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IMF Country Report No. 23/60
REPUBLIC OF ARMENIA
TECHNICAL ASSISTANCE REPORT ON PERSONAL INCOME TAX: POLICY REVIEW AND INTRODUCTION OF A UNIVERSAL DECLARATION
January 2023
This technical assistance report on Republic of Armenia was prepared by a staff team of the International Monetary Fund. It is based on the information available at the time it was completed in November 2022.
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Title Page
FISCAL AFFAIRS DEPARTMENT
Republic of Armenia
Personal Income Tax: Policy Review and Introduction of a Universal Declaration
Charles Vellutini, Graham Whyte, Andualem Mengistu
Technical Report
January 2023
The contents of this report constitute technical advice provided by the staff of the International Monetary Fund (IMF) to the authorities of the Republic of Armenia (the “TA recipient”) in response to their request for technical assistance. This report (in whole or in part) or summaries thereof may be disclosed by the IMF to IMF Executive Directors and members of their staff, as well as to other agencies or instrumentalities of the TA recipient, and upon their request, to World Bank staff and other technical assistance providers and donors with legitimate interest, unless the TA recipient specifically objects to such disclosure (see Operational Guidelines for the Dissemination of Technical Assistance Information—
Staff Operational Guidance on Dissemination of CD Information). Disclosure of this report (in whole or in part) or summaries thereof to parties outside the IMF other than agencies or instrumentalities of the TA recipient, World Bank staff, other technical assistance providers and donors with legitimate interest shall require the explicit consent of the TA recipient and the IMF's Fiscal Affairs Department.
This technical assistance (TA) was provided in part by financial support from the European Union.
Contents
GLOSSARY
PREFACE
EXECUTIVE SUMMARY
I. INTRODUCTION
II. TAX POLICY
A. Key Features of the PIT
B. Directions of Reforms
C. Impact of Reforms Options on Revenue and Progressivity
III. TAX ADMINISTRATION
A. Current Administrative System
B. Universal Declaration Administrative System
C. Implementation Governance and Project Management
D. Implementation Risks and Mitigations
IV. CAPACITY DEVELOPMENT
REFERENCES
APPENDIXES
I. Government Revenue by Source, Latest Available Year (Percent of GDP)
II. Measures of Progressive and Redistributive Capacities
BOXES
1. Summary of Recommendations
2. Declaration from the Australian tax return
3. International good practice design principles
4. Scope of Project Team Briefs
5. UX Based Design Principles
FIGURES
1. General Government Tax Revenue Mix, Latest Available Year of Actual Data (In Percent of GDP)
2. Tax Wedge (2021)
3. Progressivity and Redistributive Capacities Among Regional Comparators (2020)
4. Implication of the 2020 Tax Reform Compared to The System in 2019
5. Progressivity and Redistributive Implication of Reforming Mortgage Interest
6. Mortgage Interest Eligible for Tax Credit in the Next Two Decades
7. Implication of a Repeal of Mortgage Interest Tax Credit Compared to a Cap
8. Progressivity and Redistributive Implication of Introducing a Zero-Rated Bracket
9. Progressivity and Redistributive Implication of Introducing in-work credit
10. PIT Revenue across Scenarios
11. Implementation Timeline
12. The Three Phases
13. Implementation Cycle
14. The Governance Pyramid
TABLES
1. Armenia, Tax Revenue (in percent of GDP)
2. The 2018 Tax Reform
3. Key PIT and SSC Rates in Armenia and Comparator Countries, 2022
4. Summary Statistics based on Taxpayer Level Labor Income Data (2021)
5. Summary of Proposed Options
6. Summary of The Existing Mortgage Interest Credit System
7. Implementation Risks and Mitigations
Glossary
| AMD | Armenian Dram |
| CBA | Central Bank of Armenia |
| CD | Capacity Development |
| CIT | Corporate Income Tax |
| FAD | Fiscal Affairs Department |
| FY | Fiscal Year |
| GDP | Gross Domestic Product |
| IMF | International Monetary Fund |
| IWTC | In-Work Tax Credit |
| MoF | Ministry of Finance |
| PIT | Personal Income Tax |
| RoA | Republic of Armenia |
| SRC | State Revenue Committee |
| SSC | Social Security Contribution |
| TA | Technical Assistance |
| VAT | Value Added Tax |
Preface
