Friday, November 6, 2015

Ukrainian Tax Reform: Battle of Two Influential Ladies

Only the laziest do not speak or write nowadays about a forthcoming tax reform in Ukraine.

The Ukrainian tax system does not work very well. It surely needs a major overhaul. The faster it happens, the better it is for all of us.

So, what will the tax reform bring us and when is it likely to happen?

These are not easy questions to answer.

Regrettably, there is no single vision of the tax reform so far.

What we have now is two distinct concepts of the tax reform developed by different teams of experts

The first concept has been developed by the Ministry of Finance under the leadership of Ms. Natalie Jaresko, the Minister of Finance. This concept can be viewed as a more authoritative option as compared to the alternatives. In the spring of 2015 the National Reform Council (headed by the President of Ukraine) gave Mrs. Jaresko a mandate to prepare the concept of the tax reform.

An alternative concept has been developed by the Tax and Customs Policy Committee of the Parliament of Ukraine under the leadership of Mrs. Nina Yuzhanina, the chairperson of the Committee.

The above concepts are not reconciled with each other and somewhere offer different solutions to the same tax problems. Ms. Jaresko’s concept is more moderate and looks much more realistic in terms of its potential adoption. Mrs. Yuzhanina’s concept is purely «revolutionary» one an thus is not very likely to be implemented, at least in my point of view.

What follows is a brief description of the key provisions of the both concepts:

Tax issue
Jaresko concept
Yuzhanina concept
Corporate tax
The rate increases from 18% to 20%
The rate decreases from 18% to 15%

Corporate tax transforms into dividend distribution tax
The basic 20% rate remains in place, the reduced 7% rate for pharmaceuticals is to be abolished
The basic 20% rate decreases to 15%
Payroll taxes
Introduction of 20% flat income tax

Unified social security contribution rate decreases to 20%

Abolishment of unified social security contribution altogether from 2018 on (wages/salaries will be liable to 20% income tax only)
Decreasing income tax to 10%

Unified social security contribution rate decreases to 20%

Simplified tax system for small businesses

The scope of the simplified tax system narrows to apply only to individuals (no more to legal entities), whose yearly revenues do not exceed UAH 2 mln. (approx. USD 100 thousand)

Full abolition of the simplified tax system from 2018 on

The above table shows that, although different in their solutions, both of the concepts recognize and try to tackle the same pain points inherent in the Ukrainian tax system.

For example, both concepts are trying to address the issue of widespread payroll tax evasion. Many Ukrainian employers just do not bother to pay official salaries. They “save on” payroll taxes by paying salaries under the table.

In response to this challenge, both concepts offer reducing payroll tax burden to motivate employers to pay official salaries to their employees.

Additionally, both concepts identify the unfairness in taxation caused by the mushroomed simplified tax system that at present goes far beyond the taxation of truly small businesses. They put forward some solutions directed at greater equity in this area.

When it comes to mathematics, both concepts are not immune from serious flaws. Both approaches lower government revenues to a material extent. Some experts believe that. Jaresko’s reform could result in about UAH 60 billion (approx. USD 3 billion) loss in revenue, and  Yuzhanina’s reform could total some UAH 150-200 billion (approx. USD 7-10 billion) in decreased revenue. Against the background of the UAH 603 billion (approx. USD 30 billion) total government budget for 2015, the predicted losses are more than significant.

It comes as no surprise that the IMF, with which the Ukrainian government is closely cooperating now, is not pleased with either of the concepts. The IMF suggests that serious consideration be given either to finding replacement revenue for lower tax receipts or cutting government spending accordingly.

Ms. Jaresko and Mrs. Yuzhanina do not surrender to each other and try to do their best to incorporate exactly their versions of the tax reform into the tax legislation. Many observers hope that they will find enough wisdom to turn from opponents to allies and will negotiate a compromise package to the advantage of our country.