The modernization of the tax system began with the independence of Ukraine. In every approach to tax reform, the stakeholders’ (process participants) motives were a set of very controversial interests. For example, the main factor was the attempt to get maximum budget revenues. The second key point was the attempt to create or retain certain “holes” in tax legislation. The third main factor is an attempt to reduce the tax burden. In general, businesses and citizens were interested in this issue, but their efforts by 2014 were diffused and not structured.
The most negative factor in the development of Ukraine’s tax system was and remains its subordination to the provision of the growing appetites of the state – without considering the requirements of economic growth, the needs of sustainable development.
For this reason, the requirement of approval of any tax changes by July 1 is constantly ignored, preceding January 1 – when these changes should be implemented. In addition, a good illustration of this approach is the regular adoption of a certain list of tax changes in one package with the budget law for the next year.
Therefore, the Ukrainian tax system is one of the most burdensome in Central Asia and Eastern Europe – 51.9% (taxation of business establishments with various taxes, according to Paying Taxes research, conducted jointly with World Bank and PwC – Former PricewaterhouseCoopers).
From decrees to the Tax Code
1991-1996. The Law of the Ukrainian SSR “On the Taxation System” was adopted even before independence. It was introduced on June 25, 1991. At the same time, the following nationwide taxes, fees, and compulsory payments were initiated:
• Profit tax;
• Tax on income of foreign legal entities for the activities in the Ukrainian SSR;
• Turnover tax;
• Excise duty;
• Export-import tax;
• Income tax;
• Collective farmers payroll tax;
• Citizens’ profit tax;
• Charge for natural resources;
• Land fee;
• Income from timber;
• Ecological tax;
• State duty;
• Vehicle owners tax;
• Duty (for goods crossing the state border).
For example, the corporate income tax was 30%, while the personal income tax was 28%. High rates and double taxation were largely offset by non-payment of taxes. The system was weak, and therefore unable to charge such high taxes. Also, a wide range of privileges was introduced for enterprises with foreign investments, which subsequently gave the opportunity to use these privileges to avoid excessive tax burden.
During its operation, this law additionally introduced a system of charges on payroll and contributions to the Chornobyl and Pension Funds, the Employment Fund, and other social funds.
All of this put heavy pressure on business and citizens and contributed to the development of inflation.
The situation has become critical, which had led to early presidential elections in Ukraine. Since July 19, 1994, Leonid Kuchma ran for this office, who immediately initiated negotiations with the International Monetary Fund to support Ukraine. In October 1994, the IMF approved for Ukraine the first loan of the Systemic Transformation Facility (STF) of about 392 million dollars for system transformations in the economy. In the framework of Ukraine’s commitments under the Memorandum, for example, export duties should be abolished as a general tax instrument.
This law, with significant amendments, was in force until the Tax Code of Ukraine entry into force in 2011.
According to this law, value added tax was introduced in Ukraine on January 1, 1992 (Law “On Value Added Tax”) at a rate of 28% (22% for products sold at regulated prices). This law has been in force only since June 1993 – and was replaced by the Cabinet’s decree “On Value Added Tax” of December 26, 1992, according to which the VAT rate was reduced to 20%.
The Law “On Corporate Profit Tax” of December 28, 1994, was the most modified tax law. Over six years of its operation, it was amended by more than 140 laws of the Verkhovna Rada and decisions of the Constitutional Court of Ukraine. In the first revision, the standard tax rate was 30%, and rates for some activities were set at 45% and 60%. Of course, it could not last too long. Therefore, the rate was reduced – for the first time since January 1, 2004.
1997-1999. In 1997, the Law of Ukraine “On Amendments to the Law of Ukraine” On the Taxation System “was adopted, which introduced a new version of the Law” On the Taxation System”.
According to the new version, national taxes and duties (compulsory payments) consisted of the following:
1) Value added tax;
2) Excise duty;
3) Corporate profit tax;
4) Personal income tax;
6) State duty;
7) Real property tax (real estate);
8) Land fee (tax);
9) Rental payments;
10) Tax on owners of vehicles and other self-propelled machinery and mechanisms;
11) Crafts tax;
12) Fee for geological exploration, performed at the expense of the state budget;
13) Fee for the special use of natural resources;
14) Environmental pollution charge;
15) Duty to the Fund for implementation of measures on elimination of the consequences of Chornobyl catastrophe and social protection of the population;
16) Duty on compulsory social insurance;
17) Duty on obligatory state pension insurance;
18) State Innovation Fund Tax;
19) Fee for a trade patent for certain types of business activities.
