Ukraine has huge potential for law firms, with tax and agriculture promising significant work streams.
But as Dale McEwan finds, if it wants to attract foreign investment its legal system is going to have to clean up its act.
Ukraine’s new tax code has been a widely debated and controversial piece of legislation. Introduced at the end of 2010, the full impact of the code is still being felt and it has inevitably affected the work of law firms throughout the country.
“I think the tax code’s by far the most important [issue] for lawyers [at this time],” says Salans Kiev managing partner Oleg Batyuk. “It came out in a very complex way with various loopholes. It introduced a number of new concepts that require interpretation.”
Changed tax rules, newly introduced tax concepts, old loopholes and new uncertainties, as well as a short period for adjustment, have added significantly to tax lawyers’ workloads, explains Sayenko Kharenko counsel Dmitry Ivanusa. This includes advisory, structuring, due diligence and, most dramatically, dispute resolution.
“The adoption of the tax code was a major implementation for Ukrainian business, but it was also a major disappointment,” reveals DLA Piper Ukraine head of tax Svitlana Musienko. “It really brought us a lot of new mandates.”
One of the positive aspects of the new code has been the gradual rollback of the corporate income tax rates for major corporates, from 25 to 16 per cent by 2014, which will ultimately make the country more competitive.
Musienko explains that, despite the reduction in tax rates, the appetite for tax collection has gone up.
“The tax administration is trying to squeeze small businesses,” she says. “This is what we’re doing now, helping clients confront the unfair requests of tax authorities.”
With the introduction of the code came an increase in the powers of the tax office in Ukraine, explains Baker & McKenzie partner Hennadiy Voytsitskyi. The tax office now has virtually unlimited access to taxpayers’ premises, confidential and other sensitive information, as well as the right to conduct ad hoc tax audits.
“All this has resulted in the increase of the contentious element in our client work over the past several months,” Voytsitskyi relates.
“That’s probably one field where we’ve been getting more work,” agrees Adam Mycyk, managing partner and head of corporate at CMS Cameron McKenna Ukraine. “There are issues stemming from how the authorities are choosing to interpret the code. I think that’s causing a lot of uncertainty.”
For Beiten Burkhardt partner Julian Ries, the “disastrous” tax situation in Ukraine is not caused by deficiencies of the tax code, but by the approach of the tax authorities.
“For fiscal reasons the tax code’s always interpreted in favour of the state, and the tax authorities and the courts sometimes knowingly and intentionally apply the rules in a wrong way.”
The tax charge
The changes have also increased the amount of tax litigation cases, observes Magisters Kiev managing partner Serhiii Sviriba.
“We’re working on a number of projects where business models require restructuring due to the new tax code restructuring,” says DLA Piper Kiev managing partner Margarita Karpenko.
As a result of the increased demand from clients for tax services, many law firms are either diversifying into a new practice area or developing their existing tax practices by engaging new, mainly senior, specialists, according to Ivanusa.
DLA Piper Ukraine introduced a six-lawyer tax service line in May this year to compete with accountancy firms. Salans and Gide Loyrette Nouel have also made tax hires this year. Both Ilyashev & Partners and Asters say they will be looking to grow their tax practices in the near future.
Conversely, Ukraine’s new tax code has also decreased the number of existing and potential clients, claims Ivanusa.
“Many small businesses have retreated into the ‘shadow’ economy,” she says, “whereas most of the medium- and large-scale enterprises have slowed down their activities until the better times. Many foreign investors are generally doing the same, continuing to hold off from investing into Ukraine.”
For Clifford Chance Ukraine office managing partner Jared Grubb, the main problem with the tax code has been its rapid implementation.
“That’s just generally not helpful to businesses who are figuring out whether or not to enter the country,” he emphasises.
Baker & McKenzie Kiev co-managing partner Serhiy Chorny is of the same opinion. “It’s a time in Ukraine when it’s not easy to do business,” he says. “Those who come into Ukraine struggle with new legislation and inconsistent interpretation and application of legislation. This is really the risk of doing business in Ukraine. This is what we’re helping our clients do – navigate through the forest of inconsistency.”
“The tax code will be amended again, I’m pretty sure,” states Salans’ Batyuk.
In addition to the plethora of new tax work, firms have also had to contend with the changes in VAT for legal services. In January 2011 VAT for legal services was terminated, before being reinstated in July with an exemption for exported services.
As Chadbourne & Parke Ukraine managing partner Jaroslawa Johnson explains, the changes in VAT have generally led to additional costs for legal advisers.
When legal services were exempt from VAT, law firms had to add 20 per cent VAT to the value of their fixed assets that were used for legal services as of 1 January 2011. When the VAT exemption was eliminated, legal advisers faced the problem that no clear mechanism existed for the reversal of VAT that was previously assessed on the asset value. Accordingly, such VAT also became a cost for legal advisers.
“From the client point of view, the introduction of VAT exemption could lead to an increase in the price of legal services because of the abovementioned costs of legal advisers,” adds Johnson. “Also, an issue could arise if legal services were actually provided before 1 January 2011 but documented thereafter. The tax regime for such services was unclear.”
“If my client knew that my price was $200 per hour, they can’t understand why it’s now $260 or $300,” says Pavlenko & Poberezhnyuk Law Group partner Oleksandra Pavlenko. “So we now have problems with our clients. Some don’t want to work on this new basis.”
In other areas of work, the agricultural sector is proving to be particularly active for firms.
“The agricultural sector’s been one of the few sectors of the economy that’s been generating a lot of work for lawyers during the crisis,” according to Arzinger managing partner Timur Bondaryev.
“This is still of high interest for investments,” says Olena Stakhurska, a partner at ENWC Attorneys at Law.
Clifford Chance’s Grubb notes a general interest in wheat, barley, sunflower oil and rape seed. “When you lump them all together,” he says, “there’s been a significant increase in the proportion that’s going to the agricultural sector.”
This year Lavrynvych & Partners advised the largest agricultural producers in the country – Louis Dreyfus Commodities (Ukraine), Alseeds Group, Mriya Agro Holding and Ukragroalliance – on commercial disputes and tax.
The most recent major transaction that the firm worked on involved the IPO of shares of Industrial Milk Company, one of the biggest agricultural companies in the country.
Over at Bakers’ Kiev office, the firm has acted as a legal counsel on seven IPOs on the Warsaw Stock Exchange over the past 12 months, with four of the issuers originating from the agricultural sector.
In November this year Asters advised Sintal Agriculture, a large agro-industrial holding in Ukraine, on its acquisition of 100 per cent of the shares in agricultural company Agrica from direct investment fund Icon Private Equity.
“Agriculture’s becoming more and more involved in our filings,” reveals Schoenherr competition partner Pavel Grushko. “It seems that the consolidation of agriculture assets is happening at the moment.”
Grubb highlights that the soil in Ukraine has been fairly underutilised in the past 20 years. Estimates suggest that the country possesses around a quarter of the world’s reserves of black soil, a significantly fertile resource.
However, farmland remains the only major asset in Ukraine that has not yet
been privatised, hampering access by international investors.
The lifting of the moratorium on the sale of farmland, expected in January 2012, may lead to the market being opened up to foreigners.
When this takes place, Johnson expects an increase in work stemming from land title disputes. “As previous ownership of land may not have been documented properly, if at all, there could be more than one claimant to a parcel,” he explains.
If the government secures approval on the direct sale of land to foreigners it is going to be a major event next year.
“If it comes through, it’s going to be huge,” according to Magisters partner Olga Khoroshylova. “Everyone’s sitting and waiting for the market to open. There’s been a lot of talk. They’ve been talking about it for 10 years. If the global economics continues to stagnate, the Ukrainian government may have no choice. They may need to open up the market. As soon as the market opens up there’ll be a lot of local demand and demand from farmers outside of Ukraine.”
Agriculture is most likely going to be the bread and butter for firms, predicts Mycyk at Camerons. “That sector brings opportunities across most of the practice groups,” he attests. “I think a lot of firms are gearing up for work in that sector.”
Within Ukraine’s legal sphere corruption continues to plague the litigation world. Ukraine comes in at joint 152 out of 178 countries in the 2011 Corruption Perceptions Index (it came joint 134 in 2010 and joint 146 in 2009). Commenting on the ranking, Bakers partner Hennadiy Voytsitskyi can see no evidence of improvement on the corruption front.
“The situation with the court system in Ukraine deteriorates,” asserts Voytsitskyi.
“It’s not easy to practise litigation in Ukraine, but we still trust that it presents opportunities, which we have to try to capture.”
“The president started a campaign against corruption, but we don’t see any results in this area,” reveals Mycyk. “The Ukrainian judiciary can’t be deemed as independent.
We in the firm carry on practising. If our clients need that assistance we continue to deliver it.”
Ries at explains that Beiten Burkhardt has had its fair share of cases in Ukraine where a client has lost because the other party was bribing. “If you want to stay compliant in these cases,” he says, “sometimes that means you lose the case. The law’s on your side, but the judges aren’t.
“Our clients know that if it comes to the court and the other side’s bribing, we can’t do that. We say we can’t work with you.”
One unnamed partner says there are signs of the situation improving. “More decisions – although certainly not all – comply with international standards of judicial decision-making,” says the partner. “In other areas of law administrative bodies appear to be more susceptible to corruption than in the past.”
For Pavlenko, legislation is not necessarily the solution to solving the problem. She says court reforms last year did not help the situation.
DLA Piper’s Karpenko says she wants to develop a litigation practice within
the firm’s Kiev office, but her efforts have been hindered by corruption.
“I do have a dream that at some point in time I’ll be able to find a partner who could lead the team. This is still on my ‘to do list’, but unfortunately the situation doesn’t change for the better,” she says.
“There is work, but the risks associated with this is something that may bring more trouble than it’s worth,” adds fellow DLA Piper partner Oleksandr Kurdydyk.
Asters partner Vadym Samoilenko says the firm has taken steps to assist foreign companies operating in Ukraine to bring their activities into compliance with the UK Bribery Act and the US Foreign Corrupt Practices Act.
As he explains, international companies operating in Ukraine want to set up comprehensive compliance programmes to secure their legal positions and practices from a multijurisdictional perspective.
The firm has teamed up with US-based Arnold & Porter to deliver such a product to clients. Arnold & Porter covers the two acts, while Asters adds value by advising on the law. The latter also serves as a local liaison between client and counsel.
Clients are currently participating in an online survey created by the two firms. The next step of the joint project will be hosting a training programme for all survey participants to analyse anonymously the overall survey results in Ukraine and to present the best practices in compliance.
“Eventually we hope to receive client assignments from the participants to develop full-scale compliance programmes for their Ukrainian operations,” Samoilenko explains.
Grubb acknowledges Ukraine’s massive potential, but says there is still a lot to be done to make the rules of the game fairer.
“From my perspective the biggest challenge Ukraine faces is the rule of law,” he insists. “Investors coming in want to know what the terms are and be certain that they’re going to be enforced.
“The one thing Ukraine really needs to work on is to continue to simplify red
tape and build up a robust and respected judiciary so people have more confidence in the judiciary system if it wants to secure some additional foreign investment. [But] they don’t appear to be priorities for areas of change.”