COMMENT: Ukraine's bill on economic zones corrects many of the previous problems

By bne IntelliNews February 23, 2007

Hanna Cherednychenko of the International Centre for Political Studies -

The new bill on special economic zones (SEZs) and territories of priority development (TPDs) corrects a slew of problems associated with the previous regime governing these areas.

First, stimulating commercial activity on these special territories is not likely to seriously distort the overall competitive environment in Ukraine. Now, SEZs will be able to function only as a duty free zone and all goods manufactured in these zones will be treated as imports if they enter the customs territory of Ukraine. In this way, goods manufactured on privileged terms in SEZs will not squeeze out manufacturing on the customs territory of Ukraine. At the same time, there will be no privileges for raw materials and supplies imported to SEZs and TPDs, which should eliminate the previously widespread practice of importing goods at duty free for further domestic sale.

Second, with TPDs, where tax breaks are intended to attract investors to otherwise unappealing economic environments, a strict list of qualification criteria has been established. In this way, the possibility of giving unwarranted tax breaks to economically healthy territories will be eliminated.

Third, the approach to spurring commercial activity in SEZs and TPDs are better than the regime that was in place until 2005. Tax breaks now generally kick in when the results of commercial activities have been assessed. Opportunities for significant tax breaks without actually manufacturing anything have pretty well been eliminated, among others, because there are no longer any tax breaks on imported raw materials and supplies.

Fourth, the proposed measures to foster development in economically backward areas are more effective than those that were used in the previous programme. The application for tax breaks on TPDs is now possible only in specific settled areas that have been declared "underdeveloped" on the basis of competitive criteria. This increases the likelihood that economically lagging areas will develop more rapidly, compared with the situation earlier, where huge but unevenly developed territories were given the right to have tax breaks and their most developed areas attracted all the investment.

What is more, the bill calls for a mechanism for TPDs to be instituted to promote infrastructure development, the lack of which is often the main reason why regions lag economically: the cost of establishing or improving public capital assets within an investment project will partly count as a deduction against profit tax liabilities.

On the flip side

Still, the bill has its negative points.

The main one is that a narrow range of instruments has been established to stimulate commercial activities on SEZs and TPDs, namely tax breaks, while other important measures to improve business conditions are not anticipated. In particular, the regulatory barriers to launching commercial business, especially export operations, have not been lowered, which means that SEZs and TPDs are unlikely to make a serious difference to the country's economic development.

The bill also fails to completely regulate the issue of instituting tax breaks for those investors who registered projects under the previous SEZ/TPD regime. The bill gives such investors the right to continue working under the rules of the SEZ/TPD regimes in place at the time of registration. Since the previous set of privileges-including duty free import of goods-effectively remains in place, those particular SEZs and TPDs need to be transformed into proper customs zones to prevent a repeat of the distortions to the competitive environment and huge losses to the Budget.

Finally, although the Bill establishes the use of a regular import regime on the entry of goods from these zones onto the customs territory of Ukraine, it does not provide a mechanism for controlling the execution of this norm, especially the requirement to equip the boundaries of the relevant TPDs according to the standard rules of customs control.

Hanna Cherednychenko is economist at the International Centre for Political Studies in Kyiv

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