In addition, a list of local taxes and duties (mandatory payments) was regulated.
1) Advertising tax;
2) Council tax;
1) Hotel tax;
2) Car parking charges;
3) Market charge;
4) Fee for the issuance of an authorization certificate for an apartment;
5) Resort fee;
6) Fee for participation in horse races;
7) Fee for winnings in horse races on racetracks;
8) Fee from the persons who take part in the pari-mutuel betting on the racetrack;
9) Fee for the right to use local symbols;
10) Fee for the right to conduct cinema and television filming;
11) Fees for conducting local auction, competitive sale, and lotteries;
12) Fee for the transit on the territory of the border areas of motor transport going abroad;
13) Fee for the issuance of a permit for the placement of trade objects and services;
14) Levy from dog owners.
This system, with some modifications, lasted up to 2010.
Actually, because of the new edition of the law on the taxation system, the Law of Ukraine “On Value Added Tax”, which came into force on July 1, 1997, was adopted. This law was repealed pursuant to the new Tax Code of Ukraine dated December 2, 2010.
However, the most powerful influence during this period had the Decree of the President of Ukraine “On the Simplified System of Taxation, Accounting and Reporting of Small Business Entities” dated July 3, 1998, No. 727/98. According to it, taxpayers pay a single tax (instead of a series of taxes and fees) and have the right to simplified accounting and reporting procedures. For employees, these enterprises must pay a personal income tax and a unified social tax (UST).
The introduction of a simplified system – a single tax – compensated pressure from corrupt auditors on small business and significantly reduced reporting costs. Due to the simplified system, the Ukrainian economy quickly began to recover after the financial crisis of 1998.
Among the most powerful steps in the development of the financial infrastructure was the introduction in 1997 of the Taxpayer Identification Number. The numbers began to be issued from January 1, 1998.
2000-2010. This period is characterized by cosmetic changes and the final dismantling of specific privileged regimes. For example, since January 1, 2004, the corporate profit tax rate was reduced from 30% to 25%, according to the Law “On Amendments to the Law of Ukraine” On Corporate Profit Tax “of December 24, 2002.
Dismantling touched, or rather, liquidated tax holes, which emerged due to the introduction of too massive privileges for enterprises with foreign investments (hereafter – Joint Venture). The prime of tax schemes with the participation of enterprises with foreign investments in Ukraine began with the adoption of the Law “On Foreign Investments” of March 13, 1992. At the beginning of the 2000s, the current regime of granting privileges for enterprises with foreign investments was established by the Law of Ukraine “On the Regime of Foreign Investment” of March 19, 1996.
However, with the adoption of the Law of Ukraine “On the elimination of discrimination in the taxation of business entities created using assets and resources of foreign origin” of February 17, 2000, schemes with the use of JV started to go out of use. Powerful JV groups even resorted to obtaining decisions of the Constitutional Court, but they could not help it.
Another phenomenon appropriate for this period was the gradual increase and narrowing of the application sphere of the simplified taxation system of small businesses.
2011-2013. Attempts to codify the tax legislation occurred in the early 2000’s, but only at the end of 2010, this matter was accomplished. During the final approval of the Tax Code of Ukraine, there was an unprecedented confrontation between small business and government. Mykola Azarov’s government steamrolled many anti-business norms into the draft Tax Code, which have led to the Tax Maidan – mass rallies and protests in Ukraine against the adoption by the Verkhovna Rada of the new draft Tax Code. Under the pressure of protests, the approved by the Verkhovna Rada Tax Code was vetoed by President Viktor Yanukovych and returned to the deputies with remarks. The requirements of the Tax Maidan were partly considered. Most importantly, the simplified taxation system was maintained, although its value for business was increased, and the scope of application was narrowed.
According to Tax Code of Ukraine, the national taxes include:
• Corporate profit tax;
• Income tax;
• Value Added Tax;
• Excise tax;
• Ecological tax;
Local taxes include:
• Property tax;
• Single tax.
Local duties include:
• Car parking charges;
• Tourism tax.
Despite the negative standards, the adoption of the Tax Code was still a step forward – at least due to a significant reduction in the number of taxes and fees. Although the Tax Code of Ukraine could not avoid the frequent disease of the Ukrainian tax legislation: since the entry into force (January 1, 2011), by the end of February 2014, the Code has undergone significant changes – the Verkhovna Rada has adopted more than 50 legislative acts with amendments to the Code.
In the same period, the Ministry of Incomes and Charges of Ukraine was created through the reorganization of the State Customs Service of Ukraine and the State Tax Service of Ukraine, and their integration into a single body. The Ministry of Incomes and Charges was established as a central executive body under the Decree of the President of Ukraine on December 24, 2012. During this period, the tax system was transformed by the Azarov-Yanukovych government into a distorted fiscal double taxation system. That is, the business was forced into “platforms” to allow a significant part of the turnover to be taxed at shadow rates during the companies’ cash out transactions. The flow of funds through the “platforms” formed the movement of shadow “taxes”.
The system of “platforms” was completely formed after the establishment of the Ministry of Income and Charges, headed by Oleksandr Klymenko. However, Klymenko, while being a head of the State Tax Administration and his predecessor in the chair Vitaliy Zakharchenko laid the basis for the systemic “shadow” taxation of the Ukrainian economy.
Key players, reformers, and interested parties
At the time of the victory of the Revolution of Dignity, the Ministry of Income and Charges acted not only as an executive and as a service provider for taxpayers but also in a certain way – as changes ideologist. This self-sufficiency of the fiscal superstructure laid the foundations for the growth of repressive functions and rapid increase of the tax burden on the economy. Of course, all this happened in close cooperation with the Ministry of Finance, which, however, did not really fulfilled the functions of the body that shapes the policy in the field of public finance, taxes, and fees.
The role of the Ministry of Finance was reduced to the development of the next budget plan and control over the implementation of the already approved law on the state budget. The head of the tax superstructure took care of fiscal policy.
The Prime Minister personally or his first deputy carried out the coordination between the two departments. Draft laws were sent to the Verkhovna Rada, and the people’s deputies were simply kept out of them – the Ministry of Income and Charges was the real author of the texts that were presented as a legislative initiative of the Cabinet. The presence of a controllable majority in the Verkhovna Rada gave an opportunity to steamroll almost any bill without much resistance.
The introduction of punitive norms in the tax legislation could have been prevented by direct actions – let us remember the Tax Maidan in 2010.
The situation has changed dramatically after the Revolution of Dignity. The most important thing was the establishment of the State Fiscal Service instead of the Ministry of Income and Charges, which was already subordinated to the Ministry of Finance.
The first post-revolutionary Finance Minister Oleksandr Shlapak and the head of the State Fiscal Service Ihor Bilous were engrossed just in the maintenance of the efficiency of the public finance system. However, Natalia Jaresko, who was the head of the Ministry of Finance in late 2014, proceeded with the implementation of the tax reform.
Volunteers and various non-governmental organizations set up an active assistance to the high-ranking officials. For example, the role of entrepreneur’s associations – the Ukrainian League of Industrialists and Entrepreneurs, the Federation of Employers of Ukraine, and the Association “Fortetsya”- has increased. Also, a large contribution has been made and continued to be made by the “Reanimation package of reforms”, etc. The American Chamber of Commerce and the European Business Association quite often join in with the work on the draft laws.
Perhaps for the first time, business and taxpayers have gained the opportunity to become co-authors of tax changes.
The recovery of the composition of the Verkhovna Rada during the elections in autumn 2014 has also contributed to this.
The Government’s cooperation with the International Monetary Fund has a significant impact on the reform. Unfortunately, the influence is not always positive. On the one hand, the obligations assumed by the government in the IMF Memorandum contribute to more rapid work of the pro-government deputies in favor of changes. On the other hand, the government sometimes takes the path of least resistance: it does not hold back the growth of irrational expenditures of the state but suggests increasing the tax burden.
The settlement of such disputes formed the progression towards the tax reform.
