Leave us alone. How the Exit Capital Tax will change business behavior
Tax policy should not only foster budget revenue but stimulate the GDP growth as well. These goals may be achieved due to draft law on replacement of the corporate profit tax with the exit capital tax.
An efficient reform of the corporate profit tax may be performed via reduction of tax authorities’ discretionary powers and creation of equal conditions of taxation.
Simple tax calculation and administration provide reduction of tax authorities’ discretionary powers.
Equal conditions and rules are guaranteed by the absence of voting privileges, reduction of optimization opportunities and creation of economic incentives not to use optimization schemes.
Tax policy should not only provide the budget expenditures, but also stimulate GDP growth. The effective reform shall be performed with an observance of “Leave us alone” principle.
The draft law No. 8557 on replacement of the corporate profit tax with the exit capital tax (ECT) was introduced to achieve the aforementioned goals. Each taxpayer can see its own advantages deriving from the ECT versatility in resolving current problems of the corporate profit tax.
It`s hardly surprising that the ECT proponents provide various reasons on necessity to pass the draft law. This indicates the great potential of the reform.
Reduction of discretionary powers
The ECT essence is that it is levied only on those funds that are taken out of business. The most suitable indicator for business owners’ profit-making is withdrawal of funds from the business. The draft law specifies the list of taxable transactions.
The tax is calculated by applying the tax rate to the transaction price. Indirect taxes are charged in the same way. Are there any difficulties in calculating VAT on goods bought at the store? For example, we take price of loaf of bread (UAH 10) and add 20% of VAT to the price. No one has had the difficulties with it yet.
By contrast, having to pay the corporate profit tax, the bread producer should calculate the financial result (primary costs, exchange differences, reserves, loan discounting, depreciation, tax differences), make adjustments to the financial result and apply tax rate to the final tax base.
What difficulties may arise in calculation of the ECT on dividend payment? For example, we multiply dividend payment of UAH 100 by 15% and get UAH 15 of the tax. However, there are some auditors who deem it is difficult.
The draft law No. 8557 establish system of relations between the ECT payer and the ECT non-payer. All the ECT payers create a common business environment.
All transactions between them are not taxable and, therefore, not controlled. Here we see one of the key unique features of the ECT system, namely an increasing number of the ECT payers will simplify this system, not complicate it.
After all, if the ECT payer has contractors among the ECT payers only, there are no controlled transactions within such relations. Therefore, the more ECT payers do exist, the less efforts from both business and tax authorities will be required to administrate the tax.
Such system enables reducing the number of transactions under control in comparison with the corporate profit tax. Control is shifted to transactions conducted with the ECT-non-payers, namely individuals, legal entities using single tax regime, non-profit organizations or non-residents.
Transactions conducted with the ECT-non-payers will be identified by code indicated in payment documents. This will provide for automated tax return completion and remote control by tax authorities.
So is the ECT administration simpler than one of the corporate profit tax? Without jokes, the answer is obvious.
The ECT system significantly reduces the opportunities for tax optimization compared to the corporate profit tax. However, authors of the draft law sought to implement the “leave us alone” principle and, therefore, they made the draft law easier to understand having realized that complete prevention of tax optimization is impossible.
The emphasis is made upon elimination of capital abroad outflow major schemes. Company owner’s spending in Ukraine, having evaded the ECT, will be partially subject to VAT, excise tax, PIT or the ECT once again, for example, levied on the company’s car selling to the company owner who has previously used the ECT optimization.
The ECT is much more efficient in preventing offshore capital accumulation than the corporate profit tax. An interest payment to related non-resident is given as an example.
The interest payment may be allocated to the expenses to a limited extent. Apart from, the interest payment may be taxed by 15% of withhold tax. That we have in theory.
In practice, an interest to the non-resident under loan agreements is paid mainly by companies with accumulated losses. Such accumulated losses are due to exchange differences on the loan received. It does not matter to the borrower that the interest payment is allocated to the expenses to a limited extent. For instance, the withhold tax for interest payment to Cyprus resident is 2%.
We should consider whether transfer pricing rules may prevent capital outflow through interest payment (if so). No, it may not. The author does not know any cases where the loan interest was declared as overrated within the TP framework.
At the meeting of the Working Group in the Ministry of Finance of Ukraine representatives of the National Bank of Ukraine note that foreign lenders charge from 1.5% to 11% from Ukrainian borrowers.
Transfer pricing officers from the State Fiscal Service of Ukraine state that the Cyprus lenders provide certificates on high default risk of Ukraine. These certificates are enough to justify any interest. As a result, the companies with accumulated losses paid UAH 34 billion of interest taxed at the average rate of 2.6% to non-residents in 2017. In other words, Ukraine has UAH 884 million from such companies.
