To do business today in Ukraine is to come into contact with the shadow economy.
Be it in the form of an employee asking to be paid in cash, a bureaucrat soliciting a bribe to issue a document or a partner looking for an off-the-books offshore payment, gray schemes abound.
Operating in an entirely legal manner is possible, but requires a strong ethical stance.
“It is by no means impossible to do business in Ukraine in a true and fair way,” Volodymyr Chyzhikov, a senior manager at consultancy KPMG, told the Kyiv Post. “But you need to be ready to say no when officials or business partners ask you to do things that you don’t want to do.”
The majority of Chyzhikov’s clients are multinationals who have strict policies never to pay bribes or engage in any other unofficial practices. They operate solely in the “white” economy, paying employees’ salaries — as well as taxes and social payments — through all the proper channels.
“Almost every day we hear from the executives of international business here in Ukraine that they don’t pay any bribes at all, as a matter of principle. They are even ready to close down their business here instead of paying,” he said.
The consultant says he never has — and never will — propose that a company pay a bribe. He admits, however, that some have done so, against his advice.
In the black
Exactly how much economic activity in Ukraine takes places in the shadows is hotly debated. Depending on how it is calculated, current estimates put the figure at anything from 35 to 50 percent of gross domestic product — among the highest rates in Europe.
“The most widespread types of shadow activity in Ukraine are tax avoidance though undeclared income, unregistered sales of legitimate goods, and paying salaries in envelopes,” according to Vasyl Povorozny, of the International Centre for Policy Studies.
Some transactions remain entirely outside official calculations. One source of such activity is what is traditionally termed “the black economy.” This includes criminal enterprises such as the illegal sale of drugs and weapons, for which there are no reliable statistics.
Further such illicit flows of income come in the form of money moved offshore, including through schemes such as transfer pricing, which occurs when divisions of a company conduct transactions with each other, usually across borders.
According to think tank Global Financial Integrity, as of 2014 some $117 billion originating in Ukraine had accumulated in offshore accounts. The Tax Justice Network has put that figure at $167 billion.
Sergey Korablyn, an economics professor at Ukraine’s National Academy of Sciences, has stated that Ukraine loses an estimated $11 billion to $12 billion per year because of money being moved to offshore accounts.
Under the table
The Minister for Social Policy Andriy Reva, meanwhile, has said that one-fourth of Ukrainian workers are wholly or partially hired on an unofficial basis.
The former head of the State Fiscal Service Roman Nasirov, who is himself implicated in a high-level corruption scheme, has estimated that of the 20 million people employed in Ukraine, just over half pay tax and make social payments.
According to his calculations, 30 to 40 percent of those who do pay tax declare that they earn the minimum wage — Hr 1,600 ($60) per month in 2016 — with the rest of their salaries almost certainly paid to them in cash under the table.
Experts say because so much activity in the informal sector also contains some legal elements, it is impossible to separate out the shadow economy and then add it to official data to arrive at a figure for the “real” size of the Ukrainian economy.
“It’s quite difficult to distinguish, because if you receive the minimum wage or a little more than minimum, that is done so as not to attract the attention of the tax authorities,” said Povorozny.
“So you are both in the shadow economy and outside of it.”
To overcome this problem, gross domestic product — $90.94 billion in Ukraine in 2015, according to the World Bank — is calculated in such a way that, at least in theory, it captures all possible channels through which value in the economy is created, including shadow channels.
This metal room located at the headquarters of Ukraine’s Tax Service was built on the watch of former Minister for Revenues and Duties Oleksandr Klymenko. It’s purpose – or how it was financed – is unclear. Entrepreneurs say such a lack of transparency over how public money is spent is one of the main reasons they seek to avoid paying tax. (Pavlo Podufalov)
Cash economy
For many small and medium-sized businesses, hiding money offshore is a grander scheme than they require. Their shadow activities tend to take place at a smaller scale.
One Kyiv-based entrepreneur, who spoke on condition of anonymity, said at her start-up she routinely gives salaries to her staff in cash in order to avoid paying taxes, just like “99 percent” of businesses in Ukraine.
