Hot Period for Taxpayers
The summer season has been marked by “hot” changes in taxation. The Ukrainian Parliament adopted an unprecedented number of changes, introduced mainly by the Act of Ukraine On Amending the Tax Code of Ukraine and Some Other Legislative Acts, No.1621-VII. On 31 July 2014 Ukrainian President Petro Poroshenko signed the Act that came into force at the beginning of August. The Act’s objective is to create conditions to increase proceeds to the state budget. Let us consider the impact of the most recent changes in taxation legislation on doing business in Ukraine in detail.
How would you evaluate the Act No.1621-VII?
The amendments envisaged by the Act of Ukraine On Amending the Tax Code of Ukraine and some Other Legislative Acts (on improvement of certain provisions) generally are intended to raise additional funds to the budget. Hence, it was expected that the tax burden will not be reduced.
But, at the same time the Act has introduced some positive changes to the taxes management, which will be applicable to operations after 31 December 2014. Also, new provisions of the Tax Code provides for significantly simplified VAT budgetary refund procedure, specifically:
— cancelation of tax audits of the budgetary refunds calculations;
— added new criteria for receipt of automatic budgetary refunds. The right to claim for refund is granted for those who invested in fixed assets more than UAH 3 million during last 12 months;
— the right for VAT refund can be claimed on the base of VAT return of the reporting period, that is, a taxpayer may claim for refund in the same reporting period when excess of incoming VAT arises.
Also the Act extends temporary VAT exemption for export of grain and industrial crops until 31 December 2014.
The Act changed the rates for the use of mineral resources. How could it affect businesses in this area? What is your opinion regarding lifting special rates for production sharing agreements?
Changing the payment rate for subsoil use is supposed to have a negative feedback from the executives of those companies doing business in this field. The government’s intent to fill the budget is understandable, but before increasing the payment rate deep work to estimate all consequences had to be performed.
Unfortunately, there is a constant opinion in society that all companies that deal with oil and gas recovery are super profitable, that’s why increasing the tax rate shall not influence on their operation dramatically. However, in practice many things depend on the profitability of recovery. There are only a few oil and gas deposits with sky-high profitability, and that’s why a considerable increasing of rate for gas may cause the bankruptcy of certain companies and a rise in petrol prices.
Speaking about the rates under the production sharing agreements, it will be impossible to increase them. A number of normative documents, including the Tax Code of Ukraine, stipulate the guarantees of the government for the parties of the production sharing agreements related to tax rates. In such cases the rates stipulated at the moment of concluding agreement shall be applied. Production sharing agreements stipulate the same provisions. If the Ukrainian government decides to increase the rates, it may not only cause litigations in the international arbitration institutions (probably, not in favor of Ukraine), but it may lead to failure to perform the agreements too.
Taking into account the current economic situation, refusal from considerable investments in Ukraine (that are stipulated by most of the agreements) and, moreover, refusal from receiving alternative sources of gas are unacceptable.
The Act abolished preferences under the corporate income tax for the electricity generating companies that generate electricity exclusively by renewable energy sources (before, they were exempt from the tax until 2021). How would this influence existing projects and development of the industry in Ukraine?
The Act has introduced several important changes into taxation of oil & gas, renewable energy related projects, including abolishment of privileged taxation of electric power generation companies producing electricity from renewable energy sources. Originally, the Tax Code of Ukraine provided for exemption from corporate profit tax for such companies till 2021.
This measure will negatively impact renewable energy projects in Ukraine. The tax burden imposed on renewable energy companies will now be an additional 18% of a company’s corporate profit and may influence repayment of loans by these companies.
Representatives of relevant organizations note that such decision will adversely affect Ukraine’s performance of its obligations under the Treaty establishing the Energy Community. Ukraine aims to bring the share of renewable energy production up to 11% by 2020; in view of the fact that the current presence of renewables in electricity market is only 2%, a five-fold increase within a comparatively short time frame might seem improbable.
It is worth noting that the repeal of tax exemption for renewable energy producers will seriously reduce the investment attractiveness of projects in renewable energy sector for both foreign and national investors. Thus, consequences of the amendment might have a negative effect on other renewable energy market participants.
The Act abolished tax preferences for hospitality business. How would this influence development of the hospitality business in Ukraine?
Speaking about the consequences of the abolition of tax exemptions for the hospitality business we must first understand what real benefits local hotels had due to the tax exemptions.
Benefits for the hospitality business were introduced in the process of preparation for Euro 2012 to encourage investors in the construction and modernization of hotels in Ukraine. The changes were introduced temporarily for 10 years with the effect of 1 January 2011 and the exemption from taxation extended to the profits received by companies from providing hospitality services in the hotels of “3 stars” — “5 stars” categories where such hotels were commissioned until 1 September 2012.
Later, a new criterion for preferential taxation was introduced — not less than 75% (later — 50%) of the total income for the tax period must be received from “hosting services by providing rooms for temporary residence”.
Thus, special consideration must be given to the logic used by the legislator in the definition of hotel services, income from provision whereof was to be exempt from taxation. As everyone knows, hospitality services consist of basic and additional services. However, in their repeated explanations the tax authorities made it clear that only the basic services fall under this criterion, while the lion’s share of revenue is received by hotels from provision of additional services.
