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VAT for the chosen ones: will the state benefit from introducing a reduced VAT rate for agricultural players?

Photo: depositphotos / fotokostic
25 June 2021
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We are publishing the most interesting points of the tax discussion that took place on March 31, 2021. The speakers: Daryna Marchak, head of the Center of Public Finance and Governance, Oleh Nesterov, committee coordinator at the UCAB, Tetiana Shirochenko, Regulatory Affairs Committee coordinator at the EBA, Oleh Yukhnovskyi, chairman of the Agriculture Committee at the UCCI. 

The discussion was moderated by Yuliia Mincheva, the project’s coordinator. You can watch a recording of the discussion here.

As of March 1, a reduced VAT rate of 14% on transactions for supplies and imports of certain types of agricultural products is applied in Ukraine. These include barbarea, rapeseed, sunflower, wheat and rye, barley, corn, soybeans and other oilseeds, livestock products, whole milk, etc. This is one of those rare cases when a reduction in tax rates was strongly supported by both the Ministry of Finance and the State Tax Service but opposed by the Verkhovna Rada Committee on Finance, Tax and Customs Policy. The professional associations’ opinion is also divided. The law’s proponents argue that the “twists” and VAT evasion schemes regarding transactions with agricultural products should become less advantageous economically.  

Also, a reduction in VAT refunds is predicted, which should reduce a burden on the budget and the risks of VAT fraud. In practice, however, things are not so clear cut.

Advantages and disadvantages for different market players   

According to the analysis done by the UCCI jointly with researchers from the “German-Ukrainian Agro-Political Dialogue” project, this decision will have a negative impact on the market as it contradicts the trends in international practices for applying and administering VAT, reducing the state budget’s revenue and violating commitments Ukraine has made to international partners, in particular the IMF.

According to Oleh Yukhnovskyi, the situation on the agricultural market, in particular in the food processing industries, leaves much to be desired. In the food industry, production volumes fell 11% in January-February. Oleh also predicts an increase in the number of unprofitable enterprises in the food processing industries at the end of the financial year. The food processors were also negatively affected by high prices for raw materials in the domestic market. For some product groups, raw material prices were twice as high as the world market prices. Other negative factors include default on forward contracts and artificially lowered expectations for future harvests. Some food processing industry associations complained to the UCCI that they were unable to purchase raw materials, appealing to the Antimonopoly Committee to determine which extra-market factors were at play in this situation.

Oleh Nesterov noted that although, according to the UCAB’s calculations, the number of so-called “twists” has in effect somewhat decreased, there is still demand for cash payments for seeds, grain and other goods, and it overall does not solve the situation with the shadow market. Yet it is already clear that businesses will face problems with paying VAT, as the administration procedure for the new rate has not been worked out. Another important issue is that of investments, i.e. how to cover the tax credit, considering that companies buy equipment and a number of other goods at a VAT rate of 20% and sell grown products at a rate of 14%.

The European Business Association has supported the implementation of this initiative for grain crops and oilseeds but advocates excluding milk from the list of goods subject to a reduced VAT rate, as this will bring about an increase in the cost of raw materials for processing and the price of the end products for consumers.

The impact on public finances 

The Ministry of Finance insists on this initiative’s neutral fiscal effect, but due to the lack of information from the State Tax Service regarding the required KVED (classifier of types of economic activities), it is impossible to verify whether that is true. It is obvious, however, that the state budget does not take into account the changes brought about by the VAT reduction for budget revenue, as they were approved two days after the budget was voted. Daryna Marchak pointed out that this decision contradicts the idea of an ​​effective, fair tax policy. Different rates make the VAT administration more complicated, so it will be more difficult for the tax authorities to verify the adequacy of those transactions. There is more space for manipulation and tax evasion. Unequal conditions for different industries’ players are introduced. Daryna also noted that such steps erode the tax base, which reduces budget revenue.

Ways to resolve the situation

The participants in the discussion, representing different associations, unanimously thought it necessary to reduce the rate throughout the production chain – from raw materials to end consumers. Simultaneously, the EBA is working on amendments to the Law to remove whole milk from the list of items taxed at the reduced VAT rate. Oleh Yukhnovskyi disagrees with this insisting that all agricultural market participants should come up with a unified, comprehensive position, including those in food processing industries. Based on this position, an appropriate bill could be prepared. This position needs to be supported by calculations. To summarize, Darya Marchak said that with this decision the state sends the wrong signal to the market, i.e. that lobbying can ensure the adoption of certain decisions, despite the analysis, reasoning and other stakeholders’ positions.

The participants in the discussion expressed hope that the decision to reduce VAT on certain types of agricultural products would be adjusted to level the competitive playing field and ensure equality and fair taxation, without taking a selective approach.

This material was prepared under the Budget Watchdog project with the support of the German Government’s project “Good Financial Governance in Public Finance III”, implemented by Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH.

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