A presumptive or imputed tax is generally a proxy for the standard tax. It is applied when the tax base is too small or hard to verify, due to limited administrative resources, or improper accounting practices. According to a definition by Ahmed and Stern (1991), “The term presumptive taxation covers a number of procedures under which the ‘desired’ base for taxation (direct or indirect) is not itself measured, but is inferred from some simple indicators which are more easily measured than the base itself.
” For example, in its most common application as a proxy for income tax, the tax liability is based on the presumed capacity to earn income, measured through indirect indicators, rather than on actual income. In this context, a presumptive tax is largely a tool that addresses administrative inefficiency (i. e. high cost per unit of revenue). It may reflect low revenue capacity of the taxpayer or high propensity to evade taxes.
This implies that presumptive taxation is best used to reach the hard to tax sectors of the economy, such as the small business, agriculture or service sectors, self – employed, as well as sectors or cases, where compliance gaps are above the average. Presumptive tax aims at improving the efficiency of collection by targeting three groups of effects: a) Reducing taxpayers’ compliance costs; b) Reducing the administrative costs of compliance and enforcement management; and c) Bridging the way from informal to formal activities and from assessment based on indicators to self-assessment based on actual income.
In practice, the relative weight of these objectives in the policy mix may vary substantially across countries according to the level of market and institutional development; the average quality of company management, and the capacity of the tax administration. Origins Presumptive taxes are among the oldest taxes. Earliest forms date back to the 18th century when assets were the major source of income. Back then taxes were based on measures of wealth rather than income: size or value of land and other assets, including number of doors and windows as an indicator of the value of residence and the living standards.
Last two centuries witnessed profound changes in earning patterns, with increasing share of income and wealth generated through supplying labour, capital and fixed assets through the factor markets in return for wages, interest, dividends and rents. The emergence of the “social state” in the 20th century in turn raised the significance of equity considerations and drove the move to progressive taxation. In result, taxation evolved away from taxes based on measures of wealth towards taxes based on actual earnings in its various forms.
On the other hand, equity objectives required globalization of income, i. e. taxing total income, rather than its separate components (the so called “scheduler” taxation). Furthermore, with the development of accounting, tax collection evolved towards system of self-assessment of liability and filing tax returns. The last decades of the 20th century marked certain departure from the principles of self-assessment and globalization of income. Wherever possible, taxes would be withheld at the source, while indicator-based presumptive taxation was brought back to active use.
The driver of these new trends in tax collection is above all the fast expansion of the shadow economy around the world. The challenges of reducing tax evasion required that compliance and enforcement management distinguish better between different types of earnings and taxpayers and related risks and costs. Large taxpayer units became indispensable part of tax administration reforms in transition economies, while small taxpayer compliance and enforcement were addressed through various forms of imputed or presumptive taxation.
General Concepts Presumptive taxation is a form of assessing tax liability using indirect methods, which differ from the usual rules based on the tax payer’s accounts. Income reconstruction based on administrative practice and application on base line tax across the entire base, are some of the indirect taxation methods used. Presumptive taxation is considered an ideal method of curbing widespread non-compliance without employing excessive government resources because it addresses the concerns of both taxpayer and tax authority.
Presumptive taxation provides taxpayers with a simplified option for tax compliance without requiring full financial transparency. There are different reasons why presumptive techniques are used and some of these are: 1. Simplification This is particularly related to the compliance burden on taxpayers with a very low turnover and the corresponding administrative burden of auditing such tax payers. 2. To combat tax avoidance and evasion This works only if the indicators on which the presumption is based are more difficult to hide than those forming the basis for accounting records. 3. Provides objective indicators for tax assessment
Presumptive methods may lead to a more equitable distribution of the tax burden, when normal accounts based methods are unreliable because of problems of taxpayer compliance and administration corruption. 4. Rebuttable methods can encourage tax payers to keep proper records because the subject taxpayer to a possible higher tax burden in the absence of such accounts. Presumptive taxation can be used for any tax that is normally based on accounting records e. g. income tax, sales tax/ VAT, turnover tax and excise tax. Presumptive tax is however commonly used in the context of INCOME TAX.
Some methods of presumption completely supplant the income tax for particular taxpayers. In other, the presumptive method may determine a portion of the tax base e. g. the income from a particular business or agricultural activity. The forfeit methods for small trade often cover both income tax and VAT liability. Countries use a number of different types of presumptive methods. These different types of methods have quite different legal and administrative implication, incentive effect, revenue effect, level of complexity and distributional consequences. The use of presumptive taxes varies greatly from country to country.
Some countries employ almost no presumptive tax (USA) and some use it extensively (France). Legal constraints on the adoption of presumptive methods are considered in drafting the legislation for their application and these legal constraints are: Equality before the law Prohibition on confiscation of property Legal characteristics REBUTTABLE VS IRREBUTTABLE Presumptive tax can be rebuttable or irrebuttable. Rebuttable Rebuttable methods are those that include administrative approaches to reconstructing the taxpayer’s income and may or may not be specifically described in the statute.
