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Law No. 5600: Whether tax "surprises" will lead lead to higher housing prices

Bill No. 5600 will lead to a reformatting of financial activities and the use of more complex schemes. Photo: Fotolia.com

Bill No. 5600 will lead to a reformatting of financial activities and the use of more complex schemes. Photo: Fotolia.com

One of the most high-profile bills of this political season, No. 5600, has just been adopted. Besides political tasks, it set itself the goal of putting things in order in the construction industry. In particular, to close the sales schemes that helped to avoid taxation of developers.

Immediately after the first reading, the draft law "On Amendments to the Tax Code of Ukraine and Certain Legislative Acts of Ukraine to Ensure the Balance of Budget Revenues" was mercilessly criticized by the construction companies.

Among a number of other significant amendments in its provisions had a significant impact on the industry. In particular, it was about the increase in personal income tax (PIT) rates on the sale of real estate.

So far, the income from the sale of one property per year has not been taxed, and the sale of the second and subsequent ones is taxed at a rate of 5%. This allowed many developers to optimize costs by selling apartments to individuals, and not legal entities.

The authors of the "resource" law promised to close this opportunity. According to the document, income from the sale of the third and subsequent properties sold by an individual within one year should have been taxed at the standard rate of 18%.

But after numerous statements that the law would bring down the construction market, it was decided to significantly soften this norm in the draft law before the second reading.

Now, 18% of the tax will have to be paid not on the entire amount obtained from the sale of the real estate, but only on the difference between the amount of the sale and the price for which the real estate was transferred to the seller.

Experts and market participants see this as a significant victory over the rates stipulated in the original document. At the same time, everyone agrees that tax optimization will affect the price per square meter.

Bill 5600 caused an intensive discussion, in particular, in July, a press briefing was held where representatives of the major developers criticized some legislative initiatives, for example, the intention to impose value added tax on real estate. Volodymyr Zubyk, the President of the Association of Construction Enterprises "Intergal-Bud", was among the critics of the first version of the legislative text. He noted that excessive tax burden could lead to an increase in prices per square meter at the level of 45%.

Fortunately, the parliamentarians heeded the expert criticism from business representatives and excluded this intention from the bill before consideration in the second reading.

However, the increase in personal income tax rates from 5% to 18% was kept for the third or more sales of housing in a year and the second or more sales of non-residential real estate in a year. It should be noted that the bill provides for the possibility of reducing the amount of PIT for the third and subsequent sales by confirming the seller's expenses for the acquisition of such a property. That is, the actual tax payment will be based on the difference between the purchase and sale costs.

But how this will actually work, the question remains open. In any case, this initiative is less critical, but it will lead to higher prices in the market.

In addition, a significant number of investors will suffer, whose income scheme consisted of buying square meters at low stages of the property readiness for the purpose of the further resale. The popularity of investment in primary real estate is based on high profitability, predictability, and lower riskiness compared to investments in securities or cryptocurrencies.

With an increase in tax burden, the number of transactions for the purchase of real estate for the purpose of earning will decrease. Currently, their share is about 40%. Developers will lose some of their buyers, and Ukrainians—the opportunity to preserve and increase their own capital using an understandable and relatively safe scheme.

Major market players with their own resources to finance construction will not be particularly affected. But small developers who need to raise investments into the project from the pit may experience difficulties.

Anna Laievska

Anna Laievska

Commercial Director at Intergal-Bud

According to Tetiana Danylenko, the head of the law office, bill No. 5600 will be a step to stop abuses by real estate sellers, who have so far avoided registering the status of an entrepreneur in order not to pay taxes at a rate of 18%. The point of using a scheme with the sale of the real estate by individuals without entrepreneurial status will disappear.

Quote"In practice, the developers are selling apartments, starting from the construction stage, and what is more, at the expense of legal entities and individuals-investors. And they do this through: property rights, derivatives, and preliminary agreements. By the second reading, the initiative to tax the sale of housing that could lead to a rise in the cost of housing by 20% for new buyers and people who have invested in construction funds was removed," the lawyer explains.

According to Danylenko, although the bill actually concerns the discipline of developers regarding the conscientious payment of taxes to the state budget, but in our reality this will lead to a reformatting of financial activities and the use of more complex and valuable schemes in further work. "And as costs rise, they will ultimately be reflected in higher housing prices for buyers," the expert adds.

According to Gryhorii Tripulskyi, Director at the legal and consulting company De Jure, with the removal of the norm on the rate of 18% when selling to individuals, a loophole in the law to minimize taxes was left.

Quote"The high tax threshold was indeed a tangible obstacle to abuse. In the draft that reached the second reading, the norm was reduced too much: 18% of the difference in sales can be easily used to minimize taxes. In general, this is not an obstacle for tax manipulations and," Tripulskyi stresses.

The lawyer stresses that the law was promoted as a tool that would put things in order in the construction business, but this did not happen.

Quote"The construction companies can continue to sell through individuals. An individual buys apartments, for example, for $500, and sells $1,000 per sq. m, and at the same time pays 5% of the personal income tax, instead of the company paying the corporate income tax," he explains.

In general, the increase in PTI rates from 5% to 18% will most of all affect small construction companies that have worked and, possibly, still continue to work, mainly through preliminary sales and purchase agreements or joint activity agreements concluded between individuals.

The companies operating through co-investment institutions, construction finance funds, or housing associations will not be directly affected by these amendments.

According to the lawyers, the developers working under preliminary sales and purchase agreements or agreements on joint activities need to revise their schemes for financing construction projects and the subsequent sale of real estate and choose more optimal mechanisms.

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