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.

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