A stag­ger­ing amount of Ukraine’s econ­omy is un­taxed, rob­bing the na­tion’s fu­ture.

Kyiv Post Legal Quarterly - - Contents - By Mark Rachkevych rachkevych@kyiv­post.com

Amajor chal­lenge for the ar­chi­tects of Ukraine’s new tax sys­tem is how to un­cloak about 40 to 60 per­cent of the econ­omy that avoids gov­ern­ment reg­u­la­tion, tax­a­tion or ob­ser­va­tion each year.

The Econ­omy Min­istry es­ti­mates that 42 per­cent of the na­tion’s econ­omy, or about $18 bil­lion, was un­ac­counted for in the first six months of this year. In fact, since 2008, an av­er­age of 44.5 per­cent of the na­tion’s gross do­mes­tic prod­uct has gone un­reg­is­tered, ac­cord­ing to Friedrich Sch­nei­der, an eco­nomics

pro­fes­sor at the Jo­hannes Ke­pler Univer­sity in Aus­tria who has stud­ied the phe­nom­e­non for more than a decade.

This equals $328 bil­lion that will have es­caped of­fi­cial de­tec­tion in 2011-2015, when us­ing GDP fig­ures pro­vided by Kyivbased in­vest­ment bank Dragon Cap­i­tal. In his re­search, Sch­nei­der de­fines the shadow econ­omy as “all mar­ket-based le­gal pro­duc­tion of goods and ser­vices that are de­lib­er­ately con­cealed from pub­lic au­thor­i­ties.”

Tetyana Tyshchuk of the In­sti­tute for Eco­nomics and Fore­cast­ing at the Ukrainian Na­tional Acad­emy of Science, in her re­search, said that “white” and “shadow” economies “don’t ex­ist as two par­al­lel re­al­i­ties.”

For ex­am­ple, an em­ployee may re­ceive a por­tion of their salary legally and the rest in an en­ve­lope that avoids pay­roll taxes and pen­sion fund de­duc­tions. Ei­ther way, the money gets spent on items that get taxed.

“The list of th­ese chains, which con­sist of white and gray oper­a­tions, may go and on,” Tyshchuk said.

An­other fac­tor of which pol­icy makers should take no­tice, ac­cord­ing to Sch­nei­der, is that cer­tain as­pects of Ukraine’s shadow econ­omy are“wel­fare en­hanc­ing” for the econ­omy.

“Un­der­ground pro­duc­tion is a vi­tal branch of the over­all econ­omy. A shadow econ­omy pro­duces added-value goods and ser­vices, which are as good as of­fi­cially pro­duced ones,” Sch­nei­der told the Kyiv Post. “What’s bad is that so­cial se­cu­rity and the pen­sion fund loses, but the man on the street ben­e­fits, many have sec­ond jobs in the in­for­mal sec­tor like driv­ing a taxi or sell­ing home­grown pro­duce.”

Busi­nesses en­gaged in trans­ac­tions in­volv­ing for­eign cur­rency some­times en­ter the shadow econ­omy to avoid risks.

On a larger scale, un­de­clared work and il­licit fi­nan­cial flows re­main the prin­ci­pal prob­lems. They in­clude tax in­va­sion, cap­i­tal flight, money laun­der­ing, and mis­use of bud­get rev­enues, ac­cord­ing to the Kyiv-based In­ter­na­tional Cen­ter for Pol­icy Stud­ies.

Tyshchuk said the “most dan­ger­ous one is the shadow econ­omy in the gov­ern­ment sec­tor…it is based on cor­rup­tion and de­stroys our econ­omy.”

For Natalia Osad­cha, part­ner at Syutkin

& Part­ners, the "non-trans­par­ent sys­tem of tax­a­tion and high tax rates are the root of all evil."

Ukraine lost over $ 116 bil­lion in 2004- 2013 in “il­licit cash flows,” av­er­ag­ing $ 11.6 bil­lion a year, ac­cord­ing to a De­cem­ber re­port by Global Fi­nan­cial In­tegrity, a non- profit group in Wash­ing­ton, D.C. that an­a­lyzes the move­ment of money. Some $ 1.1 bil­lion of this was “hot” money, “es­sen­tially cash that has dis­ap­peared from the econ­omy” that wasn’t reg­is­tered with the cen­tral bank or an­other reg­u­la­tory agency, ac­cord­ing to Global Fi­nan­cial In­tegrity.

