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- Vasyl Andrusyak
The Tax System and the Peculiarities of Doing Business in Ukraine
The tax system in Ukraine consists of seven national and four local taxes and fees. According to the World Bank’s Doing Business study for the period 2005-2019 a business pays five taxes on average. Such statistics show Ukraine’s tax system from a rather good side. However, this indicator by itself is not sufficient for making a reasonable decision about running a business in Ukraine.
Another important indicator that characterizes the country’s tax system is the average amount of time spent by a business on the administration of taxes and fees. The above-mentioned World Bank’s Doing Business study indicates a global trend towards a decrease in the amount of time needed to fulfill tax obligations from more than 300 hours per year as of 2005 to an average of 233 hours as of the end of 2019. Although in Ukraine this indicator for the specified period has also seen a downward trend, in 2019 Ukrainian businesses spent an average of 328 hours annually on tax administration, which was almost a third more than the global average and significantly more compared to the closest European countries.
However, for the sake of fairness, it should also be noted that since 2020 the Ukrainian tax system has undergone a number of changes that should promote tax transparency, but also create additional obligations for taxpayers, which gives grounds to claim that the burden on administering tax has increased.
Emphasis in Administration of Taxes
Common to Ukraine and many post-Soviet countries is the emphasis on the administration of indirect taxes, such as VAT, excise, rent, in contrast to increased attention paid to direct taxes in developed countries of the Western World. Such a model for Ukraine looks justified in view of its modern history: the collapse of the Soviet Union in 1991, the transformation of the economy during the 90s, the “Orange Revolution” in 2004, the world crisis, the Revolution of Dignity in 2014, the annexation of Crimea and parts of the eastern regions by Russia, the COVID-19 pandemic, and now Russia’s full-scale war in 2022. In such conditions, it is natural that the profits of both corporations and ordinary citizens were quite unstable, which could not serve as reliable support for the state budget, which needs greater predictability. Instead, indirect taxes such as VAT, excise, rent are less sensitive to such shocks.
Based on state priorities, the tax authorities developed and implemented cumbersome electronic systems designed to prevent abuses and violations in the field of indirect tax administration – the VAT electronic administration system, the system for monitoring tax invoices for compliance with risk criteria and suspension of their registration in the event of failure of compliance, appropriate electronic systems for excise goods, etc. All these efforts by the state to step up control and transparency led to a significant increase in administrative pressure and an increase in time spent on tax administration for business.
At the same time, data on the effectiveness of such systems is quite contradictory and subject to manipulation. For example, any delay in VAT refunds can be presented as an increase in revenues from this tax for the relevant reporting period. While suspension in registration of VAT invoices may be presented as fighting with fraudsters despite the fact that most of such suspensions would be cancelled by courts.
All the mentioned difficulties are also affected by a significant level of corruption and the judicial system, which remains unreformed, which create a lot of obstacles in the restoration of violated rights and demand a lot of time to get results.
Russia’s war on Ukraine could not have a positive impact on the country’s tax system either. A sharp drop in the economy and the level of tax revenues has forced Parliament and the Cabinet of Ministers to resort to situational solutions in both areas – business support and tax revenue provision. A clear example can be the exemption of fuel from import taxes during a period of shortages on the market, with the subsequent return of taxation on fuel due to significant shortfalls experienced by the state budget as a result of this exemption.
Another significant change is that the state introduced a single tax at the rate of 2% both for companies and private entrepreneurs. Although a similar tax regime with a rate of 5% has existed for a long time, legislators have now significantly expanded the limits of business operations within the framework of such a regime, which have made it quite attractive.
Of course, this approach towards situational solutions does not create a favorable environment for economic activity, but it is justified in stressful conditions where the state’s existence is, in essence, at stake.
Recent and Expected Changes
Earlier we mentioned that the emphasis in taxation has historically been on indirect taxes. However, global trends in the administration of direct taxes and the fight against the erosion of the tax base have been actively implemented in Ukraine in recent years.
Inter alia considerable attention has been paid to transfer pricing and the proper use of the provisions of double taxation treaties, in order to prevent abuses and evasion from paying taxes in general.
Also, Ukraine has become a signatory of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting and is implementing other steps of the BEPS plan developed by the OECD. For example, the rules on CFCs (controlled foreign companies) have come into effect and this year Ukraine plans to implement CRS (Common Reporting Standard) and join the automatic exchange of tax information between signatory countries.
All these steps (MLI, CFC, CRS, etc.) will contribute to stepping up control over direct taxes of both companies and individuals.
In addition, Ukraine does not remain aloof from other recent developments in the field of taxation. For instance, the levying of VAT on the supply of electronic services provided by non-residents in Ukraine (the so-called “tax on Google”) was introduced, and a special Diia-City tax regime was introduced for the IT sector which, despite the war, continues to develop dynamically in Ukraine.
The Condition of the Judiciary in the Taxation Field
Another problem encountered by the tax system of Ukraine is the state of the judiciary in tax disputes. During 2021, 77,400 tax cases were pending in courts and although the State Tax Administration reports on the resolution of the majority of disputes in favor of the state, such decisions are quite “old” or formal and wouldn’t lead to the collection of taxes to the state budget (often due to the fact that the taxpayer in question is already dissolved or bankrupt).
Instead, the decisions issued by the courts in favor of taxpayers mostly concern the current administration of tax payments and testify to a large number of errors and abuses carried out by public officials, which force businesses, in addition to costs for their current administration, to bear additional costs for restoring their violated rights in courts.
The efforts of the state and international partners to create an alternative possibility for settling tax disputes in the form of the Business Ombudsman Council, although having a positive effect, were unable to break the negative dynamics seen in the increase in the number of litigations. The majority of summary reports on the results of the work of the Business Ombudsman Council mention a significant (and often overwhelming) number of business complaints specifically about wrongdoings carried out by the tax authorities. However, the recommendations for correcting such a situation and preventing similar violations in the future have not been properly implemented at state level.
Doing Business in Ukraine Taking Into Consideration the Tax System
The above overview could well create a bad reputation of the country’s tax system and discourage potential investors from doing business in Ukraine. However, in this context, one important thing should be emphasized – most of the problems described above concern small and medium-sized businesses or “high-risk businesses” (for example, the production of excise goods). Very often, the root of problems for such companies is the quite specific methods of running business activities dating back to the 1990s, which create grounds for claims by tax and law-enforcement authorities, as well as the lack of due attention to compliance with tax rules at the initial stage of starting a new business.
However, for international companies that conduct their activities responsibly and plan for decades ahead, all the problems described above may not be relevant. On the contrary, the state can support such taxpayers to the maximum in scaling their business and solving specific problems related to public administration.
Even today, during the active phase of military actions, possible incentives for the participation of foreign business in post-war reconstruction of the country are being considered by the state of Ukraine. Although the discussed set of such benefits is currently very wide (from exemption from income taxation for several years, to exemption from payment of VAT and customs duties during the import of equipment and new technologies), the state’s intentions are very clear – attracting foreign investors is critically important for the future recovery of Ukraine.
In any case, in the face of global recession, the potential of Ukraine’s post-war economic growth is quite an attractive option for business development. Taking into account the peculiarities of the national tax system at the stage of planning economic activity, most problems can be avoided, and all current difficulties can be solved with the least expenditure of human and material resources. Furthermore, existing problems in the administration and judiciary will definitely be subject to reform on the path to membership of the European Union and NATO.
Thus, the historical problems and challenges of the tax system are no reason for refusing to invest in Ukraine. Instead, a reasonable and balanced approach towards business planning eliminates the majority of problems and enables business growth to be attained.