## Chapter V: Corporate Profit Tax ## Source details **Canonical URL:** [Chapter V: Corporate Profit Tax](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1625.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1625.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1625.pdf.json) --- ### Mission and Preface - A technical assistance mission from the IMF’s Fiscal Affairs Department (FAD) visited Kiev July 20–August 1, 2015 to review selected tax policy issues and advise on specific tax reform proposals. - Mission composition: Messrs. Roberto Schatan (mission head), Selcuk Caner (both from FAD) and Christophe Waerzeggers (Legal Department) and Mr. Victor Thuronyi, external expert. - Additional assistance from David Amaglobeli (FAD) and from Headquarters in Washington, D.C. by Mr. Ricardo Fenochietto (FAD) and Csaba Feher (Expenditure Department). - Key bilateral engagements included Deputy Minister of Finance Ms. Olena Makeieva; Task Force on Tax Reform led by Ms. Natalie Jaresko; Ministry of Finance officials; State Fiscal Service officers; Ministry of Social Policy; Parliament (Ms. Nina Yuzhanina, Mr. Andrii Zhurzhii); civil society, USAID, EY, PwC, private sector, World Bank, and European Union officials. - IMF Kiev office support: Mr. Ihor Shpak (senior economist). Interpretation: Mss. Valentina Kukhtik and Anna Burlay. ### Executive summary — Key findings and analysis - Urgency: Social Security Contributions (SSC) in Ukraine need urgent attention. - Fiscal risk: If nothing is done, the budget is poised to lose 4.5 percent of GDP in revenues in 2016 due to a legally mandated SSC rate reduction adopted in March 2015. - Current SSC level: SSC are at 40 percent of payroll, described as above all countries in the OECD. - Informality: Ukraine hosts a very large informal sector which constrains social and economic potential; F. Schneider, A. Buehn & C. Montenegro indicate Ukraine ranked 140 among 151 countries, with an informal sector representing nearly 50 percent of GDP for 1999-2007 (cited context). - Fiscal constraint: No fiscal space to forgo tax revenues; shifting the tax burden away from labor must be revenue neutral and compensated from reliable sources. - Critique of proposed merger (SSC, Military Tax and PIT into single income tax): - Main proposal: merge SSC and Military Tax with PIT at a flat 29 percent rate on a gross-up wage. - Revenue risk: no guarantee wages would be grossed-up for everyone; coexistence of regimes would negate simplification; pensions correlated with contributions so reporting remains necessary; financing social security from the budget requires comprehensive benefit review. - Single Tax System (STS) concerns: - STS has become porous; very low tax and symbolic SSC fee for qualifying taxpayers. - Avoidance incentives: employers contracting workers as independent entrepreneurs; excessive turnover cap; VAT threshold override; admission of legal persons; incentives for employee reclassification. - Revenue potential limited given enforcement difficulty. - Policy stance on SSC and informality: - Endorse lowering SSC rates (retaining payroll tax form) and tightening regime for small self-employed taxpayers, but lowering rates alone unlikely to materially reduce informality. - Foregone revenues from SSC reductions should be recouped from reliable sources; do not rely upfront on expansion of the tax base from lower SSC rates. - Possible scenario: - Reduce average SSC more moderately, for example, to 28 percent (keeping very few of current 67 risk specific rates). - Increase the cap on the payroll tax to 25 minimum wages (MW). - Compensate revenues primarily from indirect taxes. ### Recommendations — Timing: Short Term (ST); Medium Term (MT); Long Term (LT) - Chapter II: Social Security Contributions - Take a comprehensive approach to informality, do not rely only on reducing SSC rates LT - Do not combine SSC and PIT into a single tax ST/MT - Reduce the total number of SSC rates according to risk class (67) to a handful ST - Consider reducing SSC rates gradually but as part of a revenue neutral package MT - Do not rely on potential dynamic effects of SSC reduction in employment for achieving fiscal neutrality ST/MT/LT - Do not contemplate an initial reduction below a 28% average SSC rate ST/MT - Find compensating measures primarily in indirect taxation and property taxes ST/MT - Eliminate horizontal inequity in SSC between employees and sole proprietors ST - Strengthen regulatory definitions of employee ST - Do not introduce presumptive taxation except for existing rule applying to part-timers ST/MT/LT - Consider substituting SSC with full budgetary resources only in strict coordination with comprehensive reform of SS system LT - Chapter III: Single Tax System - Eliminate legal persons from the STS ST - Eliminate VAT payers from the STS ST - Keep a concessional low fee contribution only for current Group 1 ST/MT/LT - Combine Groups 2 and 3 and tax them at general income PIT tax rates on cash flow basis ST - Set upper limit for new simplified tax regime at 2 million hryvnias per year ST - Increase the VAT registration threshold to the same level (conditional to STS reform) ST - Chapter IV: Excises - Increase substantially excise on alcoholic beverages, especially beer and spirits ST - Levy the excise at point of first sale of ethyl alcohol and permit subsequent credit for manufacturers ST - Continue to increase excises on tobacco nearer to EU standards MT - Introduce an excise credit system in the supply chain of fuels to combat extensive evasion ST - Chapter V: Corporate Profit Tax (summary recommendations) - Disallow deductions for non-business expenses, and identify specific categories of non-deductible expenses ST - Introduce a mechanism for inflationary adjustment for tax purposes that is triggered when inflation reaches a specified level LT - Tighten the thin capitalization rule ST - Change the base of the provisional payments to refer to previous year profit margin ST - Permit crediting ACP against provisional payments ST - Limit exemption for investment funds only to those that are regulated ST - Increase the CPT rate to 20%, same as top PIT marginal rate ST ### Social Security Contributions (SSC) — deficits, reforms, and revenue scenarios - Deficits and context - Social Security System runs with a large public deficit (over 5 percent of GDP). - SSC are approximately 40 percent of the wage base. - Pension fund deficit: from 7 percent of GDP in 2009 to 5 percent in 2104; projected deficit for 2015 is 3.9 percent of GDP. - Other funds add 1.4 percent of GDP to that deficit in 2015. - Recent legal changes and impact - March 2015: Rada reduced conditions for SSC reduction; 2016 reduction coefficient set at 0.6 without conditions. - May 2015: Rada approved elimination of conditions to decrease SSC rate in 2015 to 60% reduction (lowering current rate from 40 to 15 percent); President vetoed May 19, 2015 bill in July. - In 2015, 7,000 employers applied the reduced SSC rate, covering almost 700,000 employees (SFS data). - Key numerical revenue impact estimates (2014 figures applied as if in 2014) - a. Reduce the SSC rate by 40%: SSC Revenues (capped at 17 MSW): -70.8 (as % of GDP: -4.5%) - b. Reduce the SSC rate by 60%: SSC Revenues (capped at 17 MSW): -106.2 (as % of GDP: -6.8%) - c. SSC rate at 30% and increase cap to 25 MSW: Revenue Change: -46.0 (as % of GDP: -2.9%) - d. SSC rate at 28% and increase cap to 25 MSW: Revenue Change: -54.3 (as % of GDP: -3.5%) - e. Additional rate of 5% on incomes over 30,000 UAH/month: Revenue Change: 1.4 (as % of GDP: 0.1%) - Specific fiscal notes - Next year losses in SSC revenues from unconditional 2016 reduction: UAH 70.8 billion (4.5 percent of GDP). - If reduced deductible labor cost fully translated into higher CPT, negative impact could be reduced to 3.9 percent of GDP (partial offset). - Financing scenarios with CPT offsets: SSC at 30% with cap 25 MSW => 2.6 percent of GDP (text notes 2.9 percent without CPT offsets; footnote says 2.6 percent with CPT offsets); SSC at 28% with cap 25 MSW => 3.0 percent of GDP with CPT offsets (3.5 percent without). - Policy guidance - Overturn the uncompensated SSC rate reduction coefficient of 0.6 projected for 2016. - Reductions in SSC rates must be fully compensated by additional tax revenues. - Do not include in expected revenues possible effects from reducing the informal economy. - Do not decrease the base of the top marginal rate in the PIT. - Do not contemplate an initial reduction below a 28% average SSC rate ST/MT. ### Single Tax System (STS) — analysis and reform proposals - Structure and problems - Ukraine has four simplified tax regimes collectively referred to as the Single Tax (“ST”) after December 2014 reform. - About 1.3 million taxpayers are registered for ST of which 1.14 million are individuals. - ST groups and numeric thresholds: - Group 1: turnover ≤ UAH 300,000; fixed tax up to 10% of the MSW; not allowed to hire employees. - Group 2: turnover ≤ UAH 1,500,000 and ≤ 10 employees; fixed tax up to 20% of the MSW; more than 631,000 individuals. - Group 3: turnover ≤ UAH 20 million; pay 2% or 4% on turnover depending on VAT registration; more than 435,800 total of which more than 274,000 individuals. - Effective tax rates (2014 figures): - Single tax total turnover / income: 437,599,795 (000); Taxes paid 6,904,371 (000) - Individuals (ST): turnover 234,515,768 (000); taxes paid 4,968,875 (000); Effective tax rate 2.12 percent - Group 2 individuals: effective tax rate 1.01 percent (Group 2 turnovers 152,026,724 (000); taxes paid 1,529,937 (000)) - Group 3 individuals: effective tax rate 4.38 percent - Abuse mechanisms and revenue risks - Business splitting to avoid turnover limits. - Profit shifting: transfer pricing rules do not apply to transactions between resident entities or persons (Article 39). - Reclassification of employees as sole proprietors (example: IT sector anecdote ~75,000 engineers as independent contractors representing UAH 150 million per month or UAH 1.8 billion per year per sector representatives). - Leasing and other circumventions exploiting legal-form distinctions. - Reform design recommendations - Exclude legal persons and VAT payers from reformed simplified regime ST - Partition taxpayers by turnover/gross income alone; consider raising VAT threshold to UAH 2 million (conditional on STS reform) - For Groups 2 and 3 impose general PIT rates on a cash flow basis (allow immediate expensing of capital items except real property); maintain concessional nominal SSC only for micro businesses (current Group 1) - Apply normal SSC rates to entrepreneurs (except smallest Group 1) - Allow reformed simplified taxpayers to engage in any economic activity except a narrow excluded list; permit unlimited employees for reformed Groups 2 and 3 - Remove moratoria on audits and phase out audit moratoria - Revenue potential estimates (2014 data) - Imposing general PIT rates on Groups 2 and 3 individuals: potential UAH 32.6 billion (2.3 percent of GDP) - Under assumptions (one half remain entrepreneurs, 50 percent profit margin): expected revenue UAH 24.3 billion (1.6 percent of GDP) - More realistic revenue range accounting for informality: UAH 12 to 17 billion - Aggregate Group 2 and 3 totals (UAH billions): turnover/income 225.46; Single tax paid 4.64; PIT Tax Liability 37.21; Change in Tax Liability 32.57 ### Revenue effects of merging SSC and PIT into a flat PIT (Task Force proposal) - Proposal features: replace SSC, Military Tax and PIT by flat 29 percent PIT; gross up wage bill by SSC and Military Tax. - Estimated initial cost (as if applied in 2014): UAH 75.2 billion net revenue forgone. - Total PIT at 29%: 167.3 (UAH billion) - Current PIT Revenue forgone: -60.5 - Military tax forgone: -5 - SSC forgone: -177 - Net revenue change: -75.2 - Mitigating measures proposed by proponents: - Substantially increase tax burden on ST beneficiaries. - Decrease net wages of public employees. - Assume increased revenues from formalizing underground economy. - Taxing ST taxpayers under the plan: - Imposing 20 percent on gross income for Groups 2 and 3 estimated to generate close to UAH 22 billion and reduce shortfall from UAH 75.2 to UAH 53.1 billion (3.4 percent of GDP). - Detailed items: - Third Group individuals: Total income 73; Tax at 20% 14.6; Forgone ST revenue 3.4; Net revenue change 11.2 (UAH billion) - Third Group corporate: Total income 64.5; Tax at 20% 12.9; Forgone ST revenue 2; Net revenue change 10.9 (UAH billion) - Risks: switching taxpayers to CPT or informal sector, overestimation of gains, optionality undermining progressivity. ### Financing SSC reductions — menu of compensatory measures and quantified effects - VAT measures - Increasing general VAT rate by one percentage point => about UAH 7 billion (0.4 percent of GDP). - Increasing preferential VAT on pharmaceuticals from 7 percent to general rate 21 percent => UAH 20.1 billion (1.3 percent of GDP) (2014 estimate). - Eliminating special VAT regime for agriculture => conservatively 0.3 percent of GDP. - VAT alone could provide close to 2 percent of GDP fiscal space. - Excises - Based on Chapter IV recommendations, possible increase yields 0.6 percent of GDP in 2016. - PIT measures - Introduce third PIT bracket at 25 percent on incomes above UAH 15,000 => around UAH 3.5 billion (0.2 percent of GDP). - CPT and property - Increase CPT rate from 18 percent to 20 percent => around UAH 4.4 billion (0.3 percent of GDP). - Scope to increase property taxation and reduce exemptions. - Aggregate illustrative package (as presented) - SSC rate 28 percent and cap 25 MSW => revenue shortfall -54.3 (UAH billion) - 3.5% of GDP (no CPT offset) - Compensatory measures (UAH billion and % GDP): - PIT 3 rates 3.5 0.2 - VAT rate increase on medicine 13.2 0.8 - Excises 9.9 0.6 - STS reform PIT 12.0 - 17.0 0.8 - 1.1 - STS reform SSC 18.7 - 26.3 1.2 - 1.7 - CPT rate from 18% to 20% 4.4 0.3 - VAT rate increase from 20% to 21% 7.0 0.4 - Eliminate special VAT regime for agriculture 4.7 0.3 - Total Compensatory measures 73.4 - 81.0 (UAH billion) 4.7 - 5.2 (% of GDP) - Net Revenue Effect 19.1 - 26.7 (UAH billion) 1.2 - 1.7 (% of GDP) - Policy conclusion: - Do not reduce SSC rate below 28 percent and increase cap to 25 MSW. - Compensate reduction in SSC with a combination of the listed VAT, excise, PIT, CPT and STS reforms. ### Excises, public health and revenue opportunities - Excises accounted for almost 3 percent of GDP in 2014 or 8 percent of total tax revenue. - Composition (2014): domestic tobacco ~40% of excise revenue; gasoline