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Establishing clear rules in tax legislation shall contribute to improving the investment climate

Olga Marchuk
economic observer


Issues of taxation on incomes are regulated by Chapter III "Income Tax" of the Tax Code of Ukraine. Structure of existing provisions of the Code does not contribute to the full implementation of the tax object definitions using tax differences. This situation prevents final realization of strategic objectives of the Code in order to simplify definition of the income tax object through its synchronization with procedure for determining financial results in financial statements

To resolve this issue the Law of Ukraine "On Amendments to the Tax Code of Ukraine on definition of list of tax differences" is written. On more information about the document that is currently widely discussed in business environment, special for our journal spoke the team leader for developers, Deputy Head of the Methodological Council on Accounting of the Ministry of Finance of Ukraine, Doctor of Economics, Professor Ludmila Lovinska.

What caused the need for the bill?

- In 2010, it was necessary to bring to the tax authorities, business environment that accounting rules should form the basis of tax laws. Most of the opponents insisted to leave gross income and expenses, without changing anything in this area. Now there is no such discussion, there are only alternative approaches to defining the object of taxation according to financial statements. For me, that means a big step in reform of tax legislation: all are aware now that, based on best international practice; income tax is to be calculated, using methodology of accounting without taxation approach of gross income and expenses. I believe that this way we are going to introduce more sophisticated accounting methodology in determining income tax.

Result of harmonization of accounting and tax laws became an innovative method of determining taxable income, which defined in Chapter III "Income Tax" of the Tax Code of Ukraine method of calculation and correspondence between revenues and expenses. The differences between criteria of revenue and expense in accounting and tax legislation resulted in emergence of permanent and temporary tax differences.

With adoption of the Code the issue of determination of income tax on basis of financial statements by applying tax differences become more important because of method of calculation aimed at simplifying procedures to form object of taxation and tax reporting, based on existing data of accounting, financial reporting and tax differences. Temporary and permanent differences between tax and reporting data in terms of revenue and expenditure should form the basis for forming object of taxation and indicators for declaration of income tax.

However, I do not want to look like in dogma, writing a few phrases and assuring everyone that this is the best. So I'm ready to consider other proposed approaches if they are convincing. We need to find the best option of how using methodology of accounting to define object of income taxation as transparently. In addition, our bill is not perfect, and probably has some weak points that need to be improved.

That is, there is a need to regulate certain procedures for forming object of taxation and tax reporting, and other issues?

- The purpose of bill is to increase resource efficiency of economy, including lower costs for businesses in determining tax liabilities and income tax reporting and for state - to administer this tax. Based on this issue, a group of developers of document proposed to calculate object of taxation based on income as defined in financial statements, which are adjusted by permanent and temporary tax differences in revenue and spending and permanent tax differences arising from individual transactions under the Code. To do this, instead of list of revenues, expenditures and procedures for their recognition, we introduced the list of permanent and temporary tax differences and changes in procedure for determining object of taxation.

Evaluating innovation of the bill I shall note that here is pledged an approximation of certain provisions of the Code with accounting. For example, the norm is written to exclude from calculation of object of taxation the returnable financial assistance as a preventive measure to artificially reduce profits and therefore lost effect in implementation of accrual method; restrictions on recognition in expenses of enterprises the cost of repair of fixed assets as the difference that only temporarily reduce assessment of income tax, along with a significant convergence of the Code’s and accounting norms.

Also is legislated enabling depreciation on fixed assets received free of charge with simultaneous inclusion of amounts of accumulated depreciation in income that is inherent with accounting, accounting in cost using Internet during trip, which corresponds to realities of the time, creation of reserves during the year to cover these (future) costs of leave of employees as a result of incorporation of an expense for accounting data and lack of in accordance with provisions of the Code. That is, proposed innovations changed procedure for determining the object of taxation on income while preserving fiscal rules. This eliminated economically unjustified tax differences.

Is international experience considered in the new document?

- In 2010, when we began work on the Tax Code, it had fixed rules on tax differences. You also need to understand the fact that tax differences - are not the idea of a scientist, but in fact - international practice. But in many countries, these differences are interpreted in different ways. Overall, I have been doing this closely for ten years, since 2003, the world practice of determining tax object has three options. The first - the one that was in the Law on Income Tax, is working for a small business in Western Europe. Items of revenue and expense - are partial records. Therefore, where there is a system for determining object of taxation of small and medium-sized businesses, there is also a mirror-like accounting system, there are tax differences on those costs that can not be recognized for tax purposes, ie unproductive expenditure. They are - or entertainment expenses or costs associated with unmanaged activities of entity. Such a system in Ukraine in 1997 was the basis for income tax.

Now about profit. There are several approaches. First - a corporate tax, corporate income. It provides the following methodology for object of taxation: financial profit before tax taken from income statement, adjusted for certain specifically identified revenues and expenses. That is, nobody calculates any differences. There is financial income, which is deducted any amounts of revenue and expenses. This is again the same or unproductive costs or expenses not related to business activities, or any excess cost, regulated by state. This system requires a mandatory tax audit confirmation of financial statements. That is, if you take income from income statement for correction of certain specifically identified amounts of revenues and expenses, you also verify the amount of book profit. Then tax is dedicated exclusively to check the amounts that are adjusted for financial results. Thus corporations are taxed - those subjects for which audited financial statements are required. In international practice, it is a confirmation of tax reports by audit, but if a company confirmed financial statements in auditing, the tax return can confirm another audit company or the tax office checks correcting entries. This is the second model.

