Pre-conditions for its introduction
Corporate Profit Tax (‘CPT’) in Ukraine is no longer a budget-forming tax, and it is quite harmful tonormal business activity. CPT is actually a tool for direct capital withdrawal from the owner, determining the tax base as a “profit”.
And if the owner does not make any profit, it does not mean they won’t have to pay tax. Moreover, the procedure for calculating the tax base as the financial result + tax adjustments + excessive demands to primary documents + adjustment for “sham transactions” does not guarantee the predictability of the final amount of tax to be paid by the taxpayer. At the same time, the current model of CPT makes it possible, with real profits, not to pay the tax, or pay it at a rate of 0 to 5 percent.
Complicated rules of tax base calculation, providing the maximum discretion to the tax authorities in the regulations adopted by them, on the one hand, and the existence (availability) of legal mechanisms for tax optimization on the other hand, result inthere being a maximum CPT load on diligent taxpayers, while CPT is negligible for others. The practical consequences of such a situation are reflected in the following figures:
There are 269,000 CPT taxpayers in Ukraine.Some 1,086 of these taxpayersprovide more than 90 percent of the budget revenue from the CPT (they have a turnover of more than UAH 20 million ($800,000) and report profits). An analysis of this taxpayer category shows that it consists, as a rule, of companies with foreign investments and state enterprises. These are the taxpayers with an approximately constant model of behavior – they pay taxes and distribute dividends, regardless of the complications or simplifications in the regime of taxation with CPT.
At the same time, 8,000 CPT payers with turnover of more than UAH 20 million ($800,000) are loss-making companies. The loss accumulated by these CPT payers losses reached UAH 1.68 trillion ($672 billion) atthe end of the 1st quarter of 2016! Under normal conditions,losses may indicate that economy is in crisis. But in Ukraine there is a catch: Based on the dynamics of the first quarter of 2016, we can assume that the discussed loss-making companies will pay abroad about UAH 48 billion ($1.92 billion) in passive income during the year. In general, the expected amount of passive income to be paid out of Ukraine during 2016 by all categories of the taxpayer is at the level of UAH 75 billion ($3 billion).
According tothe memorandum of GLOBAL FINANCIAL INTEGRITY, the annual outflow from Ukraine is $11.7 billion. While $3 billion is the payment of passive income (as discussed above), it can be assumed that up to $8 billion are extracted through underpricing of exported goods or importing of overpriced services and goods. These are transactions that are potentially subject to the rules of Transfer Pricing (TP).
To struggle against CPT evasion, the Ukrainian government is actively elaborating legislation on controlled foreign corporations (CFCs), on bringing the rule of taxation with CPT into line with theOECD/ G20 Base Erosion and Profit Shifting (BEPS) Package on zero declarations and indirect methods of taxation for individuals.
Exit Capital Tax
The main idea (concept)of an Exit Capital Tax is that only the amountextracted from a business will be subject to taxation. The decision of an owner that results in capital extraction leads to the appearance of an object of taxation. Thus, for the owner, everything is predictable due to there being the opportunity to see the real picture of the financial results of the company. In such circumstances, it is also possible to achieve the financial recovery of enterprises due to the appearance of additional cash assets in the form of a deferred tax payments, which creates prerequisites for investment and the capitalization of companies.
The simplicity of the Exit Capital Tax model, which is constructed following the principle of administering indirect taxes, will result in the effectiveness of its tax administration. The object is a transaction (as in indirect taxes) that results in capital outflow from business. The object appears if the owner decides to pay dividends in favor of a non-payer of tax, as well as in case of there being a hidden outflow of similar payments (royalties, interests in favor of non-residents, financial assistance to non-payers of tax, investments abroad). The object also appears iftransactions that resulted in necessity to make surcharges under certain conditions (controlled transactions and transactions for which the usual prices are used). More details can be found in this presentation.
In the proposed system all transactions between the payers of the Exit Capital Tax shall not be subject to taxation. Therefore, it makes no sense to monitor all transactions that are carried out between 269,000 taxpayers. Conditionally, all payers of the Exit Capital Tax representa closed business environment. While capital circulates in this business environment – it is neutral for tax and control, as only capital outflows from this environment are controlled. This approach reduces the number of controlled transactions and allows the smart filtering of subjects of control,as well as quickly patching the “hole” of capital outflow from the system.
Control over CPT: Picture 1
Control over Exit Capital Tax: Picture 2
Since there is no such notion as losses, all adjustments under TP rulesbecome direct objects, resulting in the taxation of capital leaving Ukraine. Interest and royalties under certain circumstances also become direct objects.
The proposed system of Exit Capital Tax is a self-regulating economic model, since if no dividends are distributed, investment increases production, and as a result increases the turnover of goods and services, with an increase in revenues from VAT and payroll taxes. Keeping money in a bank account in Ukraine is simple because it is not taxed, with the current level of inflation and currency risks, it looks more like a theoretical risk. The effectiveness of this system has been proved not only by the experience of Estonia, but also by a number of studies.