Tax amnesty: What impact it may have on family business if introduced in Ukraine

Supporters of tax amnesty hope for success, appealing to the experience of Italy and USA. However, in my opinion, it would be more appropriate to compare the Ukrainian case with Russia or Georgia, and here is why.

About a year ago, several draft laws on tax amnesty were registered. Today, experts are actively discussing possible versions of a new draft law, which is expected to be submitted to the Verkhovna Rada in the near future. While Ukraine has never had implemented similar procedures before, the experience of other countries varies from “very successful” to “failed”. Therefore, it is worth exploring what benefits the tax amnesty can offer Ukrainian family businesses that comprise about 90% of private business, what surprises it may hide for Ukrainian taxpayers, and what effects it may have on the country's economy.

To start with, the tax amnesty is a one-off, limited-time offer by the government to certain categories of persons to be exempt from taxes on certain types of income, which they have not previously declared and taxed, in exchange for payment of a flat tax on the “amnestied” amount of income.

There is also a capital amnesty, which is often confused with a tax amnesty, although it is focused on legalizing assets that were acquired and incorrectly declared or not declared at all, rather than on “forgiving” unpaid taxes.

The majority of amnesties that have taken place in the world over the past 20 years represent a hybrid of tax and capital amnesties. And it is most likely that we should expect for the hybrid amnesty in Ukraine as well.

Interestingly, no one uses the term “capital amnesty” in draft laws, as this may not be very acceptable for international financial institutions in the partnership of which Ukraine is interested.

Another very important aspect of amnesties is that taxpayers are usually not only given the opportunity to legalize their funds, but are also exempt from criminal liability for failing to pay taxes for the previous tax periods.

So what is happening in Ukraine? About a year ago, several draft laws were registered, in one of which the amnesty was referred to as “special declaration”. This draft law proposed exempting from taxation previously untaxed income, subject to one-off tax payment at the rate of 2.5%, 5% or 10%. Some special conditions were offered as well. For example, in order to apply for the amnesty, taxpayers had to first transfer the respective funds to Ukraine and place them into accounts with Ukrainian financial institutions.

Another draft law on one-time voluntary declaration was introduced almost at the same time. In fact, it also provided for tax amnesty, as it proposed exempting from taxation previously untaxed funds at a reduced rate of 9%. However, the main goal was not the amnesty itself, but the desire to pinpoint the assets, and only then to impose control over the expenses of citizens. Thus, the draft law appeared to be a classic hybrid of tax and capital amnesties.

Currently, the text of new draft law has already been agreed, but it has not yet been registered in the Verkhovna Rada. Therefore, we know only some of its details. It is proposed implementing amnesty program for 9 months of 2021, and it seems that the base tax rate will be 5%, the tax rate for assets abroad – 9%, and for cash –18%.

What will the state receive from the amnesty and what risks it is exposed to?

According to international practice, the main reason for implementing amnesty programs is the poor state of public finance. Instead of focusing efforts on tracing tax evaders and making them pay all taxes due, the state is actually saying: “Share what you can, and we, in return, will partially forgive you.”

Given the current situation in Ukraine, the motivation is likely to be just that – the size of the budget deficit is quite significant, and if the amnesty will help to replenish the state treasury by at least a few billion Hryvnias, it may be justified.

But this is a short-term goal. The only benefit from the amnesty is that the state will have an additional revenue infusion for a relatively short period of time (a specific budget year). However, in the long run, the amnesty is rather controversial, as it has an adverse effect on public morality. It can have a demotivating effect on law-abiding taxpayers. Traditionally, Ukraine has always had quite a low level of trust in public authorities, and it is very unlikely that by offering benefits to those who previously evaded taxes will help improve the trust of “honest” business in the government. After the amnesty, many people can make the following conclusion: “I have not paid, I do not pay, and I will not be paying taxes, because sooner or later another amnesty will be announced and everything will be written off.”

What are the benefits for business?

Our life is changing fast, and businesses that used to work “illegally” are changing as well. Twenty years ago, no one wanted to pay taxes at all, and now the vast majority already agrees to pay “reasonable” taxes, acknowledging its responsibility to society. The taxpayers, in their turn, have own requirements – transparency, uniform rules of the game, and no arbitrariness of fiscal authorities.

