Roman Zharko: Core Problem of the Ukrainian Tax System

Where the tax authorities continue charge additional taxes and impose penalties based on target tax burden ratios for a given taxpayer not taking into account the specific situation of such taxpayer and real accounting data, the tax system will remain the main obstacle for economic and social development of the country. Based on this, we fully agree with the conclusion, that “… success of the tax reform depends more heavily on reforms in the area of tax administration than on the changes to the tax system itself”.

Conclusion

In our view, the priorities of the tax reform as they stated in the article and in the presentation made recently by the Ministry of Finance, as well as the measures proposed do not address the core problem of the Ukrainian tax system, which is widely-spread practice of discretionary use of fiscal mechanism to reach the established revenue targets.

While the tax system itself contains many problematic aspects, implementation of amendments that would bring the Tax Code close to the ideally drafted piece of legislation will have limited positive effects only. Where the tax authorities continue charge additional taxes and impose penalties based on target tax burden ratios for a given taxpayer not taking into account the specific situation of such taxpayer and real accounting data, the tax system will remain the main obstacle for economic and social development of the country.

Based on this, we fully agree with the conclusion made by the author, that “… success of the tax reform depends more heavily on reforms in the area of tax administration than on the changes to the tax system itself”.

In addition to the above conclusion, it worth to add that the specific proposals to the tax reform concentrate mainly in areas of corporation profits tax, social security contribution, VAT and simplified tax system. However, proposals for implementation of measures aimed at fighting tax avoidance are missing, though these might furnish a large increase in tax revenues. The anti-avoidance measures can include introduction of CFC rules, enhancing international tax information exchange, exchange in financial information in accordance to the initiatives of Global Forum on Transparency initiative, implementation of indirect control over income of individuals through control over expenses etc.

Below we provide our view on specific ideas analyzed in the article.

Corporate income tax

An implementation of the idea to turn to taxation of profit distribution will require establishing of a strict control over expenditures of taxpayers and will, therefore, leave a room for discretionary application of power by the SFS. The suggestion to implement profit distribution taxation without control over expenditures might be feasible in the ideal society only where all the taxpayers happily fulfill their liability to pay taxes without any enforcement.

Another suggestion made was to provide for a right to deduct capital expenditures: this idea is worth supporting as it might be an element to provide incentives in respect of certain categories of non-current assets, e.g. ecologically friendly ones.

Overall, in the current circumstances it may be suggested to leave the current system of corporate income tax as it is with some amendments to eliminate the existent technical issues. This approach would help to avoid another splash of uncertainty amongst business community and would not lead to decrease in tax revenues.

Labor taxes

The main issues in this area are the high tax burden and large portion of salaries paid unofficially.

The idea to combine the SSC with PIT without decrease in rates will not help: in any case, employees are interested in what they get after taxes rather than in how much of salary were accrued for them.

The shift for improvement may be reached by combination of two components: decrease in rates and implication of more radical steps to fight shadow economy. The question of decreasing rates is rooted in reformation of social security system and may not be solved within tax system alone.

Value-Added Tax

Suggestion of increase of VAT rates which is seen as one of the possible options would lead to a number of adverse effects, and the author shall be supported in his conclusions on this issue.

What shall be done, however in respect of VAT, is to abolish the special VAT regime that applies to agricultural business and to introduce clear and transparent mechanism of refund of the tax.

Simplified taxation

While it may be agreed that simplified taxation is used to minimize tax burden, we would not advise to eliminate the group III. What could be done is a reduction of the threshold from UAH 20 mln to the smaller amount. Also, it is advisable to introduce strict control over use of electronic cash registers to decrease underestimation of the revenues.

Also, it may be suggested to apply the group IV regime for small entities only. It shall be elaborated further how to identify which entities would fall under category of small ones taking into account whether the entity is specialized in a crop raising or in livestock breeding.

In other aspects, the simplified system might remain as it is, since it plays significant social role by incentivizing of a small business development in Ukraine.