The Role of the Tax Systems of Ukraine, Russia and Kazakhstan in Attracting Foreign Investments: Comparative Aaalysis by VKTOR HOHOTS A thesis submitted to the Faculty of Law in conformity with the requirements for the degree of Master of Laws Queen's University Kingston, Ontario, Canada August, 2000 O Viktor Serhey Hohots, 2000 National Library Bibliothèque nationale du Canada Acquisitions and Acquisitions et Bibliographie Serviœs services bibliographiques 395 Wellington Street 3%. rue Weîlington OttawaON K1AON4 OcurwaON K1AW canada canada The author has granted a non- L'auteur a accordé une licence non exclusive licence allowing the exclusive permettant a la National Library of Canada to Bibliothèque nationale du Canada de reproduce, loan, distribute or sel1 reproduire, prêter, distribuer ou copies of this thesis in microform, vendre des copies de cette thèse sous paper or electro-onic formats. la fome de microfiche/nlm, de reproduction sur papier ou sur format électronique. The author retains ownership of the L'auteur conserve la propriété du copyright in this thesis. Neither the droit d'auteur qui protège cette thèse. thesis nor substantial extracts fkom it Ni la thèse ni des extraits substantiels rnay be printed or otherwise de celle-ci ne doivent être imprimés reproduced without the author's ou autrement reproduits sans son permission. autorisation. Abstract It is hard to undervalue the impact of foreign investments in a progressive movement of transitional economies towards a fkee market economy. For this purpose, a modernized and balanced tax system plays a central role in the improvement of the general investrnent climate and attract more foreign investments. Governmental monetary and fiscal policy and, particuiarly, tax policy can have a major impact on the process of economic recovery of Russia, Kazakhstan and Ukraine. in the market type economy, taxes play an important role in the distribution of income and the allocation of resources, as well as have a decisive influence on the general economic stabilization. The forms of taxation and the amount of tax burden make a direct impact on the amount and structure of consumption and saving and, subsequently, on the arnount and structure of foreign investments. Of al1 the countries reviewed in this analysis, Kazakhstan has achieved the highest success in improving its generai environment, prirnarily through the improvernent of its tasystem. Ukraine and Russia were not able to bring their tax systems to the Ievel of simplicity, clarity and effectiveness of Kazakhstan, which has negatively affected their cornpetitiveness in world capital markets. This study also provides for an analysis of other factors influencing the general invrstrnent environment in these countries, including the regulatory fiarnework, political and economic stability, currency regime, banking system, labor resources, crime and infrastructure. This study indicates that, in order for Russia and Ukraine to become more cornpetitive in international capital markets and attract more investments into their economies, it is increasingly important for these countries to Merpursue the course of improvement, stabilization and clarification of their respective tax systems. This task is even more important for Ukraine, as far as it has to compete with the counbies possessing enormous arnounts of natural resources, giving them an additional advantage in attracting foreign investors. Acknowledgments First of all, 1 would like to express my most sincere gratitude to a distinguished professor and expert in the Canadian and international taxation, my supervisor, professor Alex Easson for his unconditional assistance, encouragement, continuous support and guidance throughout the process of execution of this thesis. 1 also owe my special gratitude to the professor and coordinator of the graduate program Sheila McIntryre, as well as professors Phil Goldman, Catherine Lahey and David Mullan for their constant support and help with my work and studies. My special thanks to the graduate assistant, Phyllis Reid, who was always there for me when 1 needed any help. While 1 feel deeply privileged and honored to be able to work and leam fiom these wonderhl people, 1 alone, bear the responsibility for any shortcomings that this work might have. Table of Contents Abstract Acknowledgment Table of Contents 1. Introduction II. Detenninants of Investments Chate A. Regdatory Framework Effecting General Investment Environment B. Political Stability C. Economic Stability D. Currency Regime E. Commercial infiastructure and Banking System F. Labor Resources G. Crime and Corruption H. Infrastructure 1. Tax system III. Investment Climate in Russia 1. General Outlook 2. The System of Taxation in the Russian Federation