De-shadowing the economy to fill the budget: what options are being considered

On August 2, EBA member companies met with Danylo Hetmantsev, Chairman of the Parliamentary Committee on Finance, Taxation and Customs Policy, and Svitlana Vorobey, Deputy Minister of Finance of Ukraine, to discuss Draft Law #11416, which provides for an increase in the rates of a number of taxes.

According to Danylo Hetmantsev, the total additional budget needs currently amount to UAH 500 billion due to the increase in defense spending. This amount will be partially covered by increased borrowing in the form of domestic government bonds and de-shadowing funds, but the Government plans to raise about UAH 125 billion through tax increases.

In turn, businesses are aware of the need to accumulate additional resources for defense needs during martial law. However, currently, the entire burden of the proposed tax increase falls on honest businesses, which can have a devastating impact - up to and including investors' decisions to stop operating in Ukraine due to unpredictability and uncompetitive conditions compared to the shadow sector.

According to the EBA members, until the Government uses the potential of the shadow economy, it is difficult to understand additional taxes exclusively on white business. De-shadowing can free up additional billions of hryvnias to the state budget. According to a study by the Institute for Social and Economic Transformation, in 2023, the potential loss of budget revenues from the shadow economy is about UAH 400 billion. In particular, most of the losses are due to smuggling at the border - UAH 80-150 billion, salaries in envelopes - UAH 70-110 billion, counterfeiting and illegal trade - UAH 46-51 billion, etc. Therefore, we would like to draw attention to the untapped fiscal potential of the shadow economy. At the same time, we would like to emphasize that without customs reform, a full-fledged restart of the BES and effective work of law enforcement agencies, an effective fight against the shadow economy is impossible.

Among other proposals to fill the state budget, the EBA experts highlight the following measures:

• Increasing the tax burden on the gambling industry.
• Implementation of measures to combat payroll tax evasion schemes through individual entrepreneurs, including salaries in envelopes. For example, raising the single tax rate for the simplified taxation system and using the existing tools of regulatory authorities to prevent business fragmentation schemes.
• In order not to harm bona fide users of the simplified taxation system, it is worth considering the possibility of applying differentiated rates.
• Strengthening the fight against gray schemes in e-commerce. Introduce a fiscal lottery to encourage the registration of all payment transactions through cash registers/PTRs.
• Study of the fiscal potential of revising the tax-free limits for import transactions (with goods up to EUR 500 in accompanied baggage and up to EUR 150 for postal and express shipments), which are currently exempt from customs duties and VAT. Determining the most appropriate threshold for the value of tax-exempt transactions and introducing a simplified/automated declaration and taxation regime.
• Review the proposed mechanism of taxation of the car market, in particular, to assess the fiscal effect of taxation of transactions in the used car segment.

Finally, if necessary, to assess the effect of raising the VAT rate, going beyond the purely fiscal effect, to assess the impact on the Ukrainian economy in the medium and long term.

In addition, the business community believes that the state budget expenditures should be optimized and some public expenditures should be reviewed. We call for increased efficiency of public spending, which includes financing socially important programs that contribute to economic recovery and strengthening defense capabilities.

The EBA has separately noted and agreed that these measures should be temporary. At the same time, the discussion participants disagreed on the timing of the introduction. The EBA proposed to introduce these measures for a fixed period of one year, while representatives of government agencies are inclined to introduce these measures until the end of martial law plus a certain fixed period.

In addition, the EBA companies voiced their comments and suggestions on specific tax rates and explained how their companies and industries could be affected by their increase.

In particular, the EBA opposes the turnover tax. For some companies with low profitability, such a tax burden will be unbearable. The turnover tax will affect the competitiveness of Ukrainian companies both in international markets and in Ukraine, as 1% of turnover will be applied at each stage of production. Business is categorically against a turnover tax combined with income tax and VAT for legal entities without any simplifications compared to the simplified system.

According to business calculations, for example, for mobile operators, a +5% tax burden on turnover will actually lead to 12-13%. For car dealers, +15% will actually be 17% of the turnover, which negates the feasibility of continuing the business of selling new cars. For jewelry, +30% of turnover will completely offset the profitability of the business. It should be noted that both the relevant VRU Committee and the Ministry of Finance listened to the arguments of the business and are inclined to understand the negative consequences and the need to exclude this initiative from the text of the draft law.

The EBA made comments on the mechanism for collecting advance payments for the fuel and lubricants retail industry on income tax, in particular, on the possibility of offsetting against future periods.

The EBA does not support the increase in taxes on legal salaries without an effective fight against the use of schemes, payroll tax evasion, in particular through the abuse of the simplified system.

We also object to granting local authorities the right to set an unlimited value of the PIT base.

We oppose the provisions on inventory during aud its and within the timeframe determined by the auditors due to high corruption risks.

The introduction of new taxes, such as the excise tax on sugary drinks without a transition period, could significantly harm companies. It will increase the cost of customizing software solutions and affect long-term fixed-price contracts. The proposed tax rate is three times higher than the European one. We propose to separate the excise tax on sugary drinks into a separate draft law and finalize it in detail with business representatives.

In addition, the EBA opposes changes in approaches to taxation of Diia City residents , as this could undermine investor confidence in the state by failing to comply with the commitment to a stable tax regime and fixed tax rates for 25 years.

Speaking to the business, Svitlana Vorobey noted that raising taxes is a necessary step, but it is the fastest way to raise funds for the state budget. The growth of defense spending entails the need to increase domestic tax and non-tax revenues. At the same time, the Ministry of Finance is open to discussions and changes to the proposed concept of tax increases, provided that the amount of additional tax revenues required remains unchanged.

We are grateful to Danylo Hetmantsev and Svitlana Vorobey and their teams for their willingness to listen to business and openness to dialogue. The EBA has officially submitted its suggestions and reservations. All additional calculations will be provided by the EBA in the normal course of business. We hope that they will be taken into account and that by working together we will be able to develop a new draft law that will help fill the budget and reduce the shadow economy without devastating consequences for the operation of white business.