Officially, she is the only one employed at her company, with others completely off the books and some working as “private entrepreneurs” which means the tax on their wages is just five percent. She told the Kyiv Post her employees do not object to being paid unofficially and that the risks to her are low.
“I’m happy that our fiscal service at the moment isn’t concentrating on small businesses,” said the source. “The amount of money which goes through my company is not big, so it’s not interesting for them.”
But working according to such gray schemes does present dangers, the biggest one being that business owners who use them leave themselves open to being blackmailed or having to pay bribes.
“The fiscal service can use it against me, that’s a risk,” said the source. “I wouldn’t know what to do if they came knocking on my door. I’d like to be more transparent in future and hire people officially, but it’s really a lot of money.”
Bureaucratic nightmare
Observers say much of the problem of undeclared economic activity lies in the many layers of bureaucracy that accompany transactions involving the state. A hangover from the Soviet era, the problem is two-fold: not only does it give officials ample opportunity to ask for side payments so that bureaucratic hurdles can be sidestepped, it also encourages businesses to simply avoid dealing with the state altogether.
KPMG consultant Chyzhikov puts it simply: “Bureaucracy leads to corruption.” He said that since many big and mid-sized enterprises were founded in the early 1990s, when lawlessness was at its peak following the collapse of the Soviet Union, a mentality of operating beyond the reach of government has become ingrained in Ukrainian business culture.
Seeing the light
Efforts to break this habit are today being made by Ukraine’s Business Ombudsman Council, which recently created a network to bring together companies who want to work transparently.
Ombudsman Algiras Semeta said that it is crucial entrepreneurs understand that by staying in the gray economy, they become part of the problem.
“Those who act in the shadows are much more prone to corrupt behavior, because they are always in a position of risk,” he told the Kyiv Post. “They’re creating opportunities for the demanding side to easily get a bribe or another corrupt payment.”
According to Semeta, shrinking the shadow economy would also have the added benefit of stimulating competition, which could in turn attract foreign investment. For now, those who conduct their business according to the letter of the law are at a disadvantage.
“Foreign businesses who want to come here see that there is a high degree of shadow economy in the sectors where they intend to enter,” he said.
“That creates a completely uncompetitive environment for them.
“Usually, Western investors are bound to compliance and business integrity rules. That puts them in an unequal situation with those who act in the shadows.”
Getting things clear
Although Semeta and his team concentrate their efforts on persuading business to quit the shadow economy, they are well aware that government has just as much, if not more, of a role to play. The Ombudsman said that more transparency and accountability from the state in its administration of the public finances is essential to solving the problem.
As an example of how things should be done, he points to Scandinavian countries, where public services are highly valued and taxes willingly paid.
“They have high tax rates but the culture of paying taxes is extremely good,” said Semeta. “That happens because every euro or dollar spent in those countries is accounted for. People know where and how the state spends their money.”
In Ukraine, by contrast, the issue is a lack of trust. Employers and employees say that they don’t know what happens to the taxes they pay and often suspect they end up misspent.
“People have seen the results of the asset declarations (made by public officials in 2016) and the millions of dollars in cash that some MPs and ministers have,” said Povorozny of the International Centre for Policy Studies. “They think, and partially it’s true, that the source of this wealth is tax money.”
Alexandra Azarkhina, an entrepreneur who runs her own public relations firm, echoes those sentiments. “You pay taxes and you don’t feel like you did a good thing,” she told the Kyiv Post. “Normally, I’d pay proudly, but in the end I wonder — where did that money go?”
Mutual understanding
For now, Ukraine is stuck in a vicious circle: low-quality public services discourage people from paying taxes, meanwhile government complains it does not have enough money. Breaking that cycle, and creating a culture of paying taxes, will take more than just time. It also requires business to start seeing the state as something more than just a problem to be avoided.
“It’s a matter of trust,” said Povorozny. “If you don’t trust official institutions, you invent informal ones.”
Kyiv Post staff writer Denys Krasnikov contributed to this article.
