Back in 2015 within the framework of the Analytical Platform of Agri-Industrial Complex we conducted the analytical assessment of the possible effects of various options of reforming the special VAT regime in agriculture and functioning of different models. The aim of the study was to summarize possible consequences of reforming of the special VAT regime in agriculture as a whole and in its sectors, as well as to study the most viable option in terms of meeting the interests of all participants of economic relations. Discussed were also the consequences of the loss of income in agribusiness, including livestock.

The research was carried out in view of the Memorandum of the Government of Ukraine and IMF, which was supposed to bring Ukrainian farming to a common system for VAT collection in accordance with international practice. The results of the study were aimed at forming the analytical basis for making optimal decisions. The focus was made on the different reform models of VAT regime that was practiced at that time (the so-called accumulation model of VAT) – from its full abolition to full saving with introduction of appropriate budget compensation mechanisms.

During the study there was analyzed a number of options for the reform of the special VAT regimes:
– “Zero option” which means preservation of the regime and continuing the practice of liberation of export operations from VAT levying on some specified goods (grain);
– The complete abolition of special VAT regime and transition to a system of budgetary subsidies provided to some agricultural sectors which require such support;
– Partial abolition of the special VAT regime in crops and saving it in animal husbandrysafety (a separate version – excluding poultry);
– Other options, including the ones with applying the special VAT regime only to agricultural enterprises that meet certain criteria (activities, revenues, land bank).

I think that INFAGRO readers are interested in particular results of the study regarding dairy farming, because just the farming provides dairies with raw milk for processing.

First of all, it should be noted that, unfortunately, in the process of defending the special VAT regime agrarian environment actually “split” because the interests of different types of agribusiness did not coincide.

In particular, manufacturers of export-oriented agricultural production (primarily cereals – wheat, corn, barley, and canola) were more in favor of the renewal of the zero rate for taxation of export deliveries since the regime exemption from VAT which was introduced in 2015 for taxation of grain supply did not provide any budget refund of VAT.

In case the zero VAT rate was renewed, the export purchase price could get maximally increased by percentage of VAT, and that would positively affect the income of producers of such export-oriented products. There is the absolute majority of such agrarian enterprises in Ukraine – more than three-quarters of the total number of farms. Even taking into account the value of money in three to four months which “freeze” the financial resources of traders for the period of acquisition and shipment of grain and actual receipt of VAT refund from the budget and available risk that the VAT will not be refund due to the recognition of some trade operations as “void”, and the costs of “persuading” of fiscal authorities in the need of refunding, traders purchase prices would increase at least by 13-15%.

Instead, for export oriented manufacturers the special VAT regime was providing only about 10-11% of additional financial resources. Accordingly, the decision to abolish the special VAT regime and the restoration of a zero rate for exports guaranteed export-oriented agricultural producers no less than 3-4% of additional revenue. And considering the saved 15% accumulation in 2016 for it meant additional 1.5%, reaching an average of 5%.

Given the obvious benefits for producers of grain, there was no unity in positions – for livestock farms it was extremely important to secure prolonging of the special VAT regime due to higher value-added production. For producers of export-oriented products it was more urgent to restore the zero VAT rate for export (so-called VAT refund). Simultaneous use of both special VAT regime zero rate regime in export operations was not considered.

As a result the “grain lobby” had won, so from 1 January 2016 the special VAT regime in agriculture was partially abolished and introduced was the differentiated VAT accumulation procedure depending on the type of agricultural production: grain and industrial crops – 15%; livestock products (milk and meat in live weight) – 80%, other agricultural products – 50%.

However, unlike the producers of grain and industrial crops that work on the markets where demand is formed by foreign markets, for producers of animal products the decision to restore the VAT refund for export of grain and derogation partial abolition of the special VAT regime was unprofitable.

Firstly, the zero rate for exports of animal products has always been applied has never been abolished. Poultry producers have used this quite effectively (take a look at the register of enterprises that received the VAT refund in 2014-2015). Therefore the issue of the renewal of VAT refund for export was not that interesting for livestock enterprises.

Secondly, the domestic animal production has been still valued not so much on the world market and had small export potential, especially after the closure of the Russian market. Accordingly, prices for livestock products, especially dairy, are formed, unlike the crop, not by the global but by domestic market with its low purchasing power due to a significant reduction in consumers’ income in recent years.

Thirdly, feed has a significant share in the structure of production costs of livestock production. In particular, in production of milk it is about 45%. Accordingly, the renewal of the practice of zero rate for exports of grain, its price increases automatically and raise the cost of production of livestock products. Based on the feed cost share in the structure of total production costs of livestock production and increase of the indicative prices for grain due to the introduction of VAT refunds for exports, the growth in cost of milk in 2016 will be at least 5%. If prices for animal products stay unchanged, this will make a negative impact on profitability. Therefore, prices for animal products, especially for milk, will increase, as it has been observed recently. The average price of milk produced in agricultural enterprises of Ukraine in May-July 2016 is 11-15% higher than that in the corresponding period of 2015, and in August 2016 the prices were different from the prices in August 2015 for more than 20% upward. In this way, milk producers are trying to compensate for increased costs, primarily the cost of feed to stay within the profitability achieved in recent years.

As the analysis demonstrates, despite the global downturn trend in prices for grain in Ukraine the grain prices, by contrast, are growing – despite the fact that the exchange rate remains virtually unchanged. In particular, prices for grains in Ukraine started growth since the end of 2015 and continued to increase during the first months of 2016, notably in corn prices.

