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Taxation in Ukraine: Major Developments In 2010
It has become a tradition in Ukraine when approval of the annual state budget law is followed by amendments to Ukrainian tax laws.
This process usually takes place in late December each year. This year, however, the state budgeting process was completed only in April in the wake of presidential elections, formation of the new parliamentary coalition and appointment of the new government. The Ukrainian parliament adopted the 2010 state budget law on 27 April 2010. The law amending certain aspects of dividends taxation was adopted on the same day. A follow-up law amending the major Ukrainian tax laws (the “Amendment Law”) was adopted on 20 May 2010. As of 28 May 2010, the Amendment Law has not been signed into law by the President of Ukraine and, accordingly, its final text has not been made publicly available. Below we provide our comments, inter alia, on certain major changes expected to be introduced by the Amendment Law should it become effective. Our comments are based on the most recent publicly available text of the draft Amendment Law which may differ from its final text.
The recent tax amendments are mainly targeted by the government to collect more taxes and combat tax evasion techniques.
A. Corporate profits tax ("CPT")
The standard CPT rate is 25%. CPT liabilities are self-assessed by taxpayers. CPT is payable on a quarterly basis. The taxable profit is determined based on adjusted gross income reduced by tax deductible costs and tax depreciation. For CPT purposes, adjusted gross income means gross income (ie. a company’s world-wide income) received (accrued) during the reporting period either in cash, in kind or in an intangible form. Gross income includes total income from the sale of goods (work, services), fixed assets and receipt of gratuitous transfers.
Ukrainian tax law generally allows reasonable business expenses to be tax deductible, although there are certain expenses explicitly disallowed or restricted by the law.
Tax losses Ukrainian CPT payers should account for tax losses on a cumulative basis (ie. subject to certain exceptions, irrespective of the type of activity which results in losses). Under applicable law, the accumulated tax losses may be carried forward indefinitely. The Amendment Law is expected to change that rule and limit the carry forward of tax losses accumulated as of 1 January 2010. If the Amendment Law takes effect, companies will be able to utilize only 20% of such losses in 2010.
According to the Ukrainian government, the aggregate tax losses accumulated by Ukrainian companies amounted to UAH1 75 billion (approximately US$9.5 billion) as of 1 January 2010. Ukrainian officials claim that UAH 10 billion (approximately US$1.3 billion) of this figure was illegally declared by taxpayers as a result of tax evasion schemes. Interestingly, the aggregate tax losses accumulated by Ukrainian banks owing solely to favourable tax legislation (ie. full tax deductibility of the insurance reserves and application of the "cash method" in assessment of tax liabilities) amount to UAH 25 billion (approximately US$3.2 billion).
Taxation of dividends
The tax laws require that a taxpayer makes 25% CPT prepayment in respect of the dividends being distributed by such taxpayer. The 25% CPT is payable in addition to dividends and is not withheld from the amount of dividends. The so-paid CPT may be further offset against taxpayer's subsequent CPT liabilities.
Pursuant to the previous version of the CPT law, the Ukrainian holding companies receiving more than 90% of their income as dividends from their Ukrainian subsidiaries were eligible for exemption from the above-referred CPT prepayment.
The lawmakers extended the above exemption. Now all amounts of dividends distributed by Ukrainian companies within the amounts of dividends received by these companies from their subsidiaries are exempted from CPT prepayment. Also, the new law exempts from 25% CPT the dividends received by Ukrainian companies from their non-resident subsidiaries (except for non-resident subsidiaries registered in the blacklisted jurisdictions). Previously, such dividends were subject to CPT. For the purposes of the above exemptions, a Ukrainian company should be deemed to have a "subsidiary" if it owns at least a 20% stake in the charter capital of such legal entity.
The state budget law has amended Ukrainian corporate laws to provide for mandatory payment of dividends by Ukrainian joint stock companies to their shareholders in 2010. These companies should pay dividends in the amount of 30% of their respective net profit for the reported financial year and/or undistributed profit.
The fiscal aspect of the said amendments is that, as a general rule, payment of dividends requires 25% CPT prepayment from the amount of dividends.
