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Tax Reform – Key Challenges and Proposed Solutions

24.08.2015 Author: Iryna Kalnytska
Source: CEE Legal Matters

The unconstructive interaction between Ukrainian taxpayers and fiscal authorities during the past years and the lack of transparency of the budget funds spending process resulted in extremely negative attitude of businesses to the tax authorities.

Businesses have no confidence in the tax system at all and are reluctant to pay taxes, since it is practically impossible to avoid disputes with the oversight authorities whether or not you are a bona fide and law abiding person.

Furthermore, taxpayers are convinced that fair administration of justice does not exist in Ukraine. As a result, most business entities do not expect fair court trials and legal grounded decisions in line with the practices of the European Court of Human Rights and are certain that the only mission of the tax system is the state budget replenishment. Due to the above facts, the shadow economy volumes have been increasing from year to year, and the number of foreign investors has been regularly decreasing.

The current tax system is outdated and provides no incentives for the development of business activity, investment or creation of new jobs. On the contrary, such system seems to be an excellent basis for corruption and is extremely complicated and confusing: in terms of complexity of its tax system, Ukraine occupies 164th position in the global index of ease of doing business.

The above specified facts indicate to the existence of urgent necessity of a tax reform that would restore the taxpayers' confidence in Ukraine's tax system and lay a foundation for voluntary payment of taxes.

Tax reform is a complex and intricate issue, and it is impossible to disclose all its aspects in a single article. Still, there are fundamental problems, resolution of which would represent a significant step forward for each taxpayer.
As such, we may outline the following urgent problems that need resolution within the tax reform scope:

Volatility and ambiguity of the tax legislation

After adoption of the Tax Code of Ukraine, Verkhovna Rada passed more than 50 acts on amendments to the Code. The Code is difficult for understanding and contains a great deal of controversial provisions that allow the oversight authorities to interpret the Code in their favor. The market players and foreign investors are unable to plan their activities in Ukraine as at any moment the legislators and regulators may introduce changes that could make their businesses unprofitable or uneconomic. In the period from 2011 to 2014, more than 1500 comments and responses were posted in the Uniform Tax Data Base, 806 of which have already lost relevance; more than 30 summary tax advice have been published by the Tax Inspection, many of which contradict each other and to the Tax Code provisions on the whole, which results in origination of numerous disputes.

Proposed solution: it would be feasible to amend the tax legislation via adoption of a single package of laws and thereafter to set a moratorium on further amendments for a period of several years.

Absence of real liability of tax authorities representatives for illegal acts and consciously illegal decisions

In most cases, the tax audit acts contain absolutely false information and conclusions that contradict the provisions of the Tax Code. Ukrainian legislation clearly specifies that an audit act should concisely and logically set forth the background information, provide the list of offences with references to specific articles of the law that were violated. Ignoring these provisions, tax inspectors prepare audit acts containing their subjective interpretation of both the legislation and the business transactions of subject entities. In case of cancellation of a tax decision, taken based on the audit act, the guilty inspector does not bear any liability, while the damages are incurred by the state in the form of reimbursement of the court and attorney's fees.

Proposed solution: introduce personal liability of the tax inspectors for preparation of illegal acts on the audit results. In case a tax authority decision is canceled by a court award, the taxpayer should be reimbursed all and any documented expenses (court and attorney's fees) using the funds from the budget of the tax authority that took illegal decision. Furthermore, it is proposed to reimburse the legal assistance charges referring to actual expenses the tax payer incurred for the purpose of remuneration of the lawyers that handled the case (not only the advocates' fees).

Excessively high tax rates, including taxes on labor market and dividend taxes

The rate of the uniform social security contribution and personal income tax rate are not in line with the current environment and are excessively high, which creates inequality of the Ukrainian investors that pay the "white" (officially declared) salary and the domestic companies that are forced to pay salaries "in envelopes".

Up to January, 1, 2015, based on clause 153.3.6 of the Tax Code of Ukraine, dividends, distributed to a taxpayer by related parties without off-shore status were not included into revenues of such taxpayer.