and other oil products ~one third. - Recent excise changes (March 2014 and December 2014) and inflation/exchange impacts: - Hryvnia depreciated by 100 percent since March 2014 tax code amendments; year-on-year inflation running at 60 percent at time of writing; many excise duties have lost real value. - Scope exists to raise excises on beer, spirits, tobacco and motor vehicles; potential additional revenue 0.4–0.9 percent of GDP in 2016 under three rate-increase scenarios. - Alcohol public-health stats and excise proposals (all revenues in billions of UAH): - Fraction of all deaths (both sexes) attributable to alcohol consumption: 34.4 percent. - Incidence of alcohol related deaths for males in Ukraine: 40 percent. - Unrecorded alcohol consumption: more than half of total consumption. - Excise rate change proposals and revenue impacts (UAH billions): - Beer: Current 1.24/lt → Year 1 2.48/lt → Year 2 3.10/lt. Change in Revenue: 2.3 (Year 1), 0.1 (Year 2); 3.4 (1/% GDP), 0.2 (% GDP) - Wine: Current 0.1/lt → Year 1 0.05/lt → Year 2 0.1; Change in Revenue: 0.13 (Year 1), 0.001 (Year 2); 0.26 (1/% GDP), 0.002 (% GDP) - Spirits: Current 70.53/lt → Year 1 105/lt → Year 2 123/lt. Change in Revenue: 3.4 (Year 1), 0.25 (Year 2); 0.2 (1/% GDP) - Cigarettes: Current 227.3/ per thou. → Year 1 273/ per thou. → Year 2 295.5/ per thou. Change in Revenue: 4.1 (Year 1), 0.3 (Year 2); 6.1 (1/% GDP), 0.3 (% GDP) - Total Change in Revenues: 9.9 (Year 1), 0.6 (Year 2); 14.8 (1/% GDP), 0.7 (% GDP) - Specific excise administration recommendations: - Levy excise at point of first sale of ethyl alcohol and permit subsequent credit for manufacturers; eliminate guarantee/promise-note system and adopt an excise credit/refund system. - Zero rate ethyl alcohol uses not for human consumption and allow refunds. - Prioritize monitoring UkrSpirt and refund claimants; request technical assistance to set up monitoring and refund processes. - Fuel excise administration: address estimated ~20 percent fuel market evasion via electronic administration and excise credit system. ### Corporate Profit Tax (CPT) — technical design, inflation indexing and administration - Inflation indexing - IAS 29 and Ukrainian GAAP No 22 provide frameworks; UG GAAP No 22 requires inflation adjustment if cumulative 3-year inflation exceeds 90 percent; possible that threshold reached by end-2015. - Recommendation: specify that comprehensive inflation adjustment comes into full effect in 2016 only if annual inflation rate for 2016 exceeds a specified level; require revaluation of opening balance for 2016. - Illustrative Articles (summary): - Art. 1—Adjustment of Opening Net Worth: opening net worth adjusted by CPI change for taxable year; adjustment subtracted from taxable income. - Art. 2—Adjustment of Increases in Net Worth: contributions and nontaxable income adjusted by CPI between transaction month and year-end; subtracted from taxable income. - Art. 3—Adjustment of Decreases in Net Worth: distributions and nondeductible expenses adjusted by CPI; added to taxable income. - Art. 4—Adjustment of Items in Closing Balance: adjusted values added to taxable income. - Art. 5—Valuation of assets and debts in closing balance: rules for depreciable assets, debts, foreign currency, publicly traded securities, gold/silver, cash. - Art. 6—Valuation of inventories and unfinished products: LIFO-like last-acquired item treatment adjusted by CPI. - Nondeductible expenses - Recommend explicit Tax Code rules listing nondeductible categories: personal/owner benefits, entertainment, passenger vehicles (unless exclusively for deliveries), fines and penalties, bribes. - Thin capitalization - Current rule uses arithmetic mean of beginning and end-year debt; easily avoided by intra-year borrowing/repayment. - Recommendation: compute amount of debt as the average for each calendar month of the tax year; for each calendar month use greatest amount of debt outstanding to related parties at any time during the month. - Suggest assimilating foreign exchange gains/losses to interest income/expense for thin cap purposes. - Observation: “The 3.5 debt/equity ratio is on the high side,” consider lowering it. - Depreciation and accounting method changes - Clarify whether tax depreciation uses historical costs or accounting revaluations. - Tax Code should include adjustments when taxpayers change accounting method (e.g., national GAAP → IFRS): differences included in taxable profit or deducted as loss. - Consolidation, long-term contracts, leasing - Require separate entity accounts for tax purposes even if consolidated financial statements prepared. - Allow percentage-of-completion for long-term contracts consistent with national GAAP/IFRS. - Clarify finance lease classification to prevent inconsistent positions. - Provisional and advance corporate tax payments - Allow crediting Advance Corporate Tax (ACT) against provisional payments. - Revise provisional payments: compute profit tax ratio from previous year (profit tax as percentage of total turnover) and apply to current provisional-period turnover (examples and numeric illustration provided). - Investment funds - Current treatment overly generous (Article 141.6.1); recommendation: limit exemptions to regulated funds only. - Two taxation options: mark-to-market with inflation adjustment or defer gains until realized with annual withholding; undistributed amounts added to shareholder cost. - Simplified CPT regime (turnover < 20m hryvnia) - Current simplified regime open to abuse; characteristics include exemption from tax adjustments and provisional payments; moratorium on tax audits for 2015–2016. - Recommendation: abolish CPT special regime and apply a single set of rules using accrual accounting under national GAAP. Consider extending cash-flow accounting for small/medium taxpayers in concert with ST reform. - Drafting and style issues in the Tax Code - Tax Code poorly drafted with inconsistent sentence and list structures, imprecise cross-references, and ambiguities that enable avoidance. - Recommendations: - Decide on consistent stylistic rules (title + subdivisions recommended). - Create an office of specialist tax drafters (SFS, MOF or Parliament) to manage amendments and ensure quality drafting. - Prioritize targeted amendments for CPT, ST and SSC changes to be enacted before end-2015; submit comprehensive new Code with reasonable timeframe for parliamentary adoption (example: adopt by end-2016 if drafted early 2016). *Preface and Executive Summary of IMF technical assistance report (IMF FAD mission, Kiev, July 20–August 1, 2015).* *Source: Chapter V: Corporate Profit Tax, _cr1625 - Chapter V: Corporate Profit Tax (IMF staff report)._* ### Preface ................................................................................................................ ### Preface ### Mission details - A technical assistance mission from the IMF’s Fiscal Affairs Department (FAD) visited Kiev July 20–August 1, 2015 to review selected tax policy issues and advise on specific tax reform proposals. - Mission composition: Messrs. Roberto Schatan (mission head), Selcuk Caner (both from FAD) and Christophe Waerzeggers (Legal Department) and Mr. Victor Thuronyi, external expert. - Additional assistance from David Amaglobeli (FAD) and from Headquarters in Washington, D.C. by Mr. Ricardo Fenochietto (FAD) and Csaba Feher (Expenditure Department). - Key bilateral engagements included meetings with: - Deputy Minister of Finance Ms. Olena Makeieva and her staff. - Task Force on Tax Reform led by Ms. Natalie Jaresko, Minister of Finance. - Ministry of Finance officials including Mr. Mykola Chmeruk and Yuriy Romaniuk. - State Fiscal Service officers including Mr. Aleksandr Rekhchuk and Mr. Sergei Naumov. - Ministry of Social Policy Deputy Minister Mr. Valeriy Yaroshenko and staff. - Parliament: Ms. Nina Yuzhanina (Chair of the Tax and Customs Policy Committee) and Mr. Andrii Zhurzhii (First Deputy). - Civil society organizations, USAID Leadership in Economic Governance Program representatives, academics, tax experts from EY and PwC, private sector representatives (including IT industry spokesmen, European Business Association, and Ukrainian Association of Investment Business), World Bank, and European Union officials. - IMF Kiev office support: Mr. Ihor Shpak (senior economist). - Interpretation and collaboration: Mss. Valentina Kukhtik and Anna Burlay. ### Acknowledgement of support - The mission expresses sincere appreciation to supporting staff and interlocutors listed above for excellent support, interpretation, and collaboration. ### Context emphasized in Preface - The mission was requested by Deputy Minister of Finance Ms. Olena Makeieva. - The mission’s mandate covered review of selected tax policy issues and advice on specific tax reform proposals. --- ### Executive Summary — Key findings and analysis - Urgency: Social Security Contributions (SSC) in Ukraine need urgent attention. - Fiscal risk: If nothing is done, the budget is poised to lose 4.5 percent of GDP in revenues in 2016 due to a legally mandated SSC rate reduction adopted in March 2015. - Current SSC level: SSC are at 40 percent of payroll, described as above all countries in the OECD. - Informality: Ukraine hosts a very large informal sector which constrains social and economic potential. - Fiscal constraint: There is no fiscal space to forgo tax revenues; shifting the tax burden away from labor must be revenue neutral and compensated from reliable sources. - Critique of a proposed merger: The plan to merge SSC, the Military Tax and PIT into a single income tax initially at a 29 percent rate on a gross-up wage is judged infeasible because: - No guarantee wages would be grossed-up for everyone; the switch would be optional and higher-paid individuals would likely remain in the old system. - Two SSC regimes would coexist, negating simplification. - Pensions remain correlated with contributions and payroll, so reporting and administrative procedures would remain fundamentally unchanged. - Financing social security entirely from the budget should only be considered alongside a comprehensive review of benefits. - Single Tax System (STS) concerns: - Originally for small entrepreneurs, STS has become porous, allowing very low tax and symbolic SSC fee for qualifying taxpayers. - STS creates opportunities for avoidance by employers contracting workers as independent entrepreneurs. - Fundamental reform needed to restore horizontal equity: address excessive turnover cap, override of VAT threshold, admission of legal persons, and incentives for employee reclassification as independent entrepreneurs. - Revenue potential is limited given enforcement difficulty. - Policy stance on SSC and informality: - The report endorses lowering SSC rates (retaining payroll tax form) and tightening regime for small self-employed taxpayers, but cautions that lowering rates alone is unlikely to materially reduce informality. - International evidence suggests reducing informality requires a comprehensive approach: regulatory environment, access to financial services, and quality social security benefits. - Foregone revenues from SSC reductions should be recouped from reliable sources; do not rely upfront on expansion of the tax base from lower SSC rates. - Possible scenario outlined: - Reduce average SSC more moderately, for example, to 28 percent (keeping very few of current 67 risk specific rates). - Increase the cap on the payroll tax to 25 minimum wages (MW). - Compensate revenues primarily from indirect taxes. - STS reform proposal summary: - Simplify STS and remove most concessional features by excluding all legal persons and all VAT taxpayers. - Adopt single threshold for VAT and STS, which could be raised to 2 million hryvnias. - Apply general personal income tax rates to a simplified cash flow accounting base for most self-employed, except very small income self-employed (current Group 1) who continue to pay a small fee. - Apply normal SSC rates, except for the smallest taxpayers in Group 1 of the ST. - Tax Code (TC) issues: - Complexity arises largely from intricate and sometimes vague TC language, causing disparate and arbitrary interpretations. - Antagonistic relationship between taxpayers and SFS is aggravated by absence of effective dispute resolution mechanisms. - Proposals that appear to simplify (e.g., fewer PIT rates, flat tax, replacing CPT with tax on distributed dividends) are often illusory—corporate profits still need calculation and may defer corporate tax collection indefinitely. - Corporate Profit Tax (CPT) recommendation: - Simplify technical legal drafting and consider policy amendments. - Consider equating CPT rate with top PIT rate of 20 percent to eliminate arbitrage and because CPT revenues are noticeably low by international standards. --- ### Recommendations — Timing: Short Term (ST); Medium Term (MT); Long Term (LT) Chapter II: Social Security Contributions - Take a comprehensive approach to informality, do not rely only on reducing SSC rates LT - Do not combine SSC and PIT into a single tax ST/MT - Reduce the total number of SSC rates according to risk class (67) to a handful ST - Consider reducing SSC rates gradually but as part of a revenue neutral package MT - Do not rely on potential dynamic effects of SSC reduction in employment for achieving fiscal neutrality ST/MT/LT - Do not contemplate an initial reduction below a 28% average SSC rate ST/MT - Find compensating measures primarily in indirect taxation and property taxes ST/MT - Eliminate horizontal inequity in SSC between employees and sole proprietors ST - Strengthen regulatory definitions of employee ST - Do not introduce presumptive taxation except for existing rule applying to part-timers ST/MT/LT - Consider substituting SSC with full budgetary resources only in strict coordination with comprehensive reform of SS system LT Chapter III: Single Tax System - Eliminate legal persons from the STS ST - Eliminate VAT payers from the STS ST - Keep a concessional low fee contribution only for current Group 1 ST/MT/LT - Combine Groups 2 and 3 and tax them at general income PIT tax rates on cash flow basis ST - Set upper limit for new simplified tax regime at 2 million hryvnias per year ST - Increase the VAT registration threshold to the same level (conditional to STS reform) ST Chapter IV: Excises - Increase substantially excise on alcoholic beverages, especially beer and spirits ST - Levy the excise at point of first sale of ethyl alcohol and permit subsequent credit for manufacturers ST - Continue to increase excises on tobacco nearer to EU standards MT - Introduce an excise credit system in the supply chain of fuels to combat extensive evasion ST *Preface and Executive Summary of IMF technical assistance report (IMF FAD mission, Kiev, July 20–August 1, 2015).