Why do exporters want to pay double taxes?

Every year Ukraine spends about 900 million dollars to train nearly 15,000 programmers, even though 5,000 of them go to work abroad. Meanwhile the remaining 10,000 manage to earn billions of US dollars for the Ukrainian economy. In particular, only last year Ukrainian IT specialists sold two-billion-dollar-worth codes worldwide. They could do even more: if the state does not stand in the way, they promise to increase exports to 10 billion dollars; if the state is helpful, the exports can exceed 20 billion. The Day learned all this from an interview with Roman KHMIL, operations manager, Ciklum (Ukraine). This company is known to have successfully organized close cooperation with the new government’s economic block (namely, with the economy minister Pavlo Sheremeta), which has already resulted in two draft laws and a platform for training IT specialists, Brain Basket.

Khmil, 37, has worked as a programmer in the US, created and sold for eight million dollars an IT company called SourceValley, led GlobalLogic Ukraine and later, its competitor Ciklum. He is convinced that “before building a Singapore in Ukraine, we must first build an India here,” meaning the level of development and governmental policy in IT industry. Khmil denounces product companies’ complaints about stimulating outsourcing in Ukraine as populism.

As this “military programmer” (a self-awarded title) shares his experiences about serving in the Ukrainian army, he says with certainty that Ukraine would be quite capable of creating an elite battalion for cyber warfare. Ukrainian IT experts have both the necessary qualifications and desire to do it.

Recently Ukrainian mass media actively circulated the report of IDC, an analytical company, which stated that in 2014 the Ukrainian information technology market would shrink in volume up to 25 percent. Do you acknowledge the dip? What caused it?

“The 25 percent dip will be observed in the domestic market, with the economic and political crisis as the main cause. Ukrainian companies have less money now, they are becoming more economical and, consequently, they place fewer orders.

“But we forecast no dump in exports. Indeed, there is a certain slowdown caused by the Ukrainian political and economic crisis: compare our previous forecast of 30-40 percent annual growth to the actual forecast of 10-20 percent. But I expect that a comparison of the 2013 and 2014 figures will show a 20 percent growth in the IT market.

“And by the way, it is important to note that it is export that provides 80 percent of Ukraine’s IT market.”

In your comments to the media you said more than once that Ukrainian exporters promised to sell 10 billion dollar worth products by 2020. What can provide such a growth? And what sort of support do you want to get from the government?

“The government must just leave us be. The industry already has the necessary growth rate. But this rate was based on one key position, which is called ‘the actual private entrepreneur taxation model.’ It is widely used in the Ukrainian IT industry, since it means 5 percent payroll tax. This enables companies to offer their staff high salaries and thus prevent employee turnover. We are able to provide our workers with attractive salaries, they need not go abroad, and thus we develop the industry at home. On the contrary, before 2000 there was a massive outflow of programmers from Ukraine.

“IT industry must not be transferred to the standard 55 percent payroll burden, it will simply kill it: companies will register to other jurisdictions and programmers will migrate abroad, where they can earn more.

“What are we telling the government? We are well aware that more taxes are necessary. But our industry can do it not by increasing the tax rate, but by increasing the turnover. For instance, it is unrealistic to expect that metallurgy, which provides 10 to 15 billion dollars in exports and is declining, would allow to harvest more taxes. But the Ukrainian IT industry is steadily growing at its ‘five and five.’

“Now we are yielding two billion, in six years’ time we promise ten, which automatically means five times more tax.

“Meanwhile, if the government agrees to some of our proposals now, we can secure double growth. We have proposed two draft laws to the Verkhovna Rada. If the parliament adopts them, Ukraine’s IT industry will grow at 60 to 80 percent annually.

“Five years ago Belarus created a special taxation regime for its IT companies and a technopark, and now it enjoys annual growth of 100 percent, even though Belarus does not enjoy a good political repute in the Western markets.

“Our new government, on the contrary, has already tried to cancel the special taxation regime for the IT industry.”

Yes, the budget must be filled.

“Of course. But a closer look shows that cancelling this special taxation regime for the IT industry yields no substantial earnings to the budget. On the other hand, it sends a negative signal to the market: a year ago the government stimulated the IT industry, and now it suddenly decided to stop it. In other words, investors will take it as a sign of deteriorating business climate. We have been able to successfully impress it on the government, and we are off the hook for the time being.”

What are those two draft laws which you have proposed?

“We propose to impose an obligatory single social payment for IT entrepreneurs, which in Ukraine is at 37.7 percent private entrepreneur’s turnover. But this payment should be calculated on the basis of two minimum wages instead of the entire payroll.”

What will this yield?

“Extra earnings for the budget. Today IT companies do not pay it at all because they are working as sole proprietors and pay their usual 5 percent tax on turnover.”

