslavia and Albania are still risky countries for investment and do not at present constitute actual competitors but this will not last forever.

There could not be a better time for Bulgaria to tip the balance to its own benefit. The introduction of tax incentives of a similar type is probably the last resort of the present government to bring to life the slumbering economy and the banking system  and should under no circumstances be  regarded as being at variance with the process of harmonization with the European legislation. The examples rendered above prove this proposition. Tax incentives are probably the finest instrument that could be used by a country in a similar situation. A good example from a historical perspective is Luxembourg. At the middle of the century the kingdom relied on the heavy steel and steel processing industry. After an estimation of the negative tendencies in the economy, the government introduced specific tax incentives effective to this date which shape Luxembourg’s image as one of the key financial centers in Europe - with prosperous banking, insurance and financial sectors, constituting the backbone of this tiny country’s economy.

Could Bulgaria hope to attain such standards or at least draw nearer to these within the next couple of years - hardly so. But that is surely quite possible in the long run when as a result of similar incentives Bulgaria’s economy would be able to register sustainable growth and will have become more flexible. At that particular point in future the country would be able to meet the criteria for EU membership and negotiations on the long- awaited membership would become an indisputable fact.