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4 July, 2011  ▪  Іrina Khodorova

Azarov’s Machine Gun

The government has shifted the blame for delayed VAT compensation to business owners

It’s finally here! For those you still do not know or have not heard: in March 2011, the Ukrainian government launched automatic VAT reimbursements, something Prime Minister Mykola Azarov and his colleagues promised back in mid-2010 when presenting the Tax Code

Two perspectives

Here is a brief summary of the problem: VAT was and remains the key source of revenue for the budget and the most corrupt in terms of administration, because the state not only levies it but also reimburses it to taxpayers. Dishonest natural and legal persons use a variety of schemes to make fictitious claims for VAT reimbursements from the national budget. Most often, goods are sold through a series of companies one of which fails to pay the tax, while another one files an application for its return. The structures that accumulate unpaid taxes are called “holes” in tax officials’ lingo. It is the fight against these holes that is cited as the formal cause behind delays with VAT returns and hence the build-up of government liabilities. This area has essentially been turned into a business of sorts – for a 20-40% kickback one can speed up the compensation procedure, while manipulations with VAT in general enable the government to selectively fill budget holes and thus set off lower receipts of other taxes. Businessmen view uncompensated VAT as crediting the government at zero annual interest rate (not adjusted for inflation) and forced extraction of floating assets which greatly jeopardizes business operations during a crisis.

The Tax Code set the waiting time for automatic VAT return at 26 days, down from the previous 40, and seemingly simplified the procedure by eliminating the mandatory on-site checks, etc. However, two months later we clearly see that the system works only for "chosen" companies and within informally set limits at that. Unlimited compensation to all bona fide taxpayers and paying off government debts are out of the question by definition. Businessmen were given to understand as much. “The budget does not have the money; they are trying to make both ends meet, particularly in the Pension Fund. It would be ridiculous and naïve to expect all VAT to be returned to us,” commented the CEO of a machine construction company who spoke on condition of anonymity. “The designed automatic compensation system is just a thing to show that the VAT will not be returned to companies that fail to meet some criteria. In other words, we are essentially being told that it is our fault!”

There is, however, a different perspective and assessment on the other side of the barricades. Vitaliy Zakharchenko, chief of the State Tax Administration of Ukraine, said: “Automatic VAT return depends primarily on taxpayers rather than tax officials. … Most companies are not eligible for it, because they fail to meet the criteria set in the Tax Code. This points to the fact that the schemes used by the real sector of the economy are not transparent.” Businessmen and tax officials seem to be talking about the same thing but emphasizing different aspects. Let us try and sort things out.

Stubborn facts

The first thing that leaps out is the number of companies recognized as eligible – there are, to put it mildly, too few of them, considering that tens of thousands of businesses in Ukraine pay VAT. The March list signed by Zakharchenko lists 24 companies as meeting all the administration's criteria, receiving a total of UAH 457 million. Listed are both large enterprises – Zaporizhstal (UAH 84 million), Odesa Portside Plant (UAH 62.65 million), Nyzhnodniprovsky Tube-Rolling Plant and Novomoskovsky Pipe Plant (UAH 62.76 million) and others – and medium-sized ones (Artemsil, Dniprovahonmash, etc.). It is easy to see that a lion’s share of these companies are state-owned or belong to oligarchs not connected to the government. One gets the firm impression that the list was drawn up so as to avoid accusations of a bias toward sponsors of the Party of Regions. But the real problem lies elsewhere. There is nothing wrong with Dmytro Firtash’s or Rinat Akhmetov’s companies receiving VAT returns on legitimate grounds. The problem is that a mere 24 out of 2,000 companies passed the selection procedure.

In April, the list was expanded to include 37 companies and the total returns added up to UAH 672.8 million. All other businesses were given … a promise. Zakharchenko said that by the end of July UAH 18 billion, half of the projected total for 2011, would be returned. Does this data really mean that thousands of VAT-paying companies must operate in the shadow? Would their owners want to undermine the credibility of their official reports by applying for returns in the face of obvious budget difficulties, the crisis and, realistically, their small chances for automatic reimbursements? These are rhetorical questions. There are scores of companies in Ukraine that are still counting on automatic reimbursements.

Vox populi

“Until recently there were reasons our company was not on the list,” Oleksiy Cherkasky, deputy director for economic and financial matters at Turboatom, told the Ukrainian Week. “But now we have removed all the deficiencies and count on receiving automatic returns as soon as next month.” Curiously, Turboatom did not make the list in March or April despite being officially lauded as the “best income tax payer” (UAH 52 million in the first quarter of 2011 alone). The state still owes the company UAH 10 million in VAT returns.

