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1 August, 2011  ▪  Ivan Hryhoriev

Regulatory Squeeze

Economic growth will not take place without true deregulation and improved tax conditions for small and medium businesses.

Throughout May and June, senior officials on numerous occasions have tried to convince the public of their sincere desire to vastly improve business conditions in Ukraine and have emphasised the tools they will use towards this goal: deregulation, a lower fiscal burden, struggle against corruption, etc. However, since Prime Minister Nikolai Azarov’s team came to power, a mere handful of laws have been adopted towards serving these goals, they have admitted,  and even those that have been passed are either half-heartedly enforced or openly sabotaged by local officials.

Place in the Sun

Despite some improved macroeconomic data, in particular GDP and declared figures for the fulfillment of the budget, small and medium businesses are still under great pressure from the state, which has been confirmed by studies carried out by international organisations. The Swiss business school IMD recently published the World Competitiveness Yearbook 2011 with rankings computed on four main factors: economic performance, government efficiency, business efficiency and infrastructure. Ukraine ranks 57 among the 59 the countries covered in the study, leaving behind only Croatia and Venezuela. The Heritage Foundation and The Wall Street Journal earlier published their annual rankings of economic freedom which placed Ukraine 164 on a list of 179 countries and at the bottom of the list of  European states or 162 in 2010 compared to 152 in 2009. Experts attribute this regression to economic overregulation and rampant corruption. Ukraine ranks 145 out of 183 countries in the Doing Business 2011 ranking published by the International Financial Corporation and the World Bank. Compared to 2010, Ukraine has better conditions for company registration but worse conditions for closures. Moreover, experts say that property registration has also become more complicated; the investor protection index has dropped; while taxation and conditions for international trade are traditionally inadequate. In general, it is harder to do business in Ukraine than in any other CIS country, except for Uzbekistan.

We are also traditionally close to the bottom in the global competitiveness rating published by the World Economic Forum. In 2010-2011, Ukraine dropped by seven positions and fell to 89th on the list of 139 countries, losing as many as 14 points in the category of regulation and business environment ending up in 134th position. A poll showed that 19.6% of senior managers in Ukraine identified tax legislation as an obstacle to doing business, while 13.9% pointed to corruption as an obstacle. In the first quarter of 2011, Ukraine witnessed a slight improvement in the investment attractiveness index drawn by the European Business Association increasing its rating from 3.28 to 3.4 on a five-point scale. However, this came amid growing risks such as problems with customs offices, introduction of export quotas and a growth in business raids. The negative consequences of the Tax Code are cited by 37% of investors, while another 23% point to increased corruption.

Written and Unwritten Laws

Nearly a year ago, the Ukrainian government announced reforms to improve business conditions and to deregulate the economy. Initially, the State Committee for Regulatory Policy and Entrepreneurship, which still existed back then and was headed by Mikhail Brodsky, set about drafting bills which small and medium businesses allegedly needed. Most of these bills faced underhand  sabotage by state and local  officials. However, Cabinet-level protection made it possible to push some of the bills through parliament. However, in practice these innovations either failed to solve business problems or were simply ignored at the local level – most often with the approval of, or on orders from, above.

For example, the declarative principle was supposed to be quite a relief for businessmen seeking permits. Under this principle, in order to launch a business they would only have to submit a letter of guarantee to the controlling body stating that their resources and equipment were in line with pertinent legislation. However, at the same time the government obtained the right to make exceptions and made ample use of it by listing as many as 91 types of business activity – from transportation of hazardous wastes to selling elite-class seed and outside advertising – that did not fall under the scope of this norm. Experts say that the number needs to be cut by half.

The silent agreement principle introduced in late 2009 is also not working. Under this principle, if a businessmen files all the necessary papers to a regulatory body and does not hear back within 10 days, he is assumed to have been granted a permit. However, officials now point to Article 164 of the Administrative Offense Code under which carrying out business activity without a permit is punishable by a UAH340-680 hryvnia fine ($40-80) and confiscation of products.

Scrapping a number of licenses was meant to be a great victory for businessmen. According to Brodsky, last year 2,046 out of 2,268 types of work no longer need to be licensed along with 23 out of 78 types of activity. Many permits which used to have an expiration date are now open-ended. These steps can only be welcomed. However, in practice they resulted in higher costs of legal consultation  which had to be obtained to obtain licenses.

Attempts were made to simplify the overblown regulation of the construction industry. On 13 January  2011, parliament adopted a law that reduced the number of licensing procedures in this sector from 93 to 23 along with the maximum processing time from 415 to 60 days. However, the law failed to be enforced in practice. “Deregulation is still nowhere to be seen,” says lawyer Viktor Yatsenko who specialises in the field of the construction industry. Licenses and permits continue to be issued to businessmen but following the personal wishes of official’s, as opposed to  laws, he adds. Moreover, recent administrative reform restructured government architecture and construction inspections and agencies and left the construction industry in complete confusion. Brodsky, who is now the government’s point man for deregulation, recently said that another package of legislative measures is close to completion. An earlier framework law - which regulates urban construction - needs to be complemented with a series of government resolutions and several amendments, he says, promising to have it all completed within a month.

