Consulting, engineering, legal, accounting, audit and other similar services will be again subject to VAT. The relevant law on the amendments to the Tax Code of Ukraine was enacted by the Verkhovna Rada (Ukrainian parliament) on 19 May 2011.
As at the date of the publication of this post, the law has not been signed by the President of Ukraine yet.
The law comes into force on the first day of the month following the month in which it is published. So, if the law is signed by the President and published until 31 May 2011, such services will be VAT taxable since as early as 1 June 2011.
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).
My colleagues have prepared a new issue of the Legal Monitor devoted to tax issues. The emphasis is placed on regulatory novelties brought by the Tax Code of Ukraine. As for me, it is worth considering the article by Dmytro Savchuk “Long-Anticipated Harmonization” covering the harmonization of tax reporting and accounting, including the introduction of the accrual method instead of the “first event rule” for the purpose of corporate income taxation and the possible impact of these novelties on doing businessin Ukraine.
The rubric “Interesting Details” is also worth attention, where you can find the information about the special relations between the world famous people such as the Beetles Rock Band and painter Salvador Dali with tax authorities.
The issue is free to download in PDF format in English and Ukrainian.
There appeared a new database on the official website of the STA of Ukraine allowing taxpayers to check their contractors with regard to the latter’s good faith.
It is expected that the tax authorities will utilize this database in the disputes with taxpayers concerning the VAT refund. At present, there is the practice of the Highest Administrative Court of Ukraine, according to which a taxpayer may be deprived of the right to VAT refund if it acted without due diligence and caution and it should have known of the violations committed by its contractors. Based on this practice, the tax authorities may argue that the presence of the contractor in the above-given database is a sufficient ground to deny the taxpayer’s right to VAT refund.
The only time will show what position on this issue will be taken by Ukrainian courts.
There is a very interesting article by my colleagues from Profit-Consul Law Firm reflecting the history of the court practice in VAT refund cases. The article contains the analysis of the court practice for few last years as well as the forecast on how it is likely to evolve in view of the application of the Tax Code of Ukraine. The article is given in Ukrainian and Russian. Unfortunately, there is no English version.
