Companies operating in Ukraine will soon be paying a tax on dividends instead of the corporate income tax. This is the result of the many years of efforts of small and medium-sized companies to change the tax system.
The Ukrainian parliament has started working on a new law thoroughly reforming the tax system. The authors of the draft legislation mainly include the representatives of the business community. The new system is modeled on solutions existing in Estonia.
Ukraine can’t go on like this
“In the conditions of insufficient current assets, high costs of credit and limited opportunities for acquiring investment, any further increase in fiscalism in Ukraine is unacceptable, as it will not be conducive to the recovery of the economy dealing with a significant debt burden,” stated the authors of the changes. They argued that if the current state of affairs is continued, it will be impossible for Ukraine to solve its economic problems. The changes are supposed to result in the creation of a modern, liberal tax system in Ukraine, and, consequently, provide the right conditions for the development of business and the emergence of the economy from the grey area.
The authors of the legislation are pointing out that the government is trying to compensate for the budget deficit not by optimizing public expenditures, but by increasing the taxation of Ukrainian companies. In recent years, the rate of GDP redistribution through the state budget and extra-budgetary state funds has reached 43-48 per cent, which leads to the creation of an administratively managed economy and the centralization of authority. This reduces the investment activity of enterprises and, consequently, leads to a slowdown in economic growth.
Meanwhile, the authors of the reform note that Ukraine achieved the highest rate of economic growth in the years 2003-2004 (9.5 per cent, and 12 per cent respectively), when the rate of GDP redistributed through the state budget and state funds remained at the level of 38-39 per cent.
What will change?
The idea is simple — the currently applicable corporate income tax (CIT) will be replaced with the so-called Tax on Withdrawn Capital (TWC), which will apply to dividends and transfers of a similar nature.
Taxation will be applied to income withdrawn by the owner in the form of dividends paid to natural persons, non-payers of income tax and non-residents, as well as other similar payments. The base rate of the tax paid by companies is supposed to decrease from the current 18 per cent CIT rate to a 15 per cent TWC rate.
According to the authors of the draft legislation, the implementation of the tax changes will not have negative consequences for the state budget. “The adoption of the new law will guarantee the reduction of the fiscal burdens on businesses, the creation of favorable conditions for attracting new investment, and the renewal of the material base of the enterprises. It will facilitate the elimination of common tax evasion methods, and bringing a significant part of the economy out of the grey area, and as a result will lead to an increase in budget revenues,” they said.
The new taxation is one of the key elements of the plan to change the current situation in which billions of dollars are being siphoned off from Ukraine to tax havens thanks to “tax optimization” schemes. This usually involves a situation where a company sells goods at a minimum price to its companies registered in tax havens, which in turn sell these products to the final recipients at the actual market price. The members of the Ukrainian parliamentary committee on taxation estimate that the changes will stimulate the growth of small and medium-sized enterprises (SME), as a result of which the budget should obtain revenues of UAH150bn from the new tax in the first five years after it is implemented.
Because of the Tax on Withdrawn Capital, it will no longer make sense for entrepreneurs to hide their incomes. It will no longer be necessary to pursue tax optimization and to use various semi-legal methods. “This is also beneficial for the companies, as exploiting such loopholes entails costs amounting up to 3 per cent of the overall turnover value,” estimates Anatoliy Amelin from the think-tank Ukrainian Institute for the Future. In his opinion, closing this loophole, which currently enables the outflow of capital, will allow Ukraine to increase its GDP by 1.5 to 2.5 per cent annually.
How much will be gained, how much will be lost
The tax policy committee at the Ministry of Finance, composed of the representatives of business organizations, has expressed its support for the changes, emphasizing the transparency and simplicity of the settlements (when income is reinvested, it is not taxed, only the funds that are moved out of the company are subject to taxation). The Tax on Withdrawn Capital will stimulate the inflow of capital to Ukraine.
“Every year USD11bn is siphoned off from the country, and no tax is charged on the greater part of that money. In this situation there are doubts about the functioning of the corporate income tax,” said Tatiana Shevtsova, the head of the committee and also one of the authors of the new legislation.
The National Council of Reforms, an advisory body operating under the President of Ukraine, upheld the draft legislation. The main objections raised by the opponents of the changes relate to the possible budget losses in respect of tax revenues, anticipated in the initial period, as well as the possibility of tax evasion by companies.
However, an opinion against the changes was also issued by the International Monetary Fund, which is concerned about the unpredictability of future budget revenues. The corporate income tax currently brings about UAH46.7bn per year. How much will the entrepreneurs operating in Ukraine pay in respect of the new tax? The number of estimated amounts is as high as the number of participants in the debate concerning the changes.
The State Fiscal Service of Ukraine is one of the bodies which presented its own calculations. It estimates that in the first two years the budget losses associated with the change may reach UAH100bn, or about USD3.8bn. However, the officials have admitted that the new tax will be much easier to manage. The estimates presented by the presidential administration point to losses reaching a maximum of UAH30bn in the initial period.
Ukraine’s new solutions are modelled on Estonia, where a similar model has been in place since 2000. “The tax revenues to Estonia’s budget regained their initial level in three years, while the volume of investments significantly increased, which was the main goal,” commented Vladimir Dubrovsky from CASE Ukraine. He believes that the estimates of the State Fiscal Service are unreliable, especially considering that the calculations of the Ministry of Economic Development show a shortage of approximately UAH25bn in the initial period after the implementation of changes.
The entrepreneurs also have different opinions. The changes were criticized by the European Business Association (EBA), which brings together companies with foreign capital operating in Ukraine. In its opinion, the new rules will lead to a situation in which some enterprises will be in a privileged situation and, consequently, the tax changes will have a positive impact on their competitiveness (under the new regulations, the tax depends not on the financial results but on specific operations performed by the company, and those companies that do not perform such operations will not pay the tax). The EBA also doesn’t like the taxation of interest paid on loans granted by non-residents associated with the tax payer (e.g. by the parent company).
Meanwhile, the changes are strongly supported by companies with Ukrainian capital. For them the positive elements of the new system are not limited to the new tax base. They believe that the new tax will also make it harder for public officials to pressurize businesses to pay bribes. “When the new model is introduced, there will be a closed catalogue of operations that are subject to taxation. The public officials will no longer require entrepreneurs to confirm every type of economic activity with appropriate documentation,” said Ekaterina Glazkova, the Executive Director of the Union of Ukrainian Entrepreneurs. According to the economist, Taras Kozak, the main group dissatisfied with the changes are international companies that have been benefiting from tax optimization by exploiting the options available abroad — tax havens, transfer prices, license fees, franchising and deliberately inflated interest rates on loans granted by their foreign parent companies, as well as companies that have recorded losses in recent years for a total amount of approximately UAH1.5 trillion, or more than USD55bn. They can deduct these against their tax liabilities under the existing system. However, according to Taras Kozak, these were largely fake losses generated on paper.