It’s hardly a secret. Ukraine suffers from serious erosion of its tax base, which harms the country, its economy, and its people.
Most of it has occurred as a result of aggressive tax avoidance, evasion, and offshore profit-shifting, experts say.
By some independent estimates, base erosion and profit shifting (BEPS) cost the state some $40-50 billion annually in lost tax revenues. Meanwhile, the entire state budget for 2020 is $50 billion, and the country’s nominal gross domestic product is only about $130 billion.
BEPS refers to tax planning techniques or schemes that often exist in legal grey areas used to avoid taxation, according to the Organization for Economic Cooperation and Development (OECD), the international institution leading the fight against harmful tax avoidance practices worldwide.
Experts here in Ukraine say that money laundering, illegal tax evasion and other financial crime – not really covered under BEPS – also hit the state coffers hard, but that the true financial impact of those schemes is harder to determine because many go undetected and unpunished.
However, a new draft law that tax experts and lawyers expect will be approved by the Ukrainian parliament in February or March aims to bring the country more firmly in line with OECD standards. It should also help the authorities to properly mount an offensive against tax avoidance and evasion.
OECD and BEPS
Jurisdictions around the world – including those with reputations as tax havens – are gradually establishing or improving legal frameworks that are in line with the OECD BEPS project, a joint venture started with the G20 group of major economies back in 2013.
Seven years ago, that project set out to tackle tax planning strategies around the globe that allowed companies and the wealthy to avoid or evade taxes by secretly shifting their profits into low tax or tax-free jurisdictions.
The project uses a set of rules designed to give governments the power to tax people and firms where economic activity took place and where value was created, as opposed to wealth being taxed where it ultimately ends up.
To achieve this, the OECD has pushed for regulators and banks to automatically share information across international borders. While many countries have been signing up, the process has also faced some resistance from multinational corporations.
Experts here in Ukraine – a country which has seen a great deal of its wealth looted, transferred into offshore tax havens or invested in European or American real estate – think that robust anti-BEPS legislation can halt the outflow of capital and replenish the country’s depleted state coffers.
“The draft law indicates a significant increase of the Ukrainian tax base,” said Viktoriya Fomenko, partner and head of tax and customs at the Integrites law firm in Kyiv.
“It also allows to tax non-distributed profits of controlled foreign companies, to tax Ukrainian-sourced income not covered by the DTT (Double Taxation Treaty),” she added.
Avoidance schemes threatened
Some of Ukraine’s wealthiest companies and its super-rich see the draft legislation – widely known as the Anti-BEPS Law – as a problem.
Experts say it seriously increases the risks associated with tax avoidance and evasion schemes that many have enjoyed using for decades.
Ukrainian companies and business people have frequently been caught using shell firms and shady accountancies – often in places like the U.K. – to secretly move funds into an offshore holding, frequently in Carribean tax havens like the British Virgin Islands, the Bahamas or St. Kitts and Nevis.
With the Anti-BEPS Law, such offshore schemes will be more easily exposed to the tax authorities in Ukraine — particularly if the capital was shifted through another jurisdiction that is also implementing OECD standards on BEPS. That includes almost all EU countries, the U.K., the United States, but also China, India, Brazil, and Russia.
Some are concerned that the law could give too much power to Ukrainian tax authorities and law enforcement. However, despite limited opposition in parliament, it is expected to be signed into law by Ukrainian President Volodymyr Zelensky in the early spring.
“The Anti-BEPS Law… was developed to target tax evasion schemes,” said Hennadiy Voytsitskyi, head of taxation law at the Baker McKenzie law firm in Kyiv. “The whole idea behind the legislation is to allocate taxing authority to the state where the value is created, combating artificial avoidance of taxes through avoidance schemes.”
“It will be an incentive for some to calculate whether the tax benefits outweigh the time, costs and risks taken in employing avoidance schemes,” said Constantin Solyar, a partner at the Asters law firm and a leading Ukrainian tax expert. “Usually tax avoidance is a risk versus benefit analysis.”
“If you increase the risk and reduce the economic benefit, you generally get less avoidance… We expect (to see) a strengthening of the Ukrainian tax base,” Solyar concluded.
Oleksandr Boboshko, director of the KPMG auditing firm in Ukraine, also thinks that typical tax avoidance structures will be “heavily affected” by the new law.
“Multinational groups will not be able to avail themselves of the double tax treaty benefits if their group structure includes companies with minimal or no economic substance,” he said, predicting that the law will likely come into effect partially in July 2020, and fully on Jan. 1, 2021.
Information exchange
To get the full benefits of its new Anti-BEPS Law, however, Ukraine also needs to quickly adopt the so-called Common Reporting Standard (CRS) on taxation, multiple experts told the Kyiv Post. This will properly align Ukraine with what are becoming international norms on taxation.
“This is a global initiative on automatic exchange of information on bank accounts,” explained Solyar. “The risks associated with aggressive tax planning grow substantially when financial information becomes available to tax authorities. This is one of the major safeguards,” he added.
This automatic exchange of data – already adopted in dozens of jurisdictions, including the U.K., the EU, Russia, China and many other countries (the U.S. and its banks exchange such data on request, but not automatically) – will enable Ukraine to receive and exchange information about funds held in foreign banks and belonging to Ukrainian citizens, or companies where Ukrainian citizens are the beneficiaries.
The potential benefits could be considerable. According to Boboshko from KPMG, a 2018 report by the European Commission on the automatic exchange of tax information found that it had a significant deterrent effect on tax avoidance in the EU: “It led to voluntary disclosures and investigations, which brought 85 billion euros in additional tax revenue,” he said.
“On the other hand, Ukraine needs to win the trust of its successful business people and to prove that data on their wealth will be strictly confidential and that it will not be illegally exploited by corrupt prosecutors or criminals,” said Solyar.
Taxing the digital economy
One area where the new draft law is not very helpful, and where the Ukrainian tax authorities will be seeking extra power, is on taxing major international tech firms, such as Facebook and Google.
Those global IT companies and other firms operating in the so-called digital economy, such as Amazon and Netflix, have faced regular criticism for earning money from dozens of different countries but paying very little in the way of taxes thanks to profit shifting and offshore arrangements.
“Taxation of digital services is not covered by the recently adopted legislation,” said Fomenko. “However, there are already discussions on this matter, and a draft law was submitted to parliament in December 2019,” she added.
“It is a rather complex issue,” said Voytsitskyi of Baker McKenzie. “The Anti-BEPS law does not immediately address the taxation of the digital economy… it poses new challenges which conventional methods of tax administration do not resolve.”
Solyar said that the digital economy requires much more sophisticated and advanced tax thinking and expertise that Ukraine currently lacks in general. It is an issue that big countries are also struggling to deal with: “Probably Ukraine will copy some of their approaches in the future,” he said.
“But when it comes to other multinationals… they are likely to fall under the improved tax scrutiny if they tried to avoid paying taxes here in Ukraine,” he said.