At the request of the Minister of Finance, a technical team from the IMF Fiscal Affairs Department (FAD) visited Armenia between August 29 – September 9, 2022 to assist the authorities in implementing a Universal personal income tax (PIT) Declaration. The mission comprised Charles Vellutini, Graham Whyte, and Andualem Mengistu. The mission met with Mr. Tigran Khachatryan, Minister of Finance, with Mr. Arman Poghosyan, Deputy Minister of Finance, Mr. Artur Manukyan, Deputy Chairman of the State Revenue Committee and various staff members of the Ministry of Finance. The mission also met with Mr. Nerses Yeritsyan, Deputy Governor of the Central Bank of Armenia and various senior staff of the CBA; Mr. David Davit Khachatryan, Deputy Minister of the Minister of Labor and Social Affairs; Mr. Ashot Muradyan, Deputy Chairman of the State Revenue Committee and his staff and Ms. Haykuhi Harutyunyan, Chairwoman of the Corruption Prevention Commission. The mission also had fruitful meetings with Mr. Ori Alaverdyan, Head of Revenue Policy and Administration Methodology Department, Ministry of Finance, who was very instrumental in coordinating government responses to the mission's inquiries. At the conclusion of the mission, recommended options for reform were discussed with the Minister of Finance and his team.
The mission expresses its gratitude to all the individuals it met with for their cooperation.
The mission also thanks Mr. Mehdi Raissi, Resident Representative of the IMF in Armenia, and Mr. Vahram Janvelyan (IMF), Ms. Marine Aleksanyan (IMF) for their valuable assistance during the mission.
Executive Summary
The government of the Republic of Armenia has expressed its intention to introduce a Universal Personal Income Tax (PIT) Declaration for individual taxpayers who are not in business. The Declaration would be implemented in phases: civil servants (in 2024 reporting FY2023 income), employees (in 2025 reporting FY2024 income), and other individual taxpayers (in 2026 reporting FY2025 income). The declaration would be annual, and it would cover all types of income.
At the request of the Minister of Finance, a team from the IMF Fiscal Affairs Department (FAD) visited Armenia to assist the authorities in implementing a Universal PIT Declaration. The joint Tax Policy and Revenue Administration mission provided recommendations to improve the PIT design and tackle potential implementation challenges of introducing the Universal PIT Declaration.
Tax Policy
The PIT is currently characterized by a strong revenue performance and low progressivity. The redistributive capacity of Armenia's PIT is at the lowest end of its regional peers. At 6.1 percent of GDP in 2021, Armenia's PIT revenue is significant. However, the 21 percent (2022) flat tax rate on employment income, the absence of standard allowance, and a regressive mortgage interest tax credit limit the PIT's progressivity. The cap on the Social Security Contribution (SSC) to the state pension system (Pillar II) further weakens progressivity.
Costly and regressive tax incentives should be repealed. Firstly, the mortgage interest tax credit should be repealed, or at least strictly capped. In addition, unless the reform deals with the existing stock of mortgages, the revenue loss will continue to be significant for the next decade. Limiting the mortgage interest credit on existing contracts rather than its complete removal may ease implementation with a minimal revenue cost and a significant increase in progressivity. Secondly, the tax credit on reinvested dividends is overly generous and should be eliminated. Thirdly, capital gains should be taxed, with an exempt allowance for private residences calibrated to cover most or all capital gains for most taxpayers.
A Universal PIT Declaration makes it possible to implement a more progressive PIT. A Universal PIT Declaration would make it possible to implement a zero-rated bracket and an In-Work Tax Credit (IWTC) through the aggregation and annualization of taxable income, and the corresponding end-of-year refunds or tax top-up. Conditionally on an assessment of sufficient administrative capacity (including auditing of individuals) and on fiscal feasibility, a zero-rated bracket or a IWTC would introduce significant progressivity and would provide incentives to comply with the Declaration (as end-of-year refunds would become possible). An IWTC would be better-targeted than a zero-bracket and encourage labor supply and formalization.
A microenterprise regime should be a simplified collection mechanism, not a preferential regime. The authorities plan to bring employees of microenterprises under the standard PIT regime, a justified reform (replacing and eliminating the monthly AMD 5,000 lumpsum tax per employee), but one leaving unchanged the total exemption of individuals themselves under the regime (not their employees).