“Our enterprise is the key company for the town. We pay countless different taxes and constantly finance social and infrastructure projects. But we were clearly told that we would not be put on the list, because there were some discrepancies in VAT payments made by our contractors… As it has turned out, the fact that the local tax administration is able to meet its quotas only thanks to us is not binding on it in any way. Why do we have to depend on how timely other unaffiliated companies pay taxes? Is this a normal approach?” the financial director of a Crimean plant asked indignantly. He insisted on speaking on condition of anonymity and refused to even have his company identified for fear of falling out of favor with the tax administration. Since the Tax Code took effect, business’s relations with tax officials have become painfully intensive and now pose a threat to any company.

Remarkably, the list does not include a single enterprise in agriculture, even though this is the country's third biggest exporting sector after metallurgy and the chemical industry. There is an explanation. “In general, traders export all the grain after buying it from intermediaries. Producers that offer small volumes for sale are of little interest to traders,” says Pro Agro CEO Mykola Vernytsky. “The law clearly says that those who purchase goods from intermediaries are advised against applying for automatic returns.” However, no agribusiness CEO we spoke with can even dream about reimbursements. They have got used to the opposite: the government’s debt in VAT payments to the agricultural sector is an estimated UAH 3 billion.

How does the tax administration actually explain its reluctance to return VAT automatically?

Strange criteria

Zakharchenko admitted that 90% of the companies that submitted their applications failed to meet two criteria: wages must equal at least 2.5 minimum wages (UAH 2,400) and tax payments by contractors must be up to date.

The former is legislative know-how. Even more surprising than its apparent concern for workers’ wages is the fact that the government has established an absurd criterion which has, in essence, nothing to do with VAT administration, while it itself fails to make VAT returns on schedule and thus hurts companies financially. The latter seemingly stands to reason – a failure by the applicant’s contractor to pay taxes may suggest financial fraud. But then it is abnormal for a conscientious taxpayer to be denied floating assets simply because someone down the line failed to pay something due, quite frankly, to inadequate administration. 

At the same time, the second criterion is a legalized possibility for the government to deny automatic VAT returns to virtually any company. It is hard to imagine how much time tax officials may need to collect and analyze data on transactions one, two or ten steps removed from the company in question. In these circumstances the taxpayer may easily be kept waiting for years. For example, the state owes ArcelorMittal Kryvyi Rih, one of Ukraine’s metallurgy giants, over UAH 2.3 billion as of end of April 2011, even though it has been on the list of companies eligible for automatic VAT return.

This fiscal casting also involves other criteria: the company has to either employ a maximum of 20 people, prove that its capital assets are worth more than the claimed sum or pay a higher-than-average profit tax in its sector. The company should not be in bankruptcy proceedings and must have its documents in order. Moreover, it should have a clean tax payment record with the state. (Obviously, any tax official can easily create problems along these lines.) In the past year, zero-VAT transactions should be at least half of the total volume of deliveries, while the total difference between the applicant’s tax credit and its contractors’ liabilities should not exceed 10% of the claimed sum. And so on and so forth.
Taken either separately or together, these criteria can be used as formal grounds to deny automatic reimbursements to anyone at any point in time. Why not unify them and pay off only those who have a portrait of the beloved prime minister in their offices? There will not be too many of them and this will automatically solve the problem even without the cutting-edge software which, if you are to believe Zakharchenko, selects the fortunate without any human interference.

Not now

Even if a company overcomes all the hurdles and is admitted to the “automatic club,” this does not necessarily mean that it will receive the entire amount it is due. ArcelorMittal Kryvyi Rih reported: “The enterprise received UAH 293 million in VAT returns via the automatic procedure. Another UAH 200 million was paid in the regular manner for January 2011. However, the problem of VAT returns for 2010 remains outstanding.” Zaporizhstal is still to receive UAH 34.5 million out of the government-approved UAH 84 million.

As of 1 April 2011, the state’s tax debt had soared to a record UAH 12.6 billion, and it virtually has no money to pay it off. There are promises though — for example, Azarov said that everyone would be using the automatic procedure by the end of the year. President Viktor Yanukovych confirmed: “To be honest, we have proposed a system, but it has not been functioning properly yet. I hope that by the end of the year it will be operating at full capacity and will indeed provide a mechanism we can use and there will be no more complaints from taxpayers.” Following this statement, Vice Prime Minister Serhiy Tihipko promised that the criteria could be tightened even more. Experts contacted by the Ukrainian Week have outlined a very simple solution: freeze the money on a special account of the company in question and carry out inspections. In case of data which does not match, the money should be returned to the budget, and the company should be fined and removed from the list of reliable companies.

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