## How to Design a Presumptive Income Tax for Micro and Small Enterprises

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### Introduction and Rationale
- Turnover taxes are a common presumptive taxation approach for micro and small enterprises (MSEs).
- Objectives:
  - Reduce relatively high compliance costs of MSEs that discourage formalization and tax payment.
  - Use sales (turnover) as a simpler base for tax administrations compared with profits.
  - Promote greater inclusiveness within the formal sector even though revenue collection from turnover tax regimes is typically below 0.25 percent of GDP.
- Trade-offs:
  - Turnover taxes disallow cost deductions, potentially generating inefficiencies and discouraging risk-taking by loss-making firms.
  - Flat-rate turnover taxes can violate vertical and horizontal equity relative to progressive PIT.
  - "What is simple cannot be precise, and what is precise cannot be simple."

### Common Presumptive Methods and Relative Merits
- Method A — Turnover: tax rate × gross sales.
  - Example: tax rate 3 percent, sales 100 → tax liability 3 (100 × 0.03).
  - Greatest simplicity; less precision across variable profit margins.
- Method B — Turnover minus notional expenses: tax rate × (sales − notional expenses).
  - Notional expenses are a fixed percentage of sales; sector-specific notional rates can reflect varying profit margins.
  - One-for-one equivalence exists between a tax rate on notional net income (method B) and a tax rate on turnover (method A).
- Method C — Turnover minus actual expenses: tax rate × (sales − actual expenses).
  - Most accurate (based on actual cash flows) but requires bookkeeping for turnover and purchases.
- Lump-sum bracket approach:
  - Example: Benin uses five turnover brackets for enterprises with turnover below 20 million XOF; lump-sum amounts equal 2 percent of the midpoint of the bracket.
  - Lump-sum regimes produce discontinuous effective tax rates at bracket edges and should be reserved for very small operators; fixed payments must be indexed or periodically adjusted for inflation.

### Reporting, Filing, and Administrative Recommendations
- Simple bookkeeping based on cash accounting is recommended.
- Taxpayers should record and keep suppliers’ invoices for cross-checking.
- Tax payment can be monthly; a single tax return can be filed, preferably online, at the end of the year.
- Design drivers: relative sizes of taxpayer compliance costs and tax administration costs determine optimal threshold and rate choices.
- Appendix 1 provides a formula for the optimal turnover tax threshold; Appendix 2 discusses empirical compliance and administration cost estimates and simulations.

### Key Policy Choices
- Which taxes the turnover tax replaces:
  - Primarily substitutes for profit tax on micro and/or small enterprises (including self-employed).
  - Often replaces requirement to register for VAT, licensing fees (patente), and in some cases payroll taxes or social contributions.
  - Turnover tax regimes are often referred to as “unified tax,” “single tax,” “synthetic tax,” or “simplified tax.”
- Eligibility criteria:
  - Turnover is the most robust and easily understood eligibility indicator versus composite proxy-based systems.
  - Other indicators discussed include assets, floor space, number of employees (employee-count criteria can be manipulated).
- Threshold determination:
  - Optimal threshold equates marginal social benefit and marginal social cost; Appendix 1 gives the formal expression and a numerical illustration.
  - Practical threshold selection balances reducing compliance burden for small firms and avoiding excessive revenue loss or distortions.
- Rate setting:
  - Low rates can attract medium firms and induce bunching; high rates can deter formalization.
  - Under method B, the notional expense share functions like sector-differentiated turnover tax rates.
  - Progressive turnover tax schedules raise equity but increase complexity and misclassification risks.

### Behavioral Responses and Bunching
- Bunching: disproportionate mass of firms just below the threshold due to underreporting or deliberate scale limitation.
  - Detection: compare frequency in the bin below the threshold to an extrapolated smooth curve from bins above the threshold.
  - Interpretation: may indicate tax burden discontinuity impeding growth; absence of a gap above the threshold suggests underreporting rather than deliberate scaling down.
- Survey evidence:
  - Coolidge and Yilmaz (2016): 18 percent and 16 percent of businesses in the turnover tax regimes in South Africa and Ukraine, respectively, abuse the regime; only 8 percent and 29 percent of eligible businesses use it (possible information gaps).

### Effective Tax Rates — Illustration (Senegal CGU example)
- Formulas:
  - ETR on profit in standard regime = CIT rate + (1 – CIT rate) x DT rate.
  - Under turnover tax (TT), ETR on profit = TT rate ÷ profit margin (profit margin = operating profits before tax ÷ turnover).
- Senegal (CGU applies to MSEs with turnover < 50 million XOF):
  - CGU rates: 2 percent for trade in goods, 5 percent for services.
  - CIT rate = 30 percent.
  - Dividend tax (DT) rate = 10 percent.
- Table 2.1 ETR values:
  - Effective Tax Rate below Threshold (CGU Tax Regime):
    - Goods Traded at 5% Profit: 40.0%
    - Goods Traded at 15% Profit: 13.3%
    - Services at 15% Profit: 33.3%
    - Services at 25% Profit: 20.0%
  - Effective Tax Rate above Threshold (Profit Tax Regime): 37.0% (for all listed sector/margin cases)
- Note: CGU ETR exceeds regular-regime ETR only for trade with a 5 percent profit margin. Compliance costs for the regular regime in developing countries are often 5 percent or more of turnover for small businesses, akin to an extra tax burden.

