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Zero Salary Tax for Software Developers

The human resources crisis

In the period 1995-2000, the “brains drain” trend had a severe impact on the Romanian ICT companies. Software developers were immigrating, mainly on economic grounds. The shortage in specialized human resources was casting the shadow of a doubt over the companies’ capabilities to develop projects, as well as over the sector’s general development. In order to solve this problem, the representatives of the ICT sector were exploring ways to encourage software developers to remain in the country. The most rapid and visible method to motivate an employee is salary - related. Eliminating the salary tax for software developers was considered the most effective way to induce revenue growth.

The solution

In 2000, Employers’ Association of Software and Services Industry (ANIS), together with the ICT associations united in the Tech 21 Coalition, initiated a legislative proposal in this respect. Varujan Pambuccian, President of the ICT Commission of the Romanian Parliament, supported the project.  

Varujan Pambuccian: “Discussions of a possible reduction of this tax started in 1998. The 40% taxation rate was a heavy burden on the operational costs of the companies, forced to pay small wages in order to keep the final price of their products and services as low as possible. The good software developers were leaving Romania. Unfortunately, at that moment we could not convince the Government. Nevertheless, in 2000, immediately after elections, we re-opened the subject with the incumbent Prime Minister. We initially suggested a 8% salary tax, but the Ministry of Public Finance proposed zero taxation, as it was easier to manage”.

In July 2001, the Romanian Official Gazette published Government Ordinance no. 94/21 regarding tax exemptions for certain professions related to software development. The tax exemption was conditioned upon fulfilment of certain requirements. As such, the income tax was eliminated from the contributions the companies were supposed to pay to the state budget on behalf of their employees.

The Government Ordinance, although very well received by companies, generated a series of debates regarding the requirements, which were argued to be restrictive for the smaller firms and for the employees originating from professional re-specialization.

These requirements stated:
1.     The positions for which a tax exemption was granted: analyst, programmer, engineer/ IT system designer, data base administrator, software engineer, IT project manager;
2.     The position is part of an IT specialized department, as specified in the company chart, such as: computing centre, direction, department, office, bureau, or similar others.
3.     The employees must produce evidence of having graduated an IT University, and a certificate issued by an accredited University in one of the following specialisations:
     1.     Automatics and industrial IT;
    2.     Computers, Economic IT, Applied IT;
    3.     Electronics, Applied Electronics, Electronics and Telecommunications;
    4.     Mathematics, IT Mathematics;
    5.     IT, Economic IT, Applied IT.
    6.     Cybernetics and Economic IT; cybernetics and economic provision; Accounting and management IT.
4.     The employer has earned and distinctly recorded in the balance sheets of the prior fiscal year an annual income of at least $10,000 $ per each employee intended to receive the tax exemption, resulting from activities related to software development.

Effects of the income tax removal

Even though the law was restrictive by limiting the beneficiaries, its effects were as follows:

1.     Creating stability in the labour market and expanding the hiring capacity of the companies (wages increased by 40%);
2.     Increase in foreign investments: multinational divisions relocated to Romania (Alcatel Research-Development Centre, Siemens Automotive Software Development Centre, Oracle Support Centres).
3.     30-50% increase in number of employees for multinationals who relocated outsourcing centers to Romania;
4.     Increase in profits and, implicitly, in investment budgets;
5.     Repatriation of IT experts (a 2002 survey ran by the Ministry for Communications and Information Technology revealed that 2% of the new employees in the software companies were repatriated);
6.     Decrease of “grey economy”, as smaller companies that were previously paying salaries without reporting them to the government return to official payment.  

Florin Talpes, ex-President ANIS: “This law has turned Romania into an attractive location for foreign companies, although our country still has a very high level of taxation.”

Critical moment

In 2005, the public authorities announced they have excluded this exemption from the 2006 Fiscal Code. The Ministry of Public Finance considered that this exemption gave an unjustified advantage to a certain professional category, and feared that this could open the door for more similar requests from other professionals. The Ministry also assumed that this regulation had a negative impact on the state budget.

