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Corporate Tax - Ukraine
Since the Tax Code came into force on January 1 2011, a number of legislative proposals have sought to boost investment opportunities in industries as diverse as shipbuilding, aircraft construction, green energy and environmentally friendly technologies, light industry, hotel services and film-making. In general, the government's aim has been to stimulate the economy by providing benefits in respect of corporate profit tax, value added tax (VAT), land tax, import duties and other charges.
Although such incentives may appear to be good news for companies, in practice they are not always as advantageous as they appear. This update outlines the effect of fiscal incentives on Ukraine's strategic markets.
With the break-up of the Soviet Union, Ukraine inherited a vast shipbuilding industry: Ukraine's shipyards had produced 30% of the Soviet Union's ships and other vessels. However, shipbuilding companies lost much of their market share and most of their international contracts in the years following Ukrainian independence - a decline attributable to global macroeconomic factors as well as to the inconsistent fiscal policies that were applied to the industry over the next two decades. Several government attempts to remedy the industry's problems have proved ineffective. The most recent tax incentives are as follows.
Corporate profit tax
Like key players in other strategic Ukrainian industries, shipbuilders benefit from a 10-year corporate profit tax exemption. Since January 1 2011 builders of transport, passenger and military vessels, tankers and other industrial shipping have been able to use their non-taxable profits to increase their production capacity. Profits from the repair and refitting of vessels may also qualify for exemption on certain conditions.
VAT benefits apply to shipbuilders that import equipment and raw materials (including components) which cannot be obtained in Ukraine. The shipbuilder may defer VAT (which is normally paid on imports) until the period in which it delivers the new ship to the customer.
For VAT deferral purposes, the shipbuilder issues a promissory note for the benefit of the customs authorities. Under the note's terms of issue, no interest or other payment is required. However, if the imported equipment is not used for shipbuilding, VAT is payable in full, along with the relevant fine.
Shipbuilders benefit from a land tax exemption until January 1 2016.
Historically, tax legislation has provided various benefits for the shipbuilding industry, but these were rarely used in practice and most were subsequently suspended by the legislature. In practice, shipbuilders tend to use a tolling scheme, which has proved effective in the Ukrainian business environment. This allows a shipbuilder to postpone payment of import VAT on equipment and certain raw material imports if the vessel in question is built within 600 days. However, interviews with a number of market players suggest that the existing tax incentives (with the exception of the VAT scheme) are relatively beneficial. This makes the Ukrainian shipbuilding industry a more advantageous option for foreign investment and the execution of long-term international contracts.
The Ukrainian aviation sector has long enjoyed a strong market share in Africa, East Asia and the former Soviet states. Ukrainian aircraft have traditionally been competitive on price and of relatively sound quality. However, several factors have counted against the industry over the past decade, including the global economic downturn, strong EU and US competition and a decline in quality.
The Ukrainian aviation market has been largely monopolised by post-Soviet-era state enterprises, with only a few state-owned companies receiving government funding and winning public contracts. This has effectively blocked market penetration by small and medium-sized companies and by global competitors such as Boeing and Airbus.
Corporate profit tax
The corporate profit tax exemption applies to manufacturers of aircraft (including helicopters), satellites and spacecraft, as well as manufacturers of components. Research and development in the field of aircraft manufacturing is tax-exempt.
Some companies in the aviation sector enjoy a VAT exemption on imports of certain goods, including raw materials, until January 1 2016. However, such companies must apply for the relevant licences and certificates for aircraft and spare-part production, as well as special licences for repair and maintenance activities, in order to be eligible for VAT relief. In addition, companies must meet at least two of three conditions, which require them to:
• conduct development, production and repair of aviation equipment and aircraft engines;
• engage in public and defence contracts for the development, production and repair of aviation equipment and aircraft engines; or
• execute international contracts for the benefit of Ukraine's international commitments for the development, production and repair of aviation equipment and aircraft engines.
In view of these requirements, only a few Ukrainian manufacturers are eligible for the import exemption. The government keeps a record of aviation companies and monitors their compliance with these complicated rules. If a company fails to comply with the regulations, the government may remove it from the VAT exemption list.