### Country Practices and Comparative Statistics (selected)
- Prevalence:
  - More than 40 countries currently use turnover (method A) as presumptive income tax base.
- Comparative statistics (as of January 1, 2022; thresholds in USD rounded in source):
  - Median threshold close to $100,000.
  - Turnover tax rates most commonly between 1 and 2 percent.
- Selected country entries (Threshold (USD); Turnover Tax Rate (%)):
  - Armenia: 240,000 AMD 115 million; 5 (trading), 3.5 (production)
  - Azerbaijan: 117,000 AZN 200,000; 2
  - Belarus: 196,000 BYN 500,000; 6
  - Georgia: 162,000 GEL 500,000; 1
  - Kyrgyzstan: 354,000 KGS 30 million; 4 (mfg., comm., agri. proc.), 6 (other)
  - Latvia: 35,000 EUR 40,000; 25, 40 (progressive; incl. soc. sec.)
  - Romania: 880,000 EUR 1 million; 1 (3 if no employees)
  - Russia: 32,000 RUB 2.4 million; 4 (B2C sales), 6 (B2B sales)
  - Rwanda: 20,000 FRW 20 million; 3
  - Kenya: 442,000 KES 50 million; 1
  - Indonesia: 336,000 IDR 4.8 billion; 1
  - Peru: 132,000 PEN 525,000; 1.5
  - France: 73,000 EUR 82,800; 1.7 (ind./comm.), 2.2 (noncomm.)
  - Italy: 57,000 EUR 65,000; 15 (5 during first five years of activity)
- Minimum turnover-based minimum taxes (MTs) context:
  - As of 2018, MTs based on turnover were in use across 31 countries with rates varying from 0.2 percent (Tunisia) to 3 percent (Bolivia, Equatorial Guinea, Guinea, and Madagascar) and average tax rate of 1.2 percent.

### Operational Innovations and Case Examples
- Brazil: Simples Nacional (2007) unified multiple taxes on gross revenues, substituting corporate income tax, various social contributions, taxes on industrial products, goods and services, and payroll taxes for social security; unification reduced compliance costs and formalization barriers.
- Latvia example: owners of microenterprises may opt for a 25 percent tax on revenues with 80 percent of receipts going to the state social contributions fund (illustrative of allocating receipts to social entitlements).
- Rwanda: M-Declaration (2013) mobile platform enables declarations via phones without internet or bank accounts; system calculates tax from declared turnover and generates reference numbers. Policy context: 2012 reform lowered turnover tax rate from 4 percent to 3 percent for businesses below RWF 50 million (reduced to RWF 20 million in July 2018); lump-sum regime for turnovers below RWF 12 million.

### Design Guidance, Detection Tools, and Seven Practical Steps
- Rate-design insights:
  - Optimal turnover tax rate balances attraction of medium firms (bunching) versus deterrence of formalization.
  - Theoretical results: when bunching is absent, the optimal turnover tax rate is independent of the profit tax rate; when bunching occurs, the turnover tax rate rises with the profit tax rate.
  - Numerical model results (simultaneous rate and threshold setting): turnover tax rate around 2.5 percent; optimal threshold between $65,000 and $85,000 depending on parameters and profit tax rate.
  - Limit number of rate categories to one or two to preserve simplicity and reduce arbitrage.
- Seven analytical/practical steps for practitioners:
  1. Assess the simplicity of the MSE regime (taxes substituted, eligibility criteria, alignment of filing obligations).
  2. Estimate taxpayer compliance costs (filing frequencies, payment options, need for e-services, reports of harassment, taxpayer information campaigns).
  3. Examine trends in taxpayer registration (anomalous migrations across regimes, disguising employees as microentrepreneurs).
  4. Plot frequency distribution of taxpayers by turnover size to detect bunching at the threshold.
  5. Calculate effective tax rates to detect misalignment between turnover tax and regular income taxes (CIT and PIT) or license fee regimes.
  6. Compare regime design with indicators of best practice and regional comparators and model-based optimal design.
  7. Inquire about tax administration practices in the MSE segment (number of inspectors, dossier exchange when turnovers cross thresholds).
- Control and monitoring:
  - Use data matching, risk-based auditing, and other administrative measures.
  - Filing and recordkeeping requirements for MSEs under the threshold should be minimal (for example, annual declaration of total turnover; payments monthly or quarterly).
  - Outreach campaigns to educate informal operators about turnover tax benefits are essential.
- Digital and third-party data:
  - Assess design changes needed for simplified administration via mobile applications.
  - Consider leveraging third-party sources (for example, bank and e-commerce platform sales information).

### Empirical Estimates of Compliance and Administration Costs (Appendix 2)
- Definitions:
  - Tax compliance cost = external professional services + in-house employee time costs + costs of tax software and hardware.
  - Compliance costs are highly regressive, implying substantial fixed-cost components.
- Baseline fixed compliance cost suggested for optimal threshold calibration (developing countries, in 2022 dollars):
  - $1,400 for profit tax without VAT.
  - $300 for a turnover tax.
- Country survey findings (preserve reported magnitudes):
  - South Africa (2011, 5 percent–trimmed averages):
    - General regime in-house cost: R53,357 ($7,360).
    - Turnover tax in-house cost: R14,030 ($1,935).
    - External compliance cost: R9,882 ($1,360).
  - Kyrgyzstan (surveys 2012–2016, average company cost):
    - General with VAT: $1,042.
    - General without VAT: $342.
    - Simplified regime: $246.
  - Costa Rica (2012 survey averages):
    - Simplified regime: micro $1,115; small $1,316.
    - General regime: micro $2,272; small $2,165; medium $3,254.
  - Brazil (2012 survey, adjusted estimates):
    - Profit tax: $2,539 (estimated).
    - Turnover tax (Simples): $971 (estimated).
- Tax administration cost benchmarks and country variation:
  - Typical benchmark: administration costs about 1 percent of tax revenues.
  - Slovakia: CIT administration cost 1.65 percent of CIT revenues; turnover-tax form of PIT 2.25 percent of PIT revenues.
  - Czech Republic: CIT administration cost 0.67 percent of CIT revenues.

