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21 October, 2016

"If people pay taxes, the state will reduce rates where possible"

The Minister of Finance on the new blueprint for tax reform, the campaign against shadow economy, corruption at the customs, State Fiscal Service reform, and the 2017 budget

Interviewed by Tetiana Omelchenko

What are the differences between the new tax reform blueprint and the two previous drafts developed last year? What were the key provisions of those drafts that made it impossible to adopt the reform in 2015, and what changes have been made to the new version?

The reform draft has actually been approved, with only a few provisions not included in the final version. Last year, I was also involved in the process in the capacity of the Deputy Chief of Staff of the Presidential Administration and worked on the Tax Code amendments. So, I understand quite well where the problems are. Most importantly, I understand how the tax office works and how the tax administration system functions.

Tax rates are not the main issue. It is the administration of taxes that determines corruption levels and affects the interests of investors. After all, when investors consider investing their money, they first of all study the Tax Code and consult legal and audit companies providing services to businesses in Ukraine.

We have reduced labor tax, and this is a positive move. But has this helped solve major business problems? No. Do businessmen argue about VAT rates? No. But almost everyone complains about the problems with VAT reimbursement, including kickbacks for such refunds. Of course, such abuses greatly discourage businesses. And this is just one of the most obvious examples.

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So, the three main differences in this year's proposals are as follows.

First of all, we focus on solving the main problem of the business: we simplify administration. Secondly, this time we have no warring camps or different reform visions, we are working as a team towards a common goal. A work group has been established that includes representatives of the Parliament's Committee on Taxation, including its Chairwoman Nina Yuzhanina and other MPs, colegislators of Bill No. 3357, business associations, community experts, and State Fiscal Service representatives. Of course, it was not always easy to compromise, but we have found solutions to all disputed issues and will deliver the results that the businesses are expecting. Thirdly, unlike last year, when the last tax reform was kept secret to the last, this time we made the process as open as possible from the very start, in order to take into account as many ideas as possible. We organized dozens of meetings and public consultations with businesses and community experts, and published draft updates on the official website of the Ministry of Finance and its Facebook page to encourage public discussion, so that absolutely anyone could make comments and suggestions.

What are the chances that the new tax reform will be approved this year and implemented in 2017? Will the Parliament become the biggest obstacle?

I don't think that the Parliament will oppose it, they are quite positive about it. Only those profiting from it today will backpedal. The voting will show. Businesses need this reform badly. They will support us, especially as far as the elimination of the tax police is concerned. However, our bill does not cover the issue of dealing with the tax police and establishing the Financial Investigation Service. A bill on that has already been drafted, it is currently discussed with the ministries, and we are planning to submit it for the Cabinet's approval separately. After all, the tax police is just one of the tools used by the State Fiscal Service, and not the most efficient one. In fact, according to businesses, its role is rather negative.

I believe that the reform will be adopted. Of course, it also has anti-corruption provisions, which some people might not like. But there's nothing we can do for them. It's now time for real change.

Does the tax reform envisage reducing the overall tax burden on the economy and the rate of GDP redistribution through the budget?

Our changes to taxation do not include the revision of rates. We use a different approach. We reduce the burden on businesses by streamlining administration. This will help businesses save both time and money.

Some might say that if the rates have not been revised, it is not a reform. First of all, we never called it a reform. It is designed to improve the administration and resolve the existing business problems. Secondly, we introduce practical changes that will have real impact on businesses. This is the most important.

Talking about the budget, I have always supported the idea of ​​a "small state." That is, I lobby for the small but efficient state apparatus. I don't like it when funds are spent inefficiently to pay those who do not perform their functions or perform them poorly. So, our goal today is to optimize the state apparatus (and we carefully study all expenditures), identify inefficiencies, find resources and channel them where necessary. We have already identified the key priorities in the budget process and will allocate resources to the areas where they are most important today. These are defense, education (especially secondary), energy efficiency, infrastructure, and diplomatic service.

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As for the other areas that are inefficient, they should undergo layoffs in order to increase wages. Take the State Fiscal Service (SFS), for example. After 30% layoffs, it currently employs 41,000 people, but I believe that its staff should be further reduced in order to increase salaries. Given the current level of salaries of the leading SFS inspectors, we can hardly hope to eradicate corruption. I am sure that every state agency should primarily look for its own resources. All and any optimization should be used to increase salaries. I would like to emphasize that the state does not have a huge vault, where it could find billions of hryvnia to dramatically raise wages for all. We have very limited resources!