An informed analysis of those barriers and criteria will lead any person to understand the reasons for the now existing situation — in fact, nobody has had any tax benefits in the hotel industry — only about 1% of hotels who managed to go through a long process of obtaining such preferences experienced reduction of the tax burden during a short period of time, but the question whether they were able to effectively use the “funds freed from tax” remains open.
In summary, we can say that the cancellation of actually inactive and inefficient market incentives will not change anything in the hospitality business.
What do you think about the changes made by the Act concerning the tax credit and VAT refund?
Our team has analyzed the new legislation on VAT administration in detail. We came to a conclusion that in general it makes it impossible to generate a fictitious (unpaid) tax credit. In order to get a VAT refund in the future, the tax should be paid to a special account in the form of tax liabilities by a supplier of goods (works, services). The idea is fairly good, but before the new legislation comes into effect (1 January 2015), taxpayers will need to accumulate funds on the account, because tax invoices can be issued and registered in the registry only after obtaining the relevant right. The right to issue tax invoices arises after funds are paid to the electronic VAT administration system or if there is sufficient VAT received under tax invoices issued by suppliers, who in their turn registered the invoices and paid the tax. The negative balance of the tax in previous periods as of 1 January 2015 wouldn’t enable taxpayers to issue tax invoices. Thus, we actually begin from a scratch. The issue is whether all taxpayers will be able to do that. There are 15 calendar days left for registration in the register of tax invoices, when taxpayers will need to find a way to get the right to issue tax invoices. And the negative balance as of beginning of 2015 will be accounted for separately. And one thing is clear: there will be no refund to the account. It does not add optimism to those taxpayers that were audited and expected refunds.
The Act put restrictions on tax preferences for collective investment entities. What do you think about this novelty concerning development of that market?
The announced earlier amendments to the Tax Code of Ukraine were intended to bring in line the taxation of investment funds in Ukraine with any other corporate entities, which could have ultimately defeated the purpose of an investment fund altogether. However, at the end of the day, the legislator took into account the opinion of market participants and the actual changes were rather limited. In particular, according to the new wording of the Tax Code, Ukrainian investment funds would not be able to treat any interest income as part of their investment income (i.e. income from transactions with investment assets, which is exempt from the corporate profit tax). We do not expect this limitation to have any material adverse effect on the investment funds market, as funds are still free to invest in all other types of assets and such profits would not be taxed at the fund’s level. Moreover, we already see where the balance of their fixed income investments could shift.
What would be the legal consequences of the changes in taxation of individuals (the Act of Ukraine On Changes to the Tax Code of Ukraine and Some other Acts of Ukraine on Passive Income, No.1588-VII of 4 July 2014 and the war tax, introduced by Act No.1621-VII)?
Historically, dividends were subject to a 5% PIT, royalties and investment income — to a 15/17% PIT, while interest was exempted from taxation. On 1 July, a progressive tax rate (of 15%, 20% and 25%) was introduced in respect of such passive income, depending on its amount. However, on 2 August, Act No.1588-VII returned a historical tax regime for dividends, royalties and investment income and introduced a 15% PIT for interest.
Basically, a major change contemplated by Act No.1588-VII involves introducing a 15% tax rate to apply to interest. From the practical standpoint, in comparison to a progressive rate, the new rules are more favorable for the owners of a significant interest income (since a rate of tax is to be the same irrespective of the amount of interest) and for the individuals receiving dividends, interest and investment income (as an attempt to introduce a progressive tax rate in respect of such income which is subject to a higher level of tax has failed).This change will also result in greater reporting obligations for tax agents (banks). Notably, banks are supposed to report only the amounts of interest and taxes without reporting a taxpayer’s details (in the meantime, the tax accrued in July is to be cancelled and is, thus, not payable).
On 3 August Act No.1621-VII has temporary (till 1 January 2015) introduced a 1.5% military tax on salary, other compensation, gains from lotteries and gambling activities. This tax is expected to result in a new tax burden for a wide range of individuals and in additional reporting and withholding efforts for tax agents (employers).
What are risks of abuse as custom duty and VAT are lifted for imports of individual means of protection and medicines for the purposes of the anti-terroristic operation/martial law?
According to the No.1560-VII and No.1561-VII Acts of Ukraine, temporary exemption from VAT and import duty is provided for certain “anti-terrorist” goods.
The introduced changes provide the possibility not only for individual volunteers but also for companies to import equipment and medical supplies necessary for saving lives of Ukrainian citizens.
However, broad exemptions create abuse risks for use of the “anti-terrorist” exemptions. For example, due to fact that the exemption should apply to registered medical supplies some importers try to apply an exemption to infant diapers, which exceeds the intent of the legislators who adopted the Acts.
Instead of applying and specifying the exemption to medical supplies that are urgently needed for saving lives during and after combat, there is a risk that the exemption could be abused to provide exemption to all medical supplies. Different importers and distributors may be inclined to use such exemptions to gain an advantage over competitors.
The Acts state that the limits and simplified procedure for import of medical supplies will be established by the Cabinet of Ministers of Ukraine, however, such limits and procedures are yet to be implemented.
Furthermore, the fact that state control over “dual-purpose goods” does not apply to the import of special individual protective clothing and equipment, it provides possibility to import such equipment not only by volunteers, who support the armed forces of Ukraine, but also by criminals and gangs (organized crime).