Next year, Ukrainian workers and their employers may be paying much lower taxes thanks to legislation expected to be introduced by parliament. Pressed by the new government, lawmakers plan to file this draft law in spring.
The tax rate will be one of the things to change.
Instead of the current combined tax of 41.5% for a single worker — which includes the 22% social tax paid by employers, 18% income tax paid by workers and a 1.5% military levy — there will be a single and greatly reduced tax rate.
The lowest rate may be 15% per employee, instead of today’s 41.5%.
The parliament has already passed 26 tax-regulating laws over the last five months, but the overhaul of income tax is a key part of the new government’s tax reform. Its aim is to make the tax code simpler and fairer, as well as to expose tax evaders and thus bring more money into the budget, the lawmakers say.
Today personal income tax provides 11% of the state budget, and changes to it are so important that Danylo Getmantsev — head of the Verkhovna Rada committee on finance, taxation and customs — calls them “the core of the tax reform.”
“This tax hasn’t changed for a long time and has grown obsolete,” Getmantsev told the Kyiv Post. “The change is overdue.”
Introducing ‘mild’ tax rates
The lawmakers led by Getmantsev — an MP with President Volodymyr Zelensky’s Servant of the People party, which commands a majority in parliament — plan to file the bill in spring 2020. They hope that parliament will pass the law in July 2020, and that it will come into force in 2021.
It seems, however, that the bill will be about much more than just uniting several taxes and reducing the personal income tax rate. At the moment, Getmantsev suggests turning it into a progressive tax rate, meaning that the rate will increase for those who earn more.
“We are talking about the fairness of taxes,” Getmantsev says. “One must take big taxes from big incomes. One dollar in a millionaire’s pocket and $1 in the pocket of a pensioner are two different things.”
The exact rates are still unknown as the Finance Ministry is calculating possible options. But Getmantsev says the difference between the rates will be “mild” — most probably up to 5 percentage points, with the maximum income tax being set at 25%.
“Such a mild progression won’t ‘motivate’ those earning big profits to evade taxes,” Getmantsev hopes.
The lawmaker insists, however, that this is just a theory and discussion of the changes continues. Today, he is only sure of the reduced rate — it will be 15%.
Mariia Lekh, a lawyer at law firm ePravo, says the progressive tax rate is hardly a new idea and many countries already use it. And this approach is fair, she thinks.
“A 15% tax can significantly affect those earning the minimum salary’s ability to satisfy their basic needs,” Lekh says. “At the same time, a wealthy person has a significant portion of income spent on excesses. Thus, the progressive taxation scale becomes a kind of ‘luxury tax.’”
Lekh thinks it can “expand solvent demand and favorably affect the development of the economy.”
Sergey Polischuk, a managing partner at law firm Juscutum, also sees the reduction of income taxes as a good sign, calling personal income an “engine for the economy.” But he warns that such changes must be implemented together with regulations on the way individual entrepreneurs are taxed.
Private entrepreneurs in Ukraine pay only 5% instead of the cumulative 41.5% work tax. This gap opens up the segment for abuse by companies, such as when a large firm hires people as if they are regular employees but then asks them to register as individual entrepreneurs to save on taxes.
The legality of using individual entrepreneurs in such cases is not only ambiguous; it also prevents the government from collecting some Hr 7 billion, or $300 million, every year, experts estimate.
“Economic temptations must be removed,” Polischuk says.
The lawyer suggests gradually increasing the 5% tax for individual entrepreneurs and eventually making both taxes — the personal income tax and the individual entrepreneur tax — similar to avoid the abuse of the current legal system.
“The direction of the changes is right,” he says, “but everything must be done as a whole. The initiative is impossible without regulating individual entrepreneurs.”
Getmantsev, however, disregards this idea. He says the government won’t consider changes to how individual entrepreneurs are taxed at the moment.
“Before the elections, we promised we wouldn’t change that. How can we do that now?” he says.
Taxing only net profit
There’s another big change that may ease the tax burden for Ukrainians: Lawmakers suggest taxing people’s net profit, instead of their income.
To that end, the bill may allow people to deduct all the necessary payments made every month from their salaries: for example, rent, the cost of medical services and money spent on care for parents older than 80. Even money spent on domestic tourism could be subtracted.
When people sell their apartment, they will have to pay a capital gains tax — a tax on the difference between the price of the flat when they bought it and when it was sold, rather than on the whole price as it is now, Getmansev says.
“The task is to tax only net profit, as much as it is possible,” the lawmaker says.
Declarations, tax perks
While Ukrainians are required to pay taxes on all their income, cheating is currently rampant.
For instance, a widespread practice among Ukrainian employers is to declare the legal minimum salary for its workers and pay the rest of the wages in untaxed cash.
The same type of tax evasion happens when selling real estate property: The parties often indicate an artificially low value of the property, paying taxes on the lower price and handing the rest of the payment over in cash.
According to Lekh, the ePravo lawyer, this cash economy makes it difficult to fight corruption: “Officials can easily spend illegally-acquired money without attracting attention to themselves.”
To eliminate these schemes and clean up the economy, the authors of the bill want to incentivize people to declare their profits and property and pay full taxes.
Getting people to declare their true income and the value of their property will strike a blow against the shadow economy and corruption while giving the government more money to spend on public services.
The government plans to offer tax perks to those who file electronic declarations, making it financially more appealing than not filing a declaration. For example, by including in the declaration both one’s rent and the official rental agreement, a taxpayer will be able to get a 15–20% rebate.
However, Vladimir Dubrovskiy, a senior economist at CASE Ukraine, is skeptical about general declarations. People earning money off the books — in cash — do not have major income. In 2018, under-the-table wages were popular among people earning Hr 12,000, about $500, or less monthly.
“This is not even lower middle class,” Dubrovskiy says. “There’s nothing to declare.”
Dubrovskiy does not believe declarations will help reduce the shadow economy, because big capital is parked offshore, while large shady businesses won’t be motivated to come clean simply by a reduction in payroll tax.
Getmantsev, however, thinks it’s not about money, as this approach may even decrease the state budget.
“This is about bringing our economy into the light; about making the relationship honest while taxing people more fairly,” he says, adding that he himself is a disciple of compulsory declarations like in the United States, where citizens have to declare their income every year.
“Filing a declaration means you understand your financial situation, how much you worked and how much the state cost you,” Getmantsev says.
“This can break our paternalistic worldview, when we perceive the state not as an institution that works for us, but as a father who always owes us something. Yes, he beats us and drinks, but sometimes he feeds us, too,” he added.
“This isn’t how it’s seen in the developed democracies.”