You were the initiator of tax holiday for small businesses. However, according to the State Statistics Bureau, 56% of all individual entrepreneurs and most small businesses work in sales and repairs, that is, they don't produce any significant added value. Does it make sense to encourage small businesses working this way?

It is necessary to look for various incentive mechanisms and see what works best. Today we have almost no small and medium businesses in Ukraine. However, it is exactly this sector that we should focus on. But there are some problems. It is always difficult for small businesses to enter even the Ukrainian market, not to mention the international one. The relative costs of market entry are disproportionate. Another disadvantage for small and medium business in Ukraine is the lack of funding. Typically, banks would not lend to them, or only provide lending at very high interest rates. In the West, programs are available for business startups through venture capital. In Ukraine, there is no such thing yet. The only option is bank financing, but it is extremely risky and expensive. Knowing this, we have proposed a tax holiday tool. But we will also look for other approaches. It is very important for small businesses that all obstacles to registering a company are removed and reporting is minimized. After all, these are all additional costs and risks for businesses. This is exactly what we are doing.

Do you agree that most of the businesses operating in the shadows evade taxes not because they don’t want to pay them, but because they won’t survive if they do? The challenge to improving efficiency of business, in turn, is the lack of proper education, management skills etc. Will fighting shadow economy be successful in such environment, and how should it be brought to light under these conditions?

Of course, it will be successful. As for going out of business, our tax rates are quite competitive compared to other countries. There are certain taxation models. We cannot say that the nation will go bust if we all pay taxes honestly. For example, in capitalist countries businesses operate successfully and pay taxes. The tax rate here is not important.

Unfortunately, our system allows for not paying taxes or paying the minimal rate. When it comes to small businesses (retail companies and stores), there is a lot of abuse there through the flat-tax system (also known in Ukraine as the simplified tax system – Ed.) Therefore, the flat tax should strictly perform its functions and prevent such abuses. I'm sure that the current laws allow for putting an end to some companies' abuses related to the flat-tax system.

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Moreover, we should not forget that the taxes paid are allocated for pensions and the public sector. That is, we have to think about the economy, rather than trying to pay as little as possible. For example, many Ukrainians today make purchases over the internet (and these are gray deliveries) or go to the shops that sell counterfeit products and don’t pay taxes.

Therefore, I believe that if we don't change the administration system to a fair one, entrepreneurs who want to work honestly will not be competitive. But this is the issue of not just rates, but also honesty. When the rules are the same for all, the model will work differently. If people pay taxes, the state will reduce some rates where possible. But now, until some of the pressing problems that I mentioned are not solved, doing this would be just irresponsible. Because today we have very realistic budget estimates. And we reject any experiments that sound too populistic. We can't afford the risk of having a hole in the budget, and the government is accountable to pensioners and those receiving state subsidies and salaries. Our task is to make sure they receive those funds. Pensioners are not supposed to pay for the fact that we have an inefficient tax administration system.

The media quite often report that that the state loses tens of billions of hryvnia through customs. For example, Kostyantyn Likarchuk mentioned about 20–50% of the officially collected amounts, that is, UAH 50-100bn. Do you have any estimates of these amounts? What are they made of? Could they be paid to the budget and what prevents that?

There are many factors. The major ones are illegal trafficking and corruption. Our customs are nontransparent and corrupt. As a result, even transit goods often bypass Ukraine. The scale of trafficking is difficult to assess, so I wouldn't believe the amounts mentioned by Likarchuk. Quite a lot of companies work honestly, especially big business and foreign companies. We have our own numbers concerning this issue. If we fight customs corruption efficiently, we could increase state budget revenues by about 40%. However, illegal trafficking at customs involves not only customs officers, but also SBU officials and border guards. In this situation, we do everything we can within the Cabinet powers.

What exactly?

We have developed the "one-stop-shop" electronic system that can handle most customs issues (except for value assessment). Customs declarations can be submitted by email. After the goods arrive at the border, they must be examined within four hours. If any issues arise, a check by the bodies that initiated them must be carried out simultaneously within 24 hours. These checks must be performed at the time agreed with the filer, and cannot last longer than 24 hours. The process will be regulated by a number of indicators. If many goods are stopped unreasonably, such indicators will be changed. The electronic declaration system is not operating yet, but we are working on it.

