Ukraine’s so-called simplified tax system first appeared in the late 1990s as a temporary remedy for small businesses struggling under byzantine tax rules.
Since then,
however, it has repeatedly expanded in scope, allowing even large businesses to
use the breaks to dramatically reduce their taxes and social payments. And far
from being temporary relief, it appears to be here to stay – to the detriment
of a coherent tax system, critics say, if not also to the amount of tax revenue
that government collects.
The legal scheme
involves employers signing contracts for services with private entrepreneurs or
“SPD,” as users of the simplified tax system are known, instead of registering
them officially as staff employees and paying in the general tax system.
Employers are happy with the rules because they get to avoid paying social
payroll taxes, which can go from 36.76 to 50 percent of the salaries of official
employees. By contrast, private entrepreneurs’ social taxes are fixed at
slightly less than Hr 400 per month ($50).
This simplified
system also enables companies to shift part of their revenue to private
entities, taxed at 5 to 10 percent, avoiding 15-17 percent personal tax, or in case of a bigger company 21 percent corporate income tax.
The State
Tax Service estimates that 1.2 million Ukrainians are registered as private
entrepreneurs. It may not seem like much in a national employed workforce of 20 million.
But the private entrepreneur system is now so popular and widespread that the government
is finding the benefit hard to reduce or take way.
In fact,
when officials tried to restrict the categories of private entrepreneurs two
years ago, tax protests erupted. The intense public opposition forced politicians
to back down.
These
benefits come at a price for the nation.
While it
could be argued that government is losing out on tax revenue through the
private entrepreneur system, the truth is that many employers and employees
were simply evading the onerous official taxes altogether – depriving
government of any revenue.
Volodymyr
Kotenko, partner at Big Four auditor Ernst & Young’s Ukraine office, said
that the nation would be better off with a unified tax system and simple rules.
“Instead of
creating a kind of internal offshore and creating unnecessary competition
between the general and so-called simplified tax systems, it’s better to have
one system that is equally simple for all that would encourage [companies] not
to hide,” Kotenko said.
Until then,
Kotenko said, businesses can hardly be blamed for taking advantage of the
ambiguities in how an employee should be registered in each particular case.
“It is a loophole, but I think it exists for
objective reasons,” Kotentko said, referring to the private entrepreneur system.
“Life is complicated and it’s hard to predict all possible business and human
relations and put them into law.”
Sometimes,
however, businesses interpret the rules in ways that are not always legal, such
as when they register permanent office staff as private entrepreneurs.
Larger-scale
retail and service companies also favor this system. It’s not uncommon that a sizeable
retail outlet, restaurant or fitness center is owned by several entrepreneurs.
This allows them to spread the income among themselves and fall below the
limits set by tax legislation.
Since the
beginning of 2012, private entrepreneurs with profits of up to Hr 5 million
($675,000) a year and hiring up to 20 employees could use the simplified
system. In July, parliament voted to increase this limit to Hr 20 million.
The new
ceiling is a dramatic increase compared to the Hr 500,000 limit at the
introduction of simplified tax regime in 1995, while paying a fixed Hr 200 a
month in taxes.
Yaroslav Lomakin,
a founder of Moscow-based consulting firm Honest & Bright, says the logic
behind the increased limit is not yet clear, but it looks like an attempt to
improve the business climate.
“All
instruments can be used in a number of ways,” Lomakin said. “A knife can cut a
sausage as well as stab a neighbor.”
Besides
lower tax rates, the system is also advantageous because of its simplicity, in
contrast to Ukraine’s overall complicated tax system. According to World Bank’s
latest Doing Business report, Ukraine ranks 181 out of 183 countries surveyed
in terms of ease of paying taxes. The country is also a world leader in terms
of the number of payments – 135 – businesses are forced to make each year.
According
to experts, one of the sectors to benefit the most from the simplified tax
system is Ukraine’s information technology industry. Some IT companies use
hundreds of private entrepreneurs, with few people on their staff payrolls. The
benefits of such tax optimization are impressive, since IT outsourcing is one
of Ukraine’s most promising industries with annual exports reaching $1 billion
and salaries constituting the biggest expense.
“The IT
industry pays wages officially. They are simply paid using somewhat different
opportunities, as with private entrepreneurs,” said Taras Vervega, president
and managing director of SoftServe Europe, a Lviv-based software development
company.
Ernst &
Young’s Kotenko said the private entrepreneur scheme is used both for tax
evasion and simply muddling through. “It is another loophole, which can be
perceived both in a negative connotation or positive, as it gives businesses an
opportunity provided by legislation,” he said.
But the
policy of creating special conditions for one group of businesses leads to
abuse, Kotenko argued. He said Ukraine needs to bring business out of the shadows
by introducing simpler rules for all, something the nation’s first
comprehensive tax code, enacted in 2011, failed to do.
Kyiv
Post staff writer Maryna Irkliyenko can be reached at [email protected].