* ### Chapter V: Corporate Profit Tax ### Chapter V: Corporate Profit Tax ### Summary recommendations for Corporate Profit Tax - Disallow deductions for non-business expenses, and identify specific categories of non-deductible expenses ST - Introduce a mechanism for inflationary adjustment for tax purposes that is triggered when inflation reaches a specified level LT - Tighten the thin capitalization rule ST - Change the base of the provisional payments to refer to previous year profit margin ST - Permit crediting ACP against provisional payments ST - Limit exemption for investment funds only to those that are regulated ST - Increase the CPT rate to 20%, same as top PIT marginal rate ST ### I. INTRODUCTION - This report discusses four topics on tax policy in Ukraine: Social Security Contributions (SSC), the simplified tax regime for small taxpayers, the Corporate Profit Tax (CPT), and excises. - Two topics—SSC and the simplified tax regime—are currently being intensively debated and are closely related; CPT and excises also need attention. - Chapter II reviews SSC; Chapter III examines the simplified tax regime for small businesses; Chapter IV explores fiscal space in excises; Chapter V (this chapter/unit) discusses improvements to the CPT. ### II. SOCIAL SECURITY CONTRIBUTIONS A. Background - Consensus: The Social Security System needs reforming. It runs with a large public deficit (over 5 percent of GDP) despite very high contribution rates. - High informality rates erode the tax base and provide strong incentives for employers and employees to opt out. - The system is weakened by generous and sometimes lax regulations governing the self-employed. - The government is considering options to simplify the system, strengthen finances, and lower contribution rates; reforms should be revenue neutral. Previous FAD recommendations - A previous FAD tax policy mission report (IMF, Restoring a Strategic Approach to Tax Reform, March 2015) noted Social SSC in Ukraine are high for international standards: at approximately 40 percent of the wage base, they are above all countries in the OECD. - The report argued the high tax burden on labor was associated with a large informal sector. - Recommendation in that report: reduce the average SSC rate, possibly by as much as 40 percent, to 25 percent of the wage bill. - The report also recommended increasing the cap on SSC from 17 to 80 monthly minimum wages; estimated cost of reducing the SSC rate by 40 percent under that condition was 1.08 percent of GDP (p.25); almost 95 percent of that amount could be recouped by introducing additional marginal rates of 20 and 25 percent in the PIT (p.31). - The report recommended drastically reducing the number of SSC rates. The policy challenges ahead - Ukrainian authorities share concerns about high SSC and informality; FAD’s recommended strategy was not adopted. Legislation changed to reduce SSC rates (though not the number of rates) without consensus on mitigating revenue impacts. - The law mandates a reduction in SSC rates without accounting for vital contextual facts: social security funds are deep in deficit; the budget in fiscal year 2016 will face additional pressure because some one-off revenue raising measures in 2015 are not renewable; and supply side effects of lower rates are not sufficiently dependable. - Reforming SSC needs to be at least revenue neutral in a static sense; revenue neutrality should not assume dynamic effects of lower SSC rates will materialize. Recommendations (from Section A) - Reduce the number of risk based SSC rates to a handful. - Reduction of SSC rates should be revenue neutral. - Revenue neutrality should not account for dynamic effects of SSC reduction. B. Deficits in social security funds - Four social benefits financed with SSC: unemployment insurance, temporary disability, accident insurance and pensions. - Pensions dominate: revenues of the pension fund are about eight times the other three funds combined. - The pension system has operated with a very significant deficit for a long time: deficit diminished from 7 percent of GDP in 2009 to 5 percent in 2104, projected deficit for 2015 is 3.9 percent of GDP. - Other funds are projected to add 1.4 percent of GDP to that deficit in 2015. Key numerical points (as stated) - Social Security System runs with a large public deficit (over 5 percent of GDP). - SSC are approximately 40 percent of the wage base. - Informal sector: F. Schneider, A. Buehn & C. Montenegro indicate Ukraine ranked 140 among 151 countries, with an informal sector representing nearly 50 percent of GDP for the period 1999-2007 (cited context). - Pension fund deficit evolution: from 7 percent of GDP in 2009 to 5 percent in 2104; projected deficit for 2015 is 3.9 percent of GDP. - Estimated static cost of the December 2014 government SSC proposal (with 2013 data) was UAH 17.5 billion (1.2 percent of GDP). - Previous FAD estimate: cost of reducing SSC rate by 40 percent under increased cap scenario was 1.08 percent of GDP. C. SSC reform: recent changes in the law and new proposals The initial proposal by the Ukrainian government (December 2014) - Proposed graduated reduction in SSC for employees with income above 2 MW. - Proposed compensation measures: a) impose a minimum base of one monthly MW on employees working less than 40 hours per month; b) raise significantly the cap on SSC. - Mission calculation: (static) cost UAH 17.5 billion (1.2 percent of GDP). Note: estimate did not include effect of lower employers’ deductions for CIT purposes due to lower SSC. The first reform adopted by the Rada - Government proposal not adopted. Rada voted for a conditioned reduction in SSC rates for 2015 (60 percent reduction conditional on payroll expansion), followed by an unconditional 40 percent decrease in 2016, without increasing the income cap nor keeping a high rate for individuals with income below two minimum wages. - The 2015 reduction of 60 percent would apply only if employers increased the payroll base sufficiently (combining new employment and increased wages). For 2016 the bill authorized a 40 percent cut without conditions. - In 2015, 7,000 employers applied the reduced SSC rate, covering almost 700,000 employees (SFS data). Compliance with conditions and the source of payroll increases (regularization, employment, wage inflation, mergers) remain uncertain. Subsequent amendments and developments - March 2015: Rada lightened conditions; allowed each company to adjust down its SSC rate according to increase in wage base paid in 2015 vs 2014, without exceeding 40 percent reduction. 2016 reduction coefficient set at 0.6 without conditions. - May 2015: Rada approved eliminating all conditions to decrease SSC rate in 2015, allowing immediate reduction to 60 percent (lowering current rate from 40 to 15 percent in 2015) with no compensating measures. Bill 2576 voted May 19, 2015; President vetoed this bill in July, 2015. - Uncertainty remains whether employers will formalize payrolls in response to cuts; absence of amnesty or credible enforcement to collect past due SSC reduces incentive to regularize. Box 1. Amendments to the SSC reform, 2014–2015 (summarized) I. Initial proposal (Dec 2014) - For wages below 1 MW (part-timers) assessment base = 1 MW. - For wages up to 2 MW current (40 percent average) rate applies. - For wages exceeding 2 MW SSC reduced to marginal rate of 26 percent for 2015, 21 percent for 2016 and 16 percent for 2017. II. Proposal adopted by Rada on December 28, 2014 - In 2015 SSC may be reduced by coefficient 0.4 if concurrent conditions met: (i) SSC base exceeds average monthly base in 2014 by at least 2.5 times; (ii) average wage higher by at least 30 percent compared with 2014; (iii) average payment per individual insured at least UAH 700; (iv) company average wage at least three minimum wages. - For 2016 coefficient set at 0.6 without conditions. III. Proposal adopted by Rada on March 2, 2015 - Taxpayers can pay a lower SSC rate in 2015 if: (i) 2014 monthly SSC base per employee increases 20 percent; (ii) average SSC payment per employee no less than 2014 average; (iii) number of employees does not exceed 200 percent of 2014 average. - Reduction in SSC rates set per company and calculated as ratio of average monthly salary in 2014 and current reporting month salary; reduction capped at 0.4. - Reducing coefficient from January 1, 2016 set at 0.6 without conditions. IV. Proposal voted in Rada May 19, 2015 - SSC lowered using 0.4 reduction coefficient beginning current year and no conditions apply. - President vetoed this bill in July, 2015. Discussion in the Task Force - Ongoing discussions; one proposal gaining traction: merge SSC and the “Military Tax” with PIT at a flat 29 percent rate (higher than the current top marginal rate). Revenues allocated between the general budget and funding social security benefits. Current SSC and Military Tax would be grossed-up to wages to increase the base of the new “combined” PIT. PIT rate would then decrease gradually to ultimately 20 percent by 2018. - Risks: merging SSC with PIT entails important revenue risks. Compensators under review rely heavily on employers legalizing underground wage bills and taxing simplified-regime small taxpayers at much higher rates—uncertain and potentially inconsistent assumptions. - Ukraine has no fiscal space for SSC reform that loses revenues. Any upfront reduction in SSC must be fully compensated by other revenue-increasing measures from certain sources. Simultaneous changes in the PIT - December 2014 tax reform increased the top marginal PIT rate to 20 percent. FAD recommended also including an additional income bracket at 25 percent. - May 2015 initiative sought to increase lower bound of the income bracket to which 20 percent applies from 10 MSW to 17 MSW, making individuals with income between 10 and 17 MW pay only 15 percent (a tax cut relative to prior 17 percent); bill vetoed by the President in July. Recommendations (from Section C) - Overturn the uncompensated SSC rate reduction coefficient of 0.6 projected for 2016. - Reductions in SSC rates must be fully compensated by additional tax revenues. - Do not include in expected revenues possible effects from reducing the informal economy. - Do not decrease the base of the top marginal rate in the PIT. *Source: Chapter V: Corporate Profit Tax, _cr1625 - Chapter V: Corporate Profit Tax (IMF staff report)._ ### 21. Traditionally social security systems have both a pension component and a welfare ### 21. Traditionally social security systems have both a pension component and a welfare safety net for the old aged ### Nature and design of social security systems - Social security systems combine: - a pension component (benefit correlated with contributions up to a point), and - a welfare safety net for the old aged (minimum pension not sufficiently funded by beneficiary contributions). - The safety net is financed by high income social security contributors and all taxpayers (from the general fiscal budget), in varying proportions, depending on the deficit of the social security system. - Defined-benefit, pay-as-you-go (PAYG) systems: - Government acquires obligation to pay retirees a specified benefit funded with SSC from current taxpayers, supplemented with revenues from other taxes as required. - Pensions are normally a declining function of contributions, providing a replacement ratio of the salary earned at retirement. - Welfare payments are not tied to contributions; they constitute a minimum pension. ### Ukraine: demographic pressures and fiscal implications - Population trends and demographics: - Population declined from 51.6 million in 1993 to 44.6 million in 2015. - The cohort aged 65+ represents today 15 percent of total population, larger than each of the cohorts between 0-14 and 15-24 years of age. - Fiscal and labor-market consequences: - Shrinking labor force combined with fast ageing → higher tax burden and higher incentive not to work or to work in the informal sector. - Dwindling payroll tax base already subject to a very high tax rate generates incentive for a growing informal sector that deprives the social security system of funds. - Result: social security benefits increasingly financed from the general budget. - Active coverage and informality: - Growth of informality reduces participation of workers in mandated pension schemes (active coverage). - Non-contributory benefits and special regimes for the self-employed expand welfare component financed from general funds — potentially creating a vicious circle encouraging informality. - Institutional aspects: - A separate social security accounting is important to preserve the legal commitment and intergenerational contract embodied in PAYG systems; separate accounting helps ensure entitlements are not renegotiated yearly in the budget process. - Even if payroll taxes are replaced by other taxes, payroll records remain necessary because pensions are a percentage of labor income and benefits depend on contribution records. Recommendation - Consider fully funding pensions from the budget only when reviewing comprehensively the social security system and its pension benefits ### The continuing allure of a flat PIT in Ukraine - Historical and recent PIT structure: - Ukraine introduced a flat tax in 2004 at a single rate of 15 percent on income of all individuals. - In 2011 a second marginal rate of 17 percent was introduced for higher income individuals, but few actually paid this top rate: 212,416 individuals – 1.3 percent of total PIT payers. - More recently the top rate was increased to 20 percent. - Political pressure: - There is a strong push to return to the flat tax and replace the current PIT, the SSC and the Military Tax. - Assessment of flat tax claims: - Simplicity argument: switching from three rates to one is of negligible administrative difference; true complexity lies in base definitions, exemptions, special regimes, ambiguous language, inconsistent rules. - Revenue effects: empirical evidence does not strongly support expectation of higher revenues from a flat tax; many countries that introduced flat taxes did not see major employment surges and suffered revenue loss. - Quotation: “Except in Russia, the second wave of low-rate flat tax reforms have been associated with a reduction in