2014-2017: new reform
On April 30, 2014, after the Revolution of Dignity, accession to power of a new Government and the fulfillment of the preliminary conditions, the IMF approved granting Ukraine a new Standby loan of USD 16.5 billion. By the end of the summer of the same year, Ukraine received tranches; however, the tax reform stipulated by the IMF Memorandum has never started. After the 2014 parliamentary elections, a new government provided an opportunity to reload the reform efforts.
In view of Russian aggression, it was necessary to introduce a war fee charged from salary. Also, the government has introduced incentives for unshadowing: subject to fulfillment of certain norms, the company could pay unified social tax with a reduced coefficient of 0.4. This experiment was implemented for a year and has not been renewed, because, from January 1, 2016, a new rate of unified social tax was introduced.
The parameters of the tax reform were revised, and they have been included in the next Memorandum. On March 11, 2015, the IMF approved the replacement of the “stuck” Stand by Program for a new four-year Extended Fund Facility Program. The first tranche of USD 5 billion under the new EFF program was received immediately after its adoption. On July 31, 2015, the IMF Board of Directors approved granting of the second tranche of USD 1.7 billion.
Accordingly, the first serious approach to tax reform took place in 2015. In the second half of 2015, there was a rather tough dialogue between the Minister of Finance Natalia Jaresko and the relevant committee of the Verkhovna Rada.
For example, a draft law 3357 – a rather radical tax reform from people’s deputies and an expert environment – was prepared and preliminarily recommended for inclusion in the session’s hall. However, the government, in the person of the Minister of Finance, refused to take it as a basis.
Principal positions of Jaresko and the chairperson of the Verkhovna Rada Committee on Taxation, Nina Yuzhanina, have not changed during three months of the debate around the reform. The committee insisted on the taxation of distributed profits, on the reduction of VAT rates and personal income tax. It was also planned to eliminate the part of the unified social tax (3.6%), which is charged directly from the employee, and establish a single rate for a part of the unified social tax paid by the employer.
As envisioned by the relevant committee, the simplified taxation system had to be limited, but not substantially. Changes were limited mainly to the revision of the annual turnover limits and gradual rates increase for entrepreneurs of the third group. Yuzhanina also insisted on the introduction of a new, supposedly “softened” system for entrepreneurs reporting and paying a 10% tax on net income.
In her turn, Jaresko supported a conservative option, which provides for an increase of tax burden. However – along with the reduction of the basic rate of the unified social tax to 20% and the abolition of the unified social tax paid by employees.
Nevertheless, Jaresko toughly demanded the total elimination of the single tax (simplified system) as such in one or two years. The government bill initially offered to significantly increase the rates of the single tax, as well as introduce total control of costs and incomes, by the introduction of cash registers for all groups of businesses within 2016-2019. There was a requirement to ban the application of a single tax to legal entities from January 1, 2016.
In the end, there were changes that from January 1, 2016, have made it possible to significantly reduce the burden on the wages fund. The unified social tax was reduced from 36.76-49.7% (the size depends on the level of occupational hazards, paid by the employer) to the unified rate of 22% except for the payment of part of the unified social tax to be paid personally by the worker (3.6% of the payroll).
The government finally managed to introduce a series of anti-corruption measures on VAT – but this case was under control of the new Minister of Finance Oleksandr Danyliuk (from April 2016). A system of automatic VAT refunds was introduced under his leadership. Although there were serious complaints about the advancement of VAT refund, in general, the system significantly reduced the possibility of irregularities through the formation of fictitious VAT. Already in 2017, an electronic VAT invoicing system was introduced – it became fully operational from July 1, 2017.
