An OECD Tax Working Paper on the design of presumptive tax regimes was published on 14 February 2023.

Presumptive tax regimes aim to simplify the tax compliance process for micro and small businesses. They aim to bring taxpayers into the formal tax system by imposing lower tax rates and reducing the compliance costs, making it easier for businesses to register and comply with the requirements. A presumptive tax may be used where the taxable income cannot be easily quantified; and will typically use alternative indicators to determine the level of taxation.

The design of presumptive tax regimes differs greatly from one country to another. The OECD working paper sets out a framework for comparing presumptive tax regimes and points to the important design aspects that need to be given further consideration. The paper also looks at the best practices in administering presumptive regimes.

The type of taxpayers that can be the subject of presumptive tax regimes include hard-to-tax businesses such as the self-employed, unincorporated businesses, micro and small enterprises and farmers. These businesses often have low incomes, are not willing to register voluntarily with the tax administration, do not keep complete records or file tax returns. Also they often engage in cash transactions and this makes them difficult to monitor to ensure compliance.

From the point of view of the tax administration, the introduction of presumptive tax regimes can reduce the administrative costs of collecting tax from these businesses and can ensuring greater compliance. Presumptive tax regimes could also result in an increase in social security coverage if they include social security contributions.

Disadvantages

The existence of a presumptive tax regime could be a disincentive for business growth, as a business may prefer to stay within the threshold that qualifies for the presumptive regime.

Businesses that are growing too large for the presumptive regime may try to artificially split their business operations or simply under-declare their sales to stay within the regime. If there is more than one presumptive regime in the country a taxpayer could try to switch from one to another in an effort to reduce the tax bill.

Presumptive tax regimes may reduce tax equity. Taxpayers subject to a presumptive regime may have very different levels of profits, but still pay similar levels of tax under the regime. On the other hand, taxpayers with similar levels of profit may be subject to very different tax rates depending on whether they qualify for inclusion in the presumptive regime.

Advantages for tax administration

The tax administration would need to monitor the presumptive regime and this could be difficult because the businesses registering for the regime could greatly increase the number of small taxpayers. The tax administration could reduce compliance costs by establishing a specialist unit for the monitoring and audit of the presumptive tax regime.

Interaction with the standard tax system

A presumptive regime should remain optional, to encourage taxpayers to join the standard tax system of the country if they choose to do so. The design of the country’s main tax system should include an incentive for businesses to move from the presumptive tax regime to the standard tax system.

Best practice in designing the presumptive tax would allow space for the presumptive regime to develop in line with the capacity within the tax administration. The tax liability imposed should be affordable for the groups targeted by the tax and where possible equity should be built into the regime. Opportunities for tax evasion should be reduced as much as possible and the relevant government agencies should coordinate their efforts to improve the regime.