The large magnitudes of tax evasion and tax avoidance are having a profound impact on the economy and citizens of Cyprus. Tax evasion is defined as the deliberate non or under payment of taxation. It is illegal, whereas the term tax avoidance refers to the use of legal methods to minimise the amount of income tax owed by an individual or a company. While the extent of tax evasion and avoidance depend on many factors including economic and tax structures, types of income, external relations and social attitudes, it is argued that weak and ineffective tax administration contributes importantly in particular to the large-scale tax evasion by Cyprus residents.
Tax Administration
The primary goal of the Tax Department is to collect and enforce the payment of taxes in accordance with tax law provisions and to do this in such manner that will sustain confidence in the tax system and its administration. In so far as tax collections in Cyprus are well below potential given current tax rates, bases, and laws, it can be argued that tax administration in Cyprus is not very effective. A large part of the shortfall in tax collections is attributable mainly to widespread tax evasion by persons and corporations.
However, it is very difficult to quantify the level of tax evasion in Cyprus or in any other country because much activity takes place in the shadow or untaxed economy. According to a recent report of the Cyprus Tax Department sent to the House of Representatives the total amount of taxes owed to the state at end-September 2023 amounted to €3.4 billion, of which nearly €900 million were deemed uncollectible. While these figures on official tax arrears largely reflect illegal tax evasion and prima facie legal tax avoidance, they are only the tip of a big iceberg on the extent of tax avoidance and, particularly of outright tax evasion, as much income is undeclared, such as by persons doing work in the large shadow (untaxed) economy of Cyprus.
On the payment of personal income taxes, it is individuals not subject to withholding taxes such as self-employed persons, including highly paid professionals, who are among the main culprits indulging in prolific tax evasion. Strikingly, it is approximately estimated that self-employed persons paid on average just €1,080 in personal income taxes in 2022, whereas employees paid on average a much higher amount of €I,920.
Effects of tax evasion
Tax evasion and avoidance not only deprive the government of revenue that could be used for financing expenditures on public goods and services, but at times even limit considerably the scope for reducing tax rates. And weak enforcement of the rich and powerful to pay their fair share of taxes ultimately hurts honest tax-payers that in the longer run are saddled with higher taxes. In addition, unchecked and poorly controlled tax evasion has built up cynicism and lack of confidence by the public toward the government, with many taxpayers viewing tax evasion as a “national sport”.
Furthermore, in Cyprus many companies remain profitable because of toleration of tax evasion and avoidance and other unsavoury favors extended by the government and banks, thus putting at a disadvantage more law-abiding businesses, that potentially could use the economy’s scarce resources with much greater efficiency.
And Cyprus with its reputation for feeble law enforcement and corruption, attracts ill-gotten gains of corrupt politicians and criminals from abroad via tax evasion and tax avoidance and related money laundering, reinforcing its tarnished reputation in the process.
Strengthening tax administration
Grossly inefficient tax administration is contributing to large-scale tax evasion in Cyprus. It is incredible that the time lag between the lodging of personal income tax returns and receipt of their processing by the tax department stating the amount of tax owed is around five years, and in turn can be subject to endless and costless appeals. In contrast, in most euro area countries personal income tax returns are normally processed within months of their lodging. Surely, such lengthy time lags and the prospect of tax amnesties in Cyprus encourage the under-reporting of taxable income and even outright tax evasion by many persons not submitting returns.
Despite regular declarations by the ministers of finance that they will tackle tax evasion very little has been accomplished. Indeed, if the current government was really serious it would have projected the collection of much higher income tax receipts from the self-employed in its budget estimates for 2024 to 2026.
But, hopefully, if there is a fundamental change in the political willingness to fight tax evasion, there should be no excuses for the government not taking concrete measures to reform and strengthen tax administration, as the Tax Department has been promised an allocation of €24.2 million from the EU’s Recovery and Resilience fund for “improving the efficiency and tax collectability of the department”.
Most importantly, to help curtail evasion as well as avoidance the increased and integrated digitalisation of the public services should improve tax enforcement by collecting greater and more reliable information on the transactions, revenues and legitimate deductions and credits of taxpayers, so enabling better verification of the accuracy of their returns. Also, digitalisation makes it possible for consumers to act as third-party reporters for determining VAT obligations, by using electronic payments information such as debit and credit card payments. Indeed, tax evasion and avoidance resulting from electronic sales suppression and over-reporting of deductions through deliberate false invoicing surely can be tackled with available technology tools.
And there should be increased coordination between the income tax and VAT units of the Tax Department through the use of a common identification number for taxpayers for the payment of income taxes, VAT and social security as is the case in most EU countries, that among other things would allow greater scrutiny of persons not registering and submitting income tax returns.
Strictly speaking, tax evasion can be somewhat deterred by making tax registration and the filing process simple and less complicated in order to encourage greater tax compliance. Notably, anecdotal evidence indicates that the less computer-literate residents of Cyprus, particularly the elderly, have difficulties in filing tax returns and in many cases have to resort to accountants for assistance, the cost of which can often deter compliance.
In addition, with penalties for late tax payments modest and delayed, and endless appeals against tax calculations of Tax Department permitted, penalties on tax delinquency should be raised and aforementioned appeals should require that a portion of the calculated tax to be paid in advance. Furthermore, it should be legislated that all persons working for paid employment full time or part time, for at least six months, should be required to file a tax return so that there can be better examination of persons claiming that their taxable income is less than the tax-free income of €19,500.
Moreover, timely tax compliance and greater efficiency in tax administration requires cooperation with employers including public companies in punctually submitting statements of their revenues and expenses as well as the incomes of employees to the Tax Department. But, the government with its populist policies regularly extends timelines for the submission of income statements and tax returns. For example, on February 22, 2024 the Tax Department stated that “the date of submission of the Company Income Statement and the Summary Table of Controlled Transactions for the year 2022 is extended until November 2024”.
It can be concluded that government policies including failing to strengthen and reform weak and inefficient tax administration and in announcing delays in the submission of tax returns and actual payment of taxes foster tax evasion and avoidance.
Such policies must be remedied through, among other things, the enhanced and integrated digitalisation of the public services and measures including harsh penalties to enforce the correct and timely payment taxes by persons and corporations. Otherwise, tax evasion will continue to run amok in Cyprus and deprive the government of much urgently-needed revenue, implicitly promote the inefficient allocation of resources, and discriminate unfairly against ordinary tax-paying citizens.
Les Manison is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus
