Interview with Vladimir Penkov for the Newspaper “Bulgarisches WIRTSCHAFTSBLATT”, October 2004
Does Bulgarian law support small and medium enterprises as do the laws of South-eastern and Eastern Europe?
A.: All the countries of South-eastern and Eastern Europe have, at last, realized that small and medium enterprises (SMEs) are not only a much needed and best partner of the major corporations, but constitute the backbone of any economy. Their ability to develop and thrive is often indicative of the level of economic development and investment climate of the respective country. Most countries of the region use appropriate legal means to encourage the creation and development of SMEs through appropriate taxation regimes, through promoting investment and innovation and creating new jobs. The entire financial and loan system is adapted to meet specific requirements.
While Bulgaria is also making some efforts in this direction, those efforts, regrettably, are insufficient. There is a specialized agency for the administration of SMEs which has created and keeps a register of small and medium-sized businesses. A positive development has been the National Centre for Information and Documentation, which provides access to new ideas, innovative products and technologies, joint projects and programmes funded by the European Union. It is also commendable that non-governmental organizations such as BCCI likewise create databases, training and consulting centres in support of SMEs. Regrettably, however, the tax system fails to promote enough investment as a whole, and innovation in particular.
SMEs not only should have access to the eligibility criteria for funding under different projects; not only should they know how to draw up business plans; they should be accorded financial preferences to be able to implement such plans. This should be combined with making the most of the SMEs’ capacity as drivers of innovation. In this context, the proposed establishment of centralized funds should rather be used for developing an information system and for training purposes, whereas businesses should be given an opportunity to create their own funds, exempted from tax for many years into the future, if they are to be able to accumulate enough money for innovation.
We regard as positive a number of specific preferences for SMEs provided under various laws and statutes, e.g. the preferential treatment under the Public Procurement Act in the evaluation of bids submitted by SMEs; or the possibility under the Protection of Competition Act for such businesses to be exempted from the ban on entry into certain agreements and concerted practices if that would increase their competitiveness.
And yet, there are still untapped opportunities as far as taxation is concerned, as the current arrangements do not correspond to the priority role of small and medium enterprises as the backbone of the economy. The provision of competitive terms for SMEs to do business in Bulgaria would be a major prerequisite for equal partnership in South-eastern and Eastern Europe.
What about the tax policy of the Bulgarian government? Which are its strengths and what must be changed about it so that this country would attract more foreign investors?
A.: On the whole, the evolution of our tax policy with respect to the various tax rates can be seen as a positive tendency, as long as it is predictable and in recent years there has been a steady trend towards reducing the tax burden, mostly in terms of the direct taxes. The introduction of tax rates that would be even more conducive to economic development, however, should be accompanied by the relevant changes in the very philosophy of taxation in determining the taxable base: only the balance of the taxpayer’s income must be taxable, after all eligible operational costs have been deducted from it. This would boost consumption, and would thence increase commercial turnover and proceeds from VAT, which will not only make up for the decrease in direct taxes but will ensure additional budgetary revenue of 5-10%.
From a business perspective, there are two important taxes: VAT and corporate tax.
With a view to promoting equal treatment of all economic players and improving competition, I believe that the threshold for VAT registration should be lowered – for example, a business should seek VAT registration from its establishment, or the above said threshold should be reduced to BGN 5,000. It makes neither economic nor legal sense for a company to not be registered under the VAT Act. Secondly, it would be advisable to broadly introduce different tax rates, if the specificities of manufacturing or sales so require. This would also be a suitable measure for promoting economic transparency. There is no justification for dairies, bakeries and meat packers to pay 20% VAT while the hospitality industry pays just 7%.
My proposal is to introduce an across-the-board 7% VAT in all those socially sensitive industries, since at present the officially declared quantities of milk, dairy products and bread produced are too low as entire sectors are pervaded by the shadow economy, which pays no VAT. Thus the honest manufacturers and merchants cannot endure the unfair competition of the ‘grey sector’; on top of that, public health is also at risk, as no one can guarantee the safety of foods produced in the shadow economy.
On the other hand, 20% VAT makes staples like bread, milk, and meat expensive products, in some cases even unsellable, which does not in any way curb the shadow economy.
It is essential for Bulgarian entrepreneurs to be treated on an equal footing with foreign ones when they participate in bidding procedures under international projects that are exempted from VAT, or when hired as subcontractors or suppliers. Similar VAT exemption should be extended to any transaction where a Bulgarian company acts as a subcontractor to a foreign one in some research program, e.g. in medicine. This will enable highly trained specialists to receive more assignments from abroad, which is about giving equal treatment to the export of services and the export of goods.
The same applies to software. Currently, Bulgarian subcontractors to foreign companies accrue VAT, which makes them uncompetitive from the standpoint of the foreign company, which prefers to use foreign subcontractors. In effect, this eliminates employment opportunities.