But more than 90 per­cent of the dirty money was due to what the group calls “mis­in­voic­ing,” when the value or vol­ume of an ex­port or im­port is mis­stated on an in­voice. Weak cus­toms en­force­ment and tools, com­bined with graft al­lows “crim­i­nals, cor­rupt gov­ern­ment of­fi­cials, and com­mer­cial tax evaders to shift vast amounts of money across in­ter­na­tional bor­ders quickly, eas­ily, and nearly al­ways un­de­tected,” the Global Fi­nan­cial In­tegrity re­ported stated.

Fraud­u­lent value-added tax re­fund schemes also fall into this cat­e­gory.

“The same with VAT, it is il­log­i­cal cor­rupted tax, the com­pany pays it, and then tries to get it back for five years, what's the point, no one knows; the word 'cor­rup­tion' comes to mind,” Osad­cha said.

Ser­hiy Kurchenko, widely be­lieved to be a front man for ex-pres­i­dent Vik­tor Yanukovych, is ac­cused of us­ing sim­i­lar fraud­u­lent ma­nip­u­la­tion of in­voices in the liq­ue­fied nat­u­ral gas busi­ness, rob­bing state cof­fers of $2.2 bil­lion. He has de­nied the al­le­ga­tions, de­scrib­ing him­self as an “hon­est businessman.”

The con­tin­ued opac­ity of the global fi­nan­cial sys­tem makes it eas­ier to shift stolen as­sets on the re­ceiv­ing end. “The opac­ity re­veals it­self in many well-known ways: tax havens and se­crecy ju­ris­dic­tions, anony­mous trusts and shell com­pa­nies, bribery, and cor­rup­tion,” ac­cord­ing to Global Fi­nan­cial In­tegrity.

At the coun­try of ori­gin of il­licit funds, “cus­toms agen­cies should treat trade trans­ac­tions in­volv­ing a tax haven with the high­est level of scru­tiny,” reads the Amer­i­can re­port. “Gov­ern­ments should sig­nif­i­cantly boost their cus­toms en­force­ment by equip­ping and train­ing of­fi­cers to bet­ter de­tect in­ten­tional mis­in­voic­ing of trade trans­ac­tions, par­tic­u­larly through ac­cess to real-time world mar­ket pric­ing in­for­ma­tion at a de­tailed com­mod­ity level.”

Tax au­thor­i­ties in Ukraine es­ti­mated last year that cash pay­ments for salaries to­tal about $17 bil­lion a year tax, with at least two mil­lion work­ers not ap­pear­ing on any tax rolls. More­over, "an­other five mil­lion re­port earn­ing salaries that are be­low the min­i­mum wage, which au­thor­i­ties say is a sign they are paid partly in cash,” ac­cord­ing to Reuters. Au­thor­i­ties are on to the prob­lem. The Kyiv Post counted 15 large-scale busts of money laun­der­ing cen­ters this year by the Se­cu­rity Ser­vice of Ukraine, to­tal­ing $160 mil­lion. About half were al­legedly used to fi­nance Rus­sian-backed sep­a­ratists in east­ern Ukraine.

State Fis­cal Ser­vice chief Ro­man Nasirov said at a Nov. 12 brief­ing in Kyiv that 50 con­ver­sion cen­ters were elim­i­nated this year with­out pro­vid­ing fi­nan­cial fig­ures. In ad­di­tion, thanks to the gov­ern­ment’s elec­tronic ad­min­is­tra­tion of value-added tax, some $8 mil­lion each month is de­tected and reg­is­tered that oth­er­wise would have re­mained hid­den.

There's also a cor­re­la­tion be­tween which in­dus­tries are most in the shad­ows and the ex­tent to which they are reg­u­lated, said Ta­tiana Ig­natenko and Ro­dion Tes­lia of the Poberezh­nyuk & Part­ners law firm.

“For ex­am­ple, in the re­tail sec­tor, the rank of the shadow econ­omy is 60 per­cent, the phar­ma­ceu­ti­cal in­dus­try is 40 per­cent in the shadow...it is worth not­ing that the afore­men­tioned in­dus­tries are con­sid­ered to be the most over-reg­u­lated sec­tors of busi­ness in Ukraine,” the two lawyers wrote in com­ments to the Kyiv Post.

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