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.