### Optimal Threshold Formula and Numerical Illustration (Appendix Box 1.1)
- Optimal threshold expression:
  Z* = (dA + G) − (dA' + G') / (d − 1)[(1 − C) t_C / (C − t)] + a
  - Variable definitions preserved as in source (Z*, d, A, G, A’, G’, t_C, t, C, a).
  - Denominator must be positive; a nonpositive denominator implies an infinitely high threshold (artifact of assumptions).
- Numerical illustration using parameter values from the source:
  - d = 1.5
  - C = 0.875
  - a = 0.025
  - G = $1,400
  - G’ = $300
  - A = $800
  - A’ = $25
  - t_C = 0.25
  - t = 0.025
  - Result: Z* = $80,444

*IMF | How to Design a Presumptive Income Tax for Micro and Small Enterprises — Jean-François Wen (June 2023).*

### Introduction......... ..................................................................................................

### How to Design a Presumptive Income Tax for Micro and Small Enterprises

### Introduction
- Turnover taxes are prevalent in developing countries as a simple form of presumptive taxation of business income.
- Purpose and rationale:
  - Reduce relatively high compliance costs of micro and small enterprises (MSEs), which might otherwise discourage formalization and tax payment.
  - For tax administrations, sales may be easier to ascertain than profits, which require verification of deductions.
  - MSEs constitute the largest segment of taxpayers but their importance for revenue collection is small.
- Revenue and inclusiveness:
  - Tax collection from turnover tax regimes is typically below 0.25 percent of GDP.
  - Main objective is to promote greater inclusiveness within the formal sector.
- Trade-offs and limitations:
  - Turnover taxes do not allow deductions of costs, potentially generating inefficiencies and discouraging risk-taking by loss-making firms.
  - Flat rate turnover taxes can result in violations of vertical and horizontal equity compared with progressive PIT.
  - What is simple cannot be precise, and what is precise cannot be simple.
- Three common simplification approaches:
  - Method A — Turnover: tax rate × gross sales. Example: tax rate 3 percent, sales 100 → tax liability 3 (100 × 0.03).
  - Method B — Turnover minus notional expenses: tax rate × (sales − notional expenses), with notional expenses a fixed percentage of sales. Example: sales 100, tax rate 5 percent, notional expenses 40 percent → tax liability 0.05 × (100 − 40) = 3.
  - Method C — Turnover minus actual expenses: tax rate × (sales − actual expenses). Example: sales 100, expenses 45, tax rate 5 percent → tax liability 0.05 × (100 − 45) = 2.75.
- Relative merits:
  - Method A: greatest simplicity, less precision due to varying profit margins.
  - Method B: permits recognition of varying profit margins by sector using sector-specific notional expense rates; one-for-one equivalence exists between tax rate on notional net income (method B) and tax rate on turnover (method A).
  - Method C: most accurate (based on actual cash flow) but requires bookkeeping for turnover and purchases; more demanding administratively.
- Lump-sum bracket approach:
  - Example: Benin uses five turnover brackets for enterprises with turnover below 20 million XOF; lump-sum amounts equal 2 percent of the midpoint of the bracket.
  - In Benin, a 2 percent tax applies directly to turnover for enterprises with turnover between 20 million XOF and 50 million XOF.
  - Lump-sum regimes are easy to understand but produce discontinuous effective tax rates at bracket edges and should be reserved for very small operators; fixed payments must be indexed or periodically adjusted for inflation.
- Reporting and filing:
  - Simple bookkeeping based on cash accounting recommended.
  - Taxpayers should record and keep invoices from purchases for cross-checking.
  - Tax payment can be monthly; a single tax return can be filed, preferably online, at the end of the year.
- Design drivers:
  - Optimal design is driven by relative sizes of taxpayer compliance costs and tax administration costs.
  - Appendix 1 presents a formula for the optimal turnover tax threshold.
  - Appendix 2 discusses empirical estimates of compliance and administration costs used in threshold formula and simulations of optimal tax rate.
- Prevalence:
  - More than 40 countries currently use turnover (method A) as a presumptive income tax base for qualifying entrepreneurs and enterprises.
- Purpose of the note:
  - Guide policymakers and practitioners on design of a turnover tax addressing:
    - Which taxes it replaces
    - Eligibility criteria
    - How to determine the optimal threshold
    - How to set the tax rate

### Key Policy Choices for a Turnover Tax
- Primary policy choices addressed in the note:
  - Which taxes the turnover tax replaces
  - Eligibility criteria for taxpayers
  - How to determine the optimal threshold for inclusion in the regime
  - How to set the turnover tax rate

### Which Taxes It Replaces
- Core substitution:
  - Intended primarily as a substitute for profit tax on micro and/or small enterprises (including self-employed individuals).
- Other taxes and charges often replaced:
  - Requirement to register for value-added tax (VAT)
  - Licensing fee (patente) common in Francophone countries
  - Payroll taxes or social contributions in some countries
- Terminology:
  - Turnover tax regimes are often referred to as “unified tax,” “single tax,” “synthetic tax,” or “simplified tax.”