This tax policy has had a positive effect, with key market players receiving multimillion-dollar public and international contracts. However, a thorough reform of the industry has not yet been undertaken. Ukraine's aviation companies are mostly state owned and intense global competition makes privatisation a priority. State governance has proved ineffective, with some state-controlled companies failing to meet their international contractual commitments. Modern corporate governance and management standards are urgently needed.
Against this background, tax incentives alone have not worked for the aviation sector, which requires a more comprehensive approach to drive strategic changes in the industry.
Energy efficiency and green energy
Alternative energy sources and energy efficiency are high on the agenda for the Ukrainian energy market. The government introduced the first energy efficiency incentives in 2008, granting tax privileges to companies involved in the development and use of energy-efficient technologies and alternative energy generation. More recently, similar tax benefits have been provided for green businesses.
Corporate profit tax
Companies engaged in the production of renewable energy equipment may enjoy certain benefits. If a company sells renewable energy equipment in Ukraine, only 20% of its taxable profits are subject to tax. A list of eligible equipment has been approved by the government.
Companies that use renewable energy equipment in their business may qualify for an exemption on up to 50% of their taxable profits. The exemption becomes effective in the
first profitable year following the implementation of energy-efficient technologies and is valid for the next five years.
Additionally, an exemption from corporate profit tax applies until January 1 2020 for:
• biofuel producers' profits from sales of biofuel;
• profits from electricity and heat generated using biofuels; and
• manufacturers' profits from sales of machinery and equipment produced in Ukraine for manufacturing and converting vehicles powered by biofuel.
Energy companies are exempt from corporate profit tax on the sale of electricity from renewable energy sources for 10 years from January 1 2011.
A general VAT exemption applies to imports of:
• renewable energy equipment;
• energy-efficient equipment;
• raw materials;
• devices for measuring, monitoring and exploiting energy resources; and
• equipment and materials for producing alternative fuels or generating energy from alternative sources.
This exemption, which runs until January 1 2019, does not apply if identical goods are produced in Ukraine.
Companies that explore land for renewable energy potential pay 25% of the standard land tax rate on the plots in question. The lease fee for land used in the generation of renewable energy may not exceed 3% of the normative land value.
The alternative energy industry is one of the few in Ukraine to have registered significant growth recently. Tax privileges have played a crucial part in this trend. Certain private companies have enjoyed significant government support in launching successful green energy projects in the Crimean peninsula. Ukraine intends to increase the percentage of alternative energy in its energy mix by 15% by 2030. This progressive policy and the existing tax regime provide numerous investment opportunities for greentech companies.
Incentives were introduced a few years ago to encourage the construction of new hotels in time for the 2012 UEFA European Football Championships, co-hosted by Ukraine and Poland.
Corporate profit tax
The Ukrainian hotel industry has been granted a 10-year tax exemption period, starting from January 1 2011. Profits derived exclusively from hotel services are exempt from corporate profit tax. In order to qualify, a company must meet certain criteria:
• The hotel must qualify for a three, four or five-star rating, as awarded by a special government commission;
• The hotel must meet a "75% rental income threshold" - that is, the hotel's activities should be primarily focused on room rental, rather than on other supplementary business activities; and
• Only hotels that have recently begun operations (ie, newly built, reconstructed or restored hotels) are eligible for relief.
In addition to these criteria, tax-exempt profits must be directed solely towards the growth of the hotel's business, the installation of new facilities or technologies, hotel services or loan interest payments.
Most of the hotels planned for the football championships are open for business, but work is still underway on some. In practice, companies that have tried to apply for hotel tax relief have faced significant difficulties, as the authorities have taken inconsistent and non-transparent approaches in providing such relief. Moreover, the authorities are under significant political pressure in light of the notorious trials against former prime minister Yulia Tymoshenko. These factors raise concerns about whether the payback period pertaining to hotel investments will fall within the intended 10-year period.
