As Ukraine’s richest businessmen rise up local and international rich lists, their companies, strangely, appear to be heading in the opposite direction.
The nation’s flagship metallurgy sector, for example – which accounts for nearly half of the nation’s exports – is still financially in the red, official figures show.
Although higher prices on Russian natural gas imports have hit margins sharply, critics say the losses are largely a grand deception. Many companies underreport their income in Ukraine in order to pay less tax, transferring profits offshore in often complicated ways that deprive the country’s budget of much-needed revenues. Many of the practices may be legal, while others appear dodgy, to say the least.
The State Statistics Committee estimates that only 63 percent of the nation’s companies declared profits in 2010, totalling $7.9 billion.
An aerial view of the Azovstal steel plant in Mariupol in 2006. (UNIAN)
Most enterprises downplay their income in Ukraine.”
– Oleksiy Blinov, head of research at Astrum Investment Management.
Small- and medium-sized businesses, meanwhile, struggle with a heavy tax burden, complex and ever-changing regulations and no ability to take advantage of these offshore schemes.
“Most enterprises downplay their income in Ukraine,” said Oleksiy Blinov, head of research at Astrum Investment Management. “The largest companies move their profits offshore through transfer pricing and other schemes so the figures they disclose don’t show the whole picture and the true financial health of their companies.”
In disclosing their 2010 financial figures, one big Ukrainian company after another posted weaker-than-expected financial results in sector after sector, including chemical makers, electric power distributors, machine builders and oil and gas companies.
Several of the companies named in this story were contacted for response, but had no immediate comment or their officials required written requests for information.
Kryvorizhstal plant on March 21, 2007. (Natalia Kravchuk)
At a briefing with journalists on March 17, Serhiy Lyovochkin, chief of staff to Ukrainian President Viktor Yanukovych, admitted to owning an offshore company of his own, but insisted it was legal.
Lyovochkin also brushed aside suspicions that the nation’s largest business groups and companies were showing little profit onshore in order to siphon it abroad and away from tax officials.
“I know the owners of many of these companies. They are patriots,” Lyovochkin said, noting that much of the business world uses offshore companies.
Azovstal and Yenakievo, Metinvests’s flagship mills, were hit hardest by transfer pricing practices.”
– BG Capital report.
In Ukraine, a good place to start examining the practice is with the metallurgy sector, which provides the nation’s top currency earnings.
As global steel demand and prices recovered in 2010, Ukraine’s metallurgical sector still managed to post an aggregate loss of almost $480 million compared to $1 billion in 2009.
A recent Ukraine steel industry report by BG Capital, an investment bank, named transfer pricing – the allocation of profits for tax and other purposes within a multinational corporate group – a factor that “outweighs all others” in harming the companies’ reported performance.
The report, which covered Alchevsk Metallurgical Plant, Azovstal and Yenakievo Metallurgical Plant, stated that the mills’ earnings before interest, taxes, depreciation and amortization were well behind the 18-24 percent margin range for Russian peers.
“Azovstal and Yenakievo, Metinvests’s flagship mills, were hit hardest by transfer pricing practices,” the BG Capital report said.
The Metinvest, the steel holding owned by billionaire Rinat Akhmetov, said that it paid Hr 11 billion in taxes in 2010.
The international financial watchdog Global Financial Integrity estimates that the financial system leaks $10.75 billion a year through the deliberate under-pricing of exports, overpricing of imports and the purchase of non-existent services – assisted through offshore tax havens in Cyprus, the Seychelles and the Cayman Islands.
Martin Raiser, head of World Bank in Ukraine and Moldova. (UNIAN)
All are designed to ensure that profits are held offshore and out of reach of the Ukrainian tax system.
There are many perfectly legal deductions that can reduce a company’s tax liability but this is certainly not the same as tax evasion, which is illegal, or tax avoidance through loopholes in the legislation regarding double taxation for instance, or transfer pricing.”
– Martin Raiser, head of World Bank in Ukraine and Moldova.
“There are many perfectly legal deductions that can reduce a company’s tax liability but this is certainly not the same as tax evasion, which is illegal, or tax avoidance through loopholes in the legislation regarding double taxation for instance, or transfer pricing,” said Martin Raiser, head of World Bank in Ukraine and Moldova. “The latter should be prevented both through better legislation and tighter controls.”
“It wouldn’t be frivolous to say that Ukrainian companies are abusing the practice of transfer pricing,” said Vladimir Kotenko, head of Ernst & Young’s tax & law department in Kyiv.