Components of tax reforms in 2014-2017
|Date||Tax||What has been done|
|From January 1, 2014||Corporate profit tax||The corporate profit tax was reduced once again. It was 18% after 19% in 2013, 21% in 2012, and 23% in 2011.|
|From May 1, 2014||Excise duty||The first high increase of excise duty rates. Starting from January 1, 2016, the government systematically raised the rates of excise duty on tobacco and alcohol in view of Ukraine’s commitment within the framework of the Association Agreement between Ukraine and the EU.|
|From January 1, 2015||Excise duty||According to the Law of the Verkhovna Rada of December 28, 2014, No. 71 “On Amendments to the Tax Code of Ukraine …”, an excise tax on the retail sale of excisable goods (beer, alcohol drinks, tobacco products, petroleum products, liquid gas, etc.) and the fee for the development of viticulture, horticulture and hop growing is canceled.|
|From January 1, 2015.||Unified social tax (UST)||On December 28, 2014, the Verkhovna Rada adopted, and on December 31, the President signed the Law No. 77-VIII, aimed at legalizing the wage fund through the application of a coefficient of 0.4 to the UST rate, on condition of unshadowing.|
|January 1, 2015||VAT||According to the Law of Ukraine “On Amendments to the Tax Code of Ukraine and Other Legislative Acts of Ukraine” of July 31, 2014, No. 1621-VІІ, the system of electronic administration of VAT (SEA VAT) was introduced.|
|January 1, 2015||Real Property tax||The Law of Ukraine of December 28, 2014, No. 71-VIII “On Amendments to the Tax Code of Ukraine and certain laws of Ukraine on the tax reform” introduced changes in taxation of real estate, other than land. That is – the taxation of residential property and other personal property has been introduced.|
|From January 1, 2016||VAT||The VAT privileges for agricultural producers were reduced.|
|From January 1, 2016||UST||The UST rate has been reduced to 22%, but the maximum surcharge base of the UST has been increased to 25 times of the living wage of an able-bodied citizen.|
|From January 1, 2016||Personal income tax||The personal income tax ceases to be progressive. Instead of a scale of 15/20%, a single rate of 18% is introduced.|
|From January 1, 2017||VAT||Substitution of VAT allowances for agrarian business on direct budget compensations.|
|From January 1, 2017||UST||The increase in the minimum wage from 1600 to 3200 UAH – thereby raising the minimum assessment base of the UST – up to 3200 UAH.|
|From May 8, 2017||VAT||On 20.12.2016, the Verkhovna Rada of Ukraine adopted the Law No. 1791-VIII, according to which using of payment transactions recorders (cash registers) and issuing of fiscal checks from May 8, 2017 is obligatory for all sellers of “technically sophisticated household goods”: household appliances, computers, smartphones and other electronics, regardless of their income or type of business.|
|From July 1, 2017||VAT||According to the Decree of the Cabinet of Ministers of Ukraine of 30.01.2015 № 20 “On Amendments to the rules of order of the Unified Register of VAT invoices,” the working operating mode of the VAT invoice registry (blocking VAT-invoices) was introduced, which made impossible to generate a fictitious tax credit. Including – due to so-called “twists.”|
Failures and successes
It must be admitted that the quality of the tax system consists of two factors: the administrative complexity and the level of tax rates. Unfortunately, the complexity remains high. Researches of the World Bank and the PricewaterhouseCoopers Audit Company show that Ukraine’s tax system continues to be one of the worst in the world. Although the amount of time required for paying taxes decreased in 2017 to 356 hours compared to 491 in 2013.
The total tax burden on the economy is most often measured as the ratio of revenues to the consolidated budget, considering pension and other social funds – on the one hand, and GDP – on the other. In 2017, considering the abolition of tax privileges and doubling of the minimum wage, the indicator is expected to be 42.3%. It is significantly higher than in 2016 when the economy felt relieved due to the reduction of the UST rate – last year this figure was 38.1%. That is, we roll back to the level of 2015 – 41.5%. In fact, this indicator varied in the range of 39.7-42.8% in the period of 2005-2014. Although it was not always like that, in 2004 – 34.4%. Conclusion – under the chairmanship of Viktor Yushchenko, the country has tasted populism; therefore, it cannot go off the rails of unlimited increase of expenditures, and therefore – is afraid of a radical reduction of the tax burden.
There remains the corporate income tax – complicated, incomprehensible, and very risky in terms of generating corruption. It is proposed to replace it with the tax on withdrawn funds, but so far, the government resists, claiming that there is a risk of a possible failure of budget revenues, even though in 2017 the consolidated budget is over-fulfilled in terms of revenues.
Therefore, in 2017, the key challenges of the reform are:
– Tax on withdrawn funds instead of income tax;
– Lowering the payroll budget burden;
– Maintaining a simplified taxation system for small businesses.