ANIS organized a working group consisting of Coalition Tech 21 representatives, ICT Commission of the Romanian Parliament, the Ministry of Communications and Information technology, as well as companies representing the industry. In order to gain more grassroots support and visibility, the support of Association of Romanian Business People was obtained in this attempt to preserve the salary tax exemption for software developers. The ICT associations surveyed their members regarding the impact that elimination of this tax exemption would have on their budgets, on a short and medium term basis.  

The reports and estimates of the working group indicated the benefit to the state budget obtained from reintroducing the taxation would be insignificant in comparison to the positive effects generated by maintaining the exemption. Moreover, eliminating the exemption (a regulation unique in Europe) would have proved to be a negative signal to foreign investors, as well as to the overall ICT sector, with side-effects on the medium and long term industry’s development trend.

The survey results and other relevant information were gathered in a position paper delivered to the Ministry of Public Finance. The associations also organised a press conference in order to make public their arguments in favour of maintaining this regulation.

The arguments of the ICT sector

According to the Coalition Tech 21 representatives, the moment chosen for cancelling the exemption was not a good one: Romanian ICT industry had not attained the minimum level of maturity necessary to be successful in a competitive European market. The associations pointed out that the Romanian ICT industry had had a constant growth of 25% for the past years. Nevertheless, the IT expenses per capita in Romania (36 Euro in 2004) remained substantially low compared to Hungary, for instance (234 Euro), or to the Western European average figure (714 Euro). This data indicated that the industry was still in an incipient developmental stage, but had a fast development rate generated by favourable economic conditions.

Due to the fact that more than 85% of the Romanian software and services industry exports (70% of the total production) were exports to the EU, both the strengthening of the national currency in connection to Euro and the tax elimination could have produced industry losses varying from 13% to 27%.

Losing the tax exemption, and taking into account that the labour market evolution anticipated constant wage raises for the next 3-5 years, the companies might have been constrained to transfer the pressure of salary costs to the investment budgets. This might have translated in a decline of the industry’s development rate and a reduction of the innovation capacity on the part of the Romanian companies (costs increase by 25%, i.e. costs covered by reducing investments).

The impact of human resources as one of the competitive advantages of the Romanian ICT industry was also a topic of debate. The associations showed that there still is a significant lack of experts the field, even though the number of new employees increased by 25%, in both 2004 and 2005. The sector’s representatives also pointed out that taking into account the limited set of incentives for the industry, eliminating this exemption would send a negative message to present and future investors.

Varujan Pambuccian, President of the ICT Commission/ Romanian Parliament: “Our competitive advantages are the high qualification of our experts and the possibility of keeping them in the country. In the long term, we take the risk of losing the specialised labour force, our economic and technological strength. We also estimate that most of the companies that have strongly invested in Romania would relocate to Russia, Ukraine, Republic of Moldova, India, China and Malaysia. Both in the US and EU, companies’ relocation meant unemployment and we have to prepare for this scenario, too.”

The public authorities believed that a zero salary tax for the software developers could be interpreted as a violation of EU regulations. The ICT sector representatives reasoned that EU would agree to maintain such regulations, and it would even accept the introduction of additional instruments to support strategic sectors, provided that there is a solid and documented rationale for it.

Varujan Pambuccian: “The EU has no competencies concerning individuals’ taxation, so this exemption cannot be interpreted as a state aid. As long as the this rule has been accepted by the Council of Europe and the International Monetary Fund without limitations regarding the enforcement period, there is no reason for suspending it ourselves”.

After these public statements, the industry’s representatives, supported by the ICT Commission, resumed meetings with the officials of the Ministry for Public Finance, analyzing in detail the advantages of maintaining the exemption and the disadvantages of eliminating it, from a medium and long term perspective. The result was that the zero salary tax for software developers is still applicable in 2008.

Varujan Pambuccian: “The law has had both positive and negative impacts. The positive effects were higher investments in the sector and an unique reputation: the global leaders in the field keep mentioning the creation of such a facility. Craig Barrett, CEO Intel, did not hesitate to declare in his speeches that there is a country where the salary tax for software developers is zero. The negative effects refer to the industry adopting the model ‘software factory,’ a role we had hoped would be transitional. The industry must take action in order to adopt the “research and development center” model. The sector, as a beneficiary of state support, should take action in this direction”.