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30 March, 2011  ▪  Marina Gnatenko

Fear and trembling

The Tax Code cut the number of small business owners in Ukraine and opened the way for the unofficial collection of taxes

We now have the official results of the effect the Tax Code has had on the national economy: less than a million registered fixed rate taxpayers down from 1,175,000 on 1 January 2010, according to the State Tax Administration.

Nearly a third of sales booths are empty at Troieshchyna Market in Kyiv, some of them are being scrapped altogether. Merchants say that the problem is twofold: taxes and consumers' lower purchasing power due to higher prices for food and utilities.

Tilting at windmills – What were entrepreneurs fighting for

After entrepreneurs’ protests on the Maidan against amendments to tax legislation, the government decided not to change the old rules of the game for many categories of individual businessmen (the President has sent Article XIV of the Tax Code back to the government for revision and improvement). This indeterminacy caused some fixed rate taxpayers to opt for a wait-and-see strategy instead of official registration — they're waiting for the government to take the next steps and are lying low for the time being. Everyone understands that the worst thing in the Code is not even the high fiscal pressure, but the extended authority of the tax police. For example, a very revealing situation could be observed at the Central Market in Vinnytsia: when a pair of tax policemen showed up there (and they were even off duty) half of the sales booths immediately closed. This is a sad tale, but there are sadder ones.

Maksym N. from Vinnytsia decided to shut down his business altogether. He says it is his dead season now anyway and he is unable to pay all his bills, so just recovering his losses is a blessing. He has three clothes and footwear sales points, including one at the market and one in a trade center. He decided to close the market outlet due to the rent which has increased twice since September 2010. Three years ago, he had five sales points and as many employees on labor agreements. In 2011, he is going to fire the last one and will sell the goods himself together with his wife. “I made about 1,000 hryvnias in the trade center in January,” explains Maksym. “I make up to 5,000 hryvnias per season. I pay 6,000 as a rent and another 1,500 as a salary for employees. I would be happy to increase prices, but there is no demand! I used to have savings, but now I'm not sure if I'll be able to feed my family!”

“If you have recently graduated from a university, have opened a new business and have faced new Tax Code - you can just quit, close your business and forget about it,” says a 50-year-old  fixed-rate taxpayer. “But what should those who are the breadwinners in their families and have to pay for their children's education do? We are left for ourselves.” The official unemployment rate grew to reach 2.2% in February. In December 2010, there were officially about nine jobseekers per vacancy. If you figure out situation with part-time employment, layoffs, and so on, the real trend is far worse. Myroslav Yakibchuk, chairman of the National Trade Union Forum, predicts that the unemployment rate will grow by 28% and the number of jobless people exceeds two million in 2011. But the initiators of the tax “reform” do not seem to worry about the social function of the fixed-rate tax system, which is supposed to secure self-employment.

What entrepreneurs got

Businessmen who pay the fixed-rate tax have had problems obtaining licenses — these were issued only to those who pay the market tax which was recently canceled. NGOs interfered and put an end to this legal collision, but a de facto market tax has not disappeared, according to Alla Aleksentseva, coordinator of the Council of Entrepreneurs’ Associations. It was simply “hidden” in the land tax, which, in its turn, led to higher market place rent rates. “I received phone calls from all over the country. There are decent market directors who have raised the rent by only a small amount. But in some regions the rates are sky-high,” says Ms. Aleksentseva.

Sources tell The Ukrainian Week that to businessmen, the ability to pay higher rent, including the unofficial one, means not only access to markets but, to some extent, protection against tax police raids. In some places there are obvious excesses. For example, in Yahotyn a number of businessmen had to close their businesses after they were told they had to pay deductions as high as in Donetsk. The administration of the market was not in the least embarrassed by the fact that the demand and purchasing capacity in a regional center cannot be compared to those in cities with populations of over one million.

Those who refuse to pay unofficial market fees face the tax police who threaten to arrest their property and show sums to be paid on cell phone screens that perfectly match those that are demanded by market administrations. All of this looks like psychological pressure. Who can bear it? Even the inspectors are nervous. For example, there was this ridiculous case in Zaporizhia: a local businessman came to a respectable institution with an envelope in his pocket only to be told that he had to come the next day because otherwise he would violate the proper order.

What entrepreneurs expect

Under the Tax Code, fixed-rate taxpayers have to pay deductions to the Pension Fund and other social funds on general conditions, which forced many to lay off hired personnel and others to go into the shadow economy. On 1 April 2011, a new surprise will be waiting for them — Article 139 of the Tax Code takes effect which prohibits legal entities to include payments made to fixed-rate taxpayers in their gross expenditures. “Roughly 100,000 more entrepreneurs with one or two employees will be forced to close business,” says Viacheslav Bykovets, first vice president of the Association of Owners of Small, Medium, and Privatized Businesses. “There is no point for them to switch to the cumbersome and corrupt general taxation system.”

