Paying Taxes Methodology

Doing Business records the taxes and mandatory contributions that a medium-size company must pay or withhold in a given year, as well as measures of the administrative burden in paying taxes and contributions. Taxes and contributions measured include the profit or corporate income tax, social contributions and labor taxes paid by the employer, property taxes, property transfer taxes, the dividend tax, the capital gains tax, the financial transactions tax, waste collection taxes and vehicle and road taxes.

Doing Business measures all taxes and contributions that are government mandated (at any level - federal, state or local), apply to the standardized business and have an impact in its income statements. In doing so, Doing Business goes beyond the traditional definition of a tax: as defined for the purposes of government national accounts, taxes include only compulsory, unrequited payments to general government. Doing Business differs from this definition because it mea­sures imposts that affect business accounts, not government accounts. The main differences are in labor contributions and value added tax. The Doing Business measure includes government-mandated contributions paid by the employer to a requited private pension fund or workers’ insurance fund. The indicator includes, for example, Australia’s compulsory superannuation guarantee and workers’ compensation insurance. It excludes value added taxes because they do not affect the accounting profits of the business - that is, they are not reflected in the income statement.

Doing Business uses a case scenario to measure the taxes and contributions paid by a standardized business and the complexity of an economy’s tax compliance system. This case scenario uses a set of financial statements and assumptions about transactions made over the year. Tax experts in each economy compute the taxes and mandatory contributions due in their jurisdiction based on the standardized case study facts. Information is also compiled on the frequency of filing and payments as well as time taken to comply with tax laws in an economy. The project was developed and implemented in cooperation with PricewaterhouseCoopers.

To make the data comparable across countries, several assumptions about the business and the taxes and contributions are used.

Assumptions about the business

The business:

• Is a limited liability, taxable company. If there is more than one type of limited liability company in the country, the limited liability form most popular among domestic firms is chosen. The most popular form is reported by incorporation lawyers or the statistical office.
• Started operations on January 1, 2007. At that time the company purchased all the assets shown in its balance sheet and hired all its workers.
• Operates in the country’s most populous city.
• Is 100% domestically owned and has 5 owners, all of whom are natural persons.
• Has a start-up capital of 102 times income per capita at the end of 2007.
• Performs general industrial or commercial activities. Specifically, it produces ceramic flowerpots and sells them at retail. It does not participate in foreign trade (no import or export) and does not handle products subject to a special tax regime, for example, liquor or tobacco.
• At the beginning of 2007, owns 2 plots of land, 1 building, machinery, office equipment, computers and 1 truck and leases 1 truck.
• Does not qualify for investment incentives or any benefits apart from those related to the age or size of the company.
• Has 60 employees - 4 managers, 8 assistants and 48 workers. All are nationals, and 1 manager is also an owner.
• Has a turnover of 1,050 times income per capita.
• Makes a loss in the first year of operation.
• Has a gross margin (pretax) of 20% (that is, sales are 120% of the cost of goods sold).
• Distributes 50% of its profits as dividends to the owners at the end of the 2nd year.
• Sells one of its plots of land at a profit during the 2nd year.
• Has annual fuel costs for its trucks equal to twice income per capita.
• Is subject to a series of detailed assumptions on expenses and transactions to further standardize the case. All financial statement variables are proportional to 2007 income per capita. For example, the owner who is also a manager spends 10% of income per capita on traveling for the company (20% of the expenses are purely private, 20% for entertaining customers and 60% for business travel).

Assumptions about the taxes and contributions

• All the taxes and contributions paid or withheld in the second year of operation (fiscal 2008) are recorded. A tax or contribution is considered distinct if it has a different name or is collected by a different agency. Taxes and contributions with the same name and agency, but charged at different rates depending on the business, are counted as the same tax or contribution (table).
• The number of times the company pays or withholds taxes and contributions in a year is the number of different taxes or contributions multiplied by the frequency of payment (or withholding) for each one. The frequency of payment includes advance payments (or withholding) as well as regular payments (or withholding).

Tax payments

The tax payments indicator reflects the total number of taxes and contributions paid, the method of payment, the frequency of payment and the number of agencies involved for this standardized case during the second year of operation. It includes payments made by the company on consumption taxes, such as sales tax or value added tax. These taxes are traditionally withheld on behalf of the consumer. Although they do not affect the income statements of the company, they add to the administrative burden of complying with the tax system and so are included in the tax payments measure.

The number of payments takes into account electronic filing. Where full electronic filing is allowed and it is used by the majority of medium-size businesses, the tax is counted as paid once a year even if the payments are more frequent.

Where 2 or more taxes or contributions are paid jointly using the same form, each of these joint payments is counted once. For example, if mandatory health insurance contributions and mandatory pension contributions are filed and paid together, only one of these contributions would be included in the number of payments.

Time

Time is recorded in hours per year. The indicator measures the time to prepare, file and pay (or withhold) 3 major types of taxes and contributions: the corporate income tax, value added or sales tax and labor taxes, including payroll taxes and social contributions. Preparation time includes the time to collect all information necessary to compute the tax payable and to calculate the amount payable. If separate accounting books must be kept for tax purposes—or separate calculations made—the time associated with these processes is included. This extra time is included only if the regular accounting work is not enough to fulfill the tax ac counting requirements. Filing time includes the time to com­plete all necessary tax forms and file the relevant returns at the tax authority. Payment time is the hours needed to make the payment online or at the tax office. Where taxes and contributions are paid in person, the time includes delays while waiting.

Total tax rate

The total tax rate measures the amount of taxes and manda­tory contributions payable by the business in the second year of operation, expressed as a share of commercial profits. Doing Business 2010 reports the total tax rate for fiscal 2008. The total amount of taxes is the sum of all the different taxes and contributions payable after accounting for deductions and exemptions. The taxes withheld (such as sales or value added tax or personal income tax) but not paid by the company are excluded. The taxes included can be divided into 5 categories: profit or corporate income tax, social contribu­tions and labor taxes paid by the employer (for which all mandatory contributions are included, even if paid to a private entity such as a requited pension fund), property taxes, turnover taxes and other small taxes (such as municipal fees and vehicle and fuel taxes).

The total tax rate is designed to provide a comprehensive measure of the cost of all the taxes a business bears. It differs from the statutory tax rate, which merely provides the factor to be applied to the tax base. In computing the total tax rate, the actual tax payable is divided by commercial profit.

Commercial profit is essentially net profit before all taxes borne. It differs from the conventional profit before tax, reported in financial statements. In computing profit before tax, many of the taxes borne by a firm are deductible. In computing commercial profit, these taxes are not deductible. Commercial profit therefore presents a clear picture of the actual profit of a business before any of the taxes it bears in the course of the fiscal year.

Commercial profit is computed as sales minus cost of goods sold, minus gross salaries, minus administrative expenses, minus other expenses, minus provisions, plus capital gains (from the property sale) minus interest expense, plus interest income and minus commercial depreciation. To compute the commercial depreciation, a straight-line depreciation method is applied, with the following rates: 0% for the land, 5% for the building, 10% for the machinery, 33% for the computers, 20% for the office equipment, 20% for the truck and 10% for business development expenses. Commercial profit amounts to 59.4 times income per capita.

This methodology is consistent with the Total Tax Contribution framework developed by PricewaterhouseCoopers. This framework measures taxes that are borne by companies and affect their income statements, as does Doing Business. But while PricewaterhouseCoopers bases its calculation on data from the largest companies in the economy, Doing Business focuses on a standardized mediumsize company.

This methodology was developed in Djankov and others (2009).