Simple registration and tax incentives are key measures to drive formalization

HA NOI (ILO News) - The "Formalization and simplified micro and small enterprise regimes: Towards reform of the Viet Nam household business legislation" from the ILO shows that low- and middle-income countries could encourage informal businesses to transition into the formal economy by implementing various measures. Most of those measures focus on simplified business registration, preferential taxation schemes, and extending social security coverage.

The author team found that governments use simplified registration regimes, tailored to micro and small enterprises (MSEs), first and foremost to gain direct access to primary data on business demographics. Low- and middle-income countries frequently use simplified regimes to facilitate the registration process, at the same time employing the use of tax exemptions or other preferential regimes to incentivize MSE registration.

These tailored procedures are usually named under specific designations, such as Morocco’s ‘auto-entrepreneur’, the ‘statut d’entreprenant’ adopted in member countries of the Organization for the Harmonization of Business Law in Africa (OHADA), and India’s ‘Udyam’ regime.

Enticing unregistered businesses with a simplified regime then creates the opportunity for providing other support services, including developing MSE capacity on effective management processes.

In addition, experts stressed that MSEs must be carefully nurtured into the system, offering them functionality embedded in simple and ideally automated, frictionless registration procedures. Some countries, including low- and middle-income countries, increasingly achieve this on high marks. Benin’s GUFE, Colombia’s VUE and India’s Udyam illustrate simplified registration frameworks that attempt at mapping out initial requirements, delivering tangible benefits to businesses such as the capacity to register property, obtain product certifications, and open a bank account.

Tax incentives and reductions in social security payments

The report also found that tax incentives and reductions in social security payments are the most impactful in reducing informality in low- and middle-income countries.

In Mexico, a 10-year income tax discount is offered to self-employed workers and small businesses, whether or not they employ others. The rebate starts at 100 per cent in the first year of the programme and gradually decreases to 10 per cent by the tenth year.

The system, known as ‘Regimen de Incorporacion Fiscal’ (RIF), applies to small businesses that have an annual income of no more than MXN 2 million (approximately USD 100,000).

Tax incentives and social security measures are, in fact, a common element in formalization policies globally.

These measures have been implemented not only in Latin America, but also across Asia, Africa, and Europe.

Additionally, fixed fees and single payments that cover both taxes and social contributions are considered good-practice entry-level mechanisms in formalization policies. They attract microbusinesses, including own-account workers, by offering the convenience of a single tax payment.

“A single tax payment tends to reflect policymakers’ priority towards registration rather than maximizing tax revenue collection,” the report says.

Additionally, the authors emphasized that access to social insurance and welfare programmes, when included in simplified registration options, is highly valued. This approach is particularly attractive in low- and middle-income countries, where significant portions of the workforce remain in informal employment and often live close to or below the poverty line.

Digital technology is key

The report highlights that e-formality, or the use of digital technology to promote formalization, has become a central theme in various countries worldwide.

Digital technology is crucial for registration procedures, tax compliance, and more. Neglecting digital advancements poses a significant risk of substantial errors in policymaking.

Experts noted that the adoption of e-formality is more influenced by the political will of national policymakers than by the level of development of individual countries. E-formality has been embraced by low- and middle-income countries like Bangladesh, Benin, India, and Sri Lanka, as well as by high-income nations such as Estonia and those in Nordic Europe.

The authors emphasized that formalization policies should encourage businesses to progress from the initial stages of simple MSE registration to more advanced stages of corporate development. Governments should design policies to broaden market opportunities and enhance business connections.

“Simplified registration and preferential taxation are just pieces in an overall puzzle in a needed continuum of policies,” the authors stressed.