In Ukraine small is not beautiful

Ukrainian small and medium-sized entrepreneurs (SME) are complaining that government does not see them as the foundation of a healthy economy and favors big business. The lockdown have hurt SMEs the most, which could negatively affect the entire system of state finances.
In Ukraine small is not beautiful

Grocery store, Uzhgorod, Ukraine (Pxfuel, Public domain)

Although SMEs are responsible for the lion’s share of the labor market in Ukraine, these entrepreneurs have not been able to persuade lawmakers to introduce changes that would facilitate their business activities and boost the economy. “The state is harassing legitimate businesses with its enormous law enforcement apparatus. At the same time, it exhibits impotence and is unwilling to deal with the unfair competition, which is killing us — the illegal factories, the contraband goods, the shady public procurement procedures, the lack of quality control in public purchases, the illegal construction works, etc.” — commented Alexander Sokolovsky from the Union of Ukrainian Entrepreneurs.

Somber moods

“I hate the proletariat” — this is what Serhiy Tihipko, then-Deputy Prime Minister in Viktor Yanukovych’s government, said in the autumn of 2010, while commenting the protests of small and medium-sized enterprises against tax changes favoring the oligarchs. The protests subsequently spread across the country and became known as the ‘Tax Maidan’. “The idea that we should be listening to ordinary people and taking their opinion into account before amending the Tax Code is absurd” — argued Mr. Tihipko. Since then, not much has changed in this area. A few months ago, Dmytro Dubilet, the minister responsible for the digitization of Ukraine, boasted that he had tracked down a hair salon operating in a government-owned building in Kiev and ensured its immediate eviction from the occupied premises. Mr. Dubilet argued that the headquarters of the government are not a good location for a hairdresser’s salon. He failed to notice, however, the economic consequences of this decision — the owner of the shut down salon will no longer pay rent or taxes, and his employees are likely to join the ranks of the unemployed.

The sentiments dominating among Ukrainian entrepreneurs are reflected well by the index of business activity expectations, which is calculated by the National Bank of Ukraine (NBU). The NBU first started publishing this index in the summer of 2019. It indicates an improvement or deterioration in the business sentiment compared with the previous month. Scores above 50 points indicate that businesses are positively assessing the economic situation and the occurring changes, while scores below 50 points indicate a negative assessment of the situation. In July 2019, the initial score was 52.4 points, a month later it increased to 54.5 points, and in September it reached the record-high level of 56.6 points. Shortly after the presidential and parliamentary elections entrepreneurs were hoping for changes that would make their life easier. However, this optimism did not last long, and in January of 2020 the index of business activity expectations fell by 8.3 points, to the level of only 40.3 points. At that point in time, as many as one-fifth of all Ukrainian businessmen were declaring that they would reduce their personnel in the near future. These are data obtained before the outbreak of the pandemic and the almost complete shutdown of the activities of SMEs.

Harsh dispute over tax reforms

“Entrepreneurs can operate effectively in any system. Even in the Soviet Union, or in an authoritarian regime. Not in mass numbers, however, but rather as an exception to the general rule. A country can only succeed if entrepreneurs are able to achieve success in large numbers without superhuman effort. When there are no barriers to launch an activity. In our case the legislators should introduce changes which would lead to the creation of two million sole proprietorships and half a million companies within one year. This is a true indicator of the effectiveness of government actions. In Poland, during the first two years of reforms, more than 600 000 companies were created. Meanwhile, in our country the regulations were tightened so much, that we cannot even get close to such results” — stated Pavel Sebastianovich from the Association of Ukrainian Entrepreneurs.

In his opinion, the areas of crucial importance for entrepreneurs include tax policy, communication with the tax authorities, and confidence in their activities. Meanwhile, a new conflict has flared up around a legislative package proposed by the government. The new regulations concern the sphere of taxation and in particular the relationship between the entrepreneurs and the tax authorities. The core element of the changes is an extensive amendment of the Tax Code, known in Ukraine as Draft Law No.1210.

The objective of Draft Law No. 1210 is to limit the entrepreneurs’ ability to hide their income in tax havens, and at the same time to improve the tax administration. “I refer to this document as the law on justice and truth. Justice in the distribution of the tax burdens, and truth about what big business has been hiding throughout the entire period of Ukraine’s independence. Tax havens are used to hide incomes not only by small businessmen, but also by persons from the list of the 100 wealthiest Ukrainians, who are commonly referred to as ‘oligarchs’. And they have been organizing the campaign against our proposed law, which would eliminate the possibility of tax evasion and which is, in fact, an anti-oligarchic piece of legislation. For small and medium-sized entrepreneurs this new law provides a lot of improvements” — argued Danylo Getmantsev, the head of the Committee on Finance, Taxation and Customs Policy of the Ukrainian parliament.