However, the relevant corporate laws were amended in a way that creates room for discussion as to whether the mandatory dividends requirement applies to all types of Ukrainian joint stock companies (ie. public and private joint stock companies existing under the new Ukrainian Joint Stock Companies Law ("JSC Law"), as well as open and
closed joint stock companies which for the time being continue to exist under the "old" companies law pursuant to an official clarification of the Ukrainian Securities Commission).
The 2010 state budget law amended both the JSC law and the "old" companies law. Pursuant to these amendments, the old law was subject to minor changes, while the actual 30% mandatory dividends requirement was included in the JSC law. Therefore, an argument can be made that open and closed joint stock companies, which continue
to be governed by the "old" companies law, are not required to pay 30% mandatory dividends.
Limitation on deductibility of reserves
Under CPT law, banks and certain types of non-banking financial institutions are entitled to tax deductibility of the so-called insurance reserves, ie. reserves formed by these institutions in respect of possible losses from loan transactions. The insurance reserves are formed by the banks and some other financial institutions pursuant
to methodology and criteria set down by the National Bank of Ukraine and other Ukrainian authorities. The current version of the CPT law entitles the banks to 100% tax deduction of their insurance reserves. Other eligible financial institutions are permitted to make tax deduction in the amount of 80% of their insurance reserves. Pursuant to the Amendment Law, a bank will be permitted to declare tax deductible insurance reserve in the amount of up to 40% of its total lendings for the period until 1 January 2011, up to 30% until 1 January 2012 and up to 20% from then on. A similar threshold of up to 10% will apply to non-banking financial institutions.
The apparent reason behind such a dramatic shift are multibillion tax deductions previously declared by Ukrainian banks as a result of huge amounts of insurance reserves formed during the peak of financial crisis in respect of bad and risky debts. So, disregarding the amounts of insurance reserves to be formed by the banks in 2010, their tax
deductibility will likely remain substantially limited.
Taxation of banks' income
The Amendment Law is also expected to affect Ukrainian banks by requiring them to declare taxable income upon accrual of loan transactions income (eg. interest payments), rather than upon actual receipt of such income. However, the banks should still be entitled to declare taxable income upon actual receipt of their loan transactions income which was accrued starting from 1 January 2009 and was not received until 1 January 2010.
B. Value added tax ("VAT")
VAT is levied at the rate of 20% on the supply of goods and services in the territory of Ukraine, and on the import of goods and services to Ukraine. VAT payable to the state budget is determined as the difference between VAT collected from customers (output VAT) and VAT paid to suppliers (input VAT).
All supply of goods and services in Ukraine, as well as import of goods and services is within the scope of VAT (subject to specific exemptions).
The VAT law distinguishes between the following major types of transactions which are:
• subject to 20% VAT. This applies to all goods and services apart from the exceptions listed below;
• subject to 0% VAT. Such transactions primarily include sales of goods outside Ukraine (export of goods);
• non-VAT-able transactions, such as insurance and reinsurance, social and pension insurance, most banking services, etc.; and
• VAT-exempt transactions: certain educational and healthcare services, etc.
According to official statistics, the aggregate state debt to Ukrainian businesses in respect of VAT refund was UAH 21.8 billion (approximately US$2.8 billion) as of 1 January 2010. The 2010 state budget law has finally offered a solution to the VAT refund problem by introducing VAT reimbursement mechanism with domestic government bonds.
This mechanism was introduced as an extra option for taxpayers.
The Ukrainian government applied securitization of VAT refund indebtedness back in 2004, and that experience is generally regarded as quite successful. As a practical matter, at that time taxpayers were able to sell the bonds at a 20-30% discount, thus receiving the VAT refund immediately. This year the VAT bonds are also expected to attract many investors, primarily financial institutions and foreign companies.
The 2010 VAT bonds issuance is planned to follow the 2004 scenario. As in 2004, the bonds should be issued in a book-entry form and will have a five year maturity. It is planned that the bonds will be redeemable in five equal annual instalments each comprising 20% of par value. The VAT bonds are expected to bear 5.5% annual interest. The aggregate amount of the bonds to be issued is yet to be determined, and it is expected not to exceed UAH 20 billion (approximately US$2.5 billion).
The government has recently announced its plan to set a ceiling on discounts at which VAT bonds may be traded.