### Eligibility Criteria
- (Content identifies that eligibility criteria are a key design issue; detailed eligibility rules and scoring using indicators such as sales, assets, floor space, number of employees are discussed in the note. Turnover is highlighted as easy for the taxpayer to understand compared with composite proxy-based presumptive systems.)

### How to Determine the Optimal Threshold
- Drivers:
  - Relative sizes of taxpayer compliance costs and tax administration costs determine the optimal threshold.
- Analytical tools:
  - Appendix 1: formula for the optimal turnover tax threshold.
  - Appendix 2: empirical estimates of compliance and administration costs used in the threshold formula.
- Practical considerations:
  - Threshold selection balances reducing compliance burden for small firms and avoiding excessive revenue loss or distortions.

### How to Set the Turnover Tax Rate
- Trade-offs:
  - Low turnover tax rates may incite larger firms to artificially reduce reported sales; rates should not be so high as to discourage formalization.
- Method interactions:
  - Under method B, choosing a notional expense share shifts policy choice from turnover tax rate to share of turnover allocated to cost recovery; this is equivalent to varying turnover tax rates across sectors.
- Equity and progressivity:
  - Some countries apply a progressive turnover tax schedule; equity gains must be balanced against simplicity costs of graduated rates.
- Administrative and compliance implications:
  - Differentiated rates by sector can increase compliance costs and create opportunities for misclassification (for example, classifying services as goods to exploit larger notional expenses).

### Country Practices with Turnover Tax Regimes
- Empirical note:
  - Table 1 (at the end of the note) presents cross-country turnover tax thresholds and tax rates.
- Usage note:
  - More than 40 countries use method A (turnover) for presumptive income tax.

### Final Remarks
- Policy summary:
  - Turnover tax regimes can promote formalization and reduce compliance burdens for MSEs but involve efficiency and equity trade-offs.
  - Design should be guided by empirical estimates of compliance and administration costs and by consideration of sectoral profit margin heterogeneity.
- Implementation recommendations:
  - Combine turnover tax regimes with taxpayer education and tax collection enforcement to improve compliance culture.
  - Use simple cash-based bookkeeping, require suppliers’ invoices for cross-checking, and favor online year-end single returns with monthly payments.
  - Reserve lump-sum bracket regimes for the smallest operators and ensure bracket indexing for inflation.

*IMF | How to Design a Presumptive Income Tax for Micro and Small Enterprises — Jean-François Wen (June 2023).*

### Box 1. National Simplified Tax System in Brazil

### Box 1. National Simplified Tax System in Brazil

### Overview
- The Simples Nacional tax regime for micro and small businesses, introduced by Brazil in 2007, substituted a single tax on gross revenues for:
  - corporate income tax,
  - the contributions for Social Integration Program and for Social Security Financing,
  - the tax on Industrial Products,
  - the tax on the Circulation of Goods and Services,
  - the tax on Services,
  - payroll taxes for social security.
- The unification of tax bases and payments significantly reduced tax and regulatory compliance costs and lowered formalization barriers for microfirms, increasing the number of registered businesses (Fajnzylber, Maloney, and Montes-Rojas 2011; Monteiro and Assunção 2012).

### Social security and incentives for formalization
- Social security eligibility can be an important reason for entrepreneurs to formalize.
- Where social security or social insurance contributions are included in the single payment scheme (generally implying a higher turnover tax rate), it is advisable to explicitly allocate a portion of receipts to taxpayers’ social security or social insurance entitlements.
  - Example: Latvia allows owners of microenterprises to opt for a tax on revenues at the rate of 25 percent, of which 80 percent of receipts goes to the state social contributions fund.
- High mandatory social contribution rates can deter formalization (Kugler, Kugler, and Prada 2017). Policy responses include:
  - Subsidizing social contribution rates of adherents to MSE tax regimes (examples: Brazil, Uruguay).
  - Allowing mandatory social contributions to be deducted from taxable turnover (example: Russia).
- Employers subject to turnover tax should be required to withhold personal income tax and social contributions on employee wages; filing frequency may be lower than for firms in the general tax regime (example: Madagascar).
- Individual entrepreneurs subject to turnover tax can be required to have an owner-manager employment contract and to pay social insurance contributions as employees.

### Eligibility criteria — Types of entities
- Turnover tax regimes typically apply mainly to:
  - unincorporated self-employed individuals,
  - partnerships,
  - may also admit limited liability sole proprietorships and close corporations.
- Publicly held corporations are typically excluded.
- Individuals in professional occupations (doctors, lawyers, engineers, accountants) are excluded in some countries.

