Exit Capital Tax (ECT): what is the benefit for business?
In October 2017, the Cabinet of Ministers of Ukraine and then the National Reforms Council passed the bill on replacing the income tax with the exit capital tax. The new tax system will be launched in 2018. For now, however, the system mechanisms have not been outlined yet. The Verkhovna Rada has not managed to do it on time as planned. But even as a draft, the new tax is promised to make the life of Ukrainian business more simple. To understand that, one would have to take a look at the existing taxation process.
How are the taxes assessed now?
The main source of replenishment for Ukrainian budget is the income tax. More specifically, the item taxable is the net profit of a company. It is calculated from the difference between the income and administrative expenses. Then, an 18% tax is deducted from the amount received. If the company income for the previous year does not exceed ₴20 million, then it files an annual financial report to the revenue service for assessing the amount taxable. If the income exceeds ₴20 million, then a taxpayer files a quarterly financial report.
What are the disadvantages of such a system?
There are problems with understanding what can actually be attributed to administrative expenses and what cannot. For example, some companies arrange their own cafés, where their employees can have a lunch. How necessary is it to record the employment costs when preparing financial statements for the revenue service? There is a similar situation with the drinking water bought by offices. These issues have been a matter of debate for a long time, thus, delaying the taxation process. Only a few years ago, the State Fiscal Service published some explanations.
Moreover, the revenue service may find other reasons to decrease the expenses reported by a company and increase the amount taxable as a result. Thus, controllers may find your agreements with suppliers to be concluded wrong and recognise your deals as fictitious sale transactions, i.e. deals existing on paper only. And since there were no deals, then there were no expenses associated thereto. There is a plenty of ways to manipulate such facts. That concerns not only the revenue service but the business as well.
Moreover, all tax inspectors spend a lot of time examining the statements. As a result, an entrepreneur spends all his/her time to communicate with them, meanwhile, he/she could be dealing with the business development and contribute to the GDP growth.
How one solve the situation with the exit capital tax?
This new tax is designed to replace the income tax. That is, there will be no need to deduct a percentage of the income for the state. All funds will remain with the owner. Spending time on tax inspections will not be necessary as well. One would be required to pass an inspection only in the event of a capital outflow. If it is the dividends that are flowing out, then the tax rate will be 15%. If the outflow takes some other form (royalty interest, financial aid, additional transfer pricing charges, etc.) – 20%.
This solution saves the entrepreneur’s time allowing him/her to manage profits more effectively. Besides, the corruption and shadow economy gets eliminated as a result. If the business does not need to file their accounting data to the revenue service, there is no need for it to conceal certain data. Tax inspectors will not have a grip on the business as deadly as before.
Dangers around the Exit Capital Tax
The income tax covers the largest share in the budget replenishment. If this tax is replaced with the exit capital tax, the state treasury is going to suffer significant losses. It is noteworthy that the sizes of losses vary. For example, an amount of ₴40 billion was mentioned at the session of the Cabinet of Ministers gathered to review the bill on introducing the exit capital tax. An independent analytical centre “Ukrainian Future Institute” insists it is ₴20-25 billion. Meanwhile, the Head of the Large Taxpayers Office, Yevhenii Bambizov, has recently announced that the potential losses will amount to ₴80 billion.
The government needs to find tools to compensate for the budget losses. One of those, apparently, will be the budget savings. The Ministry of FInance has already spoken on that. That means that once the exit capital tax is finally introduced, the government support for some sectors will reduce. On the other hand, it is too soon to tell anything until the methods for compensating the budget losses are published.
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