Experts say tax authorities are going to start cracking down on tax optimization schemes as budget revenues slip.





The difference between tax avoidance and tax evasion is the thickness of a prison wall, British Chancellor Denis Healey once said. In Ukraine, it’s hard to tell what will send you behind that wall: Vague laws, flourishing optimization schemes and flexible tax authorities have all made sailing in Ukraine’s legal waters unpredictable and complicated. 



But a year of economic hardships and the budget pinch may end all that.



“Tax authorities used to be very lenient, but now the situation is changing” as tax officials crack down on tax avoidance and evasion schemes in order to fill a widening budget gap, said Sergei Melnik of the Salans law firm.



Melnik said that “too many companies use very risky and aggressive schemes” which clearly cross the line from tax optimization into evasion.



Among the legal ways to underpay the state, companies outsource services to private entrepreneurs or hire temporary consultants to avoid staff-related social taxes. In export-import operations, businesses tend to conceal profits by selling their products for understated prices to affiliated intermediaries that are registered in a favorable tax zone. 



The offshore entity then charges the market price to end clients. Use of such transfer pricing schemes helps profits pile up outside Ukraine’s jurisdiction, where the tax rate is much lower.

Every industry seems to have its own tricks. 



Property developers start schemes, which allow delays in tax payments, until construction is over. Big companies may choose to restructure their business by moving parts of the companies to offshore zones for special tax incentives, or by forming other lucrative partnerships.  



When times are lean, however, businesses tend to abuse the system, setting off tax hounds with more rigorous inspections. 



A sugar plant in central Ukraine, which was accused of tax evasion on Sept. 7, is a case in point. Tax authorities claim management at the Vinnytsia factory siphoned off taxable profits by ordering marketing research from a company in Zaporizhya for Hr 7 million. The contractor allegedly turned out to be a fictitious entity that existed only on paper and was managed by a 90-year old woman. So, while the factory has to settle Hr 3 million in taxes and fines, authorities of the plant will face a criminal investigation. 



Hiring employees as private entrepreneurs in lieu of hiring full-time workers is also a hit in Ukraine. “There are one or two million of them,” said Vladimir Didenko, partner at the Magisters law practice. “However, only 30-40 percent of them are real. The rest involve shadow schemes, where a very symbolic tax is paid [instead of a dozen others required by law.] Our legislation is so naive that it’s hard to distinguish between abusers and valid users. Nowhere else in the world would you find such naive generosity as in Ukraine,” said Didenko. 



But the time for change may have arrived. Two years ago, businessmen could sleep well as long as they backed up their deals with contracts, which may have existed only on paper. Tax inspectors have now stepped up efforts, moving beyond simple document checks to inspecting companies on the ground, according to Melnik.



“The tax office now requires employers to be prudent when hiring a contractor. From now on, you must be able to show that your supplier can physically deliver products, has warehouses, staff and transport. Otherwise, your contract may be nullified,” said Melnik.



Fines for tax evaders differ. But in some cases, companies are required to pay several times more than the amount of taxes they had failed to pay.



Didenko of Magisters said that most investors are not worried about corporate tax rates in Ukraine, particularly about profit tax and value-added tax, which are comparable to other countries. They are more worried about the legislation, which makes it unclear how solid the legal ground they stand on is.



“It is like a moving target and can be interpreted in many ways,” he said. 



It is this tax volatility that makes some companies seek cover in offshore states, where taxes are low and the legal system familiar. “Offshore companies are so popular that 99 percent of more-or-less serious businesses [in Ukraine] will have various offshore mechanisms in their structure. A lot of people think that offshores are a way to siphon off money. It’s not always so. It’s a question of security,” said Didenko.



Cyprus and Netherlands are among the most popular destinations for high net individuals and businesses, according to experts.



However, despite various options to cut taxes legally, experts say that nearly half of Ukrainian businesses work in the shadows. More business is expected to sneak into the grey or black market to evade tax inspectors during the recession as they fight hard to fill government budget coffers. 



The worst danger to the economy comes from companies that strike deals with high-level government tax collectors themselves, experts said.



“They create unfair competition and destabilize the whole market,” said Melnik of Salans. “Up until now we had a very small number of cases when people were jailed for tax evasion. Usually some unknown, medium size enterprises get caught, while the big names known to abuse the system manage to stay out of trouble.”

Despite these shortcomings, experts say that Ukraine is getting closer all the time to defining the difference between legal tax avoidance and tax evasion that could lead to prison. And, if there is any benefit to the financial crisis, it may speed up this transformation.

Kyivpost