UKRAINE: CONVERSION OF THE RIGHT TO VAT REFUND INTO BONDS - DEJA VU

Newsletter, Beiten Burkhardt Kiew, Kyiv, Ukraine, Thu, June 3, 2010

UKRAINE: CONVERSION OF THE RIGHT TO VAT REFUND INTO BONDS - DEJA VU

Newsletter, Beiten Burkhardt Kiew, Kyiv, Ukraine, Thu, June 3, 2010

KYIV --- VAT reimbursement in Ukraine is a longstanding problem that influences many parts of the Ukrainian economy. For a long time the state was unwilling to reimburse VAT; in the past two years these refunds almost stopped. The companies most affected by this are exporting enterprises that consequently lose liquidity, which is crucial for making investments and sometimes for mere survival.

The main pre-election promise of President Viktor Yanukovych was to address the VAT refund problem. To that end the government has applied the mechanism that worked in 2004: conversion of the right to VAT refund into bonds.

According to Resolution of the Cabinet of Ministers of Ukraine No. 368 dated 12 May 2010, which came into force on 1 June 2010 (hereinafter referred to as the "Resolution"), conversion of the VAT refund into bonds shall be carried out by issuing domestic state bonds in non-documentary form, with a five-year maturity term.

The financial interest rate is 5.5% per annum. The repayment shall be made every six months in the amount of 10% of the bond’s nominal value. Interest shall also be paid out every six months.

Every enterprise whose right to tax refund was declared before 1 May 2010 and certified (approved) by tax authorities is entitled to the conversion. The nominal value of bonds to be issued is UAH 1,000 and the balance of sums to be reimbursed shall be paid out according to the usual procedure.

Conversion of the right to VAT refund into bonds is voluntary; forced conversion is not stipulated. Thus, applications for reimbursement of the value added tax through receipt of bonds must be submitted to a relevant tax authority by 25 June 2010.

On the basis of applications submitted the tax authorities prepare the lists of enterprises entitled to conversion of budget refund into bonds. It is though unclear how these lists will be prepared and, especially, how the selection will be performed if the number of the first issue bonds will not be sufficient for satisfying all the applications submitted.

The tax authorities are to issue a certificate evidencing the entry into the lists of enterprises entitled to conversion of the right to VAT refund into bonds. With this certificate as well as with other accompanying documents the enterprise shall apply to the commercial bank, which in turn sends a request to the National Depositary and upon the transfer it places the bonds in the enterprise’s account.

For this the enterprises shall open securities accounts with the respective banks. The Ministry of Finance decides which banks are permitted to participate in such transactions. However, it is also stipulated that reimbursement of the value added tax for amounts exceeding UAH 10,000,000 will be carried out only through state banks.

This procedure is described in the graph below: [USUBC: Graph not included here]
 
A distinction should be made between the conversion of the right to refund into domestic state bonds and another provision in the Law on Budget, according to which the right to refund the value added tax under a 2010 transaction may be exercised by a company in the form of general state securities or goods, which are subject to government price control and offered by the Agrarian Fund, i.e. in the form of grain crops. The latter option is likely to be acceptable, primarily for grain traders that have a relevant infrastructure for storage and sale of these grain crops.

HOPED INTEREST RATE WOULD BE CONSIDERABLY HIGHER
Many public discussions have taken place in recent months, in particular about the parameters of conversion of the right to refund into securities, hence it was hoped that the interest rate would be considerably higher than planned. The interest rate of 5.5% p.a does not cover the loss of value as a result of inflation, not to mention the losses caused as a result of their waiting for a refund.

BANKS AND OTHER INVESTORS WILL DEMAND SIGNIFICANT DISCOUNTS
The enterprises will also incur additional losses if they intend to sell the bonds, as there is no guarantee that the banks and other investors will be satisfied with the interest rate of 5.5% p.a. They will demand significant discounts.

RESOLUTION WILL NOT SOLVE THE MAIN PROBLEM
It is prudent to note that the Resolution will not solve the main problem with the VAT refund - the critical condition of the Ukrainian budget. The conversion restructures the VAT obligations, the taxpayers continue financing the state budget – and this is done on terms that the state cannot receive on the market.

Consequently, in general, one can state that restructuring of VAT debts is virtually partial default with debt restructuring. The funds for payments under these bonds need to be attracted through general tax proceeds. Whether these funds will be attracted largely depends on further steps to increase investors’ confidence and trust.

CONTACT: Dr. Julian Ries, Julian.Reis@bblaw.com; Viktoriia Fomenko, Viktoriia.Formenko@bblaw.com; BEITEN BURKHARDT UKRAINE, wul. Turhenewska, 38, 01054 Kiew, Ukraine, Tel.: +380-44-494 04 00, Fax: +380-44-494 04 01. bblaw-kiev@bblaw.com; http://www.beitenburkhardt.com.

NOTE: The information in the presented newsletters does not constitute a legal advice, which can only be obtained as a result of personal consultation with an attorney. This information is believed to be accurate at the time of publication, but it may be subject to change.