Ron Barden and Slava Vlasov, Partners in Tax and Legal Services
Ron Barden and Slava Vlasov write: Removing exemption makes sense, but discrimination that exists between exporters of services and exporters of goods should be fixed.
After only six months of operation, an important provision of the tax code has been repealed.
Since the tax code came into force at the start of 2011, most service industries were considered exempt from value-added tax.
This affected providers and consumers of consulting, engineering, legal, accounting, audit and information technology services, allowing a number of firms to de-register for VAT.
But parliament decided recently to cancel this exemption. President Viktor Yanukovych signed the changes into law this month.
When they take effect on July 1, such services will be subject to 20 percent VAT for Ukrainian clients.
It appears that this change of mind on the part of the government has come about due to shortages in government revenues.
But in the aftermath, this measure will have a significant impact on many businesses.
The supply of consulting, engineering, legal, accounting, audit and IT services will be subject to 20 percent VAT (17 percent from 2014) if provided to Ukrainian clients.
This VAT will become a cost for individuals and for those industries that perform VAT-exempt activities, such as banks, and will represent an additional cash flow issue for exporters and others.
Supply of such services by non-residents to Ukrainian residents will be subject to VAT under the reverse-charge procedure.
For Ukrainian residents providing services to non-residents, VAT will not be charged, but such residents will be required to pro-rate their input VAT.
In addition, providers of consulting, engineering, legal, accounting, audit and IT services will need to consider a number of other issues.
First, when the exemption was introduced, VAT payable by the service providers to their suppliers became an additional business cost for them (although this VAT was tax deductible for corporate profits tax services).
As a result, many providers were forced to negotiate an increase of service fees with their customers in order to cover the related VAT costs.
Once the exemption is cancelled, those customers may wish to renegotiate the level of fees being charged.
Second, with the introduction of the exemption, service providers were required to recognize deemed sales of their assets and pay VAT on these deemed sales to the budget. This represented an additional tax cost for service providers.
Once the exemption is cancelled, service providers need to consider technical arguments to recover VAT on deemed sales of assets from the government.
The tax code does not clearly address this issue and perhaps the service providers will need to address it to the upper level of the State Tax Administration.
Third, companies that have de-registered for VAT will need to re-register.
At the time of the introduction of the VAT exemption, government officials were not able to explain why the exemption should be introduced and it appears that they were not aware of the negative impact this would have on the budget.
Rather, they focused on their concerns about the ability of some businesses to generate dubious costs for such consulting and marketing services (and connected VAT) to reduce their VAT liabilities to the state or increase their refunds from the state.
In our view, the cancellation of the exemption makes economic sense, but the discrimination that exists between exporters of services and exporters of goods should also be remedied.
Ukraine has a great opportunity to develop its service industry sectors with enormous potential to attract foreign investors, increase export earnings and reduce unemployment.
However, the service sector is disadvantaged when compared to other sectors of the economy.
An exporter of goods is (technically) entitled to recover their input VAT, but an exporter of services is deprived of this entitlement.