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Structure of he tax system
Ukraine has yet to introduce a Tax Code, which is likely to happen in 2004. However, the existing Law “On the System of Taxation”, the current Ukrainian equivalent to a Tax Code establishes the regulatory framework for the operation of the tax system. It contains fundamental norms, albeit not extensive, common to Tax Codes of more developed legal jurisdictions, like, for instance, norms establishing precisely thetaxes and mandatory payments due, norms establishing the competence of authorities regarding tax issues, norms providing that reforms totax laws may only be introduced by tax laws, and norms regulating the entry into effect of reforms to tax aws, to mention a few.
As mentioned above, this law contains the list of state and local taxes and duties applicable. At the time of drafting, there are 20 state taxes and duties, the most significant being corporate profits tax; VAT; personal income tax; payroll taxes; import duties and excise tax. In addition, there are 16 different local taxes and duties, whose value is normally not significant for business. As an encouraging trend, the number oftaxes were reduced during the 1997 tax form (and also subsequently by several other reforms to specific laws), will further reduce, although only slightly in 2004 when two local duties are cancelled and will likely reduce further when the Tax Code is passed, hopefully in 2004. Thus, if this positive trend continues, the number of state and local taxes will reduce to acceptable levels and the administration oftaxes by business will become less complicated.
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Corporate Profits Tax
Prior to the 1997 tax reform, the Ukrainian corporate profits tax was everything except for a tax on profits, with a nominal tax rate of 30%, but an effective tax rate significantly higher, reaching the point of prohibitive. Thus my comment that is was not really a tax on profits.
The 1997 tax reform introduced significant changes. Amongst the most important ones was establishing principles for the deduction of costs and expenses, rather than the very limited and restrictive list of deductible expenses previously in force, which significantly increased the effective tax rate. Like in other more developed legal jurisdictions, the tax reform of 1997 also introduced a list of non-deductible expenses, list that in my view was very reasonable. Another key point of this tax reform is that it specifically banned the tax authorities from imposing any additional limitations or restricting the deductibility of expenses, unless the law stipulated those restriction.
Despite all these positive points, as I mentioned earlier the 1997 tax reform felt short in accomplishing a reduction of the tax burden on business.
Noteworthy, one of the core elements of the tax reform that will take effect at the beginning of 2004 is the reduction of the tax burden on business. In fact, from 1 January 2004 the tax rate has been reduced from 30% to 25%. Moreover, this has been accompanied by a significant increased of the depreciation rates for fixed assets, which will result in the reduction of the gap between financial and taxable profits. In addition to this, the reform has introduced clearer procedures for taxation of lease transactions and the tax treatment of bad debts. It has also removed the 5-year limitation on tax losses carry forward. Finally, it has introduced much more developed transfer pricing rules. Overall, the changes brought in by the 2004 tax reform will be very significant in reducing the tax burden on business. Thus, a well-managed business will begin to see that from 2004 the gap between the nominal tax rate of 25% and the effective tax rate ought to reduce. This is my opinion a very important trend, and one that should encourage investors.