With Good Intentions

Natalia Korolevska, chair of the parliamentary committee for industry, regulatory policy and entrepreneurship, estimates that over 200,000 entrepreneurs closed their businesses in the first quarter of 2011 due to stringent Tax Code norms. Unfavorable fiscal conditions will force 170,000 more businessmen to close their businesses. Even though the State Tax Administration reports somewhat different figures, the government is clearly worried.

Perhaps that was the reason why a series of laws were passed aimed at simplifying the launching and completion  stages of establishing business ventures. But, these documents also raise a number of questions. For example, a recently adopted law requires legal entities to have authorised capital in the amount necessary for the conduct of their business (and no bigger), reduces the registration period of a legal entity to two days, simplifies the notarisation requirement for some documents and so on. However, Oleksandra Kuzhel, former chair of the State Committee for Regulatory Policy and Entrepreneurship, believes that this law is just “one pill” that cannot cure all of Ukraine’s diseases. The government came up with a few more of these pills.

A law passed on 7 April now gives inspectors less time to check businesses that are closing. A law adopted on 21April that will come into force on 28 August 2011 introduces an official registration system for legal entities based on model statutes. The Cabinet of Ministers draws up a model statute for each type of legal persons, while a particular enterprise may choose to use it for registration purposes or write its own. Mikhail Brodsky also pins much hope on amendments to the Law “On the System of Permits” adopted on 29 April. Under this law, permits will be issued and processed only by government administrators in special centres that will function from 1 January 2012. “Entrepreneurs will not have to talk to local officials and thus the latter will have no possibility of slipping their hands into businessmen’s pockets,” said Brodsky. However, it is up to the Cabinet of Minister to draw up a list of permits affected by this law, and there is reasonable doubt that local officials will sabotage the law (which they are already doing) and will fail to establish a network of permit centres within six months. Furthermore, the government could add or remove items from the list even on a daily basis and may choose not to include permits, the issue which causes the greatest degree of headaches for businessmen.

Another law has been in effect since 7 May which cancels state registration certificates for legal entities and private individual entrepreneurs and replaces them with statements from the Integrated State Register (ISR). The sponsors of the law believe that this will save businessmen time and money, but the statements in question, which used to be valid for 30 days, will no longer have an expiration date. This means that any given statements, unless it was issued recently, is no guarantee that a particular enterprise remains officially registered and is legally operating. In practice, businesses will have to repeatedly obtain these statements to prove their legal status to their partners.

Writing but Not Fulfilling

President Viktor Yanukovych demanded from Azarov a prompt resolution of the deregulation problem. “We need to complete the process which we began in 2010… My demand for you is to complete it urgently. Mr. Azarov, this is your responsibility,” he said. The prime minister replied that they were working hard on this issue and there was a possibility that it would be completed by the end of 2011.

However, what the government has to undertake is not only to lobby for legislation through parliament that would benefit businesses but also implement it over the teeth of opposition from bureaucrats. Local-level tax officials apply such legislation arbitrarily. Even Azarov himself admitted that checks continue to be made despite the declared ban on inspecting small businesses. The government set up a hotline and the prime minister instructed competent bodies to “react to unlawful checks and punish the initiators.” Yanukovych encouraged businessmen to complain directly to him. “I appeal to businessmen through the mass media: write to me, telephone me,” he said. They replied, also through the mass media: “Which telephone number should we call? There is none.”

Senior officials are clearly unable to react to all of these complaints. This is, after all, not their task or function. Ukraine’s tradition of “telephone  law” (instructions issued over the phone, rather than on paper)  has never by-passed the often nonsensical and harmful fiscal laws and the corrupt and non-transparent government system of operation. In late May, the Group of States against Corruption (GRECO) noted Ukraine’s failure to secure anti-corruption legislation and pointed out that Ukraine’s measures fall short of European standards in 13 areas. Ukraine was criticised in the following areas: corruption is not recognised as criminal activity in Ukrainian legislation; the Prosecutor-General’s office is subject to political pressure; legal entities do not bear direct responsibility for corruption-related offences; the issue of conflicts of interest among government employees remains unresolved and so on. Two new laws “On the Foundations for Preventing and Counteracting Corruption” and “On Amending Certain Legislative Acts of Ukraine Regarding Corruption,” both drawn up by the Presidential Administration, are expected to somewhat improve the situation. However, experts believe they contain a number of norms which will permit a selective application of anti-corruption articles.

Therefore, real developments in the country (such as increasing administrative pressure on businessmen coupled with a significant deterioration of business conditions) are at variance with the authorities promises of reforms. Individual legislative initiatives will not cover up this gap between rhetoric and action.

Reviving the Flat-tax System

A sudden warming can be observed in the government’s attitude toward small businesses. In mid-May, Azarov attended a meeting of the Council of Entrepreneurs which is part of the Cabinet of Ministers and promised to preserve the flat-tax system. Legislative Bill No. 8521 “On Amending the Tax Code” was quickly registered in parliament to introduce, among other things, articles on a simplified taxation system. Businessmen contacted by Ukrainian Week say that 70% of the proposed  norms mirror those contained in an earlier bill drawn up with the involvement of over 300 business associations. Azarov personally urged parliamentary deputies to rapidly pass the bill so that it could enter into force on 1 July 2011.

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