revenue from the PIT: behavioral responses may have mitigated the revenue loss, but in no case has there has appeared to have been a Laffer effect: these reforms have not set off effects strong enough for them to pay for themselves. And in Russia, there is little evidence that the strong revenue performance after the reform was due to the flat tax itself: rather it appears to have reflected wider macroeconomic recovery.” - Distributional effects: flat taxes can worsen income distribution, particularly harming the middle class and favoring the richest brackets. - Ukraine’s Gini coefficient in 2010 was: 24.8. - International experience: - Slovakia re-introduced a progressive income tax system in 2013; tax revenues declined as a percentage of GDP from 39.6 percent in 1995 to 29.6 percent in 2013. - IMF/FAD view: - FAD’s basic recommendation in its March 2015 report: gradually reduce SSC only if a fully compensating strategy was adopted with a more progressive tax system. Recommendation - Do not overstate the simplification benefits of a flat tax system; keep a progressive structure for PIT. ### SSC rates, payroll taxes, and formal employment - Incidence and distributional features of payroll taxes: - Payroll taxes (SSC) tax wages at the same rate starting from the first unit of earnings—this imposes a relatively high burden on lower-income workers compared with PIT which often exempts an initial low income bracket and is graduated. - SSC contributions are often capped, reflecting capped benefits; this pattern creates a strong incentive to work in the informal sector, especially when social security benefits are not highly valued. - Base stability: - SSC in Ukraine collect more than double the revenue of the PIT: 11.8 percent of GDP versus 4.8 percent in 2014. - Rationale: all wage-earners are subject to SSC with no exemptions, loopholes, deductions or special regimes. - The payroll is a more stable tax base than profits over the cycle, helping protect SSC-funded entitlements from budgetary adjustments. - Empirical relationship between SSC rates and informality: - Correlation between SSC rates and informality is weak in OECD evidence; correlation coefficient for sample = .25. - Cutting SSC rates is not strictly associated with declining informality: about half of OECD countries between 2007 and 2012 reduced SSC rates while the other half increased them, yet both groups experienced an almost equivalent reduction in informality. - Other determinants of informality: - Labor regulations and other labor costs (inflexible labor regulations, high severance payments, collective bargaining) can offset effects of SSC rate changes. - Informality is multivariate; relying solely on lowering SSC rates risks little effect. - Access to financial services has a stronger empirical correlation with informality than SSC rates. - Ukraine-specific labor regulation indicators (selected comparative metrics): - Ukraine: No 50-hour workweek allowed for 2 months a year in case of seasonal increase; Maximum working days per week: 5; Premium for night work (% of hourly pay): 20.0; Premium for work on weekly rest day (% of hourly pay): 100; Paid annual leave for a worker with 1 year of tenure (in working days): 18.0; Maximum length of probationary period (months): 1.0. - Selected Eastern European countries: Unweighted average (excluding Ukraine) metrics shown for comparison; Rest of World (average) metrics shown for reference. (Source: World Bank Doing Business: Labor Market Regulation) - Minimum payroll tax base and part-timers: - International evidence: students, welfare recipients and low income workers are most likely to participate in the underground economy. - March 2015 reform in Ukraine introduced a minimum SSC base for part-timers equaling one monthly minimum wage, aiming to clamp down on full-time employees declaring earnings for less than 40 hours/month. - Potential consequence: may drive some further into the shadow economy with an undetermined net effect on revenues. - Reform does not affect unregistered payments (“brown envelopes”) of higher income individuals; expected revenue gains could be illusory. - Footnote numerical details preserved: - A proposed measure would have benefited about 140,000 taxpayers, with a cost to the budget close to UAH 51 billion. The number of taxpayers earning more than 17 MW is 76,570 (2014). *Source: IMF staff report chapter on social security, pensions, PIT and SSC in Ukraine* ### 44. Tangible benefits obtained from social security are a strong incentive in favor of ### _cr1625 - 44. Tangible benefits obtained from social security are a strong incentive in favor of ### Tangible benefits and formal employment - Pensions may be the more costly benefit, but health services for the contributing population can have greater appeal, especially to young people who may heavily discount pension benefits. - Evidence: a study in Uruguay showed that extending health benefits to dependent children of private sector salaried workers had a significant effect on informality. - Administrative rules that impose a minimum social security base, such as that in Bulgaria, do not apply to part-time employees (reference to K. Pashev). ### Some administration issues - Social security contributions (SSC) collection involves multiple authorities and requires inter-institutional coordination and clear division of responsibilities (example: in Ukraine the SFS collects SSC but does not enforce all other social security compliance rules). - Registration and record-keeping issues: - Employers must register employees and issue a registration card (procedure temporarily suspended at time of writing). - Registration records must be kept at a central office, which may differ from the workplace, complicating onsite inspections. - Registration of employees required before they start work only since January 2015. - The cash problem: - Unreported wages cannot be deducted for CIT purposes, so avoiding SSC poses a problem for employers without large cash earnings to keep unregistered. - Employers may present false invoices to substitute for unregistered cash wage payments; likely suppliers of such invoices are businesses rich in cash from non-legal origins. - SFS has limited powers to investigate such companies because bank secrecy laws restrict access to bank statements (SFS can obtain bank statements only with a court order and then generally only general account balances). - Recommendation: soften bank secrecy laws for tax purposes (e.g., require only intermediation of the central bank to obtain information). - Ukraine’s participation in international tax information exchange will require access to bank account information for sharing with partner countries. ### Recommendations (administration and design) - Keep SSC as a separate payroll tax. - Develop a comprehensive, inter-institutional strategy to combat informality. - Do not increase presumptive taxation on low income earners. - Relax bank secrecy regulations for tax purposes. - Continue to seek technical assistance on tax administration related to SSC. ### The social security regime for the self-employed - Hiring workers as if they were self-employed (sole proprietors) can be used to avoid SSC payments. - Key problem: sole proprietors under the Single Tax (ST) regime are excluded from PIT and contribute a minimal SSC. - Two types of self-employed under civil law contracts: - Service providers: treated as employees for tax purposes; withholding under general PIT and SSC rules. - Individual entrepreneurs / sole proprietors: SSC due on profits, subject to a minimum; rules differ if registered under ST. - Under ST regime: - Sole proprietors contribute at the rate of 34.7 percent of one MW, regardless of income earned. - Minimum quota applies even if no income is earned. - The regime is cheaper for anyone earning more than a minimum wage, creating incentives to hire workers as sole proprietors under ST. - Labor Code issues: - Labor Code lacks clear definition of “employee,” enabling classification of workers as sole proprietors despite de facto employment conditions. - Ministry of Social Policy inspectors may lack authority to re-characterize civil contracts as labor contracts to trigger SSC collection. - Revenue impact: - Revenue loss of reduced SSC payments by sole proprietors may be as high as UAH 3.85 billion (0.25 percent of GDP) in 2014. - Estimate based on Group 2 and 3 sole proprietors under ST: 905,195 sole proprietors, accounting for 80 percent of ST individuals. - Conservative assumption: one half of taxpayers in this group would continue to pay based on one MSW under a change. - Recommendations for self-employed regime: - Eliminate preferential SSC treatment for sole proprietors under the ST regime. - Legally define “employee” to include persons formally under contract as sole proprietors but de facto working under the same conditions as employees, and make these liable to general SSC rates. ### Revenue effects of proposed SSC reforms - Baseline and distribution (2014 figures): - Current average SSC rate: 41 percent. - Contributions capped at 17 MSW. - Out of 13.87 million taxpayers, 87 percent earn less than UAH 5,000 per month. - Those earning less than UAH 5,000 pay 61 percent of the SSC. - Annual SSC - total (in UAH billions) reported as: Private sector 323.29; Budgetary sector 129.50; Total 452.79. Average monthly SSC per person total 176.97 (Private 123.92; Budgetary 53.05). - SSC rate reductions and revenue impact (estimates using 2014 as if applied in 2014): - a. Reduce the SSC rate by 40%: - SSC Revenues (capped at 17 MSW): -70.8 (as % of GDP: -4.5%) - b. Reduce the SSC rate by 60%: - SSC Revenues (capped at 17 MSW): -106.2 (as % of GDP: -6.8%) - c. SSC rate at 30% and increase cap to 25 MSW: - Revenue Change: -46.0 (as % of GDP: -2.9%) - d. SSC rate at 28% and increase cap to 25 MSW: - Revenue Change: -54.3 (as % of GDP: -3.5%) - e. Additional rate of 5% on incomes over 30,000 UAH/month: - Revenue Change: 1.4 (as % of GDP: 0.1%) - Specific fiscal estimates: - SSC rates were reduced by 60 percent in 2015, subject to conditions, and will be reduced unconditionally to 40 percent of the old rate in 2016. - Next year losses in SSC revenues (using 2014 figures) from unconditional 2016 reduction: UAH 70.8 billion (4.5 percent of GDP). - If reduced deductible labor cost fully translated into higher CPT, negative impact could be reduced to 3.9 percent of GDP (partial offset), though full offset unlikely due to Advance Corporate Tax refund arrears and corporate loss-carry forwards. - Financing requirements with alternative scenarios (when offsetting CPT revenues taken into account): SSC at 30% with cap 25 MSW => 2.6 percent of GDP (note: text states 2.9 percent without CPT offsets, footnote says 2.6 percent with CPT offsets); SSC at 28% with cap 25 MSW => 3.0 percent of GDP with CPT offsets (3.5 percent without). - Introducing a second SSC rate: - A second SSC rate at 5 percent on individuals earning over UAH 30,000 per month generates a small additional SSC revenue: 1.4 UAH billion (0.1 percent of GDP). ### Revenue effects of merging SSC and PIT into a flat PIT - Proposal key features under Task Force for Tax Reform: 1. Replacement of the SSC, Military Tax and the PIT by a flat 29 percent PIT rate. 2. Gross up of the wage bill by the amount of SSC and the Military Tax. - Estimated initial cost of the re-arrangement (as if applied in 2014): UAH 75.2 billion in tax revenues forgone. - Breakdown (in UAH billion): - Total PIT at 29%: 167.3 - Current PIT Revenue forgone: -60.5 - Military tax forgone: -5 - SSC forgone: -177 - Net revenue change: -75.2 - Mitigating measures proposed: - Substantially increase the tax burden on ST regime beneficiaries. - Decrease net wages of public employees. - Assume increased revenues from formalizing underground economy. - Taxing ST taxpayers: - Plan would impose a 20 percent rate on gross income across the board to taxpayers in Groups 2 and 3 (legal persons and individuals), estimated to generate close to UAH 22 billion and reduce shortfall from UAH 75.2 to UAH 53.1 billion (3.4 percent of GDP). - Detailed estimates (in UAH billion): - Estimate of Revenue from Third Group of Single Taxpayers (Individuals): - Total income: 73 - Tax at 20%: 14.6 - Forgone ST revenue: 3.4 - Net revenue change: 11.2 - Estimate of Revenue from Third Group of Single Taxpayers (Corporate): - Total income: 64.5 - Tax at 20%: 12.9 - Forgone ST revenue: 2 - Net revenue change: 10.9 - Total Net Revenue Effect: -53.1 - Risks and distributional effects: - Increased revenues from taxing ST taxpayers may be overestimated: - A 20 percent tax on turnover compares unfavorably to CPT (18 percent on net income), so taxpayers could switch to CPT. - Legitimate sole proprietors could deduct expenses in the regular PIT regime and pay a lower rate if income is under 10 MW (over 60 percent of individual taxpayers in Groups 2 and 3). - Higher tax burden on this group may push many into the informal sector, eroding assumed gains in tax base. - Distributional impact: - Combining SSC and PIT into a flat 29 percent tax would change the distribution of combined tax burden: - The new flat 29 percent would have a progressive effect relative to the current system that relies on high SSC rates on low income individuals. - Lower income individuals would be relieved of the full weight of SSC; high-income individuals would face higher tax burdens as they would no longer be protected by the SSC cap. - Breakpoint identified at UAH 50,000 per month (individuals earning above this would stay in the old system under the proposal). - The proposal’s progressivity is lost if the new system is optional. *Source: IMF staff report content as provided in the source PDF.