This thought is picked up and elaborated by Ms. Aleksentseva: in 2009, the Donetsk Metallurgical Plant closed its canteen and a transportation unit and outsourced those services to fixed-rate taxpayers. In the new circumstances, they will have to register the company again. But the plant is unlikely to find this a good solution, because the services will no longer be as cheap as they used to be when the fiscal pressure was lower. “No one will benefit from it. If businesses operate at a loss, there are no taxes. Article 139 will not stop optimization schemes, because most such schemes revolve around VAT,” Ms. Aleksentseva said.

What else is being prepared

Leonid Rubanenko, chairman of the public collegium of the VR Committee for Tax and Customs Policy, confirmed the other day that amendments to the Tax Code are being worked on. The reader will remember that the president instructed the government to improve the code as he signed it. It is not clear as yet what these amendments will be. Some experts are convinced that the fixed rate tax system will be scrapped altogether. Other sources are worried that the tax police will be granted a new right — taking individuals to court to make them declare their incomes. Mr. Rubanenko has offered the most optimistic scenario: both entrepreneurs and the tax police have faced problems with implementing the code. And the latter even had more questions than any other group. “The thing is that the document is complicated and in order to make any decision, several articles of the code need to be studied. Tax officials cannot get used to it and thus they make mistakes. But it is also important that these mistakes should not be made in principle, because the code mandates that the tax police should interpret any ambiguous norms contained in the code in favor of taxpayers. We don't know of any facts so far when the tax police sided with the taxpayers in these cases,” says Mr. Rubanenko.

What matters

“No one believes that amendments to the code will make things better or easier,” says Ternopil-based entrepreneur Oleh Muliar. “Perhaps, only in theory.” He has not purchased merchandise for sale since 1 January 2011 as he has been waiting for a legal resolution of one issue — what original documentation, i.e., documents confirming economic transactions, fixed-rate taxpayers should have and be able to present. “Selective checks of original documentation have been practiced in eastern Ukraine for about two years now,” says Andrii Bodakva, head of the Dnipropetrovsk Oblast Coordination and Expert Center. “They started in Luhansk Region in 2009 and in Dnipropetrovsk Region in the summer of 2010. Stores have been the primary targets. Merchants at wholesale markets do not have original documentation, so the threat of such checks is hanging over them like the sword of Damocles. They would be able to operate in a transparent manner only if the Barabashovo or Seventh Kilometer markets started supplying merchandise with invoices and certificates.”

Mr. Muliar fears for his business. “I brought some things from abroad and some other things through Odesa and Khmelnytsky. I did not keep documentation or preserve any papers. I intended to buy locally-produced merchandise, but the quality is unacceptably low. Everyone is selling imported goods, and it’s not our fault.” A mere 20% or so of market sellers offer products with the stamp “Made in Ukraine.” It is a priori impossible to do record keeping using original documentation as required by Article 297 of the Tax Code. However, for Ms. Aleksenntseva and entrepreneurs she has contact with “it’s not a secret that there are five MPs whose companies offer services to the importers of Chinese-made goods.” “If you want to get customs clearance on your own, the cost of the procedure will be so prohibitive that you won’t sell the goods, because you’ll need to add operation costs and then some markup,” says the expert. “Meanwhile, these companies will get customs clearance at an affordable price for you but will provide dubious documents. You can’t rule out that boots will be listed as slippers.” She concludes that as long as these and other issues remain unregulated, officials do not have a moral right to demand original documentation from fixed-rate taxpayers.

What cures

Generally, the desire of the Mykola Azarov government to improve the taxation system is driving business all the more into the shadow. “The state is pushing entrepreneurs to operate outside the legal field,” says Ms. Aleksentseva. “Reforms without an analysis of causes is like a diagnosis without examination. The solution is to adopt legislation that would stimulate economic growth rather than violations.”

“Controlling agencies view entrepreneurs as people who don’t want to pay taxes,” says Mr. Bykovets. “In fact, if such really exist, they account for no more than half a percent.” Consciously or not, the government is destroying the middle class in Ukraine, thin as it is now, and laying the powerful normative foundation for building illegal or semi-legal financial relations with business.

What scares

A number of small entrepreneurs have already gone into the shadow — they have been forced to in order to provide sustenance to their families. Leonid Kozachenko, head of the Council of Entrepreneurs under the Cabinet of Ministers, offers a straightforward and apt description of the main problem which they have faced — racketeering. Mr. Bykovets confirms the fact: “There are people who come to some markets with bags. But these are not bandits. They say they collect contributions to the police and other bodies for permits and approvals and simply to keep them away. I know of dozens of cases when tax policemen entered the premises of a business and said immediately how much it would cost to draw up a record [of an inspection – Ed.] that would not lead to negative consequences.”

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