Tax system of Ukraine

Fahim Diana,

“Marketing and Management”

Faculty (2-13)

Supervisor:

Ryzhaya T.A.

Kharkiv-2011

Міністерство освіти, науки, молоді та спорту України

Харківський національний економічний університет

Кафедра іноземних мов

ПОДАТКОВА СИСТЕМА В УКРАЇНІ

Виконавець:

Фахім Д.Н.

“Маркетинг та Менеджмент”

Керівник:

Рижая Т.О.

Харків-2011

Introduction

In Ukraine the system of the taxation, taxes and levies, both nation-wide, and local, are imposed exclusively by laws which are issued by the highest legislative body of the state – the Verkhovna Rada (Parliament) of Ukraine.

Local authorities are given the power to impose or abolish local taxes and levies and to define the order of their payment according to the list and within the boundary rates established by laws of Ukraine. The tax system of Ukraine includes 28 nation-wide and 14 local taxes and levies.

Some of taxes and levies found on the list of nation-wide taxes and levies and thus stipulated by law, are not actually collected today. These include the real estate tax, the stamp duty, duties in Fund for realization of actions on liquidations of consequences of Chernobyl accident and social protection of the population, duties to the State innovative fund, for example.

In Ukraine there is a system of national pension and social insurance which provides regular insurance payments must be made by legal entities and private persons. In spite of the fact that such payments are not taxes or levies, they have an obligatory character. The system of the national insurance includes pension insurance, unemployment insurance, temporary disability insurance and insurance against incapacitating occupational accident or disease.

Corporate profits tax, value added tax and national insurance payments are paid by the overwhelming majority of business entities. In addition, many of them are the payers of excise duty, custom duty, land fee (or land tax), tax on vehicles. Businesses that use hired labor are charged with the duty to deduct income tax from an employee's pay.

Along with the general taxation system in Ukraine there are alternative (simplified) ones (a single tax, a flat-sum tax, a flat-sum agricultural tax), the essence of which is to replace a number of taxes with one alternative tax. Only certain categories of taxpayers such as small businesses or agricultural producers who meet the criteria laid down by law are entitled to select one of the simplified systems of taxation. Foreign-owned companies are taxed in Ukraine by the same rules that are set for companies established by residents.

Some provisions of Ukrainian legislation reduce the attractiveness of offshore companies as business partners of Ukrainian business entities. For example, when calculating corporate profits tax a Ukrainian company has the right to include in gross expenditures and, consequently, reduce the taxable profit, not the entire amount of the cost of goods and services acquired from offshore companies, but only 85% of this amount. The list of jurisdictions that are recognized in Ukraine as offshore is determined by the Cabinet of Ministers of Ukraine. Currently this list includes 36 offshore zones. As of the beginning of 2009 more than 60 double taxation avoidance agreements concluded with other nations of the world had come into effect. Those states include almost all European Union countries (except for Ireland, Luxembourg and Malta), Russia and all CIS countries. In addition, Ukraine has treaties with Switzerland, Norway, Croatia, Serbia, Montenegro, United States, Canada, Brazil, Israel, Turkey, India, China, Japan, UAE, Iran, etc.

The main body, which oversees compliance with tax laws, the accuracy of calculation, completeness and timeliness for payment of taxes and levies, is the State Tax Administration of Ukraine and its divisions. Some types of taxes and levies are controlled by the State Customs Service of Ukraine and the Pension Fund of Ukraine, and payments in the national pension and social insurance system - by the Pension Fund of Ukraine and relevant Social Insurance Funds.

A taxpayer, as a rule, by himself determines the amount of taxes and levies which are subject to his payment to the budget, and declares them in the relevant tax returns. In some cases the amount of tax liability is determined by the tax authority, for example, if as the result of tax audit the tax authority has identified underreporting or overstatement of tax liabilities, referred to the taxpayer in tax returns.

In Ukraine, there is an institution of tax pledge. Tax pledge arises in the case of taxpayer filing late tax returns or failure to pay tax liabilities on time.

The essence of the tax pledge is to disable the taxpayer to dispose freely of its assets to fully repay the tax debt.

Structure of he tax system

Ukraine has yet to introduce a Tax Code, which is likely to happen in 2004. However, the existing Law “On the System of Taxation”, the current Ukrainian equivalent to a Tax Code establishes the regulatory framework for the operation of the tax system. It contains fundamental norms, albeit not extensive, common to Tax Codes of more developed legal jurisdictions, like, for instance, norms establishing precisely thetaxes and mandatory payments due, norms establishing the competence of authorities regarding tax issues, norms providing that reforms totax laws may only be introduced by tax laws, and norms regulating the entry into effect of reforms to tax aws, to mention a few.