### Segmenting by turnover — Thresholds and rules
- Establishing a maximum enterprise size in terms of turnover is the most robust eligibility approach; the threshold should apply to consolidated operations as per unique tax identification number to mitigate multiple-company avoidance.
- Limits on the number of employees are common (often up to five employees), but employee-count criteria are susceptible to manipulation; requiring zero employees should be avoided.
- New taxpayers are usually assigned to a regime based on expected annual turnover; electing the standard regime commonly requires remaining in it for at least two years.
- A common recommendation: set the turnover tax threshold equal to the VAT threshold because VAT recordkeeping facilitates compliance with profit tax and harmonized thresholds aid tax administration.
- Reasons why thresholds may differ:
  - VAT threshold may be zero (examples: Chile, Peru) or VAT nonexistent (example: Comoros).
  - Historical policy interaction: when South Africa introduced a turnover tax for enterprises with gross receipts below R1 million, it raised the VAT threshold from R300,000 to R1 million because businesses could not be registered for turnover tax and VAT simultaneously (until 2012).
- Strategic argument for different thresholds: distinct thresholds smooth transition costs and may raise tax revenues (Kanbur and Keen 2014).
- Operational considerations:
  - Turnover tax cutoff can be lower than VAT registration threshold because value-added margin > profit margin (wages not deductible for VAT).
  - Example: Madagascar in 2021 doubled its VAT threshold without changing the CIT threshold to combat perceived VAT refund fraud by small enterprises.
- Default: harmonizing sales thresholds for VAT and CIT is a good default option, but country circumstances may warrant divergence.

### How to determine the optimal threshold — Key insights
- The theoretically optimal threshold equates marginal social benefit and marginal social cost from adjusting the threshold; Appendix 1 provides a simple formula for the optimal turnover tax threshold.
- Analytical insights:
  - The optimal threshold is proportional to the difference in the cost of compliance and administration between the regular and presumptive regimes. Technology innovations (digital platforms, electronic billing, e-services) reduce compliance and administration costs, warranting a lower threshold.
  - The optimal threshold decreases with the profit tax rate and increases with the turnover tax rate, because tax rates affect revenue-raising capacities of each regime.
- The optimal-threshold formula ignores behavioral responses such as:
  - underreporting of sales (tax evasion),
  - incentives to limit enterprise scale to remain below the threshold (tax avoidance / bunching).

### Bunching — Behavioral responses and interpretation
- Bunching: disproportionate mass of firms with turnover levels just below the threshold, due to underreporting or deliberate scale limitation.
- Empirical detection: compare frequency of firms in the turnover bin just below the threshold with the mass extrapolated from a smooth curve fitted to bins above the threshold.
- Interpretation:
  - Bunching can indicate a significant tax burden discontinuity that impedes growth and innovation.
  - Bunching is not necessarily policy failure; it can arise even in a first-best setting because fixed compliance costs create a discontinuity when transitioning regimes.
  - If bunching is due to firms strategically restricting output, a gap of firms just above the threshold should accompany it; absence of that gap suggests underreporting rather than deliberate output restriction.
- Survey evidence: based on surveys, Coolidge and Yilmaz (2016) report that 18 percent and 16 percent of businesses in the turnover tax regime in South Africa and Ukraine, respectively, abuse the regime; only 8 percent and 29 percent of businesses eligible for the regime use it, possibly indicating lack of information among microentrepreneurs.
- Governance risk: large firms may underreport sales and exploit presumptive tax regimes with collusion (Mbaye and Benjamin 2012).

### Effective Tax Rates (Box 2 illustration)
- Definition and formulas:
  - ETR on profit in standard regime = CIT rate + (1 – CIT rate) x DT rate.
  - Under turnover tax (TT), ETR on profit = TT rate ÷ profit margin (profit margin = operating profits before tax ÷ turnover).
- Senegal illustration:
  - Turnover tax (Contribution Globale Unique, CGU) applies to MSEs with turnover lower than 50 million XOF (about $90,000):
    - CGU rates: 2 percent for trade in goods, 5 percent for services.
  - CIT rate = 30 percent.
  - Dividend tax (DT) rate = 10 percent.
- Table 2.1 effective tax rates (values preserved):
  - Effective Tax Rate below Threshold (CGU Tax Regime):
    - Goods Traded at 5% Profit: 40.0%
    - Goods Traded at 15% Profit: 13.3%
    - Services at 15% Profit: 33.3%
    - Services at 25% Profit: 20.0%
  - Effective Tax Rate above Threshold (Profit Tax Regime): 37.0% (for all listed sector/margin cases)
- Note: The CGU ETR exceeds the regular-regime ETR only in the case of trade with a profit margin of 5 percent. Compliance costs for the regular regime in developing countries are often 5 percent or more of turnover for small businesses, akin to an extra tax burden (Coolidge 2012).

### How to set the turnover tax rate
- The optimal turnover tax rate balances two behavioral margins:
  - If too low: medium-sized firms may be attracted to the MSE regime (bunching). Practical rule: set the effective rate of the turnover tax moderately above the profit tax rate to capture part of compliance cost savings as revenue.
  - If too high: microenterprises may remain informal rather than register. Survey evidence from Ethiopia indicates reductions in tax rates would encourage informal businesses to register (World Bank 2016).
- Business registration trends can indicate whether the turnover tax rate is too low or too high; Box 3 offers guidance for detecting misalignment based on registration trends.
- Additional fraud consideration: enterprises in the turnover tax regime may generate fictitious sales to enterprises in the profit tax regime to facilitate profit-tax avoidance by the latter (Schatán and others 2019).