A. Interrelationship Between the Federal and Regional Budgets B. Broadening the Tax Base C. Federal Taxes i) Profits Tax ii) Persona1 Income Tax iii) Payroll Taxes iv) Value Added Tax v ) Excise Tax vi) Royalties vii) Customs duties viii) Replenishrnent and Environmental taxes ix) Securities issuance tax and royalties X) Road Fund taxes xi) Stamp Duties xii) Federal License Fees D. Regional and Local Taxes i ) Tax on the Property of Enterprise ii) Sales Tax iii) RoadUsersTax iv) Educational Levy V) Advertising Tax vi) Tax on the Maintenance of Housing Facilities and Land Duty vii) Tax on Maintenance of Police Force E. Double Taxation Treaties 3. Regulation of the Energy Sector 1. General Outlook 2. Taxation of the Energy Sector IV. The General Investment Environment in Kazakhstan 1. General Outlook 2. System of Taxation in Kazakhstan A. hrational Taxes i) Corporate Incorne Tax ii) Persona1 Income Tax iii) Value Added Tax iv) Registration Fee for Issue of Securities v Customs and Excise Duties vi) Minerai Resources Tax vii) Payrolt Taxes B. Local Taxes i) Land Tax ii) Property Tax iii) Vehicle Tax iv) Business Registration Tax and the Fee to Conduct Certain Businesses V) Road Tax and Fee on Auction SaIes C. Double Taxation Treaties 3. Energy Sector A. General Outlook B. Taxation of the Energy Sector V. General Investment Environment in Ukraine A. General Outlook 1. System of Taxation in Ukraine A. National Taxes i) Corporate Incorne Tax i i) Persona1 Income Tax iii) Value Added Tax i v) Excise and Customs Duties v State Duty and Stamp Duty vi) Payroll Taxes vi i) State Innovation Fund viii) Road Tax and Vehicle Tax ix) Land Tax x Natural Resowce Tax and Environmental Tax xi) Foreign Vehicle Transit Duty xii) Rent Tax and Tax for a Sale of FueVIubricants xiii) Trade License B. Local Taxes and Duties C. Double Taxation Treaties 2. Energy Sector A. General Outlook B. Taxation of the Energy Sector VI. Possible Lmprovements 1. Russia 2. Kazakhstan 3. haine VII. Conclusion Bibliograpby VITAE vii 1. Introduction For the economies of Russia, Kazakhstan and Ukraine the way out of the economic crisis is directly comected to the reform of their tax systems, which would ensure a stable inflow of budget revenues necessary for the state to filfil1 its functions. AIso, a modernized and balanced tax system plays a central role in the improvement of the general investrnent climate and heips to attract more foreign direct investments drastically needed for modemizing and restructuring the econornies of those countries. Foreign presence has a long history of existence in Russia, Ukraine and Kazakstan, but active promotion of foreign investments by their governrnents has only begun after the collapse of the Soviet Union. It has become obvious that neither country has enough national savings at the current stage of its development to promote sustainable growth. Al1 the countries equally need maximal inflow of foreign capital and technology to be able to overcome the consequences of economic failure lefi by the system of central planning and to facilitate transformation to a fiee-market economy. Extemal resources must be attracted in the form of foreign investments, including direct investment, portfolio investments or loans.' Foreign direct investments (FDI) seem to be the most attractive form as they would not only help to improve the balance of payments and the development of export capabilities of different spheres of industry, but would also provide an infusion of outside capital, technology, and expertise, and create jobs for domestic suppliers and subcontractors. FDI is very attractive as a non-debt creating source of current account finance, and more broadly as an indicator of growing international confidence in a country's sustainability of the entire process of economic reform. A steady flow of FDI would improve confidence of investors since al1 of the world's major credit rating agencies include it among their indicators of international creditworthiness. It will be argued in chapter II that the current share of accumulated FDI by Kazakhstan, Russia and Ukraine was largely due to the early and successfûl introduction of !he econornic and tax refonn by the respective countries. FDI volumes of Russia, Ukraine and Kazakhstan will be compared with other foxmer Soviet Union Republics and Eastern European countries. It will be argued that the countries that have accumulated the greatest share of FDIs invested into the region were able to do so because they had started reforming their tax systems earlier and more broadly. Governmental loans should also be attracted because they have their positive input in economic development. However, as a regular borrowing, govemmental loans have their pnce and limits. Investors' attitude can also become