At the same time, these companies prepared the TP documentation which is unnecessary, as tax authority is still unable to prove the opposite.
How does the ECT deal with the interest payment? The rate of 20% will be applied to interest payment to low-tax jurisdictions. UAH 12.5 billion out of UAH 34 billion of interest was paid to offshore.
In other words, the ECT would raise UAH 2.5 billion plus UAH 1 billion from the remaining UAH 21.5 billion taxed at a rate of 5%. Total UAH 3.5 billion against UAH 884 million within the corporate profit tax. The ECT establishes one another rule yet.
If the debt-to-capital ratio is 1.5 times, the rate of 5% is applied. If the one is 3.5 times, the rate increases to 20%.
Therefore, if the aforementioned UAH 21.5 billion would be paid by companies with the debt-to-capital ratio of more than 3.5 times, then the tax would be recalculated at a rate of 20% at the beginning of the year following the reporting year. This would result in UAH 4.3 billion of the ECT, whereas total amount of the ECT would be UAH 6.5 billion against UAH 884 million within the corporate profit tax.
The basic tax base erosion schemes used in the corporate profit tax, namely interest, royalties, purchase of securities, and under-invoicing in exports, are listed in the draft law No. 8557 as taxable transactions.
Such a mechanism eliminates the opportunity to reduce taxes using accumulation of losses. If the transaction price is used as the tax base, this approach simplifies the calculation of the transaction for the taxpayer and makes it easier to be controlled by tax authorities, It also becomes more difficult to use tax optimization.
Someone says that capital outflow is the result of mistrust to the system, namely lack of enforced property rights and fair trial.
These problems do exist in Ukraine, but there is no reason to pay less tax compared to those who invest capital in business in Ukraine. The ECT looks like an impartial tool to reward the risk of investment in business becoming the tax-free or to pay the tax on withdrawal of capital from the business having refused from the risks.
There are also economic incentives to reduce tax optimization within transactions conducted in Ukraine. It is proposed to pay the tax at a rate of 15% applied to the tax base.
This means that the effective tax rate is calculated as 13%. For example, UAH 100 of dividend payment plus UAH 15 of the tax is equal to UAH 115 which is total expense of the taxpayer in this case. Thus, 13.04% (15/115) is a tax burden on payment.
In addition to it, there is an opportunity to lower the ECT by property tax paid. Dividend income received from the ECT payer is not subject to PIT. Thus, the tax rate becomes so attractive that it creates an alternative to “shadow payment”.
The draft law provides that the purchasing of goods, works and services from related contractors using single tax regime is equal to the withdrawal of capital from business that is taxed at a rate of 20%. Consequently, the cost of such purchasing will not be allocated to the expenses.
The services purchasing from non-related contractors using single tax regime will cost from 7% to 10% which consists of 5% of the tax, up to 1% of bank’s fee and from 1% to 5% of the “assistance”. We should also consider the risks and time of transactions’ organization, the necessity to explain the source of funds to the bank in case of using the funds received from the “assistants”.
As a result, we may save only from 3% to 5%. Is it worth the existed risks and headache? Thus, the draft law expeditiously shuts down both of offshore schemes and the single tax evading schemes. It gives the great opportunity, by contrast, to pay the tax at a rate of 13%. Are there any other effective initiatives? No.
It is often said that the ECT does not cover the great area, namely, cases where company purchases property for the personal owner’s use.
First of all, not only the ECT has this disadvantage, but also the current corporate profit tax. Therefore, it is not an argument against the ECT implementation. In addition, we should rather pay attention to the PIT than to the corporate profit tax or the ECT in this case.
Secondly, tax authorities are not willing to stop such activity, even though it is quite active.
The fact is that the aforementioned tax optimization does not significantly reduce the budget revenues if assessing the situation in complex. Cars, phones, fuel and apartments are purchased in Ukraine.
Consequently, the budget receives excise tax, VAT, profit (the tax paid by sellers of goods) revenues.
Thirdly, the ECT may reduce such activity, considering that the property purchased belongs to the company, not to the individual. If something happens to the company, then its owner loses everything that belongs to the company and nothing that belongs to him or her personally.
We assume that 13% is a very reasonable price to stay calm, taking into account the business environment in Ukraine. Thus, the aforementioned activity of formalizing a title to property to the legal entities would become a thing of the past.
Honourable proponents of the corporate profit tax should keep in mind “you need to look where you have lost, not where is a light” principle and pay attention to offshore schemes where the budget of Ukraine desperately loses tax revenues.
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