Many Ukrainian business owners, having stopped employing illegal practices, want to invest abroad. However, in civilized countries, the banks, auditors, consultants as well as various regulators ask to confirm the sources of funds, sometimes checking information for the past 10-20 years. For many fellow Ukrainians, whose business was not entirely transparent, it is now important to receive an “indulgence” – a waiver from the state, so they could confidently report honestly earned money.

Restrictions on cash settlements also have an impact on business interests. Transferring cash to the banking system will require its “legalization”, and in this case, amnesty can be helpful as well.

What are the benefits of tax amnesty for family business?

In many families, the “patriarch” of family business is interested in passing it on to its children who will improve it. And such improvements can be seen already: the businesses that were founded back in the 90s and operated in accordance with the existing business practices, now try to work legally and transparently. Business owners send their children to study abroad and hope that when they take the reins of family business, they will run it based on new standards and values. Current owners of family business are interested in children and grandchildren inheriting business without the “black cash” record and the risk of losing it due to the “sins of the past”.

Thus, the amnesty can be the right and useful step towards transparency.

Another point to consider is that if a business does not evade taxes and does not keep revenue “in the shadows”, its financial statements will be more attractive to banks, partners and potential investors, and thus increase opportunities for available funding.

It is also worth keeping in mind that financial transparency provides business with greater legal security.

Let’s imagine business under the “old rules”: part of the assets are not owned by the family, but held by nominee owners, and part of the funds is cash. In this case, the ability of business to function will depend solely on the health and capacity of the “patriarch” who runs business. If anything happens to the owner, it may lead to the loss of business because his children won’t have effective control mechanisms. In contrast, a transparent ownership structure along with declared and legal assets and funds will give the next generation the opportunity to take over the family business with the least possible complications.

Risk exposure for family-owned companies

One of the biggest problems in Ukraine is a complete lack of trust. In particular, distrust in the government in general, especially within business environment. Business is not sure whether the existing rules of the game will not change overnight.

In addition, there is distrust in law enforcement agencies. Even if the law says that a person who participated in the amnesty program cannot be prosecuted, we still understand that untaxed funds do not just appear from the thin air. Usually the accumulation of such funds involves not just tax evasion, but also some other actions that may be considered criminal by the authorities, and there is the risk that law enforcement officers will use this opportunity. Moreover, there is the risk that counterparties or business partners of an entrepreneur, who decided to take advantage of the amnesty program, may be affected as well.

Given that the Ukrainian courts are not highly respected by citizens and business, and that, by no means, they are the guarantors of law and justice, many potential amnesty participants may decide not to take the risk and remain in the “shadows”.

Some Ukrainian entrepreneurs may be afraid of the reaction of foreign business partners or banks. Just imagine a situation where a Ukrainian business owner, who wants to prove its reliability and respectability, shows the certificate of tax amnesty as the proof of source of funds. Besides, Ukraine is already considered high-risk state, and other countries are not always happy to cooperate with Ukrainian residents. The “amnestied” funds can convince a foreigner not to work with respective Ukrainian investor.

What effect could be expected from the tax amnesty?

The first amnesty is a one-off action. Whether it will result in any inflow of funds to the state or not, is hard to say, but if the amnesty program proves to be a success, it may come into regular practice. Some states implement amnesty programs at intervals of 5-10 years and with a varying degree of success.

The supporters of tax amnesty hope for success, appealing to the experience of Italy and USA. However, in my opinion, it would be more appropriate to compare the Ukrainian case with Russia or Georgia, where the results of recent amnesty programs varied from “not very good” to “failed”. Such poor outcomes are driven primarily by lack of trust in the state authorities.

In any case, tax amnesty is only one of the elements that can be used to improve business climate, and this improvement is impossible without judicial and law enforcement reform, stabilization of the tax system, attractive tax rates, and less intervention of fiscal authorities in business. Otherwise, fear and distrust will remain, and any amnesty program will be doomed from the beginning.