Tax initiatives of the Finance Ministry cleared out the budget

Photo: PHL

Two months ago the government and the president persuaded the parliament to pass amendments to the Tax Code. In particular, MPs raised the rent on extraction of iron ore, oil and gas. MPs also adopted the Cabinet’s proposal to raise excise duties by 5% for tobacco products and alcoholic beverages. The new rates for the use of mineral resources came into effect in August and excise taxes were postponed by one month until September. The government explained all tax innovations by the need to fill the budget as quickly as possible due to the increase in expenditures to support Ukraine’s military forces. However, the first two months showed that it would be impossible to levy the planned amounts of taxes. The additional fiscal burden in conditions of a stagnating economy strained many businesses to the limit.

Getting below ground

The amendments to the Tax Code drafted by the Finance Ministry in July increasing the rates for the use of mineral resources almost triggered a political crisis in the country and were voted for under the threat of the resignation of Premier Arseniy Yatsenyuk, while the business community and experts clearly stated that the additional tax burden could put an end to the development of the mining industry and the implementation of the Energy Independence Strategy. “This is a question for the future – will companies patch any holes and is there any sense in doing this now? There is a risk of spending money and not covering expenses later,” says Senior Analyst at Dragon Capital Denys Sakva.

He believes the new tax requirements will lead to a situation where new holes will be drilled only in those places where companies will be 100% sure that they will find gas or oil. Due to the increasing rates of fees for the use of mineral resources, mining will be reduced in six months or a year, he says. This will definitely be the case if the government persuades the parliament to abandon the temporary status of increased rates and include them in the national budget for the next year.

“This will deal a severe blow to the industry given that Ukrainian deposits are exhausted and companies are taking serious risks in the development of new sites. After all, this tax is paid not from net profits, but from pre-tax earnings. There is always a risk that a drilled hole will be empty,” says Sakva.

Prior to the introduction of changes to the Tax Code, the increase in budget revenues from taxes on the use of subsoil was one of the most dynamic in 2014. Based on information of the State Fiscal Service (SFS), payments for subsoil use in January – August 2014 exceeded proceeds during the same period in 2013 by 20.8%. But despite the significant increase in taxes, there was only a slight increase in the amount of revenues in August.

While in July the budget received UAH 1.377 bn payment for the use of mineral resources, in August, despite doubling of fees, the budget revenues were only slightly higher – UAH 1.402 bn. Statistics were tainted by Ukrnafta, which, according to Head of the SFS Ihor Bilous, has not paid more than UAH 500 mn in rent to the national budget. The official does not rule out that in September the debt could double. The loss was the result of the introduction of new tax rates. “Currently, the company is practically not selling any gas, but must pay rent in full, which creates the debt,” says Sakva.

In terms of filling the budget the overall decline in production raises concerns as well. During the first eight months of this year oil production on the mainland territory of Ukraine decreased by 5.4% (77,900 t), production of gas condensate – by 15% (by 84,400 t), according to the Ministry of Energy and Coal Industry. Only gas production increased by 2.5% (by 318.5 mn cubic m). But at the same time Ukrnafta significantly reduced gas production – by 8.6% to 1.169 bn cubic m, including production of natural gas – by 12.6% to 874.9 mn cubic m.

Despite this, such a slight increase in the production of natural gas was supplied exclusively by private gas companies. After the introduction of the new duties several companies adjusted their investment plans. “In the drilling program reinvestment plans were at a level of US $50 – 60 mn Today, they are down to US $10 mn at best. One of the key reasons is the increase of the tax burden by 2.5 times. This simply cut our cash flow,” says General Director at the Smart Energy Group Oleksiy Timofeyev. The company’s oil and gas segment includes Regal Petroleum, a British company which has assets in Ukraine, as well as gas producing companies Ukrgazvydobuvannya and Prom-Energo Product. Representatives of Serinus Energy, which owns Kub-Gaz that produces hydrocarbons in the Luhansk oblast, also stated that in response to changes in tax treatment the company has plans to revises its investment program. Representatives of JKX OiL & Gas, a British company with assets in Ukraine, which owns the Poltava Gas and Oil Company, also mentioned the need to revise its plans due to the new tax rules.

It is cheaper to quit smoking

On the backdrop of declining consumer demand getting used to new taxes is also not easy for the manufacturers of tobacco products. Director of the Corporate Affairs Department at JTI Ukraine Oleksandr Kohut says the increase in the excise duty on tobacco products in September has been the third raise since the beginning of the year. For example, in January the minimum excise duty was increased by 6.5%, in July – by 25%, in September – by another 5%.

Overall, the excise duty has been increased by 40% since the beginning of the year. The prices of cigarettes have also been raised, respectively. Kohut says in January – September the average price of a pack of cigarettes increased from UAH 10.90 to UAH 12.34. “At the moment, it is difficult to assess the effects of the increases in excise duties, though it is obvious that the unpredictable policy in this sector destabilizes the market. The proposal to increase excise duties by 5% on September 1 was made the day before it went to vote. Prior to that the increase of duties on non-filter cigarettes was discussed with representatives of the industry and we considered it to be a reasonable proposal,” says Kohut.

The expert adds that today the cheapest cigarettes cost UAH 5 and the most expensive – UAH 35. “This is a huge gap between price segments, which has a negative impact on the amount of budget revenues from the excise duty,” he said.

Earlier, in an interview with Capital, Head of the SFS Ihor Bilous said that due to the decline in the production of cigarettes and alcohol the proceeds to the national budget were quite low. The official says Philip Morris, having reduced its production of cigarettes due to the decline of consumption volumes, did not pay UAH 1 bn in taxes. In general, in the first half of the year virtually all major companies showed a reduction in production and UAH 22 bn less payments to the budget compared to January – June of last year. Therefore, it is unlikely that the new taxes will help the government increase retail demand and stimulate production. Moreover, the Cabinet proposed to introduce an additional 5% local fee on sales of excisable products in 2015.

Making things worse

Ahead of the government’s plans, businesses are asking not to hurry with the introduction of the additional fiscal burden. At the end of last week, the Ukrvodka Association appealed to the government with a proposal to impose a moratorium on the increase of excise duties on alcoholic beverages for 2015. In addition, the association is requesting to abolish the practice of payment of the excise tax in advance before the start of production. Instead it proposed to provide the possibility of payment of the excise duty with a tax anticipation bill for a period of 90 days. Such a procedure is spelled out in detail in the Tax Code, though in fact it is not effective.

CEO of Ukrvodka Volodymyr Ostapyuk says the period of settlement of accounts between retail chains and alcohol producers should not legally exceed 60 calendar days and liability for the breach of this term should be specified. In order to facilitate the work of enterprises Ukrvodka also proposes cancellation of the order of the SFS on the mandatory receipt of certificates of the intended use of alcohol for alcohol producers. “Otherwise, the companies will be forced to reduce production, which has already lost 14.5% this year. This would also reduce tax payments and lead to cutting jobs at companies,” says Ostapyuk.

Breweries mentioned the possible shutdown of their enterprises due to the fiscal policy of the Finance Ministry. Director of the Ukrpyvo Association Halyna Korenkova says this applies to SUN InBev Ukraine and Carlsberg Ukraine. It is likely that by the end of the year one of the three operating enterprises could be closed in each company. “If the government proceeds with this approach to the rates of excise duty on beer, we will seriously consider shutting down our production in Ukraine,” said General Director of Carlsberg Ukraine Yevhen Shevchenko.