Ukraine’s Battle for New Taxes Was Inevitable – Is Business Ready for It?

Less than a month ago, the Ministry of Finance’s battle to raise taxes began. On July 18, the parliament received a bill to impose new military taxes, new taxes for entrepreneurs in general, and enforce stricter control during tax inspections.

The goal: to find an extra Hr.500 billion ($12.5 billion) for defense this year. Higher taxes will make up Hr.140 billion ($3.5 billion) of this amount.

Ukraine’s defense spending as it holds off Russia’s full-scale invasion exceeds its overall pre-war spending. But another part of the problem also lies in US military aid getting postponed for half a year.

Apart from Russia’s advance in the Kharkiv region and a critical lack of ammunition, the delay also resulted in a liquidity crisis for the country.

While the US House of Representatives was bickering about whether or not to vote for a $61 billion US aid package, Ukraine had to reallocate expenses planned for the second half of 2024 to the first half and purchase weapons from its own wallet.

A source familiar with the matter told Kyiv Post that Ukraine was already at risk of a liquidity crisis in July, but the timely financial aid from the EU covered social expenses. Now Ukraine is facing another, similar risk this autumn.

“If we do not find these funds, then already in September there may be interruptions with cash payments,” Ukraine’s Minister of Finance Serhiy Marchenko said in an interview for RBK-Ukraine.

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The grant will be allocated to the state budget and help pay social wages, including salaries for teachers.

Taxes are a quick solution.

The bill the finance ministry submitted is only in the discussion stage and has not yet been voted by the parliament and become a law.

The major change from the ministry – an increase in military tax. It was first introduced in 2014 – a 1.5 percent tax on personal income earmarked for the Ukrainian Armed Forces when Russia invaded Crimea and the Donbas, and started military action against Ukraine.

The new bill intends to increase military tax on personal income to 5 percent. For corporates, 1 percent military tax from corporate revenues is intended. For corporates trading jewelry, the state wants 30 percent of military tax from sales.

Retail consumers are expected to pay military taxes from goods: 15 percent from the first car purchase, 5 percent from telecommunications services. Producers and importers of beverages with sugar would pay excise tax – €0.1 per 1 liter. VAT from postal parcels is also planned.

Companies selling fuel for B2C will be expected to pay taxes from profits up front, if the law comes into effect. If they pay on time, they will need to pay less taxes from profits afterwards. But if they pay too much, the subsequent taxes will not be less – payments made by mistake cannot be returned, likewise if the companies paid too much. 

Taxes for fuel companies are estimated in a scheme of 0.5 from the minimum wage on 1 cubic meter of tanks for storing gasoline, diesel fuel and LNG. It may be estimated as more than Hr.3,500 ($88) per cubic meter of tanks for companies. 

The bill allows local governments to impose the minimum level of personal income tax. 

Enterprises with Sole Proprietorship (aka FOP in Ukraine) haven’t paid military tax before – but the new bill would force them to do so.

Sole Proprietorships in Ukraine have four tax groups. The bill wants 1 percent military tax from the third one, the most common among freelancers and employees who work in companies who want to avoid paying usual taxes from people’s salaries. 

Sole Proprietors in other groups would be expected to pay 5 percent from two minimal wages during the reporting period – as of 2024, it is Hr.710 ($18).

The bill also strengthens discipline to make sure letters from tax services are read online and a regular inventory of assets with tax officers present during the procedure is organized.

Critics raise your hand

Raising taxes is never easy to lobby – few people are eager to pay taxes willingly, let alone pay more.

“It is a loss aversion – people feel more pain from losing rather than gaining. If avoiding taxes is profitable, they are more likely to take such risky decisions – even if they get caught and should pay the fine afterwards,” Dr. Volodymyr Vakhitov, Director of the Behavioral Science Institute at American University Kyiv, told Kyiv Post. 

Days after the ministry submitted the bill to parliament, Ukrainian MP Yaroslav Zheleznyak called it “a shame, mix of Fanta and borscht” on his Telegram blog.