As mentioned above, this law contains the list of state and local taxes and duties applicable. At the time of drafting, there are 20 state taxes and duties, the most significant being corporate profits tax; VAT; personal income tax; payroll taxes; import duties and excise tax. In addition, there are 16 different local taxes and duties, whose value is normally not significant for business. As an encouraging trend, the number oftaxes were reduced during the 1997 tax form (and also subsequently by several other reforms to specific laws), will further reduce, although only slightly in 2004 when two local duties are cancelled and will likely reduce further when the Tax Code is passed, hopefully in 2004. Thus, if this positive trend continues, the number of state and local taxes will reduce to acceptable levels and the administration oftaxes by business will become less complicated.

Corporate Profits Tax

Prior to the 1997 tax reform, the Ukrainian corporate profits tax was everything except for a tax on profits, with a nominal tax rate of 30%, but an effective tax rate significantly higher, reaching the point of prohibitive. Thus my comment that is was not really a tax on profits.

The 1997 tax reform introduced significant changes. Amongst the most important ones was establishing principles for the deduction of costs and expenses, rather than the very limited and restrictive list of deductible expenses previously in force, which significantly increased the effective tax rate. Like in other more developed legal jurisdictions, the tax reform of 1997 also introduced a list of non-deductible expenses, list that in my view was very reasonable. Another key point of this tax reform is that it specifically banned the tax authorities from imposing any additional limitations or restricting the deductibility of expenses, unless the law stipulated those restriction.

Despite all these positive points, as I mentioned earlier the 1997 tax reform felt short in accomplishing a reduction of the tax burden on business.

Noteworthy, one of the core elements of the tax reform that will take effect at the beginning of 2004 is the reduction of the tax burden on business. In fact, from 1 January 2004 the tax rate has been reduced from 30% to 25%. Moreover, this has been accompanied by a significant increased of the depreciation rates for fixed assets, which will result in the reduction of the gap between financial and taxable profits. In addition to this, the reform has introduced clearer procedures for taxation of lease transactions and the tax treatment of bad debts. It has also removed the 5-year limitation on tax losses carry forward. Finally, it has introduced much more developed transfer pricing rules. Overall, the changes brought in by the 2004 tax reform will be very significant in reducing the tax burden on business. Thus, a well-managed business will begin to see that from 2004 the gap between the nominal tax rate of 25% and the effective tax rate ought to reduce. This is my opinion a very important trend, and one that should encourage investors.

Personal income tax

The 1997 tax reform failed to improve the outdated personal income tax norms, except for a reduction in the top marginal tax rate from 50% to 40% (in 2003 the effective tax rate levied on personal income exceeding approximately USD 300 per month was 40%). Thus, most of the 1992 norms governing personal taxation continued in effect until 2003, except for a reform introduced in 1998. This reform, however, was enacted solely with the aim of stimulating small businesses and entrepreneurial activities. This controversial reform introduced a “single taxregime” for private entrepreneurs, with simplified tax reporting and a very low flat tax payment (which substitute most other taxes otherwise payable). Leaving aside the intention of this reform, it is clear that it failed to set clear anti-abuse (or anti-avoidance) rules, with many businesses rushing to re-register their employees as private entrepreneurs (under a civil rather than labour relationship) to benefit from thesystem by abusing it.

Finally, the long-awaited 2004 tax reform will completely overhaul the Ukrainian personal income tax system. In fact, from 2004 Ukraine will introduce a flat personal income tax rate of 13% (taxing most personal income with few exceptions at this rate). This flat tax rate will be increased to 15% from 1 January 2007. The core element of this reform lies in the significant reduction of the tax burden on individuals. It also attempts to streamline and simplify the compliance procedures. However, the reform has also introduced many significant changes, ranging from major changes in the criteria for qualifying as tax and non-tax resident to changes in the taxation of certain types of income. It has also introduced anti-avoidance rules to the “single tax regime” for private entrepreneurs, effectively closing the doors to the abuse of this especialtax regime. In summary, this very positive reform also establishes, or in the case more precisely confirms that Ukraine is introducing reforms with a clear trend of lowering the tax pressure, streamlining compliance and adopting global tax principles.

