A simplified tax system is one of the essential tools for supporting small and micro businesses and self-employment in Ukraine. Entrepreneurs who are using a simplified system pay a fixed amount of tax or a fixed percentage of income. Moreover, recordkeeping and paperwork for such business entities are also significantly simplified.
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The system has existed since 1998 and has undergone many changes during this period. The problem is that although the system does, indeed, give some support to micro- and small businesses, it created different types of distortions and disincentives.
Mainly, the distortions are due to that the simplified tax system is widely used by medium and large businesses to optimize their tax expenditures. Companies make their full-time employees quasi-self-employed ones who are working under a simplified system, and thus reduce their tax burden. Society and business are divided.
On the one hand, there is the understanding of a necessity to have a tax regime that supports micro- and small business and the self-employed. On the other hand, the abuse of this regime creates imbalances in the market, distorts competition, and leads to injustice. There is a heated debate in Ukrainian society about the future of such a tax regime.
In Ukraine, the enterprises and private entrepreneurs that use the simplified tax system pay a special tax (single tax) that replaces some of the other taxes and fees – primarily corporate income tax (CIT), personal income tax (PIT), and value-added tax (VAT).
A single tax is based on a simplified accrual principle that allows its payers to reduce their accounting and reporting costs.
The simplified tax system has played a hugely positive role in Ukrainian history. Twenty years ago, in the late 1990s, it helped bring out of the shadows a large part of the people forced to solve the issue of survival on their own amid the deterioration of living conditions and the economic crisis.
To get “live” money (not, for example, goods instead of salaries), people started trading. The country then became a large “bazaar” of small traders and cooperators1. Criminals and the state immediately began to press on these entities.
The former one took a “tribute” from the traders in the markets, whereas the latter – a large number of documents written in the USSR times and penalties for non-compliance with the rules prescribed in these documents.
In order to simplify the life of start-up entrepreneurs by reducing the regulatory burden and to protect them from criminals, a combination of a simplified taxation system and legal status was introduced under the name of “Individual Entrepreneur“ (FOP). A key aspect of such a combination is simplicity – only one report and one tax with a simple registration is required.
The simplified tax system contributed to the development of entrepreneurship in the country. Soon after its introduction, partial legalization of doing business in the country took place. Kravchuk, Betliy, and Burakovsky, the authors of a study on the simplified taxation system stated, “comparing the advantages and disadvantages of different options for getting out of the shadows suggests that partial legalization may be quite attractive to business entities”2.
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2 Kravchuk, K, O. Betliy, and I. Burakovsky (2016) Simplified System: Evaluation in a Contemporary Context, Kyiv: Institute for Economic Research and Policy Consulting.