Study of Small and Medium Enterprises in Azerbaijan - IFC

Box 7.1 What is the Shadow Economy?
By definition, the shadow (or informal) economy constitutes activities that are not recorded by the government.
One of the main reasons for the very existence of the informal sector is entrepreneurs’ attempt to find a shelter from government-induced
distortions such as excessive taxes, regulation, and bribery. Companies that conceal some of their transactions pay lower taxes, thereby shifting
the tax burden onto the taxpayers who operate legally. Such companies operating within the law, however, do not have to waste resources
to conceal their activities, and therefore can develop and achieve optimum growth. This premise is supported by the Doing Business (2005)
project, which found that, “on average, in the 10 developing countries sampled, the output of shadow enterprises was 40 percent less than that
of legal businesses operating in the same economic sectors.” Therefore, operating in the shadow economy is also harmful for the businesses
themselves since they have limited ability to attract external funding. Companies that understate their profit to avoid taxes are also deprived
of other opportunities – low financial indicators do not permit them to secure bank credit or use the services of leasing companies.
Although in comparison with the previous year, Azerbaijan has made significant
progress in reducing the number of tax payments (from 30 to 23), the 2009 Doing
Business report indicates that the number of tax payments is still higher than in
certain neighboring economies such as Kazakhstan, where businesses make just 9 tax
payments per year and spend 271 hours on tax compliance (Table 7.6). Moreover,
IFC survey results indicate that on average Azerbaijani businesses have to visit
tax authorities for various reasons seven times a year, and their employees spend
approximately 3 percent of their working hours on the preparation of tax reports.
Table 7.6 The administrative burden for compliance with tax requirements in
Azerbaijan is high compared to that of Kazakhstan
Azerbaijan
Kazakhstan
VAT, number of payments per year 1-12 41 1
• compliance time, hours 162 92
SST, number of payments per year 12 1
• compliance time, hours 134 74
CPT, number of payments per year 1 1
• compliance time, hours 79 105
All taxes, number of payments 23 9
• compliance time, hours 376 271
Source: IFC/World Bank 2008
However, despite these complexities in tax reporting, only 16 percent of individual
entrepreneurs and 11 percent of SMEs indicated in the IFC survey that tax payments
and reporting procedures are problematic issues (Charts 7.3 and 7.4). Based on
interviews with focus-group respondents, there are indications that a number of entrepreneurs
are prepared and willing to engage in illicit payments in order to simplify
reporting and controls.
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See previous comment/footnote.
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St u d y o f Sma l l a n d Me d i u m Ent e r p r i s es in Az e r b a i j a n