However, the entrepreneurs have a different opinion on the matter. “The proposed changes extend the powers of the tax authorities towards smaller taxpayers to a degree that is not justified, granting them the right to determine whether a given action is a genuine business operation or whether it is fictional. The tax authorities will now judge whether an entrepreneur is responsible for any irregularity (which determines the amount of the penalty), whether they properly determined the transfer prices, what documents they have to provide, whether the purchase of services from a non-resident was justified, and many other things” — said Alexander Shemiatkin, an expert in the field of tax law. At the same time, the large taxpayers are excluded from the scope of these regulations. And it is necessary to keep in mind, that in 2017 alone such large entities carried out operations for a total amount of UAH50bn (USD1.8bn), and according to preliminary data due to their practice of underreporting the sales prices of raw materials Ukraine lost UAH5-10bn (USD181-363m) in tax revenues.

Moreover, tax changes introduced in 2018 allow tax free payment of dividends to non-residents. In 2019 alone, a company that is a part of a well-known agricultural holding paid out nearly UAH30bn (USD1.06bn) in dividends, without paying any income tax. The proposed legislative changes preserve this state of affairs. Leasing companies, financial institutions and banks have also found themselves in a privileged position and they are allowed to move money abroad and classify such funds as tax-deductible expenses. “The equality of economic entities promised by the government simply does not exist” — said Mr. Shemiatkin.

Companies are being pushed into the shadow economy

The situation was dramatically altered by the national quarantine introduced in March 2020, which prohibited any business activity of hundreds of thousand of small enterprises. In contrast to the large-scale support package for businesses in European countries, the Ukrainian entrepreneurs were largely left to fend for themselves. As a result, whereas thus far the entrepreneurs’ dispute with the government mainly concerned legal provisions, it has now turned into an open confrontation with the system. And in this case, it seems that the government is fighting a losing battle.

The introduced bans have directly threatened the existence of the entrepreneurs and their families. That’s why, together with the consumers, they have established a genuine shadow economy. This has been facilitated by the technological changes that have occurred in recent years — a massive expansion of social networking and instant messaging services, which are used by the quickly sprouting groups connecting local suppliers and customers. Today it is easy to find your favorite merchant from the local bazaar shut down by the authorities, or an agricultural producer deprived of the ability to legally sell goods, or the owner of a store closed down because of the quarantine. It is now possible to buy or sell practically anything outside of the official system, without paying any taxes. There is even a black market of hair and beauty salons. This situation is satisfying both for the customers, who oftentimes have the goods delivered straight to their home and are paying less than they would at the store, as well as for the sellers, who not only retained their livelihood, but have also been freed of all the problems with the state authorities, with which they had to deal thus far.

The amount of bribes they were forced to pay in connection with their activity also decreased. Entrepreneurs conducting a fully legal business activity or even those active in the shadow area were previously required to pay bribes to a number of institutions controlling business activities, and there was always a risk of penalties or further attempts at extortion. Now it is enough to pay off the local police in order to “turn a blind eye”, and even that isn’t always necessary. According to reports in the Ukrainian media, the ranks of businesses operating in the shadow economy include a restaurant in Kiev, which is owned by an MP from President Zelensky’s ruling party “Servant of the People”, and which is often visited by influential people from Ukraine’s political and economic elites.

As a result, the government, which has thus far been arguing with entrepreneurs about tax changes within the framework of a functioning system, may soon find itself deprived of their tax revenues and facing an expanding shadow economy spreading to successive new areas.

Those entrepreneurs who have not moved to the black market are increasingly openly speaking out against the government restrictions. In the second half of April south-eastern Ukraine saw a wave of protests organized by farmers deprived of the ability to sell their produce, as well as the merchants from the marketplaces shut down due to the pandemic. In Kherson hundreds of farmers blocked the main access route to the city, demanding the government to allow them to sell their yields. The protesters accused the government of acting in the interest of the large retail chains. They emphasized that the retail chains belonging to politically connected entrepreneurs have received the government’s consent to sell goods. Meanwhile, the shutdown of the marketplaces where they delivered their produce deprives them of their livelihoods. The national quarantine has fractured the traditional supply chains and as a result farmers are now forced to simply throw away their crops. Similar protests were held in the Odessa, Dnipropetrovsk and Zaporizhia oblasts. In Kamianske, in eastern Ukraine, desperate merchants seized the marketplaces shut down by the authorities and resumed sales, disregarding the government ban. As a result of the protests, the government ultimately allowed the operation of almost a thousand local marketplaces throughout Ukraine.

Grocery store, Uzhgorod, Ukraine (Pxfuel, Public domain)

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