The third model, which we used, is used in countries with strict accounting regulations of state. In the sample we took the Bulgarian law, which is largely combined with German law. In Bulgaria, they calculate the difference. Bulgarian difference called "rizliki", "tax rizliki". There are also permanent and temporary differences. We took it as a model and tried using this methodology to develop the law. Why this system, but not a system of corrective entries (in fact, our design is easy to convert in correction records)? Because in Ukraine taxpayers on income are not only corporations that prove their financial statements with audit, but also medium and small businesses.

What is fundamentally different in methodology for adjustment, when financial result of financial statements is adjusted for certain items of revenue and expenses, and when financial result is adjusted for the differences?

- The fact that differences are calculated as difference between what we recognized in accounting records and the fact what we must accept in accordance with the tax laws. Differences are derived from specific types of revenue and expenditure. That is, if we take as a basis financial results, and then say that it is adjusted for difference that occurs either by revenue or expenditure, giving them an exhaustive list, it is the way of showing relationship between financial results and amounts of adjustment. We understand and it is international practice, thus moving away from the need to verify financial profit, because checking how a difference is formed, we also see how a financial result is formed, as the differences are extracted from it.

What is the architecture of this Act, which tasks were set, and why, in fact, certain inaccuracies were in its preparation?

- Since writing this bill, we realized that the preparation of the Tax Code in 2010 had reached some agreement with business on a number of provisions of this law much of a difference today - "Operations of a special type" - a specific agreement with a particular business - from energy-generating companies, power plants and many others. That is, each specific provision for various industries - is a compromise of business, MinFinance and authorities at the time of adoption of the Code.

Here is an example of how one of the differences is formed. When the tax code was still in process of writing, representatives of theater community addressed to the Ministry of Finance with a request to consider interests of the Ukrainian Code of art, to put an upper limit value of low-value items for the stage- stuff - 5,000 UAH, because costumes and scenery are very expensive. One suit, unfortunately, an actor can not wear many times, since it should be cleaned, and after cleaning it loses its proper form, resulting those expensive clothes must be written off. This provision in our law was written, and you can not cancel it.

In preparing the bill we removed economically unjustified differences both did our best that budget did not receive less than it has today. We finally decided on current and capital repairs, removed the 10% limit, and also excluded the impact of repayable financial assistance. This is a big step towards solving the issue of consolidation of income tax. In addition, we have included a time relates to depreciation on fixed assets received free of charge, included in cost allowance for vacation, allowed to recover costs of Internet services, travel expenses to employees.

What did we do with the architecture of the law? Object of taxation is income that is adjusted for the difference. We propose to determine the difference in specific positions of revenue and expenditure, tax differences on individual transactions - is agreement on which today we can not go away. Some say that, well, it's hard to figure out the difference. You know, accountants still count, and no matter how easy it is or difficult. Otherwise, they can not even fill the current declaration.

Which positions you feel to be weak or not well defined?

- A lot of things in the III-d section of the Tax Code came from the Law on Income Tax and the same way they are automatically moved into our working group proposed bill. What causes it? First, the fact that some operations have specific approaches to object of taxation, which require individual interpretation in tax area. These moments we have not fully thought through, so you need to fix some nuances.

Amortization remains problematic, in my view. We tried to lighten it as much as possible, but still the optimal solution has not been found. In its defense, I will say that when communicating with colleagues in different countries (Germany, France etc.), I realized that our depreciation - is one of the easiest. For example, in Germany there are 600 groups of fixed assets, which is 600 individual terms depreciation, 600 individual approaches. Communicating with officials of these countries, we asked them: "Is there a problem for business, because it's so hard?". In response we heard: "No, because everything is automated, there are necessary programs so that everyone has tax depreciation with no problems".

Till what extent an opinion of those who then have to fulfill the rules of the proposed law is considered in the document?

- Before the bill was introduced to Parliament for consideration, we decided to conduct its public discussion among entities that in mode of interactive communication obtain specific proposals. Talking with professionals, people who every day have to practice certain provisions of the legislation, it makes the hard work of writing laws. I am very grateful that they are willing to work on improving the legal framework, together with those who wrote the laws.

For deeper introduction with the project, developers held three meetings - with representatives of the business environment at UUEE, tax advisors and auditors. Already at the first meeting, we heard positive remarks about the document. There were some comments, but the main conclusion to be made by counterparts - it is something that should work on it to bring up the completed form. At meeting with tax advisors the discussion was difficult; we received a lot of criticism. However, in course of further discussion it was found that people who deeply understand accounting, and understand the essence of this bill. That is why a large proportion of observations were made in such a constructive way, "Let we improve and replace that". Of course, we all are not perfect. However, an attempt is made to improve legislation, and now need to go on that document acquire the status of law.

Adoption and implementation of the bill does not require additional spending from the budget. According to probable assumption, temporary short-term costs of corporate income tax are possible, as depreciation of fixed assets, in which more than 70 percent - due to increased spending time on maintenance costs in full.

At the same time, setting clear rules in this area, no doubt, will improve the investment climate of economy, transparency and simplification of definition of the taxation object, reducing administrative costs.

Interviewed by Olga Marchuk.

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