VAT recovery limit
VAT law imposes certain restrictions on VAT cash refund. In particular, the amount of taxpayer's input VAT that is not offset by its VAT liabilities in a tax period (a month) should increase the amount of input VAT in the subsequent tax period. The so-called "transferred" input VAT may be declared for VAT cash refund provided that it is not offset by VAT liabilities in this subsequent tax period.
To make a taxpayer eligible for VAT cash refund, inter alia, such taxpayer's VAT-able transactions for the 12-month period preceding submission of the claim for cash refund must not be less than the amount of such claim. Otherwise, the amount of the so-accumulated input VAT (the "Accumulated Credit") should be transferred to the next tax period.
As regards the latter, the Amendment Law is expected to impose a temporary prohibition from declaring the accumulated Credit (which does not entitle to cash refund) as input VAT of the next tax period.
This prohibition should remain in force till 2011.
The government explains that the above measure is needed in order to audit the amounts of Accumulated Credit accrued by Ukrainian taxpayers and remove the tax effect of the illegal Accumulated Credit.
C. Excise taxes
Currently, Ukraine imposes excise taxes on the following groups of goods:
• alcohol and alcoholic beverages, including wines and beer;
• tobacco and tobacco products;
• motor vehicles and vehicle body frames, bicycles and motorcycles;
• motor fuels and other oil products.
The rates of excise tax are divided by the method of their calculation into ad valorem, specific, combined and mixed rates. Ad valorem rates are based on goods turnover and are set as a percentage thereof. Specific rates are determined as fixed payments for a unit of commodity. Combined rates simultaneously provide for percentage of turnover and fixed payments. Mixed rate is also a combination of ad valorem and specific rate, where tax is levied under ad valorem rate, but not less than the specific rate set for the respective goods. The Amendment Law is expected to increase tax rates for most excise goods. These changes are a part of the government's action to cover state budget deficit. They are also intended to increase the share of excise in prices, which, according to the government, is generally lower than in other European countries (eg. 11% in prices of fuels, as compared to 43% in Lithuania and 54% in Poland; 32% in prices of cigarettes, as compared to 60% in Lithuania and 68% in Poland; 34% in prices of vodka, as compared to 42% in Lithuania and Poland).
Pursuant to the Amendment Law, the expected increase in excise rates for most alcohol products varies from 15% to more than 140%. For example, the tax rate for fortified and strong wines will increase from UAH 0.50 to UAH 2.00 (approximately US$0.25) per litre. Following entry into effect of the Amendment Law, the brewing industry will find itself under even greater impact of tax rates increase, where the effect of increase of excise rates for beer from UAH 0.31 to UAH 0.74 (approx. US$0.09) per litre will be combined with increase of duties on water supply.
The Amendment Law will also influence excise rates for fuels and oil products. In particular, the excise on motor spirits with octane number (RON) of 92, 95 and 98 will be charged at €132 per ton instead of the current €110 per ton. The excise on light distillers and other special fuels, which is now charged at EUR 20 per ton, will be raised to €132 per ton.
The Amendment Law is also expected to change tobacco products taxation. Ad valorem for cigarettes with filters will be increased by 5%, and specific rates will grow from UAH 69 to UAH 90 (approx. US$11.36) per 1,000 cigarettes. The change should increase the share of excise in the price of cigarettes to 37%.
D. Other taxes
Pension fund charge
An important development is that the 2010 state budget law will cancel 0.5% pension fund charge applicable to foreign currency sale and purchase transactions. This charge will not apply starting from 1 July 2010.
The use of deposits of natural resources is subject to exploration tax provided such deposits were previously explored at the state budget expense. This tax is charged based on the volume of extracted resources and, generally, is deductible for CPT purposes. The tax rates established by the government are multiplied by the coefficient stipulated by the law since 2008. The 2010 budget law increased this coefficient from 2.17 to 3.19.
The Amendment Law is expected to increase the tariffs for water used in production of beverages. Such tariffs will be increased from UAH 3 to UAH 21.60 (approx. US$2.73) per 1 mі for surface water and from UAH 3.5 to UAH 25.20 (approx. US$3.18) per 1 mі for underground water.