Ukraine slightly amends gas, farming taxation in compromise proposal

The Ukrainian government officially submitted its tax reform proposal to parliament this weekend, which was the result of “compromises” between the draft prepared by the Finance Minister and the more radical proposal led by MP Nina Yuzhanina. The draft law slightly amended the taxation of natural gas producers and agricultural sector, as compared to the initial MinFin version.

The new draft offers private gas production companies a production tax rate cut to 29% (and 14% for wells deeper than 5000m) as of January 2016. The basis for the tax will be the average gas import price. Since 2018, the production tax rate will drop to 20% (10% for deep wells). Currently, the companies are obliged to pay 55% of the regulated gas price (28% if they produce gas from deep wells). On top of that, a new “surcharge to profit tax” will be applied to gas producers, equal to 15% of the difference between EBITDA from natural gas sales and CapEx into exploration and production. A negative difference reduces the tax base in the next tax periods. According to cover letter of the draft law, this “surcharge to profit tax” will be applied as of 2018, while the draft law itself does not contain any time limits. This means the surcharge tax could be applied since the next year, if the draft is adopted in its current edition.

According to the updated draft, state-controlled gas companies will have to pay a 70% tax (14% on gas from deep wells) until the end of 1Q16. Since then, they will pay the same rates as private gas producers (the only difference will be the tax basis, which will be the regulatory purchase price of gas supplied to households). A 70% tax rate is preserved for companies that produce gas based on agreements on joint production.

For farming companies, the draft tax reform allows for some easing of the VAT burden, as compared to MinFin’s initial draft, in which farming companies will lose all VAT benefits, but only starting from 2018. For the period of 2016-2017, agricultural companies will be allowed to retain 25% of VAT obligations for their own use, while will be obliged to pay to the budget 75% of VAT (from 0% now and).

Parliamentary Speaker Volodymyr Hroisman called a special meeting of MPs for Thursday, Dec. 17 to start discussing the tax reform and Ukraine’s 2016 budget, Interfax-Ukraine reported on Dec. 14. Hroisman referred to time constraints and the need to adopt all the laws by the year end. Parliament is not in session this week.

Alexander Paraschiy: Even though MPs will start the discussion of tax reform and the state budget this week, most likely they will adopt the budget as tradition, closer to the year end, possibly at the end of next week. Although the discussion in the Rada will be heated, we expect no significant changes to the proposed tax rules for gas producers and farmers in the final version of the tax reform.

The amended tax rules for gas producers are close to what was initially drafted by MinFin. Cleary, their approval will lead to the increased attractiveness of private independent gas producers like Serinus Energy (SEN PW) and JKX Oil & Gas (JKX LN). We also hope that the application of a “surcharge to profit tax” will start as of 2018, as promised by MinFin.

The slight easing of the VAT regime for farming companies will only slightly sweeten their pills. As we wrote before, the companies with a focus on domestic markets will likely be most negatively affected, including MHP (MHPC LI) and Astarta (AST PW), which generated 12.3% and 5.9% of their EBITDA from VAT benefits in 9M15, respectively.