Tax Reform. Analysis of the Proposed Changes and Some Suggestions

Ukrainian taxation system is one of the main obstacles for business in Ukraine (with the main ones being access to finance and corruption).


Ukrainian taxation system is one of the main obstacles for business in Ukraine (with the main ones being access to finance and corruption). For example, in the World Bank survey tax rates and tax administration are in the third and sixth places of obstacles to business respectively.

The following table compares the indicators of “paying taxes” section from the “Doing Business-2014” report. We see that Ukraine has not only one of the highest number of taxes but also the highest total tax rate and the highest amount of time needed to pay taxes among the countries in the region.

Table 1. Easiness of paying taxes
Doing business rank Paying taxes rank # of tax payments per year Time needed to pay taxes (hours per year) Total tax rate (% of profit)
Georgia 8 29 5 280 16,4
Lithuania 17 56 11 175 43,1
Poland 45 113 18 286 41,6
Slovakia 49 102 20 207 47,2
Belarus 63 133 10 319 54,0
Turkey 69 71 11 226 40,2
Moldova 78 95 31 181 40,4
Russia 92 56 7 177 50,7
Ukraine 112 164 28 390 54,9
Source:, 2014 report

Whereas the rates of the main taxes (VAT, EPT, PIT) are quite competitive, excessive social contributions, soaring compliance cost and outrage of tax inspectors all add to the challenge of doing business in Ukraine.

The current Ukrainian tax system was mostly developed by Mr. Azarov (the last Yanukovich’s prime minister) when he was the Head of the Tax Administration (TA) during 1996-2002. Since then, the tax system has been developing as a “vicious spiral”: in order to stop evasion by some taxpayers, the regulatory pressure on all firms was increased, thus providing more incentives for tax evasion – and, as a side effect, driving some enterprises out of business.

The volume of required reporting to the TA has been growing in a geometric progression, with the respective increase in both private (to file the reports) and public (to process the reports) expenditures. As a result, today Ukraine has one of the most complicated tax reporting and administration systems in the world. However, TA is still unable to stop tax evasion, so the vicious spiral continues to unravel creating a competitive disadvantage for Ukrainian enterprises and slowing down the entire economy.

In this article we analyze the main problems of the current tax system, and whether recently adopted changes to the Tax Code (concerning VAT) and proposed changes to the Tax Code concerning other taxes address these problems. We conclude with some policy recommendations.

The main problems of the tax system of Ukraine are:

1. High cost of compliance and reporting (too many taxes, too many documents to file to the TA).

It is very costly for enterprises to provide tens of reports and their supplements to the Tax Administration, Social security funds and the Statistics service (for example, to report VAT payments, one has to fill in up to 22 forms, filing EPT documents requires filling in up to15 forms, depending on the enterprise type etc.). Each mistake in a report is fined. Therefore, the accounting staff of a Ukrainian enterprise is at least twice or even three times larger than in an EU enterprise. Too general and vaguely written norms of the Tax Code allow TA to issue numerous “law clarifications” that very often contradict each other and the law itself. Therefore, it is practically impossible to comply with all the regulations. And tax inspectors use this situation for their benefit, which leads us to the second problem:

2. Wrong aims and motivation at all levels of TA with no personal responsibility at any level for the misuse of power or simply doing a bad job. At the same time, tax inspectors are punished for not fulfilling collection plans.

Before each inspection, tax inspectors receive an [unofficial] plan of additional taxes and fines that they should collect from a given enterprise to the budget. These plans are imposed by a higher-level tax authority, and initially were intended at reduction of corruption among the “field” inspectors. Since the legislation is complicated and contradictory, and lower-level tax officials often lack qualification to find real cases of tax evasion, they just invent some violations and impose additional payments and/or fines on enterprises in order to fulfil the plan (if an inspector fails to fulfill it, (s)he is financially punished). And this practice continues even now – during 9 months of 2014, tax authorities performed almost 25 thousand of inspections (of them only 3.9 thousand were planned, and others were “surprise”) and increased tax obligations of inspected enterprises by over UAH 7 billion.

Often, a taxpayer prefers to pay these unjustified fines because challenging an inspector’s decision in an administrative court is both time-consuming and costly. Even if, after one or two years of litigation, a taxpayer finally wins the case (which is a big IF, since Ukrainian judicial system is not functioning properly), tax officials never bear any responsibility. Moreover, they are obliged to appeal all court decisions won by taxpayers.