“The ministry submitted it screaming ‘we urgently need money,’ but did not provide estimates for new taxes or confidence that it will not increase the shadow economy,” he wrote.

The “shadow economy” argument is the most common among Ukraine’s entrepreneurs. They say increasing taxes will worsen the issue.

Business associations – European Business Association, Union of Ukrainian Entrepreneurs, Diia City Union and American Chamber of Commerce – share common counterarguments to Ministry of Finance initiative:

• higher taxes will burden the transparent business, not the one avoiding taxes
• tax administration should be managed better
• Ukraine should reform State Tax Service and the State Customs Service to fight corruption and work effectively
• Ukraine should also tackle illegal trade of excise products, especially products for smoking
• state budget expenditures should be reduced.

Entrepreneurs have some grounds to worry about the shadow economy, and independent analysts partly agree with them.

Business criticized the suggested 1 percent revenue tax against corporate revenues – this new tax discriminates against the existing VAT regime. “They should have planned the VAT increase from the start, not play with creating a new tax,” Oleksandra Betlii, of the Institute of Economic Policy and Development, explained to Kyiv Post.

Also, 5 percent military tax from personal income is too risky.

“While I find it fine to impose military tax for Entrepreneurs with Sole Proprietorship (FOP), five percentage points from official personal income is too much – it will indeed cause a shadow economy increase,” one Ukrainian fiscal policy expert participating in discussion with The Minister of Finance told Kyiv Post.

Business is right about smuggling at customs, but ending it completely requires political will. Customs reform has actually been ongoing since 2023.

“And here we have achieved considerable success, which the European Union and its experts noted in reports in February 2023 and November 2023. Around the same time, the President of Ukraine dismissed practically all the customs leadership precisely because of the high level of smuggling and the failure to meet state budget revenue plans. It’s a paradox,” Oksana Kuzakiv, Executive Director of the Institute for Economic Research, told Kyiv Post.

“Unfortunately, few experts are ready to show their estimates – you can’t discuss the policy with the government without them. Many people dropped out at the stage of hypotheses, which made no sense to dive into estimates either,” one discussion participant told Kyiv Post.

Serhiy Marchenko publicly refused to reduce budget expenditures in response to businesses’ demand to do so.

“There is nothing more to reduce – parliamentarians suggestions to cut some programs of a couple billion are nothing when we need Hr.500 billion ($12.5 billion),” the finance minister told RBK-Ukraine. 

In general, experts present at the discussion described it as a productive one, with the minister and deputies willing to hear amendment proposals, providing all estimates. Apparently, the Ministry is ready to talk everything through and find a compromise. 

“They decided to change the ‘one percent from revenues’ tax to VAT increase,” one participant told Kyiv Post.

Another noted the accuracy of Marchenko’s claimed that there is almost no room to reduce budget expenses. And the ones left may never be voted by the lawmakers. “No one will allow for cutting salaries for prosecutors,” he said.

The Office of Prosecutor General holds a stable leadership among state institutions in unspent cash for salaries, Fiscal Center estimated. “This source can be readdressed for defense,” Fiscal Center Chairman of the Board Victor Maziarchuk told Kyiv Post. 

Hard decision for everyone

Apart from the general unwillingness to pay taxes, there are other dilemmas. “In our culture, individual well-being is put before collective well-being. Taxes are distributed from individuals to the collective society, but the common benefits are often not obvious,” Dr. Vakhitov told Kyiv Post. 

Moreover, the absence of trust in tax institutions is deeply rooted in Ukrainian society.

“No one wants to finance other people’s luxuries like an underground cigarette factory or illegal assets of prosecutors. People perceive that officials close to the state’s cash flow steal money – no one wants to pay for this,” Vakhitov added.

But there is no room for whims anymore. “Many people wore rose-tinted glasses before talking to the Ministry of Finance. They thought everything was fine because someone had cast a good spell and brought money to the budget. But raising taxes is a reality – I say it after analyzing the budget meticulously,” Maziarchuk wrote in his Facebook post.