The Pros and Cons of Ukraine’s New Tax Code

In December 2010, the Ukrainian parliament approved the country’s first unified tax code. The new tax rules, most of which took effect on 1 January 2011, aim to simplify tax administration, raise tax revenues and attract more foreign investors to Ukraine.

Widely criticized for its vagueness and complexity, Ukraine’s tax system has consistently ranked poorly in studies by multilateral financial institutions. The creation of a unified tax code would then seem a welcome development for both taxpayers and potential investors. Yet the initial proposed rules released in June 2010 sparked protests across the country, with many Ukrainian companies claiming the new measures were too restrictive.

“The initial draft was met with a lot of resistance, mostly from small to medium businesses,” says Hennadiy Voytsitskyi, head of Baker & McKenzie’s Tax Practice Group in Kyiv. “It removed incentives under the simplified taxation system that the SMEs greatly benefited from.”

The code that was finally adopted was a significant improvement on the June 2010 draft. Incentives for small business owners under the simplified tax system were restored, and key provisions to drive investments into the country were introduced. Corporate income tax, for example, will be reduced gradually from 25 percent to 23 percent starting 1 April 2011, and ultimately to 16 percent by January 2014.

The new code also aims to boost growth in certain industries. Tax exemptions — and even income tax holidays — are now being offered to companies in a number of business sectors, including those in the hotels and hospitality industry, biofuels and manufacturing of energy-efficient technologies.

Enacting a unified code, however, is only the first step in reforming Ukraine’s tax system. The new rules, Mr. Voytsitskyi warns, are not a long-term cure for problematic tax practices that sharply reduce the country’s tax revenue, such as abusive tax minimization strategies by local and foreign businesses.

“The tax code will not frame a new tax environment for Ukraine,” he says. “Instead, it’s more a reaction of the Ukrainian government to the issues they’ve identified while administering Ukrainian taxes.”

The new code also fails to address the issue of excessive payroll taxes in Ukraine, which can be as high as 40 percent. It is, Mr. Voytsitskyi says, a nagging setback in the country’s tax collection efforts. “High tax rates are not usually an indicator of high tax revenues; in Ukraine, for example, tax revenues are low because people don’t want to pay taxes at all.”

Despite its drawbacks, the new tax code has definitely made Ukraine a more attractive place to do business. “Like most new laws, Ukraine’s tax code is a work in progress,” says Mr. Voytsitskyi who, along with other Baker & McKenzie tax lawyers, worked with civic and business associations to push for reform.

“We are happy to have been part of that effort of perfecting the tax code,” he says. “I’m sure the work on the current tax code will continue. We will see amendments introduced in the future.”