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Jerking knees and poor policy – Kyiv (Panama Papers)

April 7, 2016

Having written a few words regarding the “revelations” surrounding President Poroshenko and the offshore companies recently registered that were exposed in the Panama Papers, followed by a few more lines about the Ukrainian media missing the wood for the trees, as predicted in the first related entry knees are jerking in Kyiv – “One expected outcome for the long pending draft legislation on the use of offshore companies in Ukraine, will in true populist fashion now see it swiftly come to the vote in the Verkhovna Rada.”

That prediction, obvious as it was for a populism driven seat of power, has been outdone by presidential promises to ban offshore entities (presumably including his own – or those created to serve the purposes of those with Power of Attorney/Blind Trust responsibilities).

“I plan to spend a significant reform that can prevent the use of offshore accounts in Ukraine” – President Poroshenko 

Naturally such promises would be met with a good deal of skepticism in a normal “presidential promises” environment.  The list of unfulfilled presidential promises is long, both publicly made to the Ukrainian constituency and also privately to certain individuals.

Nevertheless, when at the centre of the storm, it is perhaps politically unavoidable but to ride the momentum and take control of the issue – and as this latest statement is born of circumstances surrounding the President himself, there is a worrying chance this may actually occur without proper consideration.

As stated in entries prior – “As much as this blog is very much against anonymously owned corporations and companies and their specific use in tax avoidance or other nefarious deeds, it will concede that under certain circumstances, offshore companies make sense if transparently owned and run.”

But isn’t the ban proposed by President Poroshenko better than the existing situation of hidden ownership, the siphoning off of nefariously acquired cash, tax avoidance and/or evasion?

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Perhaps it is – but jerking knees avoid all nuance.  It is necessary to consider other reasons for offshoring when it comes to Ukraine aside from the those headlining in popular reasoning.

The most overlooked driver for the oligarchy when it comes to backing political parties and “owning” parliamentarians, (aside from passing favourable legislation, blocking unfavourable legislation and attempting to keep their place at the subsidy and State contract trough) is one that any other investor would have serious concerns about – property rights and the protection of assets.

By taking ownership of investments outside of the jurisdiction of the notoriously corrupt and inconsistent Ukrainian judicial process, the risks of having property rights swept aside, and thus the increased security of property rights over investments, allows investors to have a little more confidence.  Add in contractual arbitration in Stockholm or London courts, and there is perhaps sufficient daylight between the Ukrainian justice system and business to make it worth the risk.

What (genuinely) foreign investor looking at, or that is already in, Ukraine will make the value of his FDI subject to the fate of the Ukrainian judiciary as the unreformed and chronically corrupted judicial system stands?  Is the presidential plan to reduce potential sources of FDI by banning offshore?  Is it not prudent to reform the judiciary and legal mechanisms in Ukraine to instill confidence prior to simply banning offshore?

Further, is it not wise to adjust and amend tax legislation not only to encourage FDI but (if deemed necessary) to tax final beneficiaries as if they were direct owners without offshore entities?  How that would effect existing Double Taxation Conventions/Treaties with other nations would require some serious legal attention and may not be as simple as it first appears, notwithstanding having unintended consequences regarding both potential FDI and existing investments/assets.

Ukrainian taxes are already very low compared to almost every other nation on the continent, thus Ukraine itself would be an attractive offshore centre if only its relevant institutions and judiciary were not so terminally corrupted, nor its statute book so replete with legislative flapdoodle and taxation codswallop.

There is then the most obvious of reactions to knee jerk bans – it makes those using offshores for entirely nefarious purposes dig even deeper underground, and perhaps even expand that category of activity having been forced from the existing legal realm.

There is nothing particularly objectionable about a ban on offshore companies, but Ukraine is in no position to simply impose a blanket ban on offshore companies at least until it offers FDI a predictable, reliable, and proportional judicial system that protects property rights.  It will have to present a tax system that severely restricts the opportunities for illicitly “soliciting” or “coercing” or “extracting” revenue from either companies directly, or from within the numerous faulty parts that form the machinery of the State system.

There is nothing wrong with a ban on offshore companies if that is to be the policy.  However that policy has to be accompanied by a strategy that will prevent the otherwise fairly clear counterproductive outcomes of a knee jerk blanket ban.

There is surely a far more nuanced policy that can be achieved that will provide more transparency, reduce tax avoidance and/or evasion, avoid FDI flight, and make Ukraine more attractive than to simply “ban” because it is the headline issue of the day surrounding the president.

Promising to address or review offshore usage in the immediate future is absolutely right – all policy should be reviewed from time to time, and now it is politically expedient.  However to state the headline issue of the day will simply be banned is really rather unwise.

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