* ### 62. The revenue shortfall would be remedied by government payroll savings and ### _cr1625 - 62. The revenue shortfall would be remedied by government payroll savings and ### Revenue shortfall and government payroll savings - Proposal envisages very significant savings in net government expenditure through: - A drastic reduction in the net payment to all public employees because government employees would not get their wages grossed up with the elimination of SSC, but they would still have to pay a 29 percent PIT rate. - For government employees the PIT tax burden almost doubles, with no increase in wages. - The rest of the change in tax bases is a wash for the government. - The new system would have to be compulsory for government employees to achieve such savings. - The mission cannot estimate how much tax revenues could increase from a shift of informal activities into the legal sector with a lesser tax burden; empirical evidence is mixed and results quite uncertain. ### Income-category impacts (selected figures from IMF FAD staff calculations; in UAH billion) - Total taxpayers: 13,872,822 - Aggregate changes (columns preserved as in source): - Change in PIT: 70.83 - Additional PIT Revenue from Gross up with SSC: 35.93 - Change in Total PIT after Military TaxSSC: 106.76 - Change in Total PIT after Gross up with SSC: 5.00 - Net Change in Taxes: 176.97 - Change in Taxes as Share of Average: (75.21) - Overall percent change: (16.6) - Selected income brackets (total number of taxpayers and key figures preserved): - 0-500: 1,131,763 — Change in PIT 0.59; Additional PIT 0.16; Change in Total PIT after Gross up with SSC 0.75; Military TaxSSC 0.02; Net Change in Taxes 0.83; Change in Taxes as Share of Average (0.10); (5.2) - 501-1000: 1,341,899 — Change in PIT 2.44; Additional PIT 0.68; Change in Total PIT after Gross up with SSC 3.13; Military TaxSSC 0.10; Net Change in Taxes 3.54; Change in Taxes as Share of Average (0.50); (5.8) - 1001-5000: 9,619,801 — Change in PIT 41.84; Additional PIT 20.14; Change in Total PIT after Gross up with SSC 61.98; Military TaxSSC 2.80; Net Change in Taxes 104.06; Change in Taxes as Share of Average (44.88); (17.7) - 5001-10000: 1,431,411 — Change in PIT 15.68; Additional PIT 8.51; Change in Total PIT after Gross up with SSC 24.19; Military TaxSSC 1.18; Net Change in Taxes 43.95; Change in Taxes as Share of Average (20.95); (19.5) - 10001-20000: 265,497 — Change in PIT 5.64; Additional PIT 3.15; Change in Total PIT after Gross up with SSC 8.79; Military TaxSSC 0.44; Net Change in Taxes 16.27; Change in Taxes as Share of Average (7.91); (19.9) - Higher brackets continue with detailed small values (preserved in source). ### Other tax measures to compensate SSC reform - Reductions of the SSC rate within the existing tax structure could be explored; previous FAD reports suggested gradual reduction if reliable revenue sources are found. - Policy option: limit compensation initially to a reduction of SSC rates to 30 or 28 percent while increasing the cap significantly, for example to 25 MSW. - Combining a SSC rate cut to 28 percent with such a cap would result in a revenue shortage of 3.5 percent of GDP, assuming no CPT offset due to lower SSC deduction by employers. - There could be sufficient fiscal space in indirect taxation and other components of the income tax to allow for a reduction in SSC rates. - Reforming the ST regime must be an integral part of this change to stop erosion of the system through the self-employed. ### VAT measures (indirect taxation) - Indirect taxes are the first choice for financing SSC reduction because they are least distorting and more growth friendly. - Examples and estimated yields: - Increasing the general VAT rate by one percentage point would generate about UAH 7 billion (0.4 percent of GDP). - Increasing the preferential rate applied to pharmaceuticals (currently 7 percent) to the new general rate of 21 percent would increase revenues by about UAH 20.1 billion (1.3 percent of GDP). (Estimate is for 2014.) - Eliminating the special VAT regime for the agriculture industry could conservatively yield an additional 0.3 percent of GDP. - VAT alone could provide a fiscal space of close to 2 percent of GDP. ### Excise tax rate increases - Other than excise on petroleum products, excise rates are relatively low. - Based on recommendations in Chapter IV, it is possible to increase tax revenues by 0.6 percent of GDP in 2016. ### Income taxes: PIT reform and inclusion of ST taxpayers - Less room to increase revenues from income taxes, but options include: - Introducing a third PIT bracket and a new marginal rate to improve progressivity and raise revenue. - Example: a 25 percent rate applied to an income bracket above UAH 15,000 (based on wage income only) would generate around UAH 3.5 billion, or 0.2 percent of GDP. - Including de facto employees currently in the ST regime into PIT: - Extreme upper bound: shifting all individuals under ST (if all are employees) would move UAH 225.5 billion into PIT; at an average effective PIT rate of 13.4 percent this would yield UAH 32.6 billion in revenues. - A more prudent estimate would assume no more than one half of that amount; this potential buffer is intentionally not included in the compensating measures listed in Table 10. ### CPT measures - Revenue yield of CPT in Ukraine has been declining; tightening the base and increasing rate are options. - If CPT measures accompany reforms and increase the tax rate from 18 percent to 20 percent, revenues could be increased by around 0.3 percent of GDP. - Potential SSC reduction effects could increase CPT revenues for companies with no tax arrears or losses to carry forward (not estimated). ### Property taxes - There is scope to increase property taxation, including reducing exemptions in residential properties and motor vehicles. - A circulation tax on luxury cars introduced in 2014 at UAH 25,000 per year is applied to a small proportion of luxury cars and can be expanded. ### Summary of measures and quantified revenue effects (as presented) - Revenue impact w/o CPT offset as % of GDP: - SSC rate 28 percent and cap is 25 MSW -54.3 - 3.5 - Compensatory measures (values preserved as in source): - PIT 3 rates 3.5 0.2 - VAT rate increase on medicine 13.2 0.8 - Excises 9.9 0.6 - STS reform - PIT 12.0 - 17.0 0.8 - 1.1 - SSC 18.7 - 26.3 1.2 - 1.7 - CPT rate from 18% to 20% 4.4 0.3 - VAT rate increase form 20% to 21% 7.0 0.4 - Eliminate special VAT regime for agriculture 4.7 0.3 - Total Compensatory measures 73.4 - 81.0 4.7 - 5.2 - Net Revenue Effect 19.1 - 26.7 1.2 - 1.7 ### Recommendations (policy menu preserved from source) - Do not reduce SSC rate below 28 percent and increase the cap to 25 MSW. - Compensate reduction in SSC with a combination of the following measures: - Increase the VAT rate from 20 percent to 21 percent. - Eliminate the preferential VAT rate on pharmaceuticals. - Eliminate special regime for agriculture. - Increase excise tax rates as recommended in Chapter IV. - Increase the CPT rate from 18 percent to 20 percent. - Introduce a third PIT rate of 25 percent on incomes over UAH 15,000. - Eliminate concessional features of the ST regime as described in Chapter III. ### Simplified taxation regimes for small taxpayers (ST) - General design objectives: - Simplify compliance and allow tax authorities to focus on larger enterprises. - Simplified systems should not aim to reduce tax burden relative to general regime; threshold design is critical. - Current situation in Ukraine: - Ukraine has effectively four different simplified tax regimes collectively referred to as the Single Tax (“ST”). - About 1.3 million taxpayers are registered for ST of which 1.14 million are individuals. - Distribution of ST taxpayers and tax liabilities (2014): - Single tax total turnover / income: 437,599,795 (000); Taxes paid on turnover / income: 6,904,371 (000) - Individuals (ST): total turnover / income 234,515,768 (000); Taxes paid 4,968,875 (000); Effective tax rate 2.12 percent - Group 1: 234,204 taxpayers; turnover/income 9,052,517 (000); taxes paid 260,018 (000); Effective tax rate 2.87 percent - Group 2: 631,046 taxpayers; turnover/income 152,026,724 (000); taxes paid 1,529,937 (000); Effective tax rate 1.01 percent - Group 3 individuals: 274,149 taxpayers; taxes paid on turnover / income 3,178,920 (000); VAT paid 245,543 (000); Effective tax rate 4.38 percent - Corporates (Group 3): 161,756 taxpayers; turnover/income 42,004,786 (000); taxes paid 1,935,497 (000); VAT paid 825,902 (000); Effective tax rate 4.61 percent - Features common to ST groups: - Choice between normal (PIT, CPT, and in some cases VAT) regime or ST; if eligible for more than one group, taxpayer may choose group (Article 291.3 TC). - Exclusions from specified activities (e.g., gambling, foreign exchange, manufacture/dealing in excisable goods, financial intermediation except insurance agency, etc.; Article 295.1 TC). - Simplified books and accounts permitted (sales registers, income/expense statements, simplified double-entry accounts; Articles 44.2 and 296.1 TC). - Longer reporting and payment cycles for ST taxpayers (Articles 294 and 295 TC). - ST taxpayers generally pay 34.7% SSC on the MSW except for legal entities of Group 3. - ST exemptions from CPT, PIT, VAT (except Group 3 taxpayers who choose the lower 2% ST rate), property tax and rental fee for water usage (Group 4) (Article 297.1 TC). *Source: IMF FAD staff calculations.* ### 79. Group 1 is for individual entrepreneurs with turnover of not more than ### _cr1625 - 79. Group 1 is for individual entrepreneurs with turnover of not more than ### Description of Single Tax (ST) Groups - Group 1 - For individual entrepreneurs with turnover of not more than UAH 300,000. - Entrepreneurs in this Group are not allowed to hire employees and must be engaged exclusively in retail trade, i.e. selling goods on market places or providing consumer services (Article 291.4, item (1) TC; A non-exhaustive list of consumer services is in Article 291.7). - Subject to a fixed rate of tax of up to 10% of the MSW for the income year (Article 293.2, item (1)). - Note: The rate is set by the municipality. - Group 2 (more than 631,000 individuals) - For individual entrepreneurs with turnover of not more than UAH 1,500,000 and not more than 10 employees. - May provide consumer services as well as services to other ST taxpayers, be engaged in the production and/or sale of goods, and provide restaurant services (Article 291.4, item (2) TC). - Subject to a fixed rate of tax of up to 20% of the MSW for the income year (Article 293.2, item (2) TC). - Note: The rate is set by the municipality. - Group 3 (more than 435,800 of which more than 274,000 individuals) - For individual entrepreneurs or legal entities with turnover of not more than UAH 20 million. - No limit to number of employees or type of activities (other than activities generally excluded from the ST regime) (Article 291.4, item (3) TC). - Taxpayers in Group 3 pay a proportionate tax rate of either 2% or 4% on their turnover, depending on whether or not they are registered for and pay VAT (Article 293.3 TC). - Individuals in Group 3 enjoy a flat rate of SSC. ### Analysis — Complexity, Concessionality, and Avoidance - Key analytical findings - December 2014 reform reduced ST groups from six to four but retained complexity: rate and base variations remain between and within groups; criteria combine legal status, turnover, number of employees, and type of activities. - Aggregate number of ST taxpayers has remained constant; former Groups 3, 4, 5 and 6 are now in the broadened Group 3. - Same taxpayer may meet criteria for more than one ST regime and can opt for the most favorable regime. - ST regime is excessively concessional - Group 1 and 2 taxpayers—whose income or turnover may be as high as UAH 1.5 million—pay a minimal flat rate of tax and SSC unrelated to turnover or income. - Group 3 taxpayers—whose income or turnover may be as high as UAH 20 million—pay low proportionate rates, and individuals in that Group enjoy a flat SSC. - Based on 2014 figures, individual taxpayers of Group 2 enjoy an effective tax rate that is thirteen times lower than the average PIT rate. - Primary abuse mechanisms identified - Business splitting - Incentives to split businesses to avoid turnover limits and to subdivide activities to maximize tax advantage (example: restaurants splitting alcoholic beverage sales). - SFS lacks specific powers under the Tax Code to combat such avoidance; only limit is on direct ownership of ST payers by legal entities which are not ST payers (Article 291.5.5), but no limits on ownership by individuals or aggregation of closely related individuals. - Profit shifting between related parties - Ukraine’s transfer pricing rules do not apply to transactions between resident entities or persons (Article 39 of the Tax Code). - Creates opportunities to shift income between entities under general regime and those under ST; absence of anti-avoidance rules hampers enforcement. - Reclassifying as entrepreneurs - Important incentive for employees to organize as ST entrepreneurs because SSC for entrepreneurs is calculated on the MSW rather than actual wages. - Anecdotal example: in the IT sector approximately 75,000 engineers are now working as independent contractors—representing salaries of UAH 150 million per month or UAH 1.8 billion per year—according to sector representatives. - Circumventing classification provisions - Example: leasing of real property is excluded only if activity is carried out by individuals; incorporating allows a 2 or 4 percent tax on up to UAH 20 million of leasing income instead of standard CPT/PIT rates. ### Design Considerations for Reforming the STS (Single Tax System) - Overarching objectives - Focus on simplification rather than tax incentives. - Case for simplification and limited concessions is greatest for the smallest taxpayers (“micro businesses”). - For larger simplified-regime taxpayers, align simplified rules closely with the normal tax regime to ensure smooth transition. - Suggested structural criteria - Partition taxpayers on the basis of turnover or gross income alone (avoid number of employees as a criterion to prevent incentives for informality or reclassification of employees). - VAT taxpayers should no longer qualify for the reformed simplified regime because VAT bookkeeping and filing imply capacity to manage the normal tax system. - Existing VAT threshold: UAH 1 million (approximately USD 47,500)—raised from UAH 300,000 (approximately USD 14,200) in January 2015. - Consideration: raising VAT threshold to UAH 2 million to allow the vast majority of current Group 2 and 3 ST taxpayers to remain outside the VAT system (more than 99% of Group 2 and more than 95% of Group 3 taxpayers). - Raising VAT threshold should be conditional to STS reform. - Legal entities should be excluded from the reformed simplified regime (common practice internationally; legal entities typically required to keep double-entry accounts). - Except for the smallest taxpayers, normal SSC rates should apply to entrepreneurs and their employees. - Micro businesses (current Group 1) could continue with nominal SSC in lieu of proportionate rate, and it would be advisable to continue prohibiting them from hiring employees. - Allow taxpayers in the reformed simplified regime to engage in any