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Farewell to Income Tax! What To Expect From New Taxation Model


Galyna Melnyk, lawyer at Ilyashev & Partners Law Firm
Source: Ekonomichna Pravda

Staring from 1 January 2018 it is planned to implement the tax on capital withdrawal instead of income tax in Ukraine. How this would impact business and economy?

The idea of radical reformation of income tax system was enshrined in the law, which changed the “New Year” amendments to the Tax Code.

Paragraph 5 of Final Provisions of this act obliged the Cabinet of Ministers to submit the Draft Law on the Implementation of the Tax on Capital Withdrawal to the Parliament by 1 July 2017.

The representatives of official authorities have repeatedly expressed their intent to implement this tax on 1 January 2018.

The idea of the tax imposition on withdrawn capital relies on the co-called Estonian income tax model.

The income tax is absent in Estonia. The tax at 20 percent rate is imposed only on profits distribution (dividends payment) without any further taxation of such profits at the level of dividends recipients.

Income generation from capital increase is equivalent to profits distribution, for example, obtainment of the amount exceeding the nominal value of share during the liquidation of Estonian company, and in certain cases — payments to off-shore companies.

The tax is not imposed prior to profits distribution. This provides for reinvesting the accumulated profits without any tax consequences.

It is expected that in Ukrainian version the tax on capital withdrawal will be imposed only to the distributed profits. However, the regulator will have to equate to the taxable profits distribution a much wider list of operation to prevent large-scale abuses of tax relief.

It is quite expected that such operations will include those that are actively used to minimize the tax burden.

These can be certain types of payments to non-payers of the tax on the withdrawn capital: payers of single tax, non-profit organizations, certain non-residents, for example, related to the taxpayer or registered in low-tax jurisdictions.

What is the purpose of the regulator in this case? Allegedly, the main goal of the implementation of the tax on the withdrawn capital is behind the title of the law, which envisaged the introduction of such tax. As the title implies, the law is aimed at the improvement of investment environment in Ukraine.

The principal of taxation only at the moment of profits distribution simplifies the maintenance of tax records, first of all due to the absence of necessity to confirm the legitimacy of incurred expenses and losses.

This makes the recordkeeping easier for tax purposes, significantly narrows the area of tax control and consequently the field for the potential conflict between the fiscal authorities and the taxpayers.

Moreover, the taxpayer will be able to decide when he is ready to pay the tax — without having to do it with a certain frequency.

This gives him freedom to maneuver and stimulates investment in the Ukrainian economy. In its turn, this is to stimulate the state budget revenues from other taxes — VAT and personal income tax imposed on salary.

In addition the new system may become the next step to the suppression of channels of doubtful tax minimization in the area of income tax, following the introduction of the electronic administration of VAT, which brought VAT laundering to the end.

It is expected that these factors will positively impact the investment potential of Ukraine in international ranking Doing business.

Among main disadvantages of the implementation of the tax on the withdrawn capital are the lowered income tax revenues to the state budget at least at the first stages of system implementation. The efficiency of this system can hardly be estimated in the long run, especially taking into consideration the Ukrainian business leaning toward loopholes in laws for nontransparent tax optimization.

Alsoб there are certain concerns that with the termination of income tax in classical meaning Ukraine may earn the fame of a special offshore country. This shall hardly impact its international image in a positive way, especially taking into consideration the fact that Ukraine, unlike Estonia, is not the member of OECD and the EU.

Adoption of the tax on capital withdrawal requires solutions to a number of issues: how the losses will be handled, accumulated by taxpayers prior to this tax adoption; on the correlation of the tax with the tax at source and the personal income tax with regard to the allocated revenues: on the viability of keeping the advance installment during dividends distribution; on the frequency of reporting; on the future of the group three of single tax; or how the system will apply to nonprofit organizations.

It is evident that the comprehensive reformation of the Ukrainian tax system, as well as the improvement and liberalization of foreign exchange regulation are required in order for the tax on capital withdrawal to be effective.

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