On the first day of spring the president of Ukraine signed the edict On Introducing the System of Individual VAT Current Accounts, whereby the cabinet was to map out and implement by July 1, 2004, the procedure of transferring value added tax payments to the budget and putting these into special accounts. Shortly thereafter, the president decided to speed up the introduction of VAT accounts by making changes to the aforesaid edict. The VAT reform deadline was backdated to April 1. March 23 saw the cabinet’s and the National Bank’s joint resolution No. 359, Some Problems of VAT Imposition, which set up the mechanism of VAT accounts.
It was decided earlier this year to try out this mechanism at Mariupil’s Illich Steel Mill, one of Ukraine’s largest exporters. In fact, the idea of special VAT accounts had been in the air well before this: it was suggested by a comparable — and quite successful — payments pattern in the electric power sector. Yet, VAT accounts began to be actually opened after the president vetoed bill No. 4000-1, in which parliament and the government made another attempt to reform the VAT law to which about 150 amendments had been made since 1997. The latter failed to produce any tangible changes for the better though. Moreover, the share of VAT has dropped from 8.3% to 4.8% in GDP and from 37.8% to 22.9% in tax revenues over the past seven years. Since 1999, the number of VAT rebates has increased threefold, while total VAT budget earnings have only seen a 1.5-times rise. The State Tax Administration of Ukraine claims the VAT deficit has amounted to UAH 6 billion since the law was passed. The once fundamental tax began to inflict losses on the national budget, which created a powerful branch of criminal business. This system was at its most ineffective in 2003, when total budget earnings of this tax made up UAH 33.2 billion against the refund bids worth UAH 21 billion (63.3%).
Special VAT accounts is not a Ukrainian invention. It is Bulgaria that faced a similar problem (a decline in VAT payments and a rapid growth of unjustified refunds) in the late 1990s. To improve the situation, that country introduced the principle of third- party liability in making decisions on whether to grant somebody the right to refund VAT. Thus, if a supplier failed to meet his VAT obligations, he could deny the taxpayer his VAT refund share. In truth, this step resulted in massive tax evasion. Yet, it is taxpayers themselves who initiated the introduction of VAT accounts in Bulgaria because they could not monitor the numerous budgetary obligations of suppliers or evade paying taxes. Before this system was introduced on January 1, 2003, there was a transition period in Bulgaria, when VAT accounts were opened on a voluntary basis.
As to Ukraine, there are, unfortunately, no great grounds today to claim that special accounts will promote greater state budget revenues. Experts of the Moscow-based Institute of the Transitional Period Economy noted that VAT accounts are designed to combat the minimization of tax liabilities — first of all, in the case of so- called one-day firms. This reform cannot solve the overall problem of VAT evasion. In particular, experts believe there may be several VAT minimization schemes even after the introduction of VAT accounts, such as concentration of the added value at the stage of retail sales followed by concealment of some earnings and non-transfer of the tax paid onto the special account, trade in losses (or tax deductions,) underrating customs costs, false export, unlawful withdrawal of funds from the special account in collusion with a bank, etc.
It should also be noted that the introduction of VAT accounts will inflict considerable losses on individual taxpayer and society as a whole. Taxpayers will incur losses, above all, due to withdrawal of some current assets, increased expenses for compliance with the tax law, and utilization of banking loans. As far as the state is concerned, VAT accounts will cause the budget to suffer direct and indirect losses connected with administering the new system.
It is not known whether there was a comprehensive analysis of the likely costs/losses resulting from the introduction of VAT accounts in Ukraine. In Russia, it was decided after lengthy consultations to reject this system of VAT accounting and payment. It will be recalled that the Russian Ministry of Finance drew up as long ago as December 1, 2003, normative documents on the introduction of special accounts first on July 1, 2004, and then January 1, 2005. The debate on the consequences of VAT accounts introduction led to an open confrontation between Russia’s two so- called superministries — of finance and economic development. According to a Ministry of Economic Development forecast, the reform could have removed up to 200 billion rubles from circulation for a period of 20 to 50 days, raised the bookkeeping expenses of enterprises, upset the uniform distribution of the tax burden among businesses, precluded new enterprises from entering the market, and, therefore, put up retail prices and the banking loan value.
This dispute was put an end to at a joint session of the two ministries attended by President Vladimir Putin. It was decided to introduce, instead, transit accounts on January 1, 2006, to monitor the money flows that occur when the VAT is being paid. This will keep tax liabilities from being frozen on individual accounts and supply tax inspectors with an additional instrument of monitoring illegal VAT refund schemes.
In Ukraine also economists take a dim view of VAT accounts. Most experts believe that introducing the latter is quite a risky step in which the losses will essentially outweigh the gains. Ukraine could make the VAT more effective by expanding the tax basis, as well as by further improving the VAT refund mechanism in, for example, the field of taxpayers’ registration, upgrading the procedure of monitoring taxpayers by tax authorities, the procedure of exposing unlawful transfer price formation, the exchange of information between the customs, tax administration and police, and by increasing punishment for failure to obey the tax law.