In the post-Soviet era, light industry has experienced a sharp drop in production, resulting in mass redundancies and serious employment issues. In order to foster growth, the government introduced a tax exemption for manufacturers of textiles, leather goods, clothing, footwear and similar products, to run for 10 years from January 1 2011. As under similar incentive schemes, profits must be used exclusively for business development, the acquisition of new equipment or similar purposes.
From a practical standpoint, the tax relief measure for light industry is controversial, as most companies cannot benefit from it. Historically, many companies in the light industry sector have made a loss, partly as a result of more competitively priced products from Asia. Moreover, the tax incentive does not stimulate dividend distribution, which is central to a would-be investor's decision making; rather, it requires potential investors to reinvest profits in the manufacturing process.
Moreover, the benefit may not be enjoyed if a tolling scheme is in place. Many Ukrainian companies use tolling transactions as a way of enjoying favourable tax treatment (ie, exemption from VAT and customs duties). Finished goods must be produced within 90 days of importing the tolling raw materials.
Unfortunately, this supposedly investor-friendly tax incentive has become ineffective due to inappropriate legal drafting (which overlooked the question of investor stimulus), the global economic downturn and a failure to take account of historical, industry-specific factors.
The publishing industry has long enjoyed preferential tax treatment. However, clear guidance on specific tax privileges has been unavailable and tax authorities have tended towards a strict interpretation of the law. The new Tax Code simply incorporated the relevant existing provisions on the industry.
Corporate profit tax
Profits generated by publishing and printing companies and derived from publishing and production is tax exempt until January 1 2015. However, companies that produce erotic books or magazines are ineligible. Exempt profits must be used for the integration of new technology, capital investment or the expansion of production.
Certain VAT rules apply to companies in the publishing industry. The following business activities are exempt from VAT:
• the supply of printing services by a company which also runs a publishing and paper production business;
• the supply of Ukrainian publications (and the paper for such products), except for erotic advertisements; and
• the supply of printed mass media, books, dictionaries and other printed products.
In order to qualify for tax relief, the publishing company must be included in a special state register of publishers, manufacturers and distributors. Moreover, foreign investment in the publisher's charter capital may not exceed 30%. If the threshold is exceeded, a publishing company is excluded from the register and the corresponding benefits.
The tax authorities have indicated that benefits provided to the publishing industry have proved relatively effective. The key players in the industry have benefited from the preferential regime which has provided significant stimulus to the development of the newspaper and magazine business. However, irrespective of the tax benefits, further development of the industry depends largely on the further democratisation of Ukraine.
Corporate profit tax
Income received by producers of live-action or animated films is not taxable until January 1 2016. Tax relief applies on condition that the non-taxable amounts are reinvested in the production of Ukrainian films (ie, Ukrainian-language films that are produced in Ukraine by Ukrainian film-makers).
A VAT exemption for certain business activities applies until January 1 2016. In particular, Ukrainian film-makers, cinemas and distribution companies are exempt in respect of:
• the supply of Ukrainian films, as well as services for the production and copying of Ukrainian and foreign films (if the latter are dubbed or subtitled in Ukrainian);
• the reproduction, dubbing or subtitling of films in Ukrainian; and
• the promotion and distribution of Ukrainian-language films (whether they are made in Ukraine or abroad).
Producers of Ukrainian films are exempt from land tax until January 1 2016. The government has approved a list of eligible producers. Historically, such companies have used significant areas of land for film production, making land tax a considerable expense.
The Ukrainian film industry has not become a high-margin business on the basis of the tax privileges provided. The tax incentives have neither developed the film-making industry nor attracted significant foreign investment; indeed, Ukrainian film production companies are more attractive to foreign investors for the land that they own. As such, the tax incentives will be more helpful to local film production companies than to the international film industry.
Considering the numerous tax regimes across different industries, there has clearly been a positive shift in Ukrainian fiscal policy towards making domestic industry more globally competitive. Ukraine has much work to do to improve its World Bank rating for tax payment, but its tax law framework is promising. The government's priorities should be to fight double standards in tax administration practices and improve transparency.