*Source: Box 1. National Simplified Tax System in Brazil, htnea2023002.*

### Box 3. Examining Data for Turnover Tax Rate Misalignments

### Box 3. Examining Data for Turnover Tax Rate Misalignments

### Migration of enterprises to the simplified regime
- Unusual registration trends toward the presumptive regime and the absence of a substantial category of medium-sized businesses can indicate system abuse.
- Kazakhstan example:
  - Sudden increase in number of individual entrepreneurs with declared turnover in the band below the simplified tax regime threshold (KZT 20–40 million) in 2009 coincided with a reduction of the turnover tax rate from 5 percent to 3 percent.
  - Simultaneous decline in number of individual entrepreneurs in the band above the eligibility threshold and comparatively low number of incorporated businesses in the medium taxpayer segment (KZT 40–100 million).
- Table 3.1. Number of Active Medium and Small Taxpayers in Kazakhstan (selected figures)
  - Individual Entrepreneurs, Turnover KZT 20–40 million:
    - 2007: 2,208
    - 2008: 2,998
    - 2009: 4,745
  - Individual Entrepreneurs, Turnover KZT 40–100 million:
    - 2007: 820
    - 2008: 1,120
    - 2009: 893
  - Legal Entities, Turnover KZT 20–40 million:
    - 2007: 8,464
    - 2008: 8,587
    - 2009: 8,665
  - Legal Entities, Turnover KZT 40–100 million:
    - 2007: 10,073
    - 2008: 10,043
    - 2009: 9,339

### Lack of take-up of the simplified regime by MSEs
- Low take-up of the turnover tax regime by eligible MSEs can indicate the tax rate is too high or information barriers exist.
- Tajikistan example:
  - Turnover tax rate of 4 percent (5 percent for turnover above SM 200,000).
  - Less than 40 percent of the retail and construction enterprises eligible chose the turnover tax regime over the regular regime.
- Possible causes of low take-up:
  - Excessive effective tax rate for activities with low profit margins (retail, construction).
  - Taxpayers lacking information about benefits of the regime (survey evidence cited).

### Key theoretical insights on setting the turnover tax rate
- The optimal turnover tax rate depends on bases in the regular and presumptive regimes, threshold, incentives for informality and bunching, compliance and administrative costs, and the social value of public funds.
- Theoretical analysis yields:
  - The optimal turnover tax rate is independent of the profit tax rate when bunching is absent. However, when bunching occurs, the turnover tax rate rises with the profit tax rate.
  - The optimal turnover tax rate is inversely related to the profit margin in the informal (untaxed) sector. Stronger enforcement (making informal production less attractive) can accompany a higher turnover tax rate.
  - The optimal turnover tax rate is positively related to the taxpayer’s cost of complying with the regular regime (relative to the presumptive regime) when there is bunching. E-services that reduce compliance costs in the regular regime can create space to reduce the turnover tax rate without inducing bunching.
- Numerical model results when turnover tax rate and threshold set simultaneously:
  - Turnover tax rate around 2.5 percent.
  - Optimal threshold varies between $65,000 and $85,000, depending on parameter values and the profit tax rate.
  - The effective tax rate on profit implied by the optimal turnover tax rate is not necessarily above the statutory profit tax rate in the regular regime.
  - Allowing some amount of bunching can be a consequence of optimal policy.

### Other considerations for designing the tax rate and structure
- Limit number of turnover tax rate categories to one or two (for example, commercial and industrial activities versus services). A taxpayer with several activities should calculate and pay tax separately for each activity.
- Simplicity and elimination of arbitrage across activity categories are essential; flat-rate turnover tax is conducive to administrative innovations (mobile declaration and mobile money payment platforms).
- Choice of self-employment versus employment:
  - Administrative rules may be needed where a gap exists between effective tax rates on earnings of employees versus self-employed to prevent reclassification abuses (examples of conditions suggesting employment relationship are listed).
- Turnover taxes resemble turnover-based minimum taxes (MTs) used to shore up CIT bases:
  - As of 2018, MTs based on turnover were in use across 31 countries with rates varying from 0.2 percent (Tunisia) to 3 percent (Bolivia, Equatorial Guinea, Guinea, and Madagascar) with an average tax rate of 1.2 percent.
  - To avoid discouraging transition of MSEs to the standard income tax regime, the turnover tax rate for MSEs should be superior to the MT tax rate on turnover.

### Country practices and comparative statistics
- Country practices (selected) illustrate wide variation in thresholds and rates as of January 1, 2022:
  - Median threshold close to $100,000.
  - Turnover tax rates between 1 and 2 percent are most common.
- Selected country entries (Threshold (USD); Turnover Tax Rate (%)):
  - Armenia: 240,000 AMD 115 million; 5 (trading), 3.5 (production)
  - Azerbaijan: 117,000 AZN 200,000; 2
  - Belarus: 196,000 BYN 500,000; 6
  - Georgia: 162,000 GEL 500,000; 1
  - Kyrgyzstan: 354,000 KGS 30 million; 4 (mfg., comm., agri. proc.), 6 (other)
  - Latvia: 35,000 EUR 40,000; 25, 40 (progressive; incl. soc. sec.)
  - Romania: 880,000 EUR 1 million; 1 (3 if no employees)
  - Russia: 32,000 RUB 2.4 million; 4 (B2C sales), 6 (B2B sales)
  - Rwanda: 20,000 FRW 20 million; 3
  - Kenya: 442,000 KES 50 million; 1
  - Indonesia: 336,000 IDR 4.8 billion; 1
  - Peru: 132,000 PEN 525,000; 1.5
  - France: 73,000 EUR 82,800; 1.7 (ind./comm.), 2.2 (noncomm.)
  - Italy: 57,000 EUR 65,000; 15 (5 during first five years of activity)
  - (Note: thresholds in US dollars are rounded to the nearest $1,000 in the source table.)