Tax Administration
The Universal Declaration Administrative System is a major reform in size and scope. It will require a significant Information Technology (IT) build, will have wide ranging community impacts, and will require good communication with all stakeholders, in particular the affected taxpayers. There are many of the necessary foundations in place. These include a mature withholding tax system, a register of employees, and mandatory electronic lodgment of the withholding return. There are significant implementation risks that need to be managed.
While the detailed Policy is being developed, it is essential that the State Revenue Committee (SRC) and Ministry of Finance (MoF) work together on the detailed design. This is to ensure that it can be implemented efficiently and effectively with low costs of compliance by the taxpayers. A working group should be formed to finalize the design with both senior MoF and SRC staff and the staff who will build and operate it. Once the design is finalized this group will cease and a steering group would be formed.
The mission team recommends that in line with international good practice, SRC prefills the Universal Declaration as much as possible through maximizing the use of third-party information and withholding taxes. This should include all types of income. Armenian banks are currently not required to report interest income with a unique identifier for the holder of the account. This means that interest income will not be pre-filled, and this may undermine the policy intent. This gap must be addressed by the Government by amending Bank Secrecy laws to ensure that interest income can be prefilled. Should the authorities bring employees of microenterprises under the standard PIT regime the employers must be included in the reporting regime and their universal declarations prefilled.
To ensure strong governance and accountability during the implementation phase, a steering group should be formed immediately. The steering group should have very senior chairmanship and members should be drawn from all ministries with an interest in the reform. It provides strategic leadership and direction, to oversee the work of a Project Management Board. The Project Management Board should include experts with relevant technical and project management skills and experience and be chaired at the Deputy Chairman level. It is charged with managing and coordinating the work of project teams identifying and managing resource bottlenecks and other risks.
There are several issues that need to be considered, particularly the taxpayer register. compliance with the current system, and the withholding system. For example, there is no register of individuals who earn passive income. It is also important that the withholding system is robust and as many employers are in it. High compliance levels with the current system will ensure a smooth transition. Using Compliance Risk Management principles, SRC should undertake Risk Assessments on the risk areas and develop Compliance Improvement Plans, including recommendations for law changes.
Individual taxpayers must be subject to audit based on proper risk-assessment. The introduction of a Universal PIT Declaration, and the collection of comprehensive information on individual taxpayers, is an excellent opportunity and justification to include natural persons in the scope of possible audits.
Capacity Development
The authorities may consider requesting assistance on a possible reform of the taxation of micro and small enterprises. The SRC may consider requesting capacity development assistance from the IMF on implementation of the Universal Declaration. The area that may be of greatest assistance is addressing the risks identified and advising on international good practices to mitigate them.
Summary of Recommendations
Tax Policy Recommendations
Repeal the tax credit on mortgage interest, with grandfathering of existing contracts with yearly interest below an upper limit in the range of AMD 245,0000-300,000.
Repeal the tax credit on reinvested dividends.
Introduce a 10 percent (same as on interest) withholding tax on capital gains, excluding capital gains on housing to the sale of a taxpayers' primary residence up to a specific amount to be calibrated to cover most or all capital gains for most taxpayers.
Conditionally on an assessment of sufficient administrative capacity (including auditing of individuals) and on the fiscal feasibility of the measure, introduce a zero-rated PIT bracket with an upper threshold in the range of AMD 240,000-300,000 annually.
Conditionally on an assessment of sufficient administrative capacity (including auditing of individuals), consider the introduction of an In-Work Tax Credit that is annually capped at AMD 53,000 and phase out for income above AMD 800,000.
Seek FAD assistance on micro and small enterprise taxation.
Tax Administration Recommendations
As a matter of urgency, create a joint SRC and MoF working party to co-design the new system so that all administrative and policy issues are considered, and an efficient and effective system is implemented. Once the design is finalized this group will cease and a steering group etc. would be formed.
Implement the governance and project management structures and arrangements as set out in Section III, Figure 13 and 14 below. As a matter of urgency, implement Stage 0 (setting up of governance structure, agreeing action plans, and initiating consultations).
Amend the Bank Secrecy law so that it is mandatory for banks to provide the SRC with all interest payments and a unique identifier so that the interest can be pre-filled into the individual tax declaration.
Amend the Tax Code to allow tax audits of individuals.