What will business win?

“The thing is that our sole proprietorship model is not transparent and clear for Western investors. That is why big Western companies like IBM, Google or Apple stay away from our market. They see our standard payroll taxation model and say ‘No way.’ On the other hand, the scheme of hiring private entrepreneurs with 5 percent tax is not clear for them and for auditors. Because of this, shell companies proliferate in our country, such as ours, or Luxoft, or EPAM, which assume the risks of working according to such schemes. If the state wants us to grant the status of employees to all the sole proprietors that we hire, it has to make it painless for us. For example, in such a case we are prepared to pay 10 percent, but not 55 percent payroll tax. We have done some constructive thinking, and now we know how this can be done. A single social payment on the basis of two minimum wages is equivalent to the sole proprietor’s 5 percent income tax.

“The taxation regime in Malaysia, Romania, or Belarus is around 5 to 10 percent. The goal there is not to raise the tax rate to the maximum, but to ensure the maximal growth of the industry.”

You initiated the creation of the Brain Basket platform. If I am not mistaken, it is aimed to allow companies assist the state in the training of IT specialists at universities. Does it mean that in the future Ukraine can completely cancel state funding for the training of IT students, with the market financing the education of the specialists it needs?

“No, you got it wrong. We rely heavily on help from the state. I reckon that today Ukraine is spending some 300 million for the training of IT specialists in their fifth year of study, plus another 600 million for their undergraduate training. The problem is that we are actually preparing a part of these specialists for other economies, that is, Ukraine is just giving away tens if not hundreds of millions in dollars to the European, American or some other IT industry. We are producing graduates who simply cannot find a job here. On the one hand, our task is to rig the education system in such a way that the state’s investment in IT students should earn money for our economy. On the other hand, simultaneously we must create a system of commercial education, which will produce competition. Under current conditions it is next to impossible to make the state invest in specialist training more efficiently. Schools have virtually zero motivation for introducing up-to-date training practices and ensuring providing quality education, their lecturers are still using some Stone Age class materials, enroll students who skip classes, and give them credits for nothing, and yet they get their salaries. I would not say that this description fits all, but at least half of schools it does fit, I am sure. It is very hard to make them live in a new way. Only the rise of a parallel commercial segment will be able to do it, which will attract the best applicants, investments and so on.

“The global demand for programmers is rampant. In the nearest five years Europe is planning to create another million jobs, the US three to four million. A part of these jobs (some 10 percent) is to be filled directly, another 90 percent is outsourced to other countries. Let us figure out, where Europe could place 900,000 programmers in the next five years. Where? In India? Europeans are well aware of the relative quality of Indian programmers. This is why it is crucial that Ukraine sends a message that we are ready to generate 30, 50, or 100 thousand programmers in five years.

“According to our calculations, 100,000 is our real figure. This is approximately equal to what is produced in the state-funded and private education in Ukraine, adjusted for growth forecasts. So we made a statement in the European market. We are convinced that there will be guaranteed jobs for all these 100,000 experts. Even today an average programmer in the Ukrainian market finds a job after two weeks at the most.”

When do you think Ukraine will reach a level where it will be able to produce not only workforce, but also world-class IT brands?

“We already have PocketBook, with 10 percent of the global market. But it is surely too little for a country like ours. That is why I reckon such a goal will require no less than 10 to 15 years, on condition someone will be working really hard on it. This is very difficult. Firstly, Ukraine must learn to protect intellectual property. If you have some know-how of your own, you want to make a lot of profit on it. There are many jurisdictions across the world where this right is guaranteed: the UK, the US, etc. But Ukraine needs a sound judicial system in the first place, and patent law after that. All of this has to earn a good repute, and this is not the end of it. This is just the beginning, a message to the investor who will read it and begin to put his money in some ideas. Here the second stage begins, the formation of the venture capital market. These investments involve high risks. In principle, it is a win-win game. But you have to begin with at least 100 million dollars, which you can spread among a hundred startups. Then, according to the statistics, ten of them will earn you a billion, and you will compensate your costs. The remaining 90 will yield tenfold, with five to ten years to go. This is statistics. But you need to have 100 million for one venture fund. Besides, you need to have a hundred ideas as to where this fund will invest its millions one by one. And it is very hard to generate these hundred ideas if you stay here in Ukraine.”

What do you mean?

“The market where IT solutions sell is now limited to Europe and the US. To come up with a productive idea, you have to be part of this market, feel it, see which way it goes, and predict where it will be in two years’ time. Someone has already invested in the market’s actual needs, this is already done. It is impossible to run in this race if you are staying in Ukraine. Here we can only ‘see’ those products which let us feel the demand. That is why Ukrainians write so many products for programmers: because programmers in the US need the same products as programmers in Ukraine, and we understand this need.”