### Rwanda case: M-Declaration (administrative innovation)
- Rwanda launched M-Declaration in 2013: a mobile phone platform to help small entrepreneurs declare taxes via phones without internet, PCs, or bank accounts.
- System features:
  - Calculates tax based on declared turnover and generates a reference number.
  - Reduces time and cost for taxpayers and eases monitoring and collection for the revenue authority.
- Policy context:
  - 2012 reform lowered turnover tax rate from 4 percent to 3 percent (applicable to businesses with turnover below RWF 50 million—reduced to RWF 20 million in July 2018).
  - Created a lump-sum payment regime for firms with annual turnovers below RWF 12 million (lump-sum amounts vary across five turnover bands and are equivalent to 3 percent of turnover at the lower limit of each band; firms in the first band of the lump-sum regime are exempt).
  - Simpler, uniform tax rates facilitated development and adoption of the M-Declaration platform.

### Final remarks: operational guidance and analytical steps
- Presumptive turnover taxation simplifies tax calculations and payments for MSEs while allowing tax administrations to focus on larger firms.
- Appropriate threshold and turnover tax rate depend on country-specific factors: prevalence of informal activities; taxpayer capacities; quality of tax administration; use of digital technology; average profit margins; statutory corporate and personal income tax rates; and whether threshold is joint with VAT registration threshold.
- Turnover taxes should be accompanied by control and monitoring: data matching, risk-based auditing, and other administrative measures.
- Filing and recordkeeping requirements for MSEs under the threshold should be minimal (for example, annual tax declaration stating total turnover; payments monthly or quarterly).
- Outreach campaigns to educate informal operators about turnover tax benefits are essential.

- Seven analytical/practical steps for practitioners designing a turnover tax regime:
  1. Assess the simplicity of the MSE regime (taxes substituted, eligibility criteria, alignment of filing obligations).
  2. Estimate taxpayer compliance costs (filing frequencies, payment options, need for e-services, reports of harassment, taxpayer information campaigns).
  3. Examine trends in taxpayer registration (anomalous migrations across regimes, disguising employees as microentrepreneurs).
  4. Plot frequency distribution of taxpayers by turnover size to detect bunching at the threshold.
  5. Calculate effective tax rates to detect misalignment between turnover tax and regular income taxes (CIT and PIT) or license fee regimes.
  6. Compare regime design with indicators of best practice and regional comparators (Table 1) and model-based optimal design.
  7. Inquire about tax administration practices in the MSE segment (number of inspectors, dossier exchange when turnovers cross thresholds).

- Considerations on information technologies and third-party data:
  - Assess whether policy design changes are needed to allow simplified administration using mobile applications.
  - Consider leveraging third-party sources (for example, bank and e-commerce platform sales information).

### Appendix Box 1.1 — Formula and numerical illustration for the optimal turnover threshold
- Optimal threshold expression (for given tax rates):
  Z* = (dA + G) − (dA' + G') / (d − 1)[(1 − C) t_C / (C − t)] + a
  - Variables (as defined in source):
    - Z*: Optimal turnover threshold separating the tax regimes
    - d: Marginal value of public funds
    - A and G: Fixed cost per firm of tax administration (A) and taxpayer compliance (G) in the regular regime
    - A’ and G’: Fixed cost per firm of tax administration (A’) and taxpayer compliance (G’) in the turnover tax regime
    - t_C: Profit tax rate in regular regime
    - t: Turnover tax rate
    - C: Production cost per unit of output of firms in the regular regime
    - 1 − C: Before-tax profit margin for firms in the regular tax regime (price of output is $1)
    - a: Additional cost per unit of output of firms subjected to the turnover tax regime (so 1 − C − a is profit margin in the turnover regime)
  - The formula requires the denominator to be positive; a nonpositive denominator implies an infinitely high threshold (artifact of assumptions).
- Numerical illustration using reasonable parameter values:
  - d = 1.5
  - C = 0.875
  - a = 0.025
  - G = $1,400
  - G’ = $300
  - A = $800
  - A’ = $25
  - t_C = 0.25
  - t = 0.025
  - Result: Z* = $80,444

_Italic: Source: IMF | How to Design a Presumptive Income Tax for Micro and Small Enterprises (Box 3 content, selected tables and appendices)._

### Appendix 2: Estimates of the Costs of Tax Compliance and

### Appendix 2: Estimates of the Costs of Tax Compliance and Administration

### Taxpayer Compliance Costs — definitions and general findings
- Tax compliance cost = sum of:
  - cost of external professional services,
  - in-house employee time costs,
  - costs of tax software and hardware.
- Tax compliance costs are distinct from general accounting costs insofar as they are attributable to tax-related activities (becoming informed about tax laws, recording information for tax purposes, calculating tax, completing tax returns and paying, communicating with the tax administration).
- Compliance costs increase as firms extend markets and product lines because formal systems must be put in place to address growing complexity (Dodge and Robbins 1992).
- Compliance costs are highly regressive, implying a substantial fixed cost component in addition to variable costs.
- Compliance costs vary widely across countries due to differences in tax design, administrative practices, and salaries used to value in-house costs.
- Baseline fixed compliance cost suggested for calibrating optimal turnover tax threshold in developing countries:
  - $1,400 for profit tax without VAT (in 2022 dollars),
  - $300 for a turnover tax (in 2022 dollars).

