Obtaining value-added tax refunds is a major problem for many investors in Ukraine. On numerous occasions, the authorities have declared that they are on the verge of resolving this critical issue. But, in practise, the results have been far from impressive.
In 2007, the authorities claimed that they returned 78 percent of VAT claimed and, at the beginning of 2008, then-Prime Minister Yulia Tymoshenko announced that the VAT refund problem would be resolved by April 2008. Despite these declarations, claims for refunds have grown and currently exceed Hr 30 billion ($3.75 billion).
The issue of VAT refunds continues to be of critical importance for all existing and potential investors. Many companies have refunds outstanding for more than two years but the law does not provide for any interest on the money owed.
A number of international investors have declined to invest in Ukraine due to the uncertainty around obtaining a VAT refund in a timely manner. The refund problem seriously hits exporters as they do not generate output VAT (on goods and services sold) that could offset VAT input (on goods and services purchased). Many exporters of grain, oilseeds and metals experience serious difficulties with obtaining refunds.
In practise, the tax authorities make every effort to reject the amounts claimed as a refund. They don’t accept tax returns, delay tax audits and reject a substantial portion of refund claims. In many cases such rejections do not appear to have a legal basis, but challenging such a decision in court is time-consuming and expensive. Even if the taxpayer wins in court and proves the right to a refund, enforcing the court decision is problematic, and it is increasingly difficult to obtain money from the state.
The global economic crisis has exacerbated the state’s ability to collect sufficient amount of revenues, and now the authorities recognize that there is a shortage of funds to satisfy all refund claims. The current government has now proposed the provision of VAT refunds through government domestic loan bonds (VAT bonds).
Effectively, this is a revival of a vehicle first implemented in 2004. At that time many business entities agreed to obtain VAT bonds and subsequently sold them at a 15-30 percent discount on the secondary market.
There are many uncertainties surrounding the new procedure – and more importantly it does not address concerns about future VAT refunds. It only provides for the use of the bonds for VAT refunds confirmed by the tax authorities as outstanding as of April 30. The interest on the bonds of 5.5 percent per annum is extremely low. The authorities promised to issue Hr 20 billion in bonds, which they believe is the outstanding debt on refunds, repayable in installments of 10 percent of the bonds' nominal value twice a year over five years. Eligible entities should apply to local tax authorities by June 25 to receive the bonds.
It is evident that the VAT bonds idea is not perfect, but it appears to be one that could somehow resolve the existing problem. It is likely that many companies will accept the bonds and then sell them on the secondary market at a significant discount (although the authorities do not expect the discount to be higher than 10 percent). Those who do not need immediate cash may hold on to the bonds and recover funds over the coming years, although the interest rate may not truly reflect the cost of borrowing.
At this stage it appears that the issuance of bonds is the only mechanism that the government will consider for dealing with VAT arrears. It also needs to deal with the future refunds in a clear and transparent manner. It should consider allowing future VAT credits to be automatically offset against other taxes, if the taxpayer so decides, and reintroducing promissory notes for import VAT. This would be a clear sign that the government is serious about making Ukraine a more attractive investment location.
Brave taxpayers (mainly exporters) may consider other ways of reducing VAT amounts claimed as a refund. This could involve generating VAT output through selling a portion of the goods to local entities who then further export these goods from Ukraine. In this case VAT output on domestic sale would reduce VAT input to be claimed as a refund. This mechanism should be properly structured and documented in order to avoid challenge by the tax authorities.
The last tip is that any requests by the taxman to delay applications for the VAT refund should be approached cautiously. According to the law, such a delay may be viewed as a voluntary agreement not to request the refund at all. If the tax authorities pick up this issue during a tax audit, they are empowered to restrict the refund and input VAT could only be offset against future VAT payable. This is a murderous condition for exporters because they never have VAT payable.
Businesses may be successful in getting money back using a combination of all available methods. This will require significant administrative efforts, but, unfortunately, there is no alternative. In the long-term, we hope that a much-needed, significant overhaul of the VAT refund procedure is carried out.
Ron Barden is the lead partner with the tax and legal department at PricewaterhouseCoopers Ukraine. He can be reached at email@example.comIgor Dankov is the senior manager with the tax and legal department at PricewaterhouseCoopers Ukraine. He can be reached at firstname.lastname@example.org.