economic activity except a narrow, well-defined list of excluded activities (financial intermediation, lottery and gambling, mineral resource extraction, manufacturing of excisable goods). For micro businesses maintain existing limitations. - Tax base and method - Imposing PIT on entrepreneurs of Groups 2 and 3 on a cash flow basis is superior to a flat tax on turnover. - Advantages: - Businesses can immediately deduct capital expenses (capital items, except real property, immediately expensed). - Closer approximation to tax burden under the regular system and smoother transition to the normal regime. - Requires only moderate record keeping (sales and purchase records). - Recommended simplifications: - Exclude deductions for real property to further simplify and prevent abuse. - Financial income (interest and dividends) subject to normal withholding; financial expenses such as interest not deductible. - Table 13 contrasts GAAP (accrual) and Cash flow treatment (summary reproduced in source). ### Revenue Implications and Estimates - Potential revenue gains from moving individual taxpayers of Groups 2 and 3 to general PIT rates - Imposing general PIT rates on individual taxpayers of Groups 2 and 3 has a revenue potential of UAH 32.6 billion (2.3 percent of GDP) based on 2014 data (see Table 14). - Accounting for allowance for business expenses on a cash flow basis reduces the revenue gain. - Assuming: - Half of the affected taxpayer population (Groups 2 and 3) is or could convert into legitimate independent entrepreneurs. - They could obtain a 50 percent profit margin. - Expected revenue gain would be UAH 24.3 billion (1.6 percent of GDP). - Behavioral risk: taxpayers could move into the informal economy. - If they behave as the average does, anywhere between 30 and 50 percent of income would be informal and remain untaxed. - More realistic potential revenues could range between UAH 12 and 17 billion. - Assumption: legal persons moved into the general regime would not pay more taxes than now. - Revenue estimate table highlights (aggregated from SFS data and IMF FAD staff estimations; figures in UAH billions) - Group 2 totals (in UAH billions) - Number of taxpayers: 631,046 - Total turnover / income: 152.03 - Single tax paid, UAH: 1.53 - PIT Tax Liability: 24.70 - Change in Tax Liability: 23.17 - Group 3 totals (in UAH billions) - Number of taxpayers: 273,795 - Total turnover / income: 73.44 - Single tax paid, UAH: 3.11 - PIT Tax Liability: 12.51 - Change in Tax Liability: 9.40 - Total (Group 2 and 3) (in UAH billions) - Number of taxpayers: 904,841 - Total turnover / income: 225.46 - Single tax paid, UAH: 4.64 - PIT Tax Liability: 37.21 - Change in Tax Liability: 32.57 *Source: SFS data and IMF FAD staff estimations (as presented in the source document).* ### 93. In addition to paying general PIT rates Group 2 and 3 entrepreneurs would also pay ### _cr1625 - 93. In addition to paying general PIT rates Group 2 and 3 entrepreneurs would also pay ### Social Security Contributions (SSC) and Single Tax (ST) Groups 2 and 3 - Under the proposed regime in Chapter II, aggregate SSC payments by Group 2 and 3 entrepreneurs would increase from UAH 5 billion to UAH 55 billion—an increase representing 3.2 percent of GDP. - Most additional SSC revenue would be generated from taxpayers with an annual turnover or gross income under UAH 1 million, but this is likely unrealistic because: - Not all individuals in these groups are employees. - Many may move fully or partially into the informal economy or reclassify under Group 1 due to income overlap across groups. - Using the same assumptions as for PIT revenue estimation for ST taxpayers (one half remain as entrepreneurs with a 50 percent profitability rate), the potential SSC that could be raised from individuals currently under Groups 2 and 3 would be between UAH 18.7 and 26.3 billion (1.2 to 1.7 percent of GDP). - Collection challenges: these amounts may prove difficult to collect due to administrative difficulties in taxing this segment. ### Treatment of Incorporated Businesses and Revenue Effects - Incorporated businesses currently in Group 3 would be excluded from the simplified system and pay normal CPT. - The revenue effect of excluding incorporated businesses from the simplified system would be negligible because under the ST regime their effective tax rate is higher than the effective tax rate of taxpayers paying under the CPT system. ### Revenue Administration Considerations - The current design of the ST and lack of administrative control have been driven largely by mutual distrust between taxpayers and the SFS; concerns of taxpayer harassment and corruption are widely reported. - Sustainable reform of the ST and SSC (and the tax system generally) must be premised on gradual improvement in the quality of tax administration and restoration of mutual trust between taxpayers and tax authorities. - Concretely, moratoria on audits must be phased out and should not be reintroduced. ### Recommendations (as stated) - Keep the ST regime for individual entrepreneurs of Group 1 unchanged, and replace the ST regime for individual entrepreneurs of Groups 2 and 3 by a simplified tax system imposing normal PIT rates based on cash flow. - Allow entrepreneurs in the reformed simplified tax system for Groups 2 and 3 to engage in any type of economic activity (except for a narrowly defined list of excluded activities) and to employ an unlimited number of employees. - Impose proportionate SSC at normal rates on all entrepreneurs in the simplified tax system, including on their employees. - Exclude all VAT taxpayers—including those who are voluntarily registered for VAT—from the simplified regime. - Exclude all legal entities from the simplified regime. - Consider raising the VAT registration threshold to up to UAH 2 million. - Remove—or at least do not extend or reintroduce—moratoria on tax audits, including of taxpayers under a simplified regime. ### Excise Taxation — Room for Increasing Rates - Excise taxes accounted for almost 3 percent of GDP in 2014 or 8 percent of total tax revenue. - Domestic tobacco contributes almost 40 percent of total excise tax revenue; gasoline and other oil products account for about another one third of total excise tax revenue. - Most excise rates are specific (except tobacco and electricity); tobacco has a specific and an ad valorem component; excise on electricity is ad valorem. - Recent policy and rate changes: - March 2014: specific excise tax rates raised on tobacco by 33 percent, on beer by 40 percent and on ethyl spirits by 25 percent; diesel fuel rates unified and the maximum rate increased by more than 30 percent. - December 2014 tax reform: (i) increased proportional taxation of petroleum products substituting for an environmental tax; (ii) introduced electricity as an excisable commodity; (iii) unified excise tax rates on filtered and unfiltered cigarettes at a higher rate; (iv) introduced a new excise tax on retail sales of alcohol and tobacco at 5 percent of the sales value. - Exchange rate and inflation effects: - The hryvnia depreciated by 100 percent since the March 2014 tax code amendments that increased excise tax rates. - Year-on-year inflation is currently running at 60 percent, making most excise duties a smaller share of retail prices. - As a result, excise tax rates on tobacco and alcohol are among the lowest compared to most other countries in the region. - There is significant scope to increase excises on selected commodities to restore real values, given low elasticity of demand for these goods and relatively easy administration at production/import points. - Caution is advised to account for cross-border transactions (legal or illegal) and to internalize negative externalities of tobacco, alcohol and petroleum consumption. ### Potential Revenue from Excise Rate Increases and Scenarios - Ukraine could potentially raise additional revenue of 0.4–0.9 percent of GDP from excises in 2016 (three rate increase scenarios calibrated to bring rates closer to neighboring countries), while remaining below EU average rates. - The largest room for increasing rates is for beer, followed by ethyl spirits, tobacco and motor vehicles; proposed increases in motor fuels are more modest because Ukrainian rates are higher than CIS peers. - Estimates assume consumption of excisable goods remains unchanged from estimated levels in 2015 (current projections of GDP and import growth are 2 and 7 percent, respectively) and ignore possible increases in illegal production and smuggling. - Considering recent increases in excise taxes, selected rate increases could target additional revenues of up to 0.6 percent of GDP over the next two years (examples cited include raising excise on natural wine from UAH 0.01/liter to UAH 0.05/liter). ### Fuel Excises and Administration - There is potential to generate additional revenue from fuel excises without increasing rates by strengthening administration. - Industry estimates indicate about 20 percent of the fuel market evades paying taxes. - Common evasion schemes: smuggling, counterfeit fuels, re-labeling into different fuel types with lower excise rates. - Draft tax code amendments (submitted July 2015) propose electronic administration of the excise taxation on fuel products similar to VAT electronic administration to help curb evasion. ### The Special Case of Alcoholic Beverages — Externalities and Consumption - Ukraine has very high per capita alcohol consumption: in 2010, male consumption was 22 liters per year of pure alcohol equivalent (population 15+ years of age). - This male consumption level is considerably higher than in North America (Canada, U.S. and Mexico) where consumption ratios are 12-15 liters per year. - The most risky patterns of alcohol consumption (binge drinking) are observed in Ukraine (alongside Russia), according to WHO. *Source: IMF staff report text contained in the supplied content unit.* ### 107. High consumption of alcohol comes with high costs in public health. In Ukraine the ### High consumption of alcohol comes with high costs in public health. In Ukraine the ### Public-health findings and statistics - Fraction of all deaths (both sexes) attributable to alcohol consumption is 34.4 percent. - Incidence of alcohol related deaths for males in Ukraine was 40 percent. - Most other countries this number is somewhere in the range of 3 to 6 percent. - Ukraine presents a rare case of declining life expectancy and a high mortality rate, leading to a sustained population decline in the last 15 years. - Strong link between alcohol use and suicide rates; Ukraine has one of the highest suicide rates in the world, ranking 16 among 170 countries according to WHO data. - Ukraine has the highest unrecorded consumption of alcohol in the world: consumption of home brews or illegally produced alcohol beverages represents more than half of total consumption. - Ratio of unrecorded consumption in Belarus is 22 percent. - Ratio of unrecorded consumption in the U.S. is 6 percent. ### Excise-rate levels and projected revenue changes (all revenues in billions of UAH) - Current Rates (UAH) | Year 1 | Year 2 | 1/% GDP (UAH) | % GDP - Beer Rate (UAH) - Current: 1.24/lt - Year 1 proposal: 2.48/lt - Year 2 proposal: 3.10/lt - Change in Revenue: 2.3 (Year 1), 0.1 (Year 2), 3.4 (1/% GDP), 0.2 (% GDP) - Wine Rate (UAH) - Current: 0.1/lt - Year 1 proposal: 0.05/lt - Year 2 proposal: 0.1 - Change in Revenue: 0.13 (Year 1), 0.001 (Year 2), 0.26 (1/% GDP), 0.002 (% GDP) - Spirits Rate (UAH) - Current: 70.53/lt - Year 1 proposal: 105/lt - Year 2 proposal: 123/lt - Change in Revenue: 3.4 (Year 1), 0.25 (Year 2), 0.2 (1/% GDP) - Cigarettes Rate (UAH) - Current: 227.3/ per thou. - Year 1 proposal: 273/ per thou. - Year 2 proposal: 295.5/ per thou. - Change in Revenue: 4.1 (Year 1), 0.3 (Year 2), 6.1 (1/% GDP), 0.3 (% GDP) - Total Change in Revenues: 9.9 (Year 1), 0.6 (Year 2), 14.8 (1/% GDP), 0.7 (% GDP) - Source of rates and revenue calculations: Ministry of Finance and IMF FAD staff calculations. ### Policy rationale - Strong negative externalities from alcohol consumption justify a more aggressive approach to raising excise rates on alcoholic beverages. - Empirical literature finds strong evidence that increasing the price of alcohol reduces excessive alcohol consumption and related harms. - Ukraine combines excise-payment timing options: excise is paid when producers of alcoholic beverages (PAB) sell to distributors, but PAB must guarantee payment when purchasing pure alcohol from distillers via a promissory note to the SFS; the note is cancelled when excise is paid by PAB, otherwise the SFS redeems the guarantee. - This hybrid timing/guarantee system requires intricate and labor-intensive SFS controls and high compliance costs; it increases administrative burden and vulnerability to illicit trade. - Given that ethyl alcohol is produced and sold by a single enterprise, a state monopoly (UkrSpirt), a credit/refund system analogous to VAT would be more efficient than guarantees in many respects. - Ethyl alcohol has non-alcoholic uses (medicinal, chemical industry) that should be zero rated; current exemptions are limited to quotas authorized by the Cabinet of Ministers and require promissory notes and subsequent certification of use. - Taxpayers have poor experience with refunds from the SFS; technical assistance may be useful to adapt the SFS to refunds as a normal feature. - Monitoring should focus on UkrSpirt operations and on entities claiming refunds to prevent diversion of ethyl alcohol to illicit uses. - Current high unrecorded consumption (> half of total) indicates the current system does not work and exacerbates public-health risks and tax evasion. ### Specific recommendations - Increase excises on beer to UAH 2.48/lt and 3.10/lt in the next two years. - Increase excise rate on wine from UAH 0.01/lt to UAH 0.05/lt and UAH 0.1/lt in the next two years. - Increase excise rate on spirits from UAH 70.53/lt to UAH 105/lt and UAH 123/lt in the next two years. - Increase excise rate on cigarettes from UAH 227.3/thou. sticks to UAH 273/per thou. sticks and UAH 295.5/thou. sticks in the next two years. - Tax the sale of ethyl alcohol and allow credits against the tax on the sale of alcoholic beverages and eliminate the system of guarantees. - Zero rate all products derived from ethyl alcohol which are not for human consumption and allow refunds. - Prioritize monitoring operations of UkrSpirt and those which claim refunds so that ethyl alcohol is not diverted to illicit uses. - Request technical assistance to set up this monitoring program and the refund process. *Source: Ministry of Finance and IMF FAD staff calculations; WHO; IMF staff analysis as presented in the provided text.