Accordingly, we conclude that due to the restoration of the zero VAT rate, the grain price dynamics in Ukraine was opposite to that in the relevant segment of the world market. This made negative impact on the level of costs of livestock producers, and therefore the level of their income.

Changing the order of operation of the special VAT regime in 2016 had a negative impact primarily on milk producers. Due to changes in the procedure of collecting VAT in agriculture in 2016, livestock enterprises suffered the double impact – on the one hand, prices for grain (for feed base) have increased, on the other – producers lost the right for full accumulation of VAT losing half of the VAT support (producers of milk and meat cattle lost 20%). Accordingly, on the one hand, expensive feed, which resulted in increased costs by an average of 3-5% (depending on the proportion of purchased feed) on the other hand – milk producers lost the right to 1/5 of VAT-support (the latter was more than 12% of the amount of income, again, depending on the proportion of their feed).

Accordingly, the profitability of milk production in 2016 due to changes in VAT functioning decreased by 7.8%, and manufacturers are now trying to “fight off” their loses increasing the cost of realization. It is worth mentioning that according to the State Statistics the profitability of milk production in 2015 averaged 12-13% and taking into account the VAT support it was reaching 24-26%. The profitability of milk production in 2016 will depend on the price situation – whether producers will be able to “fight off” the negative effects of price changes due to the changes in VAT functioning.

Since 2017, according to the draft state budget of Ukraine for 2017 (with a / c number 5000 of 15 September 2016), the government plans to fully cancel the special VAT regime for agricultural enterprises and replace it with provision of the state financial support through direct budget programs. As a result, grain prices may rise further. First of all it depends on the world market, the exchange rate, whether the full VAT refund mechanism will be operating and whether traders will be confident in the timely refund of VAT. Milk producers will be deprived almost 10% of the extra income that they received in 2016 due to partial (80%) saving of VAT accumulation.

Calculations show that without the state financial support and a corresponding increase in prices of dairy production, the dairy farming in Ukraine will be low-profit (in enterprises with low productivity of cows even unprofitable), so that they will go out of business. This is the case in recent years, although in 2016 the rate of decline in livestock production slowed slightly.

Saving the special VAT regime for livestock, particularly, for cattle, even partial saving in certain proportions (50/50; 75/25) is extremely important. The decision taken in favor of the saving will signal to the entities that the state is interested in the development of relevant activities, stimulating its development. It is necessary to consider that in recent years the share of income from animal husbandry in the total agricultural income was rapidly declining – from 36.7% in 2006 to 20.0% in 2015, but excluding poultry – from 20.8% in 2006 year to 8.4% in 2015 (decrease of 2.5 times). Livestock husbandry is characterized by a significantly higher level of added value share created by higher costs of labor. It also makes positive impact on rural employment.

As for the state support. In the process of reforming of the special VAT regime for agricultural enterprises we should consider the significant level of support for milk producers abroad, particularly in the former Soviet countries and the EU. Even though in recent years the volume of such support is reduced, the level available allows foreign animal products manufacturers benefit from competitive advantages.

In Ukraine in recent years all support was directed through the special regime of VAT, and the amount of financing budget programs were scarce. Thus, the budget program 2801540 “State support of animal” is characterized by scarce funding amounts that are not capable to significantly influence the situation in the livestock industry. In 2015, under this program there were planned UAH250 million funding, of which utilized were only 40.6 million (16.2%). In 2016 there was only planned UAH50 million, and it was aimed only for compensation of the cost of purchased animals. The state is stimulating the growth of livestock number through direct support measures, but it does not provide a break-even of these activities. Unfortunately, with the full cancellation of the special VAT regime there is a great danger that direct budget support will not be effective.

And finally, on the specifics of milk production. It should be taken into account that t
structure of milk production in Ukraine is very specific, in particular, there is a significant share of private farms in its total number (more than three quarters of 2015).

By 2009, when the practice of zero rate VAT on the supply of milk and meat in live weight to processing enterprises was in operation, the share of private farms in total supplies of milk for industrial processing was overwhelming – almost 2/3 of the total supply. In 2015, the share of private farms in total supplies of milk for industrial processing was only a third.

Small agricultural producers unable to compete with large agricultural enterprises because of the special VAT regime, firstly because the agricultural enterprises as VAT actors receive reimbursement of the input VAT (the so-called tax credit), and they leave at their disposal the amount of VAT due payment to the budget. Accordingly, unless special regime of VAT is in function in livestok, until discrimination will be existing regarding small producers, who actually di not have the opportunity to register as VAT payers due to burdensome taxation system, in particular registration of tax bills.

In the EU this problem is resolved by applying a special scheme for collecting VAT from farmers. It is called the special scheme of taxation of farmers with the compensation rate. In this way the EU partly solves serious problem of levying VAT in agriculture in the environment where many small producers are outside the official registration of payers of this tax.

Due to the tax related factors milk production in household farms is significantly lower than the corresponding figures in agricultural enterprises (the milk price for private households is no more than 75% of the price for agricultural enterprises). When it concerns agricultural enterprises the tax factor in terms of VAT works actually twice:
– Firstly, the accrued VAT can be compensated by the amount of input VAT paid in the price of purchased production factors;
– Secondly, the regime of VAT accumulation enhances the profitability of milk production on farms for more than 12%.

By current legislation private households are deprived of such support and cannot take advantage of it. As a result, the difference in income between the agricultural enterprises and private households that produce milk is too noticeable. This puts agricultural enterprises in a privileged position.