Of course, this model is for the businesses that work transparently. As for the shadow businesses, anti-corruption procedures should be introduced to deal with them. Primarily, it is automatic distribution of custom declarations. Very often companies use the services of a specific inspector, after striking a hefty deal with him. An electronic system could break these ties, so that the inspector does not know in advance whom he will be checking.

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Another new introduction is audio and video recording. The purchase of cameras will require significant funds, but this control method will pay for itself. "Mobile groups" have been launched (20 teams have been planned for). We wanted to create a supervisory mechanism for customs without any direct contact with them. So, we created an autonomous analytical center (with access to SFS databases), reporting to the Finance Minister. If any risks or abuse are identified at the customs, mobile groups are sent there that are allowed to stop vehicles even after they went through all the checks. We are also establishing a "pricing center," because one of the problems is discretionary value assessment, which gives room for corruption. We strive to minimize discretion by using world market reference prices as a benchmark. When we have full information exchange with the customs services of the neighboring countries, abuse opportunities will be gone for good. Of course, cross-border smuggling will remain, but this is another issue.

You have mentioned SFS earlier. In 2016, there was a lot of discussion about the three-year SFS reform plan agreed with the IMF. How much of this plan has already been implemented, and what are the stumbling blocks?

There are no stumbling blocks as such. But I would rather not discuss any abstract plans. What matters is not to what degree the plan has been implemented, but to what effect. It would be better to ask the business community, since they are the main indicator. The plan could be implemented almost in its entirety, but if businesses feel no relief... At the moment we introduce our proposals to it, because I am not satisfied with it. I believe that businesses have the right to see some changes already today. Everyone understands that the country has problems with SFS. We propose to take the tax databases out of the SFS control and give them to the Ministry of Finance. This is my principled position, and it is fully supported by the Parliamentary Committee on Taxation and Customs Policy and its Head Nina Yuzhanina.

Next, we plan to abolish the tax police and create the Financial Investigation Service (an analytical center employing a maximum of 2,500). This should happen in late autumn, and I hope for a positive outcome of its work. We are catalyzing the reform of SFS district units: there will be no audits there. Why wait another two years as per the plan? The layoffs currently taking place at the regional level will encourage people to switch to other work methods (namely, electronic ones). This will enable us to slightly reduce the staff in order to raise the salaries to other employees. It is necessary to speed up these systemic changes, because they will result in reduced pressure on business.

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What is the motivation behind taking tax databases away from the SFS?

Today, everything is administered via electronic systems. And we have several reasons to believe that at this stage the databases should not be held by the SFS. The most important of them is the conflict of interest. The SFS, if it operates as a service, should not have any temptations. By they do exist, and the SFS often cedes to them. Of course, we can try to make sure that they don't yield to temptations. But it's easier to solve the issue systematically. After all, there have been instances when the entire system suddenly "collapsed," and nobody except for the SFS could have access to it or verify it. There was also an electronic VAT system (for agribusinesses) that gave too many refunds. In fact, if someone "plays around" with those databases, they can hide anything there. Because when the system "collapses," all information is lost.

As the Finance Minister, I am responsible for the SFS work. But when we make a request for information from the database, we can only get it within two or three days. However, over this time it can be "adjusted." Therefore, we proposed to transfer all databases to the Ministry of Finance. We will maintain them in proper condition and not allow any non-transparent "adjustments" by the SFS.

BIO

Oleksandr Danylyuk, born in 1975 in Moldova, graduated from the Kyiv Institute of Investment Management and the Kyiv Polytechnic Institute. He earned his MBA from Kelley School of Business at Indiana University (USA). He started his career as a stock broker. Later, Danylyuk worked for three years with Baker & McKenzie projects in London and Moscow. He headed an investment fund in London. He also served as a supernumerary advisor to President Viktor Yanukovych and headed the Coordination Center for Economic Reforms. In July 2014, he was appointed Presidential representative in the Cabinet of Ukraine. In September 2015, he became Deputy Chief of Staff for the Presidential Administration. On April 14, 2016, he was appointed Finance Minister of Ukraine.

Translated by Anastasia Asianova

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