It is necessary to shorten the time limit for VAT refund to no more than 15 days, and to hold each link of the chain individually liable for defaults and violations. In other words, if somewhere along the line there was a shell company that did not pay VAT, why should this affect the conscientious taxpayer at the end of the chain? Since only the State has the law enforcement agencies and the leverage to perform VAT audits on companies, its inaction must not damage the interests of law-abiding businesses.
To promote investment, the amounts invested should be made tax deductible, while possibilities for accelerated depreciation of fixed assets should be provided. This is especially important for small and medium enterprises which, before starting their business, usually invest in a piece of real estate as the chief fixed asset for their future operation. The depreciation period of that is currently 25 years, which makes it incumbent upon the relevant business to invest 5-6 times in overhauls and upgrades.
Introducing a legal possibility for accelerated depreciation of the enterprise will allow it to freely and flexibly manage its own investment processes, until it develops the ability to quickly adapt to the dynamic of the economic conditions and improve its investment capability.
According to our estimates, allowing taxpayers to determine their own depreciation policy will have a negligible impact on budgetary revenues: no more than 0.05%; therefore the benefits of this approach far outweigh the negligible detriment to the financial interests of the State. On the other hand, the possible introduction of accelerated depreciation will only benefit the taxpayer for the brief duration of such depreciation, after which no depreciation of that asset will be eligible for deduction from that enterprise’s taxable income.
To provide a genuine incentive for further investments (similar to the preferential treatment for creation of new jobs under Art. 23(3)(4) of the Corporate Income Tax Act), the cost of fixed assets directly related to the principal sphere of business of an enterprise should be deducted from its profit when declared for tax purposes, while at the same time the relevant depreciation should also be made tax deductible.
The legislator could consider adopting a provision to the effect that the cost of any assets with a unit price under BGN 1,000 (e.g. computer, copy machine, some other tool etc.) would be made tax deductible irrespective of the nature of the asset, provided that its acquisition is evidenced by a duly issued tax invoice. This will promote transparency while considerably simplifying the financial accounting of businesses; it will also enhance consumption, and thence budgetary revenue from indirect taxes. Ultimately, such a decision on the part of the legislator will not in any way harm the financial interests of the State, as it will ensure the kind of taxation that is more in line with the new tax philosophy. All of this will help considerably increase manufacturing and consumption, thus boosting revenue from VAT, which will revitalize the economy and will ultimately further increase budgetary revenue.
The budgetary surplus of BGN 1 billion came as no surprise to me. It was largely the product of lower taxes and the ensuing improved collection rate, combined with active investment. A change in the basic philosophy of taxation will bring out in the open most of the shadow economy; it will incentivize significant investments subject to better lending conditions; it will encourage the creation of new jobs; it will boost turnover and produce significant economic growth and higher budgetary revenue.
What are the characteristics of the corporate registration system in Bulgaria from a foreign business perspective?
A.: The business community is not happy with the current system of corporate registration through the law courts, because it is too sluggish, lacking uniform criteria, accountability or self-analysis. It also lacks a unified information system since the e-document and e-signature are difficult to introduce. Last but not least, documents are only issued in the Bulgarian language, which is not good enough, especially as Bulgaria is entering the home run of its accession to the EU. Therefore I stand by my idea for corporate registration to be taken out of the court system, as well as from the system of public administration, as both are equally plagued by the flaws I described. In my view, it would be advisable for corporate registration to be entrusted to NGOs such as BCCI, which have their own capacity to instantly register and issue all relevant documents, including the necessary certificates, in a foreign language. This will help create a unified national electronic register to cover the entire country, unified administrative practices and requirements, the introduction of a single identification number, as well as easy access to information, while also enabling effective control and accountability.
The reform of the judicial system is a major hurdle to our accession to the EU. What steps are necessary, in your view, to overcome that problem?
A.: Let me say that, after all, the judicial system is not the weakest link in Bulgaria. Reform in the civil sphere should be aimed at creating a unified information system, specialization, replacement of prescriptive deadlines with enforceable ones, and the harmonization of judicial practices. In this context I believe that it would be advisable to establish a specialized commercial court as part of the judicial system,that would hear all cases of a commercial nature (disputes on business contracts, corporate law, registration disputes and bankruptcy cases). Thus judges will be better qualified in the commercial subject matter and will be in a position to pass more pertinent judgments in line with the needs of a better, faster and more efficient jurisprudence.
According to recent studies, Bulgaria ranks as average on the corruption scale of the region. What does your lawyer’s practice tell you?
A.: While I, too, have been following reports in the press and find them worrisome, I have never personally encountered such cases in my legal career. I am thankful to Fate for sparing me such inconveniences and for having a client list of corporate entities that are all proper and transparent market players. Our law firm, Penkov Markov & Partners, does the utmost to protect their interests within the confines of the law and in line with our professional creed and philosophy.