### Appendix Box 2.1 — Empirical compliance cost estimates (country case evidence)
- South Africa (Smulders et al. 2012; 2011 survey):
  - Enterprises with turnovers below R1 million (about $150,000 in 2011) can opt for a turnover tax replacing general tax system (including VAT and profit tax) except employee taxes.
  - 40.5 percent of survey respondents had turnovers below R1 million.
  - 5 percent–trimmed average in-house cost of complying with the general tax regime: R53,357 ($7,360).
    - Of this, VAT accounted for R20,318, profit tax for R15,822, and employee taxes for R16,533.
  - 5 percent–trimmed average in-house cost of complying with the turnover tax: R14,030 ($1,935).
  - Average external taxpayer compliance cost for all taxes: R9,882 ($1,360); smaller businesses (turnover < R1 million) tended not to incur these external expenses.
  - Progressive turnover tax likely more costly for microenterprises to comply with than a standard proportional turnover tax.
- Kyrgyzstan (World Bank 2018; survey years 2012, 2014, 2016):
  - About 60 percent of sampled firms had turnovers below KGS 1 million ($12,000).
  - VAT threshold was KGS 4 million ($48,000 in 2016), increasing to KGS 8 million on July 1, 2016.
  - Businesses with turnover below KGS 1 million accounted for 80 percent of adherents to the turnover tax regime in the surveys.
  - Average company cost of tax compliance (external plus in-house), reported in US dollars over the three surveys:
    - $1,042 for the general regime with VAT,
    - $342 for the general regime without VAT,
    - $246 for the simplified regime.
  - Reported figures are lower bounds because respondent-evaluated time costs used formal salaries, while actual labor costs exceed formally declared salary.
- Costa Rica (United Nations 2014; 2012 survey):
  - 87 percent of the sample had sales below $100,000.
  - Simplified tax (Régimen de Tributación Simplificada) applies to enterprises with annual purchase volumes not greater than C 15,000,000 ($31,000 in 2012) and with no more than five employees; it combines income tax and sales tax and determines tax liability by applying specific coefficients to total taxable purchases.
  - Total tax rate on purchase volumes varies between 2.5 percent and 7.5 percent depending on industry.
  - Average total compliance cost:
    - Simplified regime: micro $1,115 and small $1,316,
    - General regime: micro $2,272, small $2,165, medium $3,254.
- Brazil (Inter-American Center of Tax Administrations; 2012 survey):
  - Distinction between corporate income tax payers and Simples Nacional payers (optional simplified regime).
  - Average total compliance costs found:
    - BRL 19,770 ($10,156 in 2012) for payers of tax on actual income,
    - BRL 7,563 ($3,885 in 2012) for payers of Simples.
  - Methodology did not disentangle tax costs from total accounting firm charges.
  - Federation of Brazilian accountants attributes one-quarter of total accounting costs strictly to tax compliance activities, implying approximate average total compliance costs of:
    - $2,539 for the profit tax,
    - $971 for the turnover tax in Brazil.

### Tax Administration Costs — typical estimates and variation
- Tax administration costs include: administrative overhead, salaries, and IT-related expenditures (Organisation for Economic Co-operation and Development 2011).
- Typical estimate: administration costs are about 1 percent of tax revenues (Smulders and Stark 2019).
- Country-specific estimates:
  - Slovakia (Nemec, Pompura, and Šagát 2015):
    - CIT administration cost: 1.65 percent of CIT revenues,
    - Turnover tax form of PIT: 2.25 percent of PIT revenues.
  - Czech Republic (same study): CIT administration cost: 0.67 percent of CIT revenues.

### Key quantitative takeaways (preserve reported magnitudes)
- Baseline fixed compliance cost for calibration in developing countries:
  - $1,400 for profit tax without VAT,
  - $300 for a turnover tax (in 2022 dollars).
- South Africa (trimmed averages, 2011):
  - General regime in-house cost: R53,357 ($7,360),
  - Turnover tax in-house cost: R14,030 ($1,935),
  - External compliance cost: R9,882 ($1,360).
- Kyrgyzstan (average company cost, surveys 2012–2016):
  - General with VAT: $1,042,
  - General without VAT: $342,
  - Simplified regime: $246.
- Costa Rica (2012 survey average compliance costs):
  - Simplified regime: micro $1,115; small $1,316,
  - General regime: micro $2,272; small $2,165; medium $3,254.
- Brazil (2012 survey, adjusted estimates):
  - Profit tax: $2,539 (estimated),
  - Turnover tax (Simples): $971 (estimated).
- Tax administration cost typical benchmark: about 1 percent of tax revenues.
- Country variances observed: CIT administration costs reported at 0.67 percent (Czech Republic) and 1.65 percent (Slovakia); turnover tax form of PIT at 2.25 percent (Slovakia).

*How to Design a Presumptive Income Tax for Micro and Small Enterprises — Appendix 2: Estimates of the Costs of Tax Compliance and Administration*

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_Source: https://www.imf.org/-/media/files/publications/howtonotes/2023/english/htnea2023002.pdf_