* ### 4. International and national accounting standards prescribe inflation indexing rules ### _cr1625 - 4. International and national accounting standards prescribe inflation indexing rules ### Scope and standards - IAS 29 (Financial Reporting in Hyperinflationary Economies) does not identify a specific annual inflation rate for application, but requires amounts expressed in national currency to be valued at the balance sheet date. - Ukrainian GAAP standard No 22 requires inflation adjustment if cumulative 3-year inflation exceeds 90 percent. It is possible that this level will be reached by the end of 2015. - Countries that applied IAS 29 principles for tax purposes include Chile, Argentina, Brazil, Israel, and Mexico; some later ceased adjustment as inflation fell, but adjustments can be applied even at very moderate inflation rates to measure corporate profits more accurately. ### Mechanics of comprehensive inflation adjustment (corporate) - Principle: Value each element of taxable profit at price levels prevailing at the closing balance date so profit equals: - net equity in closing balance sheet minus net equity in opening balance sheet, plus dividends and distributions during the tax period, minus contributions to capital — all indexed to end-of-period price levels. - Practical rules: - Closing assets: valued at historical acquisition costs adjusted for inflation between month of acquisition and balance sheet date. - Opening equity: adjusted for inflation between beginning and end of year. - Dividends/distributions and capital contributions: adjusted for change in price level between transaction month and year close. - Recommendation: Amend the Tax Code to specify that comprehensive inflation adjustment will come into full effect in 2016 only if the annual inflation rate for 2016 exceeds a specified level. - Require comprehensive revaluation of assets for the opening balance sheet for 2016 so depreciation and gains/losses on dispositions are based on end-2015 values. - Specify that comprehensive inflation adjustment for inflation occurring during 2016 should apply only if the inflation rate for 2016 exceeds a specified rate. ### Individuals: complexities and practical approaches - Individuals typically lack double-entry books and opening/closing balance sheets; inflation adjustment must therefore adjust specific transactions. - Wages: each monthly wage indexed to that month’s price level and summed; tax withheld in a month should be indexed when computing annual withheld credit—unless withholding each month is already accurate, in which case annual aggregation is unnecessary. - Interest income: conceptually determine erosion of loan principal due to inflation and subtract that from interest received (interest accrued monthly should be indexed to year-end levels). Same applies to debts with deductible interest. - Practical simplifications: tax systems often adopt ad-hoc solutions (e.g., low flat-rate final withholding tax on interest). - Capital gains of individuals are most complex: must adjust acquisition price and corresponding interest expense, and determine treatment of inflation that occurred before indexing rules came into effect. ### Ad-hoc adjustments for corporate profit tax (CPT) — current law effects and options - Current differential effects of inflation on CPT base include: - Depreciation: Tax balance sheet value for depreciable assets reflects inflation adjustments to December 1, 2014; further inflation adjustment appears stopped as of January 1, 2015. Tax Code ambiguity may allow taxpayers to use accounting revaluation for tax purposes (revaluation shows up on capital account and not current profit/loss). - Foreign currency exchange: Gains and losses taken into account in closing balance sheet; inflationary (currency appreciation) gains are taxed and accrued foreign exchange losses allowed as deductions even without realization. - Inventory: LIFO not allowed; inflationary gain is recognized when inventory is sold, increasing corporate tax base. - Securities, investment real estate, biological assets: Valued at fair value under national GAAP and IFRS, resulting in inclusion in income for accounting and tax purposes; inflationary gains taxed even without realization. Financial instruments held to maturity are not revalued at fair value, so inflationary gain taxed at realization. - Interest: Where interest expense is deductible, lack of inflation adjustment benefits the taxpayer; some interest is capitalized and some nondeductible due to thin capitalization rules. - Withholding tax: Interest paid by corporations is subject to withholding on nominal interest without adjustment. Local currency borrowing from residents faces a 15% withholding tax on interest due to investors; this can occur directly (corporation borrows from an individual) or indirectly (corporation borrows from a bank which pays withholding on local-currency deposit interest). - Ad-hoc policy options: - Accept accounting revaluation for tax depreciation purposes. - Specify Tax Code inflation adjustment mechanism for depreciable assets. - Assimilate foreign currency gains/losses to interest income/expense and adjust net amount for inflation. - Allow LIFO for inventory to defer inflationary gains. - Offset fair-value gains on securities and other assets by an inflation adjustment. ### Illustrative inflation adjustment rules for corporate profit tax (summary of Articles) - General: Applies to enterprises preparing financial statements; closing balance items adjusted for inflation during the year and total inflation adjustments added to taxable income. Opening net worth adjustment is subtracted from taxable income, with adjustments for transactions during the year producing changes in net worth. - Art. 1—Adjustment of Opening Net Worth: - Opening net worth adjusted for inflation for the taxable year; adjustment subtracted from taxable income. - If opening net worth is negative, subtraction increases taxable income. - Net worth = total assets in tax balance sheet minus sum of debts and reserves taken into account under the Code. - Inflation-adjusted opening net worth = opening net worth adjusted according to percentage change in the consumer price index for the taxable year; opening tax balance sheet = closing tax balance sheet for preceding taxable period. - Art. 2—Adjustment of Increases in Net Worth: - Contributions to capital and nontaxable income adjusted for inflation between transaction month and close of taxable period; total of these adjustments subtracted from taxable income. - Definitions specify adjustment according to percentage change in consumer price index between transaction month and end of taxable period. - Art. 3—Adjustment of Decreases in Net Worth: - Distributions to owners and nondeductible expenses adjusted for inflation between transaction month and close of taxable period; total of these adjustments added to taxable income. - Definitions specify adjustment according to percentage change in consumer price index between transaction month and end of taxable period. - Art. 4—Adjustment of Items in Closing Balance: - Adjustment amount = adjusted value of asset or debt minus historical cost (if acquired during year) or its value on previous balance sheet; this amount added to taxable income (subtracted for debt adjustments). - Art. 5—Valuation of assets and debts in closing balance: - Assets (other than inventory) and debts valued per this Article. - Values adjusted according to percentage change in consumer price index for taxable year or between acquisition month and year end. - Depreciable assets: valued at historic acquisition cost adjusted for inflation and reduced by cumulative depreciation. - Debt claims and debts: include accrued interest (including original issue discount or market discount) and accrued adjustments to principal. - Foreign currency and foreign-currency-denominated items: valued at prevailing foreign exchange rate at year end. - Publicly traded securities: valued at market quotation at year end. - Gold or silver bullion or coins: valued at market price at year end. - Cash and assets denominated in national currency: valued at nominal value. - Art. 6—Valuation of inventories and unfinished products: - Goods of a particular type valued at cost of last-acquired item of that type, adjusted according to percentage change in consumer price index between acquisition month and year end (applies if last-acquired item was acquired during taxable year). - If no item of such type acquired in taxable year, goods valued at opening balance value adjusted according to CPI percentage change for the taxable year. - Produced (not purchased) goods and unfinished products valued according to same principles relative to production costs. - Acquisitions at artificial prices are ignored. ### Appendix B — Other design issues with the CPT: nondeductible expenses - Absence of rules on nondeductible expenses in the Tax Code is problematic; allowing deduction for any accounting-book item is prone to abuse. - Recommendation: Include rule that only expenses related to the business are deductible; clearly list personal expenditures and those incurred in favor of shareholders, directors, or employees as nondeductible. - Categories that Tax Code should specify as nondeductible: - Entertainment expenses (including meals, parties, sporting and cultural events, live entertainment, memberships or rights to visit saunas, sport or fitness clubs, and similar items); simpler approach: deny deduction for meals in all cases. - Cars and associated expenses: deny deduction for passenger vehicles and associated costs unless vehicles used exclusively for deliveries and not available for private use (private use includes transportation to/from home). - Fines and penalties: typically nondeductible; include amounts payable to government for violations, including tax law violations. - Bribes: deny tax deduction; definition should be broad and include bribes, kickbacks, and other illegal payments. *Italicized source: IMF staff content from _cr1625 - 4. International and national accounting standards prescribe inflation indexing rules* ### 3. The current thin capitalization rule based on the average loan value as of the ### _cr1625 - 3. The current thin capitalization rule based on the average loan value as of the ### Thin capitalization - The current thin capitalization rule based on the average loan value as of the beginning and end of the year is easily avoided by arranging borrowing during the year and repaying it before year-end. - Recommendation: compute the amount of debt as the average for each calendar month of the tax year; for each calendar month the applicable amount is the greatest amount of debt outstanding to related parties at any time during the month. - Recommendation: assimilate foreign exchange gains and losses to interest income and expense for thin capitalization purposes so that foreign currency losses on liabilities are treated as interest expense and foreign currency gains on foreign currency deposits, other loans, or currency holdings are treated as interest income. - Note: if inflation adjustment rules are adopted, coordinate them with the thin capitalization rule to avoid double denial of a deduction. - Observation: “The 3.5 debt/equity ratio is on the high side,” consideration could be given to lowering it. - Interaction: if a comprehensive adjustment for CPT is adopted, most of the benefit from deducting interest expense will be eliminated and there will be less pressure on the thin capitalization rule. ### Depreciation - There are many reasonable options for designing depreciation systems; absent a compelling reason for change, it may be best to leave the existing system as is but make technical corrections. - Technical corrections recommended: - Clarify whether tax depreciation is based on historical cost or can take into account revaluations of assets made for financial accounting purposes. - Refrain from making an adjustment to accounting policy on which small-value assets are treated as depreciable property, perhaps with a value limitation. ### Change in method of accounting - Problem: The Tax Code currently does not include in income amounts resulting from a change in method of accounting (e.g., switching from national GAAP to IFRS, or a change in accounting policy within GAAP or IFRS). - Example: switching to a method where a closing balance is 150 rather than 100 can exclude 50 from income in the absence of adjustment. - Recommendation: Tax Code should provide that adjustments must be included in taxable profit (or deducted as a loss) in case of a change in method of accounting. - If a change increases the value of the opening balance compared with the prior closing balance, the difference should be included in income for the current year. - If the opening balance is lower than last year’s closing balance because of the change, a deduction should be allowed for the difference. - Implementation note: countries vary—some include the adjustment immediately, others over a specified period of years. ### Consolidation - Although consolidated accounting is allowed under IFRS and national GAAP, the Tax Code contains no provision explicitly requiring separate accounting. - Recommendation: Tax Code should require taxpayers who prepare consolidated financial accounts to continue to prepare and submit separate accounts for tax purposes, reflecting no conscious policy decision to depart from entity-by-entity reporting. ### Long-term contracts - National GAAP and IFRS provide for percentage-of-completion accounting for long-term contracts. - Flexibility in national GAAP on determining percentage of completion is acceptable for tax purposes as long as the broad principle exists. ### Leasing - The Tax Code contains a detailed definition of finance lease but its role is unclear (Article 14.1.97 of the Tax Code). - Normally, tax law treats the lessee under a finance lease as owner for corporate profit tax purposes; current law seems to reach this result through interaction with national GAAP or IFRS. - Risk: accounting and Tax Code definitions of finance lease may differ, giving taxpayers flexibility in classification. - Recommendation: clarify that lessor and lessee may not take inconsistent classification positions; delete the definition of finance lease from the Tax Code if the term is no longer used in the Code. ### Recognition of income where liability to provide future service - Accounting standards allow deferral of income where there is a liability to provide future service. - Policy concern: for tax purposes such deferral is generally disfavored because it postpones tax payment and is especially important under inflationary conditions. - Recommendation: formulate rules providing for a tax adjustment where income is deferred under accounting standards because of an associated future liability. ### Provisional and advance corporate tax payments - Current system duplicates prepayment: Advance Corporate Tax (ACT) and provisional CPT payments based on last year’s tax. - Rationales: - ACT assures corporate tax is paid where there is a distribution to shareholders even if end-of-year corporate profit is nil. - Preliminary monthly payments based on last year’s tax assure a stream of corporate tax revenue and are important in an inflationary environment. - Recommendation: allow taxpayer to credit ACT against provisional payments during the year; only if ACT liability exceeds preliminary payments made at the time the ACT liability arises should the taxpayer pay the net amount to the budget. - Proposal: revise provisional payment liability to align with current year’s sales by computing a profit tax ratio for the previous year (profit tax as a percentage of total turnover for profit tax purposes); provisional payments would equal total turnover in the provisional period multiplied by last year’s profit tax ratio. - Alternative: use turnover for VAT purposes, adapted for financial institutions and taxpayers with substantial VAT-exempt sales. ### Investment funds - Finding: current tax treatment of investment funds is overly generous—amounts in a fund are free of tax until distributed to investors (Article 141.6.1 of the Tax Code; investment funds also exempted from making provisional payments; see Article 57.1 of the Tax Code). - Recommendation: special tax rules for funds should be no more generous than if an individual made a direct investment in fund assets. - Two general options for taxation: 1. Mark-to-market all securities of an investment fund, with inflation adjustment; fund calculates withholding tax as if gain were distributable to individual shareholders. 2. Defer gains until realized by the fund; determine amounts of interest income, dividend income, and capital gain income and subject these to withholding taxes as if there were a distribution at year-end. - Under both options undistributed amounts would be added to the shareholder’s cost for calculating shareholder gain on sale of shares during the subsequent year. - For amounts allocable to a domestic legal person, a withholding tax at the general CPT rate could apply. - Recommendation: only regulated funds subject to special tax rules; other investment vehicles subject to normal tax rules. ### Simplified CPT regime for taxpayers with turnover less than 20m hryvnia - The simplified CPT regime for taxpayers with less than 20m hryvnia turnover is open to abuse (Article 134.1.1. of the Tax Code). - Characteristics of the regime: - Exemption from tax adjustments to accounting profits; taxpayers account for tax on income determined under financial accounting without tax adjustments. - Exempt from making provisional tax payments (Article 57.1 of the Tax Code). - Provisionally exempt from tax audits for 2015 and 2016 (see point 3 of the concluding provisions of the Law of Ukraine «On Amending the Tax Code of Ukraine and Certain Laws of Ukraine re Tax Reform» of December 28, 2014, No.71-VIII). - According to one estimate about 95% of CPT payers apply this regime. - Even if audited after the moratorium expires—but before the period of limitations—there would be no penalty for improper filing of their 2015 tax return. - Abuse vector: absence of aggregation rules allows establishment of multiple corporations to qualify repeatedly; subsidiaries can be used to exploit inconsistencies between tax and accounting rules (e.g., acquire fixed assets for accelerated depreciation under national GAAP). - Recommendation: abolish the CPT special regime and have a single set of rules for all CPT taxpayers using accrual accounting under national GAAP. - Note: together with ST reform proposed in Chapter III, consider extending the cash-flow accounting method proposed there for small taxpayers to medium sized CPT taxpayers (this group would need further definition). ### Other exempt enterprises - Policymakers have largely eliminated CPT exemptions; few exempt enterprises remain and no evidence of abuse was found by the mission. - Concern: exemption of religious or charitable organizations carrying out businesses unrelated to their non-profit purpose risks abuse (facilitates paying employees off the books, supplying invoices used for informal payments). - Recommendation: tax nonprofit organizations on business operations not related to their exempt purpose, except for operations that are very small. ### Appendix C: Drafting issues — Style and user friendliness - Finding: Tax Code is poorly drafted and lacks structure; numbering system exists but stylistic rules for article structure are not consistently followed. - Problems identified: - Inconsistent sentence and list structures across articles (examples: Article 133.2 versus 133.1; Article 134.1; Article 138.3 and 139). - Repetitive language that could be eliminated by cross references (example: repetition in 134.1.1 about “adjustments to the financial result before taxation of all differences...” and repeated language about taxpayers with annual income not exceeding twenty million hryvnias). - Two possible stylistic rules offered: 1. At the one-decimal level there should be one complete sentence and two-decimal level subdivisions of that sentence. 2. Each one-decimal level should be a title followed by one or more sentences at the two-decimal level (recommended as more user-friendly). - Recommendation: decide on basic stylistic rules and consistently follow them; reorganize and redraft the Code (editing rather than major rewrite). - Annex II referenced as showing how a title-plus-subdivision approach could look. *IMF staff report content as provided in the source excerpt.* ### 7. Another drafting problem of the Tax Code are rules that seem to have been drafted ### _cr1625 - 7. Another drafting problem of the Tax Code are rules that seem to have been drafted ### Drafting defects and taxpayer response - Thin capitalization rule (Article 140.2): - Limitation on deductible interest applies where amount of debt with related persons exceeds 3.5 times the equity capital. - Amount of debt defined as the arithmetic mean of the values of debt and equity at the beginning and end of the fiscal period. - Drafting creates an avoidance opportunity: any loan contracted after the beginning of the year and repaid before the end of the year is not taken into account, allowing taxpayers to plan around application of the rule. ### Ambiguous language and imprecise cross-references - Amortization and disposition timing (item 11 of Section XX, subsection 4): - Quoted provision (Ukrainian) restricts the rule to calculation of amortization under пункт 138.3 статті 138. - Unclear how gain on disposition of an asset after January 1, 2015 should be calculated under Article 138.2: whether to use historical cost less accumulated depreciation, or balance sheet value as of December 31, 2014. - Problem arises because item 11 refers to depreciation under Article 138.3, while the gain on disposition is calculated under Article 138.2. - Suggested fix: more precise reference to Article 138 rather than only to depreciation under Article 138.3. - Foreign-source income definitions: - Two differing definitions for corporate income tax: Article 14.1.54 (general definitions Article) and Article 141.4.1. - Wording differs and definitions are often vague, complicating determination of what is subject to withholding. - Consequences: - Imprecise cross-references or ambiguous language create situations where taxpayer and tax administration may take differing views, making tax compliance difficult. - While ambiguity cannot be entirely eliminated, substantial reduction is feasible. ### Excessive simplification - 2014 reform of the CPT eliminated rules for simplification but removed some rules necessary for proper functioning (e.g., rules defining nondeductible expenses). - Taxation of the nonprofit sector was radically simplified: nonprofits are no longer taxed on their unrelated business profits. - Redrafting of Section III should review 2014 changes to determine whether prior-law provisions were eliminated with excessive haste; not all earlier rules necessarily need full restoration. ### Redrafting process and timing - Revision of the entire Tax Code should be attempted only with sufficient time. - Parliament typically needs at least the better part of a year to adopt a completely new Tax Code. - If a draft new Tax Code is presented early in 2016, there is a reasonable chance of adoption by the end of 2016. - Policy changes intended to come into effect on January 1, 2016 should be formulated as targeted amendments to the existing Tax Code and kept to the minimum necessary to be enacted before end-2015. - Work can proceed on parallel tracks, but immediate priority: enact necessary amendments to implement the desired policy changes for 2016. ### Institutional recommendations for drafting quality - Establish an office with specialized personnel responsible for all Tax Code amendments to ensure best drafting practices. - Office location can be SFS, MOF, or Verhovna Rada; key is recruitment and retention of qualified personnel. - Office may be small; staff should be lawyers specialized in taxation, possibly fairly young but with highest academic credentials and skills. - Role division: - Tax specialists in government develop legislative proposals. - Specialist drafters translate proposals into legislative language and interact with subject-matter specialists to pose right questions and develop draft language for Parliament. ### Recommendations (as listed) - For any future redrafting of tax laws: - (i) decide on and consistently follow stylistic rules for the Tax Code, - (ii) eliminate unnecessary language and ambiguities, and - (iii) draft rules in anticipation of taxpayers’ reactions. - Adopt a reasonable timeframe for submitting a completely revised Tax Code to Parliament in view of its adoption by end-2016. - Prioritize the drafting of amendments needed to implement the recommended CPT, ST and SSC changes by end-2015. - Improve government capacity and management of the tax law drafting function, including through the recruitment and long-term employment of specialized tax lawyers. ### Annex I — Illustration of proposed rules for Provisional Payments and ACT - Monthly provisional payments of corporate tax due at time established for filing the VAT return for the preceding month, amount: - A X B, where - A is the total turnover for the preceding month, and - B is the ratio of the profit tax liability for the most recently filed tax return to the total turnover for the period corresponding to that return. - ACT offset rules: - Taxpayer’s obligation to make payments of Advance Corporate Tax (“ACT”) with respect to dividend distributions is offset against provisional payments of corporate tax made for the current tax year prior to the date of the distribution. - Any excess ACT remaining after this offset is offset against subsequent obligations to make provisional payments of corporate tax, until this excess is exhausted. - Numerical example: - Corporate tax liability for 2014 and for 2015 is 10, and total turnover in each year is 100. - Therefore, in 2016, the taxpayer uses a tax/turnover ratio of 10% in calculating provisional payments. - Suppose that in January through April 2016, turnover is 150 in each month. The taxpayer pays provisional CPT payments of 15 per month. - In May 2016 the taxpayer makes a dividend distribution, with respect to which the ACT is 90. - Provisional payments of 60 have been made for January through April, and the net payable by way of ACT is 30. - For May and June, if sales continue at the same level, the taxpayer can credit the remaining ACT paid in May against the liability to make provisional payments. - Note: under inflation adjustment, all the above payments would be adjusted for inflation. ### Annex II — Stylistic example (excerpt in Ukrainian) - 133.1. Платники податку - резиденти - 133.1.1 Платниками податку - резидентами є: - 1) суб'єкти господарювання - юридичні особи, які провадять господарську діяльність як на території України, так і за її межами, крім: - а) бюджетних установ; - б) громадських об'єднань, політичних партій, релігійних, благодійних організацій, - в) пенсійних фондів, - г) суб'єктів господарювання, які застосовують спрощену систему оподаткування, обліку та звітності, визначені главою 1 розділу XIV цього Кодексу. - 2) Управитель фонду операцій з нерухомістю, який здійснює діяльність відповідно до Закону України "Про фінансово-кредитні механізми і управління майном при будівництві житла та операціях з нерухомістю" щодо операцій і результатів діяльності із довірчого управління, що здійснюється таким управителем через фонд. - 133.1.2 Метою організацій, які зазначені у підпункті (б) підпункту (1) підпункту 133.1.1.пункту 133.1 статті 133 цього Кодексу, не може бути одержання і розподіл прибутку серед засновників, членів органів управління, інших пов'язаних з ними осіб, а також серед працівників таких організацій. - 133.1.3 З метою оподаткування центральний орган виконавчої влади, що реалізує державну податкову політику, веде реєстр всіх установ та організацій, які зазначені у підпункті (б) підпункту (1) підпункту 133.1.1.пункту 133.1 статті 133 цього Кодексу. - 133.1.4 Установи та організації, які зазначені у підпунктах 1(а), (б) або (в) підпункту (1) підпункту 133.1.1.пункту 133.1 статті 133 цього Кодексу,, не є платниками податку на прибуток лише після внесення таких установ та організацій до Реєстру неприбуткових організацій та установ контролюючими органами в порядку, встановленому центральним органом виконавчої влади, що забезпечує формування та реалізує державну податкову і митну політику. - 133.1.5. Національний банк України здійснює розрахунки з Державним бюджетом України відповідно до Закону України "Про Національний банк України". *._cr1625 - 7. Another drafting problem of the Tax Code are rules that seem to have been drafted (excerpt)._* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1625.pdf_