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 Many of the suits accused the company of minor violations of
Ukraine’s labeling law – such as not placing a "quality seal" on
tiny memory cards and wafer-thin batteries inside mobile phones.
Foxtrot said it placed the seals on the external packaging, which
the law also allows.
Viacheslav Povrokznick, Foxtrot’s CEO, said agency officials
proposed a deal – pay $1 million in cash and the lawsuits would
disappear. "We said no," he said. "It was like a kind of extortion."
Today, the company still faces a mountain of litigation.
Six months after a popular uprising toppled President Viktor
Yanukovich, Ukraine’s new leaders are fighting wars on two fronts.
One struggle is against Russian-backed insurgents in the east. The
other is against staggering corruption that top officials say
infected every level of government - and continues to this day.
"It is hard to name an agency that was not involved in any of the
scams," said Vitaliy Kasko, a deputy prosecutor general who is
trying to recover billions of dollars in assets allegedly stolen and
stashed overseas. Prosecutors say they believe that Yanukovich and a
circle of associates stole vast sums of government money and
profited from illicit schemes. Last week, the prosecutor's office
detained a deputy head of the central bank on suspicion of
involvement in the theft of more than $170 million in state funds.
Corruption has plagued Ukraine since the country gained independence
from the Soviet Union in 1991. But under Yanukovich, it grew far
worse. The sheer scale of the graft – involving tax evasion,
fraudulent value-added tax claims, bribery and extortion – helped
set off the chain of events that has embroiled Ukraine in a
separatist war.
A Reuters examination of the rampant tax and extortion rackets finds
that the toll on the Ukrainian treasury was so great that the state
was mortally weakened, leaving it at the mercy of outside powers.
Top government officials told Reuters that by the time Yanukovich
fled to Russia in February after four years in power, Ukraine was
bankrupt. That is why the country sought and took a $17 billion
bailout this year from the International Monetary Fund.
Igor Bilous, a former investment banker who now heads Ukraine’s tax
agency, said in an interview that the government lost between $6
billion and $9 billion last year through just one scheme - a complex
"tax minimization" racket that had the tax office’s blessing.
Where did the money go? "In pockets, obviously," Bilous said. "I
don’t think much can be recovered. A lot was taken out of the
country … in dollars and gold."
The looting ultimately backfired on Yanukovich, helping to set in
motion his downfall.
AN IMPROVED FORM OF GRAFT
Last year, desperately needing billions of dollars in assistance to
replenish the treasury, his government first looked to the European
Union for help.
Yanukovich initially supported an association agreement with the EU
that would have opened a path to European aid and closer ties to the
West. Instead, the pro-Russian politician decided to abandon the
agreement and sign a treaty with Moscow to provide monetary aid.
That about-face sparked the popular revolt led by pro-Western
protesters who occupied the capital’s Independence Square, known
locally as the Maidan, culminating in deadly clashes that ultimately
led Yanukovich to flee to Russia.
The reverberations are still being felt: Russian President Vladimir
Putin annexed Ukraine’s Crimean peninsula, and pro-Russian
separatists are fighting to hold territory they’ve seized in eastern
Ukraine. On Wednesday, NATO warned that Moscow had massed 20,000
troops on the border and could be poised to send them across.
Yanukovich did not pioneer Ukrainian graft. Prior presidents, too,
have been accused of corruption. Instead, according to business
executives, government officials and independent watchdog groups,
his administration and associates took control of, systematized and
expanded various schemes that had existed on a smaller scale for
years.
"The current situation with corruption is rooted in Soviet times,"
said Andrei Marusov, chairman of the board of Transparency
International Ukraine, an anti-corruption organization. "What
happened under Yanukovich was the centralization of corruption.…
Everything went through this centralized hierarchy of state
governance, by steps, by layers, from town, to municipality, then
regional, then the ