Ukraine’s Business Ombudsman on Evolution From Oligarchy to Capitalist Democracy – Kyiv Post Interview (Part I)

What saves businesses, entrepreneurs and investors’ money? Actions to unblock tax invoices or stop unwarranted fines imposed by Ukraine’s Tax Service? Negotiating with Ukrainian customs officials when they arbitrarily change the prices of the imported goods? Voicing the needs and concerns of the business sector to the government?

These are the most common matters where enterprises may ask for the Business Ombudsman’s help. However, it is also prepared and standing by to investigate complaints about any official’s violation of the law. Ukraine is often perceived as a corrupt country – but Roman Waschuk believes it has vastly transformed since 1991 and suffers more from misgovernance rather than corruption.

Waschuk, Ukraine’s Business Ombudsman, was appointed a month before Russia’s full-scale invasion of Ukraine, in January 2022.

The institution was established in 2014 and aims to protect legal business rights before the state.

Since then, it conducted 115 investigations and saved Hr.25.8 billion ($645 million at the current exchange rate of 40 hryvnia per dollar but rates have varied since 2014).

Kyiv Post spoke with Waschuk about how Ukraine became home to competitive global companies despite the war and post-soviet mindset in state institutions. Waschuk gave an overview of the Ministry of Finance policy and what changes to the business climate could be made tomorrow without spending an extra penny, or kopiika, from the state budget.

Let’s start with a short one: how would you describe Ukraine’s business climate in one sentence?

[Ponders for a couple of seconds, looking up at the ceiling]

I would say: selectively open, selectively difficult.

What are the 3 major problems of Ukraine’s business climate?

First, not the fiscal policy, but the implementation of a fiscal framework. Problem one is tax and customs administration. Problem two is selective law enforcement. This often flows from problems in the fiscal framework and its administration.

Number three is the wartime exigencies factor – unpredictable changes in regulation.

There are safeguards, but not all of them work all the time. For example, there is a provision in the tax code that says that no tax changes can be made in less than 6 months. But they’re implemented and just got overwritten yesterday. 

So, now we can move on to the advantages of Ukraine’s business climate. 

The first thing there would be a high level of digitalization. Which means that permits, especially for smaller-scale retail projects, are simpler than in many other countries. And, again, a simplified tax structure for micro and small businesses.

Second, is operational resilience. Although it’s often not convenient or comfortable for foreign investors, but certainly, it keeps a thriving Ukrainian micro and small business segment.

And third is decentralization. At the local level, interest in a project, succeeding, and many of the levers to make it succeed are now aligned.

Whereas 20 years ago, you could have gone to a town, and the mayor would have said: “Wow, it would be great if you could build a factory here.” But [that mayor] had very few of the levers to make it happen. You’d have to travel to Kyiv. Most of that is now delegated to the local level. The flip side is if you have a problematic local community, then, the problems are aligned. 

Yet in Ukraine, the phrase “a country with a huge potential” is a decades-old joke. What projects or initiatives can Ukraine showcase to prove itself as a country for serious investment?

What’s important for outside observers to bear in mind is that Ukraine is now also home to hundreds of successful medium-sized companies that have emerged over the last 20 years. They have nothing to do with the state and nothing to do with previous state-owned enterprises.

They’re not privatized, they are greenfield companies. There are companies like Nova Poshta, Avrora and others, which are very dynamic. They are expanding outside Ukraine, which means their business models are robust enough to actually work in an EU environment or in other countries’ environments.

The stereotype of Ukraine is oligarchs, old state factories, and a kind of a wasteland caused by war.

Whereas, in fact, what you have is millions of micro and small entrepreneurs operating under favorable conditions, almost amounting to an internal offshore zone. Now that comes with advantages. It also comes with disadvantages. The IMF and others don’t like the low tax regulation. 

But it keeps millions of Ukrainians employed and provides services to millions of other Ukrainians. Despite the circumstances, they continue operating. 

I was, for example, visiting the Poltava region in December and met with the Poltava Business Association.

I thought, “Who are these people? What do they do?” Well, they include, for one thing, Avrora, which is a very dynamic retail chain. But also, for example, a company with 1,000 employees that designs and manufactures warehousing automation systems. You’ve got the programmers. You’ve got the people building the hardware, creating the software, etc.

Then you have foreign companies investing in Ukraine. 

One thing you notice is that almost none of them have left. If you think about the membership of the American Chamber of Commerce and European Business Association, 90% plus of pre-February 24, 2022, companies are operating.

And in fact, they’ve actually added members since then. None of the things I just mentioned would be possible if the business environment were super toxic.

So, we can say Ukraine evolved from the image of an oligarchic country into a nation with something closer to a normal capitalist economy?

I would say so. And a lot of it’s happened while people have complained about the previous conditions. And the transformation has passed largely unnoticed. 

Ukrainian businesses are used to adversity. They suffered 30 years of misgovernance at the national level. So, it is not as delicate as business in other countries that live in stable and predictable regulatory frameworks. The shock of war hasn’t had the same devastating impact on many of these companies as it might have in, let’s say, Canada. 

Whereas Ukraine, again, has both the benefits and the disadvantages of a coping culture. Prior to 2022, Ukrainian companies generally did not borrow a lot of money. The successful ones grew organically and not through large-scale lending.

That meant that when the crisis hit, they were not forced to sell to service their debts because they didn’t have any.

I’ve talked to Western investment fund representatives who were a bit disappointed that they could not just buy Ukrainian companies ultra cheaply the way they could in Southern European countries during the global financial crisis of 2008 when the companies often were deeply indebted. 

Switching to business compliance in Ukraine then. We’re currently facing accession to the EU and a wave of grants that has opened through banks and through the Economic Ministry. When I spoke to banks, the first thing that they told me was that they had few bankable projects and that companies can’t file proper financial statements to allocate money. What is the compliance approach of Ukrainian companies compared to Western companies?

Over the decades, compliance in Ukraine has not been rewarded. So, if you’re a Western company and you engage in compliance, you do it because then you have no more trouble with the tax office. You get a pat on the head from your local tax inspector and can continue doing business. 

In a situation where for most of independent Ukraine’s existence, the tax office has been, I would say, semi-predatory and sees itself as extracting.

Money from nontransparent companies that aren’t really presenting it with fair accounts. What has happened is that when you engage in totally compliant behavior, they still don’t believe you. And their corporate culture is optimized, to be fined and then to reassess.

And if you don’t do that, then the tax auditor and inspector have a lot of explaining to do back at the regional or head office. 

Again and again, I have heard from Ukrainian auditors and accountants who say, you know, the smart Ukrainian accountant will leave 2 or 3 minor mistakes that will allow the tax office to then issue a minor fine. But then prevent them from getting angry and issuing a big fine, which is what you might get if you’re totally compliant.

The incentive structure here is completely jumbled. It needs to get realigned. And that includes different KPIs [key performance indicators] for the tax collectors.

Do you think that Ukrainian business is ready to adhere to stricter compliance than the one in the West?

I think medium sized and up, yes. And you can tell because that’s what they do when they enter another company’s market. For that, they need to then make sure that their home country arrangements meet the compliance requirements of the new environments in which they are operating.

Micro and small? I think not.

They exist in this very, very lightly regulated and lightly taxed environment. You can see that anytime someone tries to put either more regulation or more taxes on this segment, you get an attitude of “save it for later.” It’s a segment that does not, by and large, pay value added tax [VAT].

You have the phenomenon, and I think visitors to Ukraine have experienced it, when you go to a hotel or resort, and every person you deal with is allegedly a separate personal entrepreneur [Sole Proprietorship legal entities, also known as FOP in Ukraine, that allow some businesses to pay lower taxes – Kyiv Post].

Restaurants also.

So, I’ve been to a spa. The person renting the towels is a separate entrepreneur. The person serving drinks is a separate entrepreneur. The person admitting you to the pool is a separate entrepreneur. Something with this is not quite right.

It’s tax “optimization” using this system that was designed to support micro business. But bigger businesses abuse it.

Again, everyone is trying to protect their own interests. So, people say, oh, you can’t consolidate the towel guy and the pool guy because you’re destroying small business in Ukraine. Well, no.

Actually, you’re simply mirroring the tax structure of a medium sized spa business. So, it’s not a kind of, you know, everybody in business in Ukraine is a white hat good guy and the government is always a black hat.

A system has evolved over 30 plus years where everyone has found niches that work for them in the short to medium term.

And creating a more EU compatible, transparent, more compliant system means businesses giving up some of the “optimization” advantages and opportunities to extract personal benefits from administering that situation.

It requires adaptation in a positive law-abiding direction from everyone involved in the system.

If we were to change something tomorrow, what would be the top three tasks for business? What should they do to be on more friendly terms with the state?

For one thing, reassess how you optimize taxes. Look at successful Ukrainian companies – they are ones who have optimized internal processes, internal logistics, and largely stopped “optimizing” taxes. Not hundreds of FOPs pretending to be a company. That makes you less vulnerable to inspections and being held up by the state. 

In our practice we often have to do a bit of life coaching for companies. Look, are you seriously paying people Hr.4,000 a month? Maybe you should reconsider pay levels, make them a bit more realistic. You know, are you really running the company with one person?