False Start of Prime Minister

Populism of Prime Minister harms not only the public’s expectations, but also the investment climate in the country

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The Prime Minister announced the beginning of the denunciation procedure of the agreement for the avoidance of double taxation with Cyprus. This suggests that the government prefers to focus on populism and refuses to deal with the real problems.

While explaining the reasons behind this decision of the government, Mr. Yatsenyuk said:

“I am saying that (our) taxation should correspond to the tax rates and levels of taxation of European Union countries. Among other things, there should be finally canceled zero tax rates on the purchase and sale of any property, shares and other assets that are not currently taxed since the parliament refused to annul the agreement.”

Let us examine this statement by the Prime Minister in more detail.

First of all, Cyprus is an EU member.

Second, rates stated in the Cyprus agreement are the same as the average rate in contracts with other EU countries.

Third, in some EU countries rates are lower than in Cyprus (for example, in the Netherlands or the U.K.).

Fourth, the tax on capital gains, which apparently meant Yatsenyuk, can be introduced via changes in domestic legislation, rather than by denunciation of international agreements.

There are two ways to solve the problem stated by the Prime Minister. One is simple and the other one is sophisticated. We will talk about it further in the text, but as for now let us say a few words about the problem itself. The main issue here is that when selling a successful business built in Ukraine, its owners may want to avoid paying taxes.

In order to do this, just before selling a business it is enough to create a shell company in offshore jurisdiction, transfer there the shares of Ukrainian company at their nominal value and then sell these shares to the final buyer at a price much higher than a nominal value. The difference between the nominal value and the sale price is exactly the capital gain, which now will be taxed not in Ukraine by its rules, but in the offshore, where the shell company was created according to the rules of the country or territory. The territory is chosen in such a way that the rules allow in this situation not to pay anything. At its time all Ukrainian banks had been sold using this scheme, and their owners that collected billions of dollars in profits did not pay to Ukrainian treasury a penny.  The Prime Minister duly noted this problem.

The easiest way to its partial solution is the introduction of the excise tax on the sale of corporate rights of Ukrainian companies. In Ukraine, the excise tax was applied in 2013 towards certain categories of shares, and it was non-publicly and without much discussion canceled by the end of the year in response to a powerful lobby opposed the measure.

The sophisticated way is the creation of taxation rules of so-called foreign-controlled companies (FCC). In our example, this company will be known as the shell company. Although it was created outside of Ukraine, but it is controlled by Ukrainian owners, so her income should be taxed according to the Ukrainian rules.

Excise duty is a simple solution that is much easier to administer than the tax rules of FCC. But the excise tax could be unfair if the procedure does not promise profits to the seller. And it often misses the target, if a capital gain arises from the sale of corporate rights of the intermediate company, but not the Ukrainian one, or if the rights are sold at nominal value and the actual price paid using other methods. For instance, in our example, the excise tax would be paid only from the nominal value of the shares.

Thus, taxation of FCC profits does not have any alternatives. This direction is believed to be of high priority according to leading experts in the field of taxation. It is hard work. Many people are skeptical about the possibility of Ukrainian fiscal authorities and courts to master these techniques and apply them correctly in practice. But we don’t have another option. And while we are engaged in populism, in the neighboring Russian tax rules of FCC will start working since January 1, 2015!

Without offering similar measures to Ukraine, the government also refused to introduce excise duty. As we have shown, even though the excise tax is not perfect, but it is at least some response to the problem.

The denunciation of agreement about double taxation with Cyprus can be considered completely irrelevant to the discussed issue, because this measure will be only a signal to business to replace less attractive Cyprus with other jurisdictions within the EU.

The issue discussed by Mr. Yatsenyuk resembles the working methods of the lustration government. It is simple and mindless but popular among the people solution that does not bring the slightest results. It is an imitation rather than a thoughtful reform of monitoring system of officials’ and judges’ lifestyle.

This is not the first time when the Prime Minister made populistic claims concerning the fight against offshores, creating in the society high expectations of the government’s results. In October, on the eve of the elections, Mr. Yatsenyuk claimed from the tribune of Parliament that “offshore era is over in Ukraine”, presenting to the public a bill on the introduction of modest one-time tax (in the amount of UAH 8500) on offshore ownership of the Ukrainian business. Inflated public expectations are doomed not to be justified, because the government does not even begin to think in the right direction.

Populism of Prime Minister harms not only the public’s expectations, but also the investment climate in the country. The agreement with Cyprus entered into force recently and after years of difficult negotiations. Ukrainian businesses and investors adjusted their business plans taking into account this agreement, a draft of which was available to the investment community in advance, which gave some time to the business to prepare itself. After all, the new agreement, which appeared in order to replace its Soviet predecessor, only equalize rules of passive income tax with the rules that manage relationships with other trading partners of Ukraine. The statement by the Prime Minister, if we take it seriously, cancels these business plans, and undermines investor confidence to the new government. We can’t call this move of Prime Minister in any other way than a false start and a disservice to the liberal reformist government.

We should find a better use for the government’s efforts than unilateral denunciation of standard contract with one of the EU countries that has been discussed for years.


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The author doesn`t work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations