Horizontal Monitoring in the Ukrainian Way ~ U-Tax Blog

Friday, May 20, 2011

Horizontal Monitoring in the Ukrainian Way

The State Tax Administration of Ukraine (the STA) decided to endow taxpayers with a new method of tax control, horizontal monitoring. The option is not offered to all, but only to a few large taxpayers. According to publicly available information there are five such lucky taxpayers, including Metro Cash & Carry Ukraine " and " Donbass Industrial Union.


The mechanism of horizontal monitoring involves the active participation of the taxpayer in the tax control. Before carrying out or taxing a certain transaction bearing tax risks, the taxpayer discloses the information on such a transaction to the tax authorities. The tax authorities process this information in an urgent way (allowing for real time limits needed for conducting business transactions) and provide the taxpayer with the tax consultation. Moreover, the STA promises to reduce or even cancel tax audits for those participating in the project and issue them with a timely automatic VAT refund.


Horizontal monitoring is not a product of the imagination of the Ukrainian tax authorities. This method of tax control was first introduced in 2005 in the Netherlands, from where it successfully migrated to other countries such as Germany, Austria and Slovenia.

The undeniable advantage of horizontal monitoring is handling tax risks in the real time mode. Once faced with the uncertainty of the applicable legislation in respect of a certain transaction, the taxpayer addresses the tax authorities and immediately obtains a tax consultation on how to proceed further. Thus, at the moment of the transaction the taxpayer is already aware of how, in the opinion of the tax authorities, such a transaction must be assessed, rather that endure the state of uncertainty until the next tax audit. Of course, if the taxpayer does not agree with the stance of the tax authorities, nothing abolishes its right to defend its position by suing the tax authorities.

The main challenge for the successful implementation of horizontal monitoring in Ukraine is the shortfall of the relevant legislation. The legislation of Ukraine does not accord the tax authorities the right to enter into horizontal monitoring agreements with taxpayers, which must be in place in accordance with the international practice. Nor does it set forth the duty of the tax authorities to abide by the obligations laid down by these agreements, including those aimed to reduce the scope of tax audits and those related to the issuance of the tax consultations in an urgent mode.

Since under the Constitution of Ukraine (Article 19), the tax authorities being the governmental bodies are obliged to act on the basis, within the powers and in the manner dictated by the Constitution and laws of Ukraine only, there is an extremely high risk that the horizontal monitoring agreement will be found void and therefore unenforceable by the taxpayer.

Thus, in the realities of today’s tax laws of Ukraine the horizontal monitoring agreement seems to be a "gentleman's agreement”, whose implementation is solely dependent on the discretion of the parties, rather than a full-fledged legal instrument. In case the tax authorities breach the obligations imposed under such an agreement, including those related to the reduction in the number of tax audits, the taxpayer is unlikely to protect its rights in court.

In practical terms, horizontal monitoring brings additional risks for businesses linked with the protection of confidential information and the possible impact of the tax authorities on the selection of the contractors.

Although tax laws protect confidential information, including trade secrets, owed by a taxpayer from the disclosure, taking account of the high level of corruption in our country, the taxpayer cannot excludes the situation where the impious tax inspector sells its most intimate secrets to an unfair rival for a "modest pay”.

The negative consequences of such a disclosure could be much more severe than in the case with the classical method of tax control. The point is that in the course of horizontal monitoring the tax authorities receive information not on the business operations conducted several months or even years ago, but on very recently conducted ones or even those planned to be carried out, which is much more valuable "trophy" for the competitor.

It is very common nowadays for the tax authorities to deprive a taxpayer of the right to VAT refund, citing the fact that its contractors within the supply chain are involved in activities aimed at the generation of artificial input VAT (shame companies). It is clear that under these circumstances the tax authorities may suggest the taxpayer to work or not to work with particular contractors. If such suggestions will carry the "corruption component”, the costs of the taxpayers for purchasing goods, works or services could rise.

In sum, the horizontal monitoring appears to be a progressive and favorable for taxpayers way of tax control. Unfortunately, given the shortage of the respective legislation and the high level of corruption in Ukraine its successful implementation in Ukraine at present is rather doubtful.

Below, you can find a brief TV program on horizontal monitoring (in Ukrainian).

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