Today, the Tax Code of Ukraine does not provide such participation exemption, and the dividends or return on equity paid out by a non-resident that is not a Ukrainian taxpayer are not deductible anymore. The practice of application of the participation exemptions is widespread and common in all European countries, which along with their national legislations observe international directives (Parent subsidiary directive, Swiss-EU savings agreement) making it possible to absolutely legal reduce the tax burden on the cross-border companies.

Furthermore, the tax on dividends to physical persons is also excessively high (20% versus 5% that was in effect before amending the Tax Code). Introduction of such tax rates provides the incentives for withdrawal of capital abroad and for tax evasion in Ukraine.
 
Proposed solution: reduce income tax rate, uniform social security contribution rate, and the rate of the dividends tax. It is necessary to implement a reform thanks to which the income tax would be fixed at a level that would make the tax evasion practice senseless.

Lack of efficient procedure for administrative challenging of resolutions of the tax authorities

Ukrainian legislation envisages a procedure for administrative challenging of resolutions of an oversight authority in the form of filing the complaints to a superior authority or court appeals.

Naturally, the procedure for administrative challenging is less costly than the court proceedings, whereas the claimant does not have to pay the court fees. At the same time, in practical terms, the administrative challenging procedure has no effect in Ukraine at all.
The statistics of the past years testify that based on results of administrative proceedings the Ministry of Revenues and Taxes cancelled only 3.6 % of the challenged decisions. And in case when a complaint reaches the court, most decisions are given in favor of the taxpayers. This statistics indicates to the reluctance of the taxmen of all levels to observe the laws and evidence that tax inspectors are primarily willing to meet the budget replenishment targets.

Because of these reasons, taxpayers are forced to appeal to the courts in order to protect their rights and avoid the administrative appeal procedure as senseless. As a result, despite the fact that the Tax Code places the controlling authority under obligation to prove the validity of a ruling, the proof burden is factually shifted to business entities. In other words, the mechanism of recourse against tax authorities decisions factually fails to be used in practice and an obligation of resolving tax disputes is shifted to administrative courts that must fulfill the work of tax authorities. When considering such disputes, the court investigates all source documentation and quite often requires the taxpayers to provide documents relating to business operations of their counterparties. Consequently, these results in violation of a principle of individual responsibility specified by article 61 of the Constitution of Ukraine and in ignoring of provisions of article 71 of the Code of Administrative Proceedings, which states that tax authorities should prove the validity of their decisions.

Proposed solution: we suggest that an efficient mechanism of administrative appeal of decisions of tax authorities should be implemented. In particular, such decisions should be supported by reasoned opinions in terms of criteria set by the European Court of Human Rights. Specifically, tax authorities must justify their decisions by providing proper grounds underlying such decision-making; each important argument of a taxpayer must be analyzed. Inherent to such justification will be a statement that whenever a court ruling adopted as a result of hearing an appeal does not meet the set criteria, such ruling shall be deemed adopted for the benefit of a taxpayer.

Efficient tax audit procedure

Currently, the Tax Code contains numerous grounds for conducting extraordinary tax audits of taxpayers. Recent amendments with regard to the moratorium on making such audits have turned to be inefficient and factually resulted in an increase of number of criminal proceedings. Any audit report containing an amount of additional payments in excess of a qualification limit, as set out in article 212 of the Criminal Code of Ukraine (evasion of taxes), is filed immediately with a tax police department for further criminal proceedings. It should be noted that opened criminal proceedings do not depend on whether a taxpayer has challenged such tax notice (decision) or not. Such criminal proceeding provide the tax authorities with an opportunity to pursue extraordinary tax audits and inspections of taxpayer's counterparties without securing approval of the Cabinet of Ministers of Ukraine and are used mainly to squeeze a taxpayer.

Proposed solution: we suggest that the system of audits and the number of underlying reasons for such audits be reviewed and decreased respectively. In addition, it would be appropriate to clearly state the individual responsibility of a taxpayer in the Tax Code and ban the deduction of amounts supported by tax invoices received from the so called doubtful counterparties from the amount of tax credit or loss.

The above-mentioned shortcomings in the tax legislation are one of the issues to be resolved within the tax reform in Ukraine in order to create a favorable investment climate and restore the trust of taxpayers in the state and its controlling agencies.
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