Taxes for individual taxpayers in Ukraine

31.08.2023, NV Business

Last year, while writing a series of articles on the history of taxes, I indulged in a bit of fantasy about the ideal tax system for Ukraine and what it should be like.

From my perspective, we need a real tax revolution to bring our society about fundamental changes. To name a few:

• Transaction taxes rather than “discretionary” taxes: the focus should be shifted from taxation of income or profit to taxation of consumption.
• Taxes without tax inspectors: no discretion – no official responsible for controlling, regulating, calculating and fining. The state saves on the salary of the official and avoids corruption risks.
• Freeing up taxpayers’ time: once the taxation is automated, which makes it “inconspicuous” for the payer, piles of reporting will become a thing of the past and we will be saved the trouble of complicated filling out tax returns.
• Tax as payment for public service: with just one click on the smartphone, the taxpayer could block the money he has paid as tax from being spent on things he considers unnecessary (e.g. drums for bomb shelters, repairs to the newly renovated courthouse, or a new road for the owners of Bukovel).

Unfortunately, these are still something from the world of fiction, and we can’t expect the Ukrainian parliament to make such radical steps in the near-term. So all the country can count on is just cosmetic changes that, instead of reshaping the existing system, will just adjust certain elements—the tax base, rates or tax incentives. And It is questionable whether these adjustments will be for the better.

In view of the above, I offer to look into the landscape of personal income tax (PIT), being one the most important taxes. Does Ukraine need to change the PIT taxation rules and what will the changes result in?

How do other countries deal with this matter?

There is no common approach to the collection of PIT in the world, let’s face it. Some countries—to name a few, Monaco, the United Arab Emirates, Kuwait, Qatar, Bahrain or exotic Bermuda or Cayman Islands—do not tax incomes of their resident individuals. At the other extreme we can see high-tax jurisdictions where you sometimes have to give more than 50% of your earnings to the state: countries like Sweden, Germany, Denmark, Austria or the Netherlands may be called a real “tax hell”, at the same time, their taxpayers receive many perks from governments by way of compensation. In addition to personal income tax, some states collect a so-called “solidarity tax” from particularly wealthy citizens while others levy a special defense tax.

Ukraine is in the group of countries with an “average” tax burden. Almost all our neighboring countries in Central Europe and the post-Soviet space (and not only them) have tax rates at pretty much the same level as those in Ukraine. To illustrate, PIT rate in Romania, North Macedonia, Bulgaria, Bosnia, Kosovo, and Kazakhstan is 10%; in Moldova – 12%, Hungary and Montenegro – 15%, Serbia, Georgia, Estonia, and Armenia – 20%.

We should also keep in mind that, apart from “normal” tax rates, there often exist preferential ones. A person may pay high tax on salary or fees but much less tax on his passive income (dividends or interest) received during the tax year. A good example is Spain, where tax on “ordinary” incomes vary from 19% to 47%, but on dividends or interest – only 19% to 28%.

In some countries, all adult people must self-file tax returns and pay taxes; in others – they can choose to declare taxes as a family, receiving benefits and discounts for each child. Also, each country has its own rules for allowances and deductions, and in some cases you can significantly reduce your taxes by deducting various expenses—even the cost of gas used to get to work—from the income you receive.

There are states that apply significant tax rates to gifts or inheritance and states where these types of income are not taxed at all.

Another important thing to remember is that though the modern world taboos the “tax competition between countries”, it continues to exist in the real world. Over the past years, many countries have introduced various incentives to encourage wealthy foreigners to invest and reside in the country. A vivid example is the taxation of “non-domiciled” residents: an individual who has lived in his “new” country not long enough to acquire a domicile—that is a factual connection of sufficient strength—is exempt from certain taxes (usually taxes on passive income) for a rather long period. Cyprus, Great Britain, and Portugal adopt this approach to attract new residents every year.

Another way to attract wealthy investors is to introduce a flat tax. To illustrate, a foreign national who has moved to Switzerland, Italy, or Poland will have to pay a fixed amount annually, regardless of the actual level of income for the year in question.

However, it would be wrong to think that these countries struggle for millionaires only. For example, Cyprus has introduced a special incentive for foreign high earners: if the annual salary exceeds 55,000 euro, half of this amount becomes PIT exempt. And some other countries—Croatia is a striking example—have exempted from taxes so-called “digital nomads”, foreign nationals who have moved in the country but continue to work for a foreign employer. This category of young, educated professionals with high earnings and clear criminal history is welcomed in any country and, therefore, given tax holidays.

What about Ukraine?

Personal taxation in Ukraine can be viewed in different ways. On the one hand, the Ukrainian PIT rate is not excessive, and dividend income is taxed at preferential rates of 9% and 5%. On the other hand, domestic personal taxation rules are quite imperfect and pose significant challenges to taxpayers. Here are just a few examples:

1. As from 2022, the CFC rules (taxation of the profits of controlled foreign companies) require that Ukrainian nationals having business abroad report on such business and generated income, but many developed countries have no CIC rules for individuals at all.
2. “Discrimination” of foreign income of Ukrainian residents. A textbook example is exemption from taxation of inheritance or gifts from close relatives; however, this rule “does not work” in case the inheritance is received from a relative who lived abroad, in which case you have to pay tax of 18%. Another case is taxation of dividend income: a Ukrainian resident pays 5% on dividends from their Ukrainian business while dividends from a foreign company are taxed at 9%.
3. Imperfect rules for taxation of investment income. Many Ukrainians who work for foreign companies and receive special rewards from their employers in the form of stock options end up suffering double taxation in Ukraine. PIT is accrued twice: first, on the cost of the shares received for free and then on the full amount of income from their sale, which cannot be reduced by the amount of their cost as no expenses were incurred.
4. Artificially created double taxation of income in different countries. In Ukraine, generally, the foreign tax credit rules do not allow to exempt from Ukrainian taxes any foreign-earned income, in respect of which the foreign tax has already been paid. But the situation is even worse when a Ukrainian resident is abroad and continues to receive salary in Ukraine. The hosting state may collect tax on their income. Under such circumstances, when an international treaty allows the hosting country to do so, Ukraine is supposed to refund the previously collected PIT to the payer, but tax authorities refuse such a refund under the pretext of absence of a tax refund mechanism in the legislation.

In addition, the Ukrainian personal taxation rules, which were implemented long before the war, take no account of today’s realities. Ukraine is challenged by the situation when millions of Ukrainians may not return from abroad, which requires an adequate response from the government and implementation of all possible measures, including tax incentives, to attract new human resources. Here are some ideas:

• Benefits for “non-domiciled” residents (examples: Cyprus, Great Britain, Portugal) — exemption from taxes for foreign nationals who arrive in Ukraine for the first time and stay here, provided that they invest or create new jobs in Ukraine
• Benefits for Ukrainians who return home after living abroad (example: Poland) — reduced taxes for several years for Ukrainians who lived in other countries for a long time but decided to return
• Benefits for highly qualified foreign professionals (example: Cyprus) —reduction of the PIT rate for foreigners who will reside in Ukraine and receive a salary that exceeds a certain “threshold”
• Benefits for “digital nomads” (example: Croatia) —exemption from taxes or introduction of a preferential tax rate for foreigners who have moved to Ukraine and perform work remotely for foreign employers or customers, if their salary exceeds a certain “threshold”

All these steps, taken in line with the adjustment of the most blatant shortcomings of the current legislation, will allow Ukraine to make the national personal tax treatment very attractive both for Ukrainian citizens and for potential highly qualified and wealthy migrants.

Source: NV Business