Let’s start from the beginning and bring the general concept of SSCs into focus. SSCs are autonomous, centralized operating units providing services to different businesses and geographical entities in group companies. The fund¬ing and resources of these services are shared within the organisation. SSCs may be created in different ways; however, quite often a separate legal entity that provides services to other com¬panies from the group is established. Traditionally, the key drivers in develop¬ing SSCs were a need to reduce costs (often achieved through economies of scale), standardization and centralization of processes, allowing businesses to focus on their core activities. Over years of practical application it appears that in addition to the above, companies also benefit from increasing control over certain processes and ongoing performance improvement.
SSCs are typically utilised for high volume-based functions such as finance, accounting, IT, human resources, logis¬tics, procurement and other back-office operations. Setting up an SSC allows companies to ensure that standard operating processes are being used across the business. SSCs can support business units on a regional, national or international level. Once it’s decided to set up an SSC and determine the scope of its activity, the question of suitable location appears. Naturally, the first thought goes to the criteria related to the potential cost reduction (including labour costs and tax optimisation). Lviv, as the predominant city in West Ukraine and capital of a region with approximately 2.5 million inhabitants, provides a large pool of potential workers. With more than 35 higher educa¬tion institutions (with around 150,000 students), Lviv has significant strengths in accessibility of employees educated in finance, IT and business matters with proficiency in foreign languages.
It is worth mentioning that based on the results of research done by the Finan¬cial Times: “European Cities & Regions of the future 2010/11”, Lviv was ranked fourth among large European cities and regions in the category ‘Human resources’ (and third in the category ‘Cost Effectiveness’). Labour costs are among the lowest of all East European cities, with an average salary level in the Lviv region of approximately UAH 2,000 (based on data of State Statistics.
Committee of Ukraine). This positive picture is spoiled by the high cost of social security contributions (over 36% of gross salary); however, overall salary costs are still relatively low compared to other countries in the region. On the other hand, one cannot disregard difficulties that investors will face when deciding to operate an SSC in Ukraine, such as non-flexible and relatively old-fashioned labour regulations and challenging tax environment. As for labour issues, the Ukrainian government is working on the new Labour Code, which according to officials should be more business-oriented and is planned to be finalised by 2012.
From a tax point of view, Ukraine is definitely not the most compliance-friendly country in the world. A joint study by the World Bank, the IFC and PwC entitled ‘Paying Taxes 2011: The global picture’, ranked Ukraine as the third most difficult country in which to pay taxes out of 183 countries surveyed.
The current corporate income tax (CIT) rate is relatively high (25%) in com¬parison to other countries in the region (e.g. Slovakia, Poland, Hungary and the Czech Republic - 19%, Romania 16%).However, these tax rates are not the major issue for Ukraine, but rather the required level of tax administration.
Although the implementation of the country’s new Tax Code from 1 January 2011 generally raised a wave of criticism among businesses, it should be seen as a step toward the system¬atization and simplification of tax rules in Ukraine. It is definitely better to have codified tax rules in place of the hun¬dreds of previously existing laws, regu¬lations and interpretations, which in many cases were inconsistent with one another. Positive changes implemented by the Tax Code include the abolition of a number of rather immaterial but burdensome local taxes, simplification of tax accounting rules (which will now be much closer to financial accounting), and finally, a step-by-step decrease of the main tax rates (CIT gradually de¬creasing by 2% points a year starting from 1 April 2011, to finally reach 16% from 1 January 2014, and VAT decreas¬ing from the current 20% to 17% starting from 1 January 2014).
There are several areas that are, how¬ever, unfavourable for potential inves¬tors considering the establishment of an SSC in Ukraine including limitation of deductibility of consulting fees and royalties paid to non-residents unless such a foreign entity has a permanent establishment in Ukraine and is taxed accordingly and restrictions on voluntary registration for VAT purposes which will result in non-recoverable VAT incurred by new businesses at the start-up phase. It is also worth men¬tioning that many services that are usually provided by an SSC are now covered by VAT exemptions. Under the Tax Code, the list of services not subject to VAT has been expanded to include consulting, accounting, legal, auditing, actuarial and other similar services of a consulting nature, as well as services on the development, supply and testing of software, data process¬ing and consulting on informational services, including services assisted by computer systems. Such services are not subject to VAT irrespective of whether they are provided to/by a resident or a non-resident. Taxpayers providing such non-VAT able services will not be able to recover VAT incurred on local purchases or import (e.g. rent, telecommunication services, purchase (including import) of fixed assets, etc.), which will increase the costs of their activity. Finally, the new Tax Code does not offer any specific tax incen¬tives for foreign investments. While the incentives as such should not be a decisive factor for an investor to make a decision to invest or not, they may serve to differentiate Ukraine from neighbouring countries in the eyes of a particular investor.
These tax and regulatory issues are very important, but they count on the level of selecting the national location of an SSC rather than the potential re¬gion or city. What else can be impor¬tant when choosing a particular loca¬tion? For services like those typically provided by an SSC, the key issue will be access to infrastructure, including
telecommunication facilities. Lviv is known as one of the leading IT centres in Ukraine; however, to effectively compete with other European cities, there is still work to be done in order to provide high-quality European-class business centres with proper infrastructure.
Last but not least, companies also need to take into account the availabil¬ity and access to professional experts that may support the establishment and further operations of the SSC when needed. Lviv, as the predominant city in western Ukraine, is home to a number of branches of well-known in¬ternational firms offering such services. PwC, for example, opened its office in Lviv in 2008.
In summary, with the right level of governmental support, Ukraine could effectively compete with the likes of Poland, Hungary, Slovakia and Romania as an SSC destination of choice in the CEE region. To achieve this, however, there are certain areas in which improvement is needed, particularly in implementing more flexible labour regulations, im¬proving tax effectiveness, decreasing social security charges to make use of Ukrainian employees more attractive and possibly revisiting the approach to stimulating foreign investment activity and implementing specific incentives for foreign investments.
On the local level, Lviv, mainly thanks to its labour resources and geographic location, has quite an advantageous po¬sition relative to other Ukrainian cities. However, to effectively compete with other cities in the region, it should focus on further development of efficient infrastructure. An investor-friendly attitude on the part of officials would also serve as a factor raising the positive image of Lviv among potential investors who usually struggle to comply with all of the required formal registrations and permission procedures.
Magdalena Patrzyk (email@example.com) is a Senior Manager at PwC
with Tax and Legal Services practice in Ukraine. She is in charge of
the Tax Management & Accounting Services team. For almost 3 years Magdalena has
managed and developed PwC Lviv office focusing on provision of tax advisory and legal
services to clients in the West Ukraine region.