Payroll taxes

Through several reforms to the various laws regulating these taxes, the overall rate of payroll taxes due by most employers decreased from 51% in 1996 to the current 37.64%. This 37.64% covers the employers contributions to the Pension Fund; Social Security Fund; Unemployment Insurance Fund; and Fund for Social Insurance of Accidents at Work (the contributions to this last fund, however, depend on the level of risk of accidents for each sector of the economy). In turn, employees are also required to contribute to the State Pension Fund; Social Security Fund; and Employment Insurance Fund (for Ukrainian national employees only), with contributions generally reaching 3%.

Although the rates might be perceived as high, Ukrainian lawmakers introduced a cap on the base subject to social contributions (maximum monthly salary per employee subject to payroll taxes). This cap has been amended several times, but it has always been maintained at reasonable levels, with both employers and employees subject to payroll taxes for 2003 only on the first UAH 2,660 of salary per employee per month. Again to ratify the trend mentioned above, it is clear that taxes are going down and compliance is becoming less burdensome.

Finally, although still on the drawing board, Ukrainian lawmakers have been debating a reduction of the rates of contributions to the various funds, and the simultaneous substitution of all the current payroll taxes with a “unified social tax”, which ought to significantly simplify the current system.

VAT

VAT was initially introduced in Ukrainein 1992 and until 1997 it functioned as a form ofturnover tax. In 1997 the VAT law completely reformed emulating the main principles under which this taxoperates in the European Union. At that point Ukraineintroduced a VAT rate of20% on most transaction, with certain exemptions, and obviously also the 0% (zero rate) amongst other for exports. Despite many shortcomings during the development ofthe innumerable reforms that have been introduced in respect ofthis tax, VAT is finally taking the shape ofa realtaxon the value added by each participant in the chain from producers to consumers. The only really significant issue that still needs to be tackled and which is causing considerable problems is the refund ofVAT to exporters, something that Parliament and the Government must deal with and resolve urgently. In any case, there is also a proposal to decrease the VAT rate to 17%.

Customs

In 2002 Ukraine adopted the new Customs Code, which becomes effective from 1 January 2004. Among other changes, the Customs Code introduced a new concept of customs value that complies with GATT/WTO requirements. In particular, customs value shall include license and other fees for the use of intellectual property that the buyer must pay, either directly or indirectly, as a condition of sale of the goods if such fees were not included to transaction value. This new Customs is a significant step in WTO accession, which is planned for 2004.

Administration of taxes

Starting from 2002 amongst others the procedures for administration of all taxes and duties, application of fines and appeals against the taxauthorities’ decisions, were unified under specific legislation. Among many positive changes, the law limits the number of tax audits by the taxauthorities and provides for the possibility of obtaining tax clarifications (although not legally binding) from the tax authorities for use bytaxpayers. In summary, this law sets a rather clear framework for interaction between taxpayers and the tax authorities and thus represents a very good step towards further development and improvement of the Ukrainian tax system.

Double taxation treaties and trade agreements

In any countries the Double Tax Treaty network plays an important role in encouraging foreign investment. Ukraine consistently works on widening its treaty network and by the time of writing concluded double taxation treaties with 43 countries. At the same time Ukrainecontinues honouring the double taxation treaties of the former Soviet Union until new treaties replace them.

Ukraine is not an easy country in which to pay taxes. In the recent "Paying Taxes" study released by PricewaterhouseCoopers and the World Bank, Ukraine was identified as one of the most difficult countries in which to pay taxes out of the 185 countries surveyed. Many companies employ tax accountants in addition to financial accountants as tax accounts are separate from financial accounts. The study estimated that a modest-sized domestic business would need to make 98 tax payments each year, and would require 2,185 hours per year to comply with its tax compliance requirements.

For several years, there have been discussions about consolidating the various revenue laws into a single Tax Code, which should ease compliance and administration. A new initiative is underway to have this introduced into Parliament sometime in 2007, and to apply from January 2008.

An interesting feature of the Ukrainian tax system is a simplified or unitary tax available for many small businesses. Qualifying sole proprietors opting to use the system pay a fixed amount of tax, while eligible entities pay a fixed rate of tax based on their revenues. In both cases, the businesses are exempted from income tax, a number of other small taxes, and potentially value-added tax (VAT). The corporate regime is discussed in Corporate tax system, while the regime for individuals is discussed in Private entrepreneurs.

Direct and indirect tax burden

Taxation accounts for around 73% of government revenues. More than three-quarters of this is collected through corporate income (profits) tax (CPT), personal income tax (PIT), and VAT.

Tax collections have increased rapidly over the past five years. The trend in income tax and VAT collections for the period 2002 to 2006 is illustrated in diagram 1.

It can be seen that the reduction of the individual tax rate in 2004 significantly increased the collection of individual taxation.

