The state tax administration is striking a painful blow against companies already struggling to survive in Ukraine’s tough business climate by using a new interpretation of accounting rules that prevents companies from carrying tax losses forward.
Business advocates say that a whopping Hr 140 billion, or $17.5 billion, is at stake in losses that Ukraine’s companies may not be able to deduct from their tax bill.
The change, unless reversed, would mean a huge windfall for a financially struggling government at the expense of businesses that suffered greatly during the economic crisis.
“In addition to being a big hit for businesses, it once again instills a feeling of instability into an environment in which you need to reassure business,” said Jorge Zukoski, president of the American Chamber of Commerce in Ukraine. “When you play with the rules and not by the rules, this makes the investment community very nervous.”
According to the internationally used Generally Accepted Accounting Principles, when a company reports net operational losses, either because its costs surpass revenues or some expenses drive it into the red, it can deduct them from taxes due in future reporting periods.
This practice encourages investment and growth as companies can carry forward losses incurred during periods of expansion over the following seven years, according to the international standards to which Ukraine broadly adhered under previous tax policies.
It also helps companies overcome periods of recession, acting as an automatic stabilizer – increasing the tax burden in good times and reducing it in bad ones.
Yet this practice may now be discontinued. A Sept. 8 explanatory letter from the head of the state tax service suggested regional tax collectors only acknowledge losses incurred during the previous quarter, or in certain cases not at all.
The new interpretation comes amid reports from businesses large and small of increasing shakedowns from state tax authorities desperate to fill budget coffers. The World Bank noted no improvement in the tax regime over the past year in its Doing Business report, published at the end of October.
Vladimir Kotenko
Basing itself on a comparison of 2010 and 2007, the tax administration is arguing that companies are grossly overstating losses, which have risen roughly 3.5 times, in an attempt to dodge taxes.
This, the administration claims, could threaten the country’s stability.
Yet Vladimir Kotenko, partner at the international auditor Ernst & Young, said this comparison was groundless, given that 2007 was a boom year while in 2010 the economy had not yet recovered from the first wave of the crisis.
Acknowledging the government’s need to raise revenues, he said it should focus on creating conditions for businesses to develop instead of squeezing their resources.
The tax administration is now somewhat softening its stance, noted Anna Derevyanko, executive director of the Kyiv-based European Business Association, saying that those companies that can prove the legitimacy of their losses may be allowed to deduct them.
Kotenko, however, is unconvinced the administration will follow through.
“In the regions, they are still employing every tool they can to achieve this objective [of maximizing revenue],” he said.
Moreover, the idea of treating every company differently is dangerous, he argued, as such arbitrary decisions could further fuel corruption.
Zukoski said the whole affair is yet another case of the Ukrainian government taking a machete to do a job that requires a scalpel.
While it is understandable that the tax administration is trying to maximize its revenue, he argued, the current Tax Code, unlike the previous regime, does not allow for the use of letters to circumvent legislation.
The state tax administration argues that its letter should be considered as an opinion, not an instruction.
However, Derevyanko explained, any opinion by the tax office is in fact considered an instruction by regional tax offices.
Indeed, experts say the tax administration’s decisions are absolutely groundless from a legal perspective, which is hardly helping Ukraine’s image of a country with a dicey application of the law.
Anna Derevyanko
A meeting on Nov. 3 between Prime Minister Mykola Azarov and representatives of business, international financial institutions and the diplomatic corps, failed to reach a definitive conclusion.
However, the prime minister promised a solution for companies working “honestly and transparently” and with an impeccable business reputation.
Derevyanko explained that one meeting was insufficient to come to a conclusion, given that the amount of losses to be carried forward, around Hr 140 billion ($17.5 billion), was very tangible.
It remains unclear how big of a tax deduction will be allowed, and, perhaps more importantly, how it will be divided.
Ironically, the scandal has erupted smack in the middle of a visit by the World Bank’s oversight panel in charge of evaluating the progress made in modernizing Ukraine’s state tax service.
Meanwhile, if the current policy is pursued, the result is that companies which are effectively losing money will be forced to pay taxes anyway.
“In the case of some businesses, particularly those hit hardest by the crisis, this could be suicidal,” Kotenko said.
Kyiv Post staff writer Jakub Parusinski can be reached at [email protected]
