You're reading: Update: Ukraine softens tax blow on small business

Dec. 2 (Reuters) - The Ukrainian leadership on Thursday backed down in the face of big street protests by thousands of small business owners and softened a new tax code that would have made them pay higher taxes.

Thousands of entrepreneurs who have rallied in Kyiv from across the former Soviet republic for weeks in protest against the reform let off fireworks in jubilation on hearing the news.

Reforming the tax system in Ukraine, among the most inefficient in the world, has been a key demand of the International Monetary Fund, a vital financial prop for Ukraine.

Abandoning the reform also raises questions over efforts to bring the budget deficit down.

In its original form, the tax code would have ended generous tax breaks for thousands of small businesses — from taxi drivers to market traders, cafe owners and hairdressers. Many entrepreneurs said they would be either driven out of business or forced to spend their lives dodging the tax man.

President Viktor Yanukovych, who on Tuesday vetoed the first draft of the new code, put amendments to parliament proposing that small businesses be exempted from being brought formally into the tax system.

He proposed keeping the present system under which they pay ad hoc monthly payments instead of a tax on profits like larger companies. Parliament later hustled the amended tax code through with little discussion.

The outcome is likely to leave Yanukovych unscathed in the eyes of the general public, but it is a clear defeat for Prime Minister Mykola Azarov and his deputy, Sergei Tigipko, architects of the original tax code.

ACHIEVING IMF GOALS

Ukraine needs to cut its budget deficit to 3.5 percent of gross domestic product in 2011 from the 5.0-5.5 percent expected this year under its $15 billion deal with the IMF.

While neither the government nor the IMF had expected the original tax code to immediately boost budget revenues, extending tax breaks for small businesses now might make it harder for Ukraine to achieve the deficit target.

The danger for the Ukrainian leadership had been that a delay in passing a new tax code could hold up preparations of a 2011 budget which would, in turn, have endangered disbursement of a $1.6 billion tranche of IMF credit by the end of the year.

Speaking in parliament on Thursday, Yanukovych’s economic adviser Iryna Akimova said a new tax code was vital for drawing up a 2011 draft budget.

"If we want to stimulate our production, come closer to European standards, then we must understand that the budget must be approved on a new tax base … We need a tax code. We must approve it," she said.

Other challenges lie ahead for the Yanukovych government.

Next year, under the IMF deal, Ukraine needs to start gradually raising the retirement age for women to 60 from 55 and continue increasing the price of gas for households.

The protesters, many of whom had erected a small tent city on Kyiv’s Independence Square, had provided an uncomfortable reminder for Yanukovych of the "Orange Revolution" protests of 2004.

Those protests, against a rigged presidential election of which he was the beneficiary, led to a third ballot in which he was defeated by the pro-Western Viktor Yushchenko.