A 15% increase in overall tax revenues is forecast for 2007.

Assessments

Taxpayers make returns and payments on a self-assessment basis. However, if the tax authorities determine that the tax shown on the return is incorrect, they may assess taxes within 1,095 days (three years) from the deadline for filing a return or the date on which the return is actually filed, whichever comes later.

There is no limit on the period in which an assessment may be made if a taxpayer has deliberately evaded tax (if proven in court) or when a taxpayer fails to file a return. The tax authorities will also charge significant penalties for late filing or understatement of tax liabilities.

Appeals

Assessments may be appealed administratively or through the court system. The initial appeal is made to the local tax office that issued the assessment. If an appeal is rejected, a taxpayer may appeal in turn to the regional and national office.

An administrative appeal must be filed to the relevant level of the tax administration within ten calendar days of receiving an assessment or official advice that an administrative appeal has been rejected at a lower level.

The tax authorities must respond to the appeal within 20 calendar days. If they fail to do so, the appeal is deemed to be decided in favour of the taxpayer. The 20-day period may be extended by up to 60 days, but only if the authorities advise the taxpayer in writing within the initial 20-day period.

At any stage of the process, or if the national office rejects the appeal, a taxpayer is entitled to pursue an action through the courts instead.

Submitting an appeal suspends the requirement to pay the assessed tax, as well as the accrual of interest and penalties. Interest and late payment penalties will apply only if the taxpayer fails to pay the taxes by a revised due date after the appeal is finally resolved.

Withholding taxes

It is very important to ensure that withholding taxes are properly deducted and accounted for. Businesses generally have an obligation to withhold tax on payments to individuals (including sole proprietors) and payments to non-residents. Failure to withhold tax can attract a 200% penalty, as well as interest.

Withholding tax must be remitted to the authorities no later than the date when the payment is made to the income recipient.

Passive income (dividends, interest, royalties) from Ukrainian sources that is paid to non-resident entities is generally subject to 15% withholding tax. Other payments, including "engineering services," lease payments, agency and brokerage fees, are also subject to 15% withholding tax, but payments for most other services are not subject to withholding.

In addition, 15% withholding tax applies to gain on the sale of property, including real estate and securities, when paid by a resident to a non-resident entity.All withholding tax rates may be reduced under a relevant tax treaty.

Payments to non-resident persons for advertising services performed in Ukraine are not subject to withholding. However, the resident payer is required to pay, from its own funds, a 20% tax based on the value of such services.

A resident payer is similarly required to pay, from its own funds a 12% tax if a payment is made to a foreign insurer or reinsurer whose rating of financial reliability does not meet requirements set by the authorised state agency. A 0% rate applies otherwise.

As the taxes on advertising and insurance are levied on the resident party, they cannot be relieved using a tax treaty.

Statute law

According to the Constitution, taxes and levies, as well as penalties for non-compliance, may only be established by laws enacted by Parliament. Parliament exercises this prerogative frequently, and it is quite common for more than twenty amendments to be made to the various Ukraine tax laws each year, sometimes with potentially retroactive effect. Although many amendments are very minor, the frequent changes, as well as the government's failure to proceed with declared intentions and schedules for tax reform, have earned Ukraine the reputation of having an unpredictable tax system.

Strictly speaking, the State Tax Authority (STA) does not have discretion to amend the law, but in practice, the STA often issues tax clarifications that are not always consistent with the law, although this can be a function of ambiguities in the law as much as anything else. Nevertheless, it is prudent to consider STA interpretations and the risk of conflict with the STA before taking a position based on the law.

Conclusion

Although the process of reforming the tax system will only be completed when the TaxCode is enacted, it is clear that the reforms introduced have modified the tax system and have made it more investor-friendly. It is also clear that the general trend is to reduce the tax burden, streamline the compliance process and introduce tax principles and concepts used in more developed tax systems.

The main purpose of the 2004 tax reforms is to decrease the overall tax burden by means of reducing the tax rates while simultaneously widening the tax base. This is very good step forward.

It is clear that the Ukrainian Parliament and Government have accomplished significant developments in developing the tax system. It is also clear that the 2004 tax reform is likely to encourage new investors. However, it is also evident that Parliament and the Government must continue working to improve the tax system. A clear and friendly taxenvironment is the cornerstone upon which the investment climate in Ukraine will flourish to its full potential.

List of references:

1. Tax system in Ukraine- http://juveko.com.

2. My Ukraine- http://myukraine.info

3. Tax system and administration- http://pwc.com

4. Ukraine should implement tax reform despite the crisis -http://debaty.org

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