Tax avoidance and minimization isn’t limited to Ukraine’s big steel industry.
Four of Ukraine’s major chemical producers who make key agricultural inputs also posted negative pre-tax profits in the first nine months of 2010, investment bank Phoenix Capital reported.
Stirol, Odesa Portside Plant, Dniproazot and Rivneazot posted a combined $105 million negative bottom line in the first three quarters of 2010. Stirol was $58.2 million in the red after September 2010.
Ukraine’s largest oil and gas company, Ukrnafta, posted weaker than expected 2010 financial results due to transfer pricing, Dragon Capital, another investment bank, reported.
The Privat Group-controlled company posted a $332 million 2010 net income because non-market price dealings with the Ukrtatnafta refinery, a company that’s also in Dnipropetrovsk-based Privat Group’s orbit.
“We … think that there exists a risk of further financial deterioration should Privat continue with its transfer pricing scheme boosting Ukrtatnafta’s profitability at Ukrnafta’s cost,” a recent Dragon Capital note to investors read.
Dragon Capital also reported three electricity generators performed poorly in 2010. Zakhidenergo, the third largest Ukrainian thermal generator and Donbasenergo posted $42 million in losses while Dniproenergo posted a net income of $23.8 million, 21 percent below Dragon’s forecast.
Machine maker Sumy Frunze saw net income sink by four times year-on-year to $12 million. Steelmaker Azovstal posted an unforeseen 2010 net income loss of $23 million while the Yenakievo and Alchevsk Metallurgical Plants were in the red $224 million by the end of September 2010.
And despite solid production last year MMK Illicha, which Metinvest took over in 2010, had a negative $52 million bottom line in 2010.
It wouldn’t be frivolous to say that Ukrainian companies are abusing the practice of transfer pricing.”
– Vladimir Kotenko, head of Ernst & Young’s tax & law department in Kyiv.
“The poor results support our view that MMK Illich’s new owner is likely to position MMK Illich as a cost center with the holding, similar to its other steel mills, by supplying iron ore and coke at above export prices,” a BG Capital note said.
Such schemes to maximize profits are far from Ukraine’s small- and medium-sized business owners, suffocated by regulations, red tape and official and unofficial shakedowns.
“Although Ukrainian small businesses under the simplified tax system pay little tax, both small and medium size businesses face significant administrative burdens,” said the World Bank’s Raiser. “We have argued in the past for a reform of the simplified system to accommodate true small businesses, but only in parallel with simplifying tax administration,” Raiser added.
The goal of such a progressive tax system, according to experts, is to allow Ukraine’s struggling small and medium-sized business to blossom, which would support development of a prosperous middle class that is key having a healthy economy.
Achieving this, economists say, would put Ukraine’s economy on more solid footing.
“What’s needed is a fairer tax code and administration,” said Ihor Burakovsky, director of the Institute of Economic Research and Political Consultations. “Taxes shouldn’t have a universal approach to everyone, plus economic recovery isn’t always related to increased public financing, what matters is how taxes are calculated, collected and it’s also about corruption.”
What’s needed is a fairer tax code and administration. Taxes shouldn’t have a universal approach to everyone, plus economic recovery isn’t always related to increased public financing, what matters is how taxes are calculated, collected and it’s also about corruption.”
– Ihor Burakovsky, director of the Institute of Economic Research and Political Consultations.
But despite the government trumpeting its new tax code, passed into law last year, this hasn’t happened.
According to Ernst & Young’s Kotenko, the new tax code, which went into force Jan. 1, isn’t “conceptually” new at all.
“The old rules and norms have mostly just been shuffled around. The old bureaucratic system is still preserved, the document as a whole is still archaic, the parameters are still extensive though,” Kotenko said, adding that only larger companies are better equipped to cope with the extensive tax compliance burden.
He said Ukraine’s largest companies can still “enjoy some historically available tax optimization schemes” leaving the government little to tax.
The bad news is that this scheme of hiding profits from the tax inspector seems to be accelerating, according to figures from Ukraine’s State Tax Administration. In the first half of 2010, exports to offshore companies increased by 54 percent to $1.6 billion.
The figures would suggest that companies are purposefully shying away from complying with tax rules and regulations and thus aren’t paying their fair share of taxes.
Kyiv Post staff writer Mark Rachkevych can be reached at [email protected].
