Tuesday, December 9, 2014

VAT-Revolution: Modification

It is more than a month has passed since the publication of the article on the new system of VAT administration. Over this period of time, some important points have shown up. 
Firstly, there is a high likelihood of the new administration system being revoked. The revocation of the new system is provided for by the Coalition Agreement. Moreover, the bill No 1141 on the revocation of this system has been registered by the Verkhovna Rada (Ukrainian parliament).

Secondly, the blocked VAT-accounts will not be opened at the Clearing Сenter for Servicing Contracts in the Financial Markets. Pursuant to the effective resolution of the Cabinet of Ministers of Ukraine No 569 such accounts will be rather opened at the State Treasury of Ukraine.

Thirdly, on 4 December 2014, the State Fiscal Service of Ukraine published a methodological document "Basic Rules of the Electronic VAT Administration." The document provides clarification on many aspects of the operation of the new system of administration.

*- Photo from http://www.slovoidilo.ua

Friday, December 5, 2014

Blocked VAT-Accounts: Not That Effective

Over the time that has passed since the publication of my article on the new system of VAT administration, I have lost my illusions as to 100% efficiency of the new system. 

Blocked VAT-accounts are well able to resist VAT-fraud when it comes to transactions between taxable persons. However, they are virtually powerless against VAT-abuses when it comes to transaction between taxable and non-taxable persons. A sham company can supply goods/services to a non-taxable person and fail to declare its output VAT. A limit on the registration of VAT invoices in the unified electronic register will not help here. The sham company just will not issue a VAT invoice at all thereby avoiding depositing funds into its blocked VAT-account. The VAT "saved" in such a way the sham company will be able to transfer to an unconscientious trader by providing him with “all-loved” consulting services plus, of course, black cash in suitcases.

Let me illustrate this loophole of the new administration system by way of example.

Company A is willing to convert UAH 1 mln. into black cash and still enjoy fake input VAT.  Company A reaches out to Company B (a sham company). The parties enter into a contract for consulting services (Company A is the client, and Company B is the contractor) at the amount of UAH 1 mln., inclusive of UAH 166.66 thousand of VAT. Company A transfer UAH 1 mln. to Company B as an advance payment for the consulting services.

Company B does not hurry with the issuance of the VAT invoice to Company A for the amount of UAH 166.66 thousand. The point here is that for registering such a VAT invoice in the unified register, Company B would have to fund its blocked VAT-account for UAH 166.66 thousand. Instead, Company B seeks a possibility of issuing the VAT invoice to Company A without depositing any funds into its blocked VAT-account.

To this end, Company B buys for the same UAH 1 mln. computer equipment from Company C (a taxable person) and gets for itself a VAT invoice for the amount of UAH 166.66 thousand. The purchase is of true nature. Company B really gets the computer equipment.

Now, having the VAT invoice confirming its entitlement to UAH 166.66 thousand of input VAT, Company B issues a VAT invoice to Company A for the same amount with no funding of its blocked VAT-account.

At the final stage Company B sells the purchased computer equipment to Company D (non-taxable person) for UAH 1.1 mln., including UAH 183.33 thousand of VAT. Again, it is a true nature transaction. The computer equipment actually goes to Company D.

It seems as if there were no options for Company B, but to fund its blocked VAT-account for UAH 183.33 thousand necessary for the issuance of the VAT invoice to Company D. However, Company D resorts to “unexpected maneuver”. It does not issue the VAT invoice and does not record its resultant output VAT in the VAT return.

Company D is not a taxable person and by and large does not need the VAT invoice. Therefore, it will not complain to the State Fiscal Service of Ukraine about Company B failing to issue it with the VAT invoice. Furthermore, the law itself does not provide any enforcement mechanism that can be used to compel Company B to provide Company D with the VAT invoice. A provision setting out 15 days time limit for registering a VAT invoice in the unified register is not enshrined by any effective legal sanctions.

After receiving the funds from Company D Company B illegally converts them into black cash and transfer the obtained black cash to Company A, of course, less of the conversion fees charged.

By the way, the question arises as to the amount of black cash conversion fees. It appears that a 27-30% fee mentioned in my preceding article is rather an overstated amount. Arguing that the amount of the fee would soar that high, I was premised on the assumption that the new administration system would completely close the gap allowing sham companies to evade VAT.