If taxpayer disagrees with the results reached, the rebuttable methods gives the taxpayer the opportunity to justify that his tax liability accrued on the basis of general taxation rules is smaller than the one calculated under the presumptive method. The taxpayer can arrange the reduction of his tax liabilities with the tax authorities in the framework of administrative procedures. Rebuttable taxation encourages small enterprises to conduct accounting. In this context, the presumptive tax rates can be set at relatively higher level, since the tax liabilities of some taxpayers which were found can be adjusted.
Irrebutable Irrebutable presumptive assessment should be specified in statute or in delegated legislation. If taxpayer disagrees with the results reached, he cannot contest his liability on the basis of proving his actual income. Irrebutable taxation imposes restrictions on the rights of the taxpayer under presumptive methods. The application of irrebutable taxation requires a greater precision in terms of legislative determination of the procedure for application and accrual of the tax. MINIMUM VS EXCLUSIVE Irrebuttable presumptive taxes can be divided into two subcategories: minimum taxes and exclusive taxes.
Minimum Presumptive minimum tax establishes a tax liability that cannot be smaller than the liability established according to the rules of presumptive taxation. Exclusive Presumptive exclusive tax establishes a tax liability exclusively on the basis of the rules of presumptive taxation, even if application of the general taxation rules may lead to higher tax liabilities. As an example of the presumptive exclusive tax can serve agricultural tax, the basis of this is determined only by the value of the land, regardless of the actual crop yields.
The exclusive presumptive taxes are relatively simple in comparison with minimum presumptive taxes because the latter require assessment and comparison of the two taxable bases. At the same time, the drawback of the exclusive presumptive taxation is the frequent violation of the principle of fair taxation. MECHANICAL VS DISCRETIONARY Presumptive methods can also be identified on the basis of the degree of discretion (freedom) provided to the tax authorities for the definition of tax liabilities: mechanical (formal) methods and discretionary methods.
Mechanical Tax liabilities are determined in accordance with the preliminarily set rules. Some presumptive methods are quite mechanical, allowing no discretionary. Methods based on a percentage gross receipts or a firm’s assets are examples. Mechanical methods can be both rebuttable and irrebuttable. In some cases the method can be mechanical and irrebutable, however, the tax authorities can be free to apply or not apply it upon their discretion. Discretionary Imply high degree of freedom of the tax authorities when determining tax liabilities.
Some methods such as the net worth method, involve a large degree of discretion for the agent applying them. Discretionary methods are, as a rule, rebuttable, since otherwise the tax authorities would get too broad opportunities for arbitrary actions. There are shortcomings to both mechanical and discretionary presumptive taxation methods. The application of discretionary methods creates pre-conditions for corruption. Mechanical methods can lead to excessive taxation, since they do not take into account the specific circumstances of individual taxpayers.
In the case of limited administrative resources it is generally appropriate to use formal methods of presumptive taxation. Targeted people Presumptive methods can be distinguished according to the types of taxpayers who are targeted. Three groups of taxpayers have been the source of problems against which presumptive methods have been directed. The most common problem is noncompliance by small businesses and professionals. A second problem is noncompliance by individuals (this may be related to the first, but the focus is on amounts that individuals have taken out of their businesses or received from other sources and used for consumption).
A third group of targeted taxpayers is businesses as a whole, including large companies. Small businesses and professionals Small and medium enterprises employ the majority of taxpayers in any developing country. Yet, many Small Medium Enterprises (SMEs) remain in the informal sector because they lack sufficient resources, administrative infrastructure and accounting sophistication to comply with government tax regulations. The result is that many employers are ineligible to receive the benefits the formal sector offers, which inevitably compromises their financial viability.
Presumptive taxation addresses these concerns by offering a streamlined method for moving from the informal to formal sector. Income is no longer assessed from accounting records but from indicators such as the value of a farmer’s land, gross turnover of an SME, or signs of individual wealth. This approach to estimating income on which tax is levied removes the administrative burden of financial transparency traditionally required for compliance. Individuals and businesses as a whole Tax administrations are quite cognizant of the burden tax compliance places on individuals and businesses.
However, non-compliance amounts to a lack of funds for the public works and social service programs governments consider central to national development. Thus, governments often introduce presumptive taxation as a retribution-free method for providing incentives to citizens and businesses to enter the formal tax net and increase the country’s tax base. Areas not covered by presumptive taxation in Zimbabwe The Ministry of Finance has acknowledged that measures to bring the informal sector under the tax net have not been effective and if 60% of business is
in the informal sector, the loss could be higher than 20%. Taxation of the informal sector is a challenge for the region. In Zimbabwe, presumptive tax was introduced to bring the informal sector into the tax net, but it is a stop gap measure. There has however been minimal progress in terms of revenue generated due to non-compliance by most informal sector businesses. In terms of the law all persons with taxable income should register and submit returns and pay taxes and this is what ZIMRA should address. Not all operators in the informal sector are small or poor.
At Mbare Market there are big operators with large quantities of stock who target people boarding buses for rural areas. There are transporters with three or four trucks. Many of the people who make furniture in the high density suburbs are not small. References Tax Law Design and Drafting (volume 1; International Monetary Fund: 1996; Victor Thuronyi, Ed. ) Chapter 12, Presumptive Taxation International Studies Programme Working Paper : Presumption Taxation of the Hard- to- Tax Centre for the study of democracy Working Paper: Presumptive Taxation and Gray Economy by Dr Konstantin Pashev www. zimra. com