3. High social contributions (47-51% of salary fund) is the main cause of “salaries in envelopes”. Today, the estimates of “black salary” in the economy range from UAH 20 to 50 billion per month, while total salary payments averaged to UAH 54 billion per month in 2013. “Salaries in envelopes” not only reduce budget revenues but also support the entire shadow industry of “cashing centres”. Some politicians have already suggested the reduction of these contributions, but the problem is that there will be some time gap between lowering their rate and salary deshadowing, and during this time revenues of the Pension Fund and other social funds will fall. So, a monetary “cushion” is needed to cover pension payments during this transition period, which Ukraine currently does not have.

4. VAT refund. VAT refund has always been one of the largest sources of corruption. It is widely known that honest exporters could get VAT refund for 30% to 50% of “payback” to responsible officials. At the same time, fake exporters related to authorities received the refund fully and in time. Besides, the government has used VAT refund as a mean to close “budget holes” when its revenues dropped. Thus, VAT refund arrears rose from their minimum of UAH 3.5 billion at the end of 2004 to UAH 21.8 billion at the end of 2009 (the lowest point of the economic crisis), then decreased to UAH 4.5 billion at the end of 2011, and afterwards started rising again reaching UAH 15 billion at the end of 2013.

5. EPT payments “in advance” that reduce working capital of an enterprise. While theoretically advance EPT payments are not a problem (this practice exists in EU countries too), its application in Ukraine causes problems:

  • TA created a difficult system of advance payments administering (17 additional budget accounts were opened). This resulted in taxpayers’ errors when the tax was paid in time but to a wrong account, and the tax authority fined taxpayers for non-compliance;
  • Often, TA simply orders enterprises to pay additional amounts of EPT in advance in order to fill in the budget (this practice became very widespread in 2012-2013) thus reducing enterprises’ working capital and future budget revenues;
  • Sometimes, tax officials refuse to take into account these additional advance EPT payments when calculating future EPT obligations.

However, recent changes to the Tax Code (proposed as well as already adopted) hardly address these problems.

Changes to the Tax Code concerning VAT (will be enacted since January 1st 2015)

These changes are completely within the paradigm of the current tax system – they are aimed at reducing tax evasion, but at the same time they further increase the compliance cost. The main changes are as follows:

  1. every deal that foresees VAT payment (and issuance of VAT invoice) will have to be registered by the TA. If not, the buyer would not be able to file a tax credit on the deal and thus would lose 20% of the deal price. Currently, enterprises can use unregistered VAT invoices for domestically produced goods/services if the sum of a deal is less than UAH 10 thousand. No need to say that this novel increases the cost of compliance.
  2. advance VAT payments. Now the VAT for the VAT invoices issued during the current month is paid to the budget at the end of the next month. After January 1st 2015, an enterprise will have to pay the VAT to the budget before the VAT invoices are issued. This novel allows to practically stop VAT evasion but at the same time this will reduce working capital by about 1.5 of average monthly VAT payments.
  3. the price of a good or service, which is the base for VAT calculation, should be no lower than producers’ cost. So, if a firm’s product is in low demand and it has no other choice but to sell below cost, it will not only encounter losses but also will have to pay taxes from the revenue that it did not earn.
  4. The VAT refund procedure remains quite vague. Currently, to be eligible for the “automatic” refund (i.e. without tax administration approval), a company must be financially sound, have no tax arrears, employ no less than 20 people and pay them no less than 2.5*minimal salary. During 2012-2013, over 50% of VAT refund was provided automatically. At the same time, there is still no obligation of the TA to refund VAT to companies that do not have the right for “automatic” refund.

The newly adopted legislation introduces new limitations on the enterprises that are eligible for the automatic VAT refund:

    1. the amount declared for the refund has to be lower than 1/12 of depreciated cost of a company’s fixed assets, and a taxpayer must (1) either have a share of export revenues no less than 40% or (2) invest no less than UAH 3 million during the last 12 month;
    2. a large taxpayer should have no losses in the previous financial year.

So, as the previous innovation, this one will punish enterprises already in a financial trouble.

Although it is true that some enterprises show losses in order to minimize tax payments, the above-listed law changes will adversely affect all the taxpayers.

Changes to the Tax Code proposed by the Draft Law introduced to the Parliament on September 15th, 2014, have already received some very negative feedback. We must admit that although this draft has some positive ideas, it does not solve the problems of the tax system listed above, at the same time providing new opportunities for corruption. The main changes proposed by the Draft Law are analyzed below.

1. To simplify the tax system, the number of taxes and duties is reduced from 24 to 11 (one of them being military duty introduced recently as a temporary measure, which has a big chance to become permanent) through elimination of seven taxes (amounting to 1,4% of total tax revenues) and merging of ten other taxes into four.

The next table compares current and proposed tax systems.

Table 2. Comparison of current and proposed tax systems

State level taxes

Current system % of budget revenues* % of GDP* Proposed system
EPT 15.5 3.8 EPT
PIT 20.4 5.0 PIT
VAT 36.2 8.8 VAT
Excise tax 7.8 1.9 Excise tax
Ecological tax (levied on sales of fuels) 1.1** 0.3**
A duty on electricity and heating tariff (except electricity and heating produced by cogenerating power stations or with renewable energy sources) 0.7 0.2
Excise tax on operations with securities 0.03 0.008 Cancelled
Ecological tax (except for fuel) 1.1** 0.3** Ecological tax
A duty for usage of forests 0.1 0.02
Payment for the first registration of a vehicle 0.16 0.04
Payment for extraction of natural resources 4.0 0.98 Rent payment
Payment for usage of radio frequencies 0.27 0.06
Payment for usage of water 0.42 0.1
Custom duty 0.05 0.01 Custom duty
Rent for usage of pipelines (gas, oil, ammonium etc.) 0.32 0.08 Cancelled
A duty on natural gas usage tariff 0.47 0.11 Cancelled
A duty directed to development of vineyards, orchards and hop-growing 0.31 0.08 Cancelled
Land tax 3.6 0.88 Transferred to local level
Military duty no data no data Military duty

Local taxes

Property tax (excluding land) 0.006 0.002 Property tax (including land)
Single tax (excluding single agricultural tax) 1.9 0.46 Single tax (including single agricultural tax)
A duty for performing certain types of economic activity (123 000 payers) 0.16 0.04 Cancelled
Tourist duty 0.01 0.003 Cancelled
Parking duty 0.02 0.004 Cancelled
Excise tax on retail sales of alcohol, tobacco and fuels
*2013 data, consolidated budget**only aggregate data on ecological tax is available

Whereas cancelation of some non-economical taxes is undoubtedly a positive step, merging of taxes is good only in the medium to long run. In the short run it will lead to increased cost of tax administration and reporting due to changes in reporting forms and respective software. In order to soften the short-run negative effect, it would be a good idea to provide a 6-12 months adjustment period before taxes are actually merged.

2. To simplify the compliance, a separate tax accounting is eliminated, and EPT is computed on the accounting profit base.

At the same time, accounting profit of 5% of the largest firms (those with annual revenues over UAH 20 million) will be corrected (i.e. tax base will be increased) for three types of operations instead of 49:

  • Loss provisions (reserves);
  • Amortization (a limit on amortization rates for profit tax calculation);
  • Financial operations (a limit on the sum of interest expenditures)

Other firms will pay EPT based on the accounting profit.

If adopted, this change would be really innovative and positive, but there are some caveats:

  • there will be short-run adaptation cost while tax authority designs new rules and reporting forms for the new taxation system, and the enterprises get used to them;
  • the Draft Law proposes to provide TA with the right to check financial accounting records. This proposal seems to be logical because accounting will be directly related to the taxation. However, TA does not have enough qualified personnel who could check the accounting records made even according to the national standards, let alone the international ones. And it seems that nobody expects a tax inspector to be qualified enough to check the accounting records. Currently TA inspectors often make claims that contradict both the law and the common sense; nothing will prevent them from doing this in the future.

As for tax reporting, the Draft Law does not provide any simplifications. Moreover, it introduces some additional reporting. Namely, if the proposed changes are adopted, the enterprises would have to report to the TA any sales operation with the unit price exceeding 10 minimal salaries (currently UAH 12 500 or slightly less than $1000). This means that for buying, say, a new piece of furniture, a buyer would have to show his/her passport, and a seller would file a report to TA on each of such operations.

3. To avoid tax evasion by individuals, an indirect method of PIT base calculation (i.e. comparison of a person’s revenues with his/her expenses) is introduced.

Simultaneously, the Draft proposes a tax amnesty – if a person declares his/her assets and money holdings between January 1st and October 31st of 2015, (s)he is freed of the need to provide sources of these assets and pay taxes on them, as well as from the criminal responsibility for tax evasion.

While generally the idea to introduce an indirect method for PIT calculation is good, its implementation in the Draft Law raises serious questions.

First of all, there are no clear criteria for selection of taxpayers for inspection. The law states that taxpayers whose expenses in a given period exceed revenues for over 40 minimal salaries (currently about UAH 50 thousand) can be inspected, but the decision to conduct an inspection of a specific taxpayer is taken by the local tax office head, who can be “asked” to close his eyes on some individuals and pay attention to other persons.

Second, until the inspection is over, all assets of a person can be arrested, so tax inspectors get practically unlimited leverage over a taxpayer. It would be naive to think that this norm will hurt only oligarchs and corrupt officials. It can be easily applied to those who made a large purchase using their multy-year savings, to those who get (or got some time ago) their salary “in envelope”, and even to those volunteers who collect donations on their personal accounts to buy, for example, army supplies.

Third, the Draft Law does not define the information that can be used for calculation of expenses of a person and how this information should be verified (the draft law states only that TA can use information received from “other” sources – perhaps implying the evidence collected by the tax police).

There is also no mention of the rights of a taxpayer during the inspection and protection of those rights. And of course, there is no responsibility of tax inspectors for their unjustified actions during application of this method to a taxpayer.

4. VAT refund. The Draft Law proposes to publish the list of enterprises that got VAT refund every month. This is a good idea because greater transparency usually lowers corruption.

5. The problem with social contributions is not addressed by the Draft Law – perhaps because it is beyond the scope of the Tax Code.

6. The tax base of the property tax is considerably extended to include all housing and commercial property, and tax rates are unified. The changes are summarized in the following table:

Table 3. Proposals on the property tax Tax rate, % of minimal salary
Property size, square metres Current system Proposed system
Up to 120 for a flat, up to 250 for a house;up to 370 if an owner has several objects 0 Up to 2% (at the discretion of local government)
120-240 for a flat, 250-500 for a house, up to 740 – if an owner has several objects 1%
Over 240 for a flat, over 500 for a house, over 740 if an owner has several objects 2.7%
Commercial property 0

Extending the base of this tax and letting local governments decide on the rate fits into the logic of the decentralization reform. Perhaps, local governments would be willing to provide some privileges to the poor because payment of UAH 750 per year for a 30-metre flat would be quite substantial for a pensioner getting UAH 1200 per month. Surely, it would be more fair to levy tax on the market value of property rather than on its area but perhaps the government chose easiness of administration over fairness (the area of a house or a flat, unlike its value, can be easily  computed).

7. Similarly with the property tax, the land tax is transferred to the local authorities’ responsibility. In the current Tax Code, land tax is collected to the Central budget, and within cities/towns fixed rates per 1 sq. m are set depending on the size of a settlement. The Draft Law proposes to let local authorities decide on the rate, setting only the maximal rate – 3% of a land plot value in settlements (where prices of land are defined), 1% of the oblast (regional) average value of a unit of land for agricultural land and 5% for non-agricultural land (in many instances value of land plots is not defined because land market in Ukraine is not developed. Agricultural land cannot be traded at all).

8. The Draft Law proposes to further simplify the simplified taxation system by increasing eligibility limits and reducing tax rates. See the next table.

Table 4. Simplified taxation system

Current system

Proposed system

Eligibility criterion Tax rate Eligibility criterion Tax rate
entrepreneurs working in trade and services;no employeesannual revenue ≤ UAH 150 thousand 0-10% of minimal salary* entrepreneurs working in trade and services;no employeesannual revenue ≤ UAH 300 thousand up to 10% of minimal salary*
entrepreneurs working in production, trade or services, except for real estate and jewelry;≤ 10 employees;annual revenue ≤ UAH 1 million 2-20% of minimal salary* entrepreneurs working in production, trade or services, except for real estate and jewelry;≤ 10 employees;annual revenue ≤ UAH 1.5 million up to 20% of minimal salary*
entrepreneurs with≤ 20 employees andannual revenue ≤ UAH 3 million 3% of revenues with VAT**,5% of revenues w/o VAT entrepreneurs or enterprises with any number of employees and annual revenue ≤ UAH 20 million 2% with VAT and 4% w/o VAT
enterprises with≤ 50 employees andannual revenue ≤ UAH 5 million
entrepreneurs withany number of employees;annual revenue ≤ UAH 20 million 5% of revenues with VAT7% of revenues w/o VAT
enterprises withany number of employees;annual revenue ≤ UAH 20 million
agricultural producers with share of agricultural products in total output ≥ 75% 0.03-1% of the value of land/water owned/rented
*defined by local authorities**the enterprise can choose whether to pay lower share of revenues and VAT or higher share of revenues without separate VAT payments. The first scheme is usually chosen by entities selling to businesses, the second one – by those selling to final consumers.

9. Tax privileges. The proposed Draft Law, although cancels some tax privileges, introduces new, more modest, ones. Usually, these privileges are suspended every year by State Budget laws, so by and large they are useless but this practice raises instability of the taxation system. So it would be good to cancel them altogether.

The comparison of current and proposed set of privileges is presented in the following table:

Table 5. Tax privileges (zero EPT rate if profit is reinvested)

Current system

Proposed system

For investment projects developed according to the law “On stimulation of priority industries…” (0% EPT until 2018, 8% EPT until 2023) Until 2017 – for investment projects proposed by local authorities and approved by the Cabinet of Ministers that:- exceed UAH 20 million or employ over 100 people;- offer minimal salary that exceeds 3*official minimal salary
For alternative energy producers and producers of equipment for alternative energy generation – until 2020 cancelled
For enterprises extracting and using methane from coal mines – until 2020 cancelled
For enterprises with annual revenue less than UAH 3 million and average salary no less than 2*official average salary (except for exporters, enterprises working in jewelry, real estate, wholesale trade, financial services or production and sales of excise-taxed goods) – until 2016
Until 2021 for:

  • newly built or renovated hotels (related to Euro-2012)
  • light industry
  • shipbuilding
  • plane-building
  • agrarian machine-building
Until 2017 for:

  • military production;
  • agrarian machine-building;
  • software production;
  • plane-building;
  • extraction and sale of oil and gas from wells built after 31.12.2014
For UEFA activities and “Airport express” project (related to Euro-2012) cancelled

Summing up, the proposed changes to the Tax Code imply only marginal improvements. While containing many good ideas, the Draft Law proposed by the government does not address the main problems of the taxation system.

Policy suggestions

Ideally, the tax reform should be drafted together with the general state management reform in order to ensure enough tax revenues to implement the (hopefully curtailed) functions of the state at each level of governance. Also, ideally, the newly designed tax system should comply with the general taxation principles (neutrality, fairness, simplicity, inclusiveness, convenience, efficiency, predictability etc). These principles are listed in the Article 4 of the current Tax Code but are hardly applied to the rest of the document.

Definitely, the tax reform should be adopted after a wide expert and social discussion, and there should be a sufficient adjustment period (6-12 months) between adoption and implementation of the reform.

It is beyond the scope of this article to redesign the entire taxation system for Ukraine (some valuable suggestions for this “big” reform can be found here and here). However, some changes easing the life of business (let us call them the “small” reform) can be introduced immediately.

“Small” reform – redesigning tax administration.

An obvious policy suggestion following from the discussion above would be to reduce the compliance cost for enterprises. One possible way to do that is to form an independent committee of experts comprised of [former] tax officials, entrepreneurs, accountants/auditors, lawyers etc. that would develop simple but informative reporting forms, as well as go through sub-legal acts issued by tax administration and produce the list of documents that should be cancelled as contradicting the law or creating rent-seeking opportunities. An ideal solution would be to include into the law the closed list of documents that can be demanded by tax authorities and prohibit tax authorities to issue “law clarifications”. Of course, to achieve this, the Tax Code itself must be much more specific and clear than now.

Besides, the range of problems left at the discretion of a tax inspector should be considerably narrowed. For example, inspectors should be prohibited to decide which items can be included into an enterprise’s expenses or to claim a deal to be void – there should be a relevant court decision on the issue. The inspectors should bear personal responsibility for unlawful charges (up to dismissal), and this responsibility should be explicitly prescribed in the legislation.

This implies raising the qualification of the tax officials (and their respective salaries!), which can be done at no additional budget cost via optimization of the TA staff. Today, there are about 45 thousand tax officials in Ukraine, which is more than 13% of all state officials. Tax administration is the body that consumes the highest amount of state budget funds for staff salaries – over UAH 3 billion per year. At the same time, a “field” tax inspector gets UAH2000-2500, which is 25-40% lower than the average salary in the economy. Consequently, as discussed above, the quality of their work is low and temptation for rent-seeking is high.

To further reduce not only incentives but also opportunities for corruption, the contact between a tax inspector and an enterprise that (s)he is inspecting should be minimized. This can be achieved (1) by easing electronic submission of documents and (2) by strict distribution of documents collection and analysis functions between the front and back office of the tax authority.

Finally, the practice of imposing plans of “additional taxes and fines” collection should be abandoned, and the presumption of innocence principle should be applied to taxpayers, as prescribed by the current Tax Code.


The authors do not 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