As the aforesaid example shows I was wrong. The new system of administration still permits sham companies to evade VAT, but this will be much more difficult than it is today. Sham companies will incur additional operating expenses. To secure a "deal" they will have to at least carry out a real purchase of goods and find a non-taxable customer ready to buy such goods from them at prices close to market ones.

Given the additional operating expenses, sham companies will charge more for their services. How much will it be - it is difficult to say. However, it is clear that it will be something above the current 7-10%, but below 27-30% suggested in my previous article. Perhaps, it will be something around 12-15%.

What could the government do to block/restrict the VAT-evasion possibilities open to supplies involving non-taxable customers?

In my opinion, the government may consider assigning certain controlling responsibilities to banks or to non-taxable customers, in particular those of them being sole traders or legal entities.

Banks can be prohibited from processing payments made by non-taxable persons to taxable persons, until the taxable person (supplier) provides the bank with the confirmation of the registration of the corresponding VAT invoice in the unified register.

As for non-taxable persons, they could be obliged to complain to the tax authorities about their taxable suppliers failing to provide them with the confirmation of the registration of the VAT invoices in the unified register. This obligation would be appropriate to safeguard by means of a fine being equal to the amount of the VAT for which the VAT invoice should have been issued. The presence of such a significant fine would encourage the non-taxable persons to complain to the tax authorities about the taxable persons failing to issue the VAT invoices. The tax authorities would therefore be able to receive promptly the information about the abuse and would be able to respond to it accordingly.

Monday, November 17, 2014

Free Economic Zone “Crimea”: How to Pay Taxes?

Co-authored by Andrii Kuleba 
 (Junior Associate of 
Lavrynovych & Partners Law Firm)
Crimea is not ours anymore

The armed aggression of Russia has led to the annexation of the Autonomous Republic of Crimea in March 2014. Finally, in August 2014 the Verkhovna Rada (Parliament) managed to adopt the Act setting out rules for conducting business in the temporarily occupied territory of Crimea.

This is the Act of Ukraine “On the Creation of the Free Economic Zone “Crimea” and Specifics of Conducting Business in the Temporarily Occupied Territory of Ukraine” (hereinafter – the Act).

According to the Act the whole territory of the Autonomous Republic of Crimea, including the City of Sevastopol, becomes the free economic zone “Crimea” (hereinafter – the “FEZ “Crimea”).

The specific feature of the Act is that it establishes two different regimes of conducting business in Crimea. First one is actually the FEZ “Crimea” (Chapter I of the Act). Second one is the FEZ “Crimea” under temporary occupation (Chapter II of the Act).

What follows is a brief review of the tax treatment in respect of the FEZ “Crimea” under temporary occupation:

- Individuals and legal entities residing/located in the territory of the FEZ “Crimea” are equated to non-residents for the purposes of taxation (hereinafter – “persons equated to non-residents”).

- Ukrainian tax registration of persons equated to non-residents is cancelled. The FEZ “Crimea” source income of such persons is not liable to Ukrainian taxes and duties.

- Persons equated to non-residents may pay Ukrainian unified social contribution on a voluntary basis.

- FEZ “Crimea” source income of Ukrainian residents is treated as foreign source taxable income.

- Non-FEZ “Crimea” source income obtained by persons equated to non-residents in the territory of Ukraine is subject to Ukrainian withholding tax. Inasmuch as Ukraine does not recognize the annexation of Crimea, it is quite reasonable that the double tax treaty between Ukraine and Russia will not apply to this income.

- Transactions involving persons equated to non-residents (irrespective of whether the parties to them are related enterprises) are considered to be controlled transactions for the purposes of transfer pricing rules. Unfortunately, it is not clear from the Act whether such transactions are recognized as controlled automatically or only after reaching a value limit of UAH 50 million. At the moment, the State Fiscal Service of Ukraine sticks to an approach being favorable for the taxpayers. According to its position such transactions become controlled only after reaching the aforementioned value criterion (the letter of 6 November 2014).

- Goods supplied from the territory of FEZ “Crimea” to the other territory of Ukraine fall under the import regime with the payment of import duty, excise tax and VAT. However, such goods can be exempt from import duty where they are of Ukrainian origin confirmed by a certificate issued by Ukrainian chamber of commerce. The exemption at hand is confined to import duty only and does not apply to VAT and excise tax.

- Ukrainian goods from the other territory of Ukraine to be supplied to the FEZ “Crimea” fall under the export regime. According to the logic of the Tax Code of Ukraine, these goods must attract a zero rate of VAT. However, pursuant to an oral statement made by the leaders of the State Fiscal Service of Ukraine at a meeting with the members of the European Business Association held on 14 November 2014, there are no grounds for the application of the zero rate to such goods.

- Some tax incentives are made available to enterprises changing their location from the territory of the FEZ “Crimea” to the other territory of Ukraine. Such incentives, inter alia, include: (1) the cancelation of tax debts and the relief from sanctions for the failure to file tax returns since the beginning of the temporary occupation; (2) the exemption from import duty, VAT and excise tax for fixed assets and stock evacuated from the temporarily occupied territory; (3) possibility to deduct for the tax purposes an amount of documented expenses with respect to the evacuation of fixed assets and stock as well as to apply 100% depreciation charge with regard to the evacuated fixed assets.

Photo from http://alp.org.ua/

Wednesday, October 29, 2014

Ukrainian VAT-Revolution

The Law of Ukraine of 31 July 2014 № 1621 "On Amendments to the Tax Code of Ukraine and Certain Legislative Acts of Ukraine" introduced a radically different system of VAT administration. The new system, called the electronic system of administration will take effect from 1 January 2015.


The system of electronic administration is called to combat a favorite item of many unconscientious Ukrainian entrepreneurs – conversion of non-cash funds of their enterprises into unaccounted (black) cash. It is quite possible today to transfer a huge amount of money to a sham company for, say, something like "consulting services" and receive that amount, less about 7-10%, in cash. By doing so, an entrepreneur "kills two birds with one stone":

- Reduces the tax burden of VAT and corporate income tax (the costs of the "purchased" services are deductible for the functioning of the both mentioned taxes);

- Utilizes the resultant unaccounted cash for the “purposes of the business activities" (paying salaries “under the table”, all sorts of bribes, etc.), as well as for personal needs (something like paying dividends to yourself).

It is noteworthy that the system of electronic administration will not likely get rid of the business of sham companies at all, but it will strike a severe blow to their effectiveness. An attractive price of 7-10% of the converted money is largely achieved through the evasion of VAT. Sham companies either do not declare output VAT arising from the supply of their goods/services at all, or fail to remit the reported VAT to the state revenues. The electronic system of administration is directed exactly at closing the above VAT evasion possibilities currently available through the recourse to sham companies.

Sham companies will be obliged to pay VAT, and this will mean a significant rise in prices for their services. By adding 20% VAT to the price of 7-10%, we obtain 27-30% price. This price will be high enough to expect a significant decline in the business of the operators of sham companies.

First of all, the new system of administration will benefit the state by enlarging VAT revenues. Conscientious business players will also gain from its introduction. Their unconscientious competitors will no longer receive unjustified tax benefits arising from the “cooperation” with sham companies.
How will this work?

Under the current administration system, VAT is payable after the end of a taxable period. A taxable person reports his input and output VAT for a taxable period (as usual, a calendar month) in his VAT return. Where the output VAT exceeds the input VAT, the taxable person remits the surplus to the state revenues. The problem of the current system is the lack of a direct link between a purchaser’s input VAT and a seller’s output VAT. The seller can issue a VAT invoice entitling the purchaser to the enjoyment of the input VAT without either declaring his output VAT or remitting it to the state revenues.
The electronic system will make this swindle impossible due to the implementation of the principles of "prepayment": a seller first remits VAT to the state revenues and only after the remittance has actually been made the purchaser can enjoy its input VAT deduction.

The “prepayment” principle is implemented through the introduction of special VAT accounts and the imposition of a limit on the issuance of VAT invoices.

VAT accounts. VAT accounts are special bank accounts on which the amounts of VAT will be held. These bank accounts will be opened in a centralized manner by the State Fiscal Service of Ukraine (hereinafter - "SFSU") for each taxable person. The accounts will be opened automatically. Taxable persons will not have to carry out any formalities for having them opened. All VAT accounts will be opened at Clearing Сenter for Servicing Contracts in the Financial Markets, which has the status of a bank under Ukrainian law.

Funds into VAT accounts will be deposited by only taxable persons to whom such accounts belong. The transfer of funds to these accounts by the counterparties of taxable persons (purchasers of goods/services) will not occur.
The system will work in such a way that the amounts accumulated on VAT accounts are usually equal to the amounts of VAT remittable to the state revenues. Such amounts will be withdrawn by the SFSU itself according to the relevant registers to be submitted to the bank. Moreover, it is envisaged that in the event of VAT deregistration, all the funds held on the VAT account of a deregistered taxable person will be transferred to the state revenuers.

Limit on the issuance of VAT invoices. There will a limit on the issuance of VAT invoices that are not guaranteed by the remitted VAT. There will be a special formula to determine the maximum amount for which a taxable person is eligible to issue a VAT invoice.

The formula is as follows:

Σ VATInv = Σ RecVATinv + Σ Cust + Σ Dep - IssVATinv - Σ Ref -Σ Surp, where:

RecVATinv input VAT under VAT invoices received from suppliers;

Σ Cust –input VAT equal to the amount of VAT remitted to the customs authorities on the importation;

Σ Dep - amount deposited into a VAT account;

Σ IssVATinv – output VAT under VAT invoices issued;

Σ Ref – amount of VAT claimed as VAT refund;

Σ Surp -surplus of the output VAT indicated in VAT returns of a taxable person over the output VAT specified in the VAT invoices issued by him.

The surveillance of the amount for which it will be possible to issue a VAT invoice will be carried out automatically by the system of electronic administration on its own. For the purposes of this surveillance, there will be the cancelation of the printed paper format of VAT invoices and the introduction of all-embracing compulsory registration of VAT invoices in the Unified Register of VAT Invoices (hereinafter - "URVI "). The registration in the URVI will be done, regardless of the amount of VAT concerned. A right to an input VAT deduction will be conferred only by those VAT invoices that have been registered in the URVI.

The aforesaid formula will apply at the stage of the registration of VAT invoices in the URVI to determine whether a VAT invoice is within the specified limit. If the VAT invoice does not fit in with the limit, its registration will be denied. Before registering such a VAT invoice in the URVI, the taxable person should deposit a respective amount of funds into his VAT-account, thereby increasing the above limit to the sufficient level.

Example. As one can see, the new administration system is quite complicated. For a better understanding of how it works, it is worth considering a simple example.

Company A registered as a VAT taxable person on 15 January 2015. On 20 January 2015 it purchased from Company B (VAT taxable person) stationery for UAH 120,000, including UAH 20,000 of VAT. In addition, on 22 January 2015 Company A imported stationery valued at UAU 150,000 and remitted UAH 30,000 of VAT to the customs authorities. On 24 January 2015 Company A supplied all the foregoing stationery to Company C (VAT taxable person) for UAH 420,000, including UAH 70,000 of VAT.


1. Should Company C transfer the VAT included in the price of the goods supplied, to the VAT-account of Company A?

2. Does Company A need to deposit some funds into its VAT-account with a view to issue Company C with a respective VAT invoice? If so, what amount it should be?

Answer to the first question. Company C transfers all the funds in return for the purchased goods to the current account of Company A. No funds should be transferred by Company C to the VAT-account of Company A. If needed for the purposes of issuing a VAT invoice to Company C, it is Company A that must deposit funds into its VAT-account out of the funds received from Company C.

Answer to the second question. To determine whether Company A needs to deposit additional funds to its VAT-account for the issuance of a VAT invoice to Company C, the formula given above must be conferred with.

Given that in the case under consideration Company A is a newly registered taxable person, the two following parameters will be decisive in the application of the formula:

- RecVATinv input VAT under VAT invoices received from suppliers and

- Σ Cust VAT remitted to the customs authorities on the importation.

By way of adding RecVATinv, the amount of which is UAH 20,000 (purchasing the stationery from Company B), and Σ Cust, the amount of which is UAH 30,000 (the import of the stationery), together, and subtracting Σ IssVATinv, Σ Ref and Σ Surp equaling collectively to zero, we arrive at UAH 50,000.

Thus, one can conclude that Company A’s limit for the issuance of VAT invoices is UAH 50,000. In order to issue to Company C a VAT invoice for the amount of UAH 70,000 of VAT, Company A should deposit an extra UAH 20,000 into its VAT account. 
To what should business be prepared?

Adverse impact on cash flow. With the introduction of the new system of administration, there will be a need for additional liquidity. Under the new system, VAT must be remitted to the state revenues much earlier than it is today.

Currently, the overwhelming majority of taxable persons remit VAT within 30 days after the end of the taxable period (20 days for filing a VAT return, plus 10 days for remitting the tax the state revenues). Under the new system, a taxable person will part with the money much earlier. In the course of a taxable transaction a seller will need to deposit funds into his VAT-account so as to enable the issuance of a VAT invoice to the purchaser. After the transfer of funds to a VAT-account, a taxable person loses the possibility of disposing of such funds. Therefore, the time at which the money is being transferred to a VAT-account can be put on the same footing as the remittance of VAT to the state revenues.

Depending on the time of the implementation of a taxable transaction, the remittance of VAT to the state revenues can occur about 30-60 days earlier. For instance, if a taxable transaction takes place at the beginning of a monthly taxable period, the VAT should be remitted about 60 days earlier. If it takes place at the end of the taxable period, the remittance should be made about 30 days earlier.

Supplies/purchases planning. In view of the new administration system, taxable persons should take a more careful approach to the planning of theirs supplies/purchases to prevent the excessive "freezing" of their working capital on the VAT accounts.

Under the present system of administration the sequence of supplies/purchases made within the same taxable period has no special significance for the determination of the VAT bill. The VAT payable to the state revenues is calculated at the end of the taxable period as a difference between output VAT and input VAT. If this difference is positive, a taxable person remits it to the state revenues. If it is negative, a taxable person can claim it as a VAT refund payable from the state revenues.

Under the new system the sequence of supplies/purchases comes to the fore. An amount which a taxable person should deposit into his VAT-account will be determined at the stage of implementation of a taxable transaction, rather than at the end of the taxable period.

It will be in the interests of taxable persons to organize their work in such a way that the purchases precede the supplies, and not vice versa. Due to such purchases a taxable person will be able to accumulate the input VAT which can be taken into account in the increase in the amount for which it is possible to issue VAT invoices without depositing extra money into the VAT-accounts. Thus, the taxable person will be able to save part of the cash that would have been transferred to the VAT-account had the supply preceded the purchase. 
Potential problem for retailers. Para 201-1.4 (“в) of the Tax Code of Ukraine poses a potential problem for retailers and other businesses that sell most of their products/services to customers for cash. This paragraph provides that VAT collected from customers when selling goods/services for cash goes to a VAT-account. 
It is not clear enough from the paragraph at issue whether the transfer of the collected VAT to the VAT-account is a right or an obligation of a taxable person. If the SFSU clings to the position that it is an obligation, retailers and other similar businesses can get in a very difficult situation. The transfer of all the VAT received from the customers to VAT-accounts will mean that those accounts will be in a state of permanent "overpayment" (amounts accumulated on the VAT-accounts will be much greater than those calculated in accordance with the above formula). Given the necessity of complying with a number of formalities for getting the overpaid tax back, the existence of such "overpayments" can be quite a blow to the liquidity of the taxable persons concerned.

It is hoped that DFSU will take a weighted approach to this issue.

In Lieu of Conclusion

The electronic administration system is primarily designed to combat the currently wide-spread illegal business of sham companies concerned with the conversion of black cash. Hopefully, it will succeed in its mission and the above illegal business will quickly shift from a state of prosperity to a deep recession or even sink into oblivion.

In spite of its progressive nature, the electronic system of administration is not deprived of certain drawbacks as compared with the classical system. The new system is more complicated to understand and use. Furthermore, it creates additional pressure on the cash flow of taxable persons. Businesses will need to seek additional financial resources for the implementation of the new system. It is not excluded that such a quest for additional financial resources will lead to a general rise in the prices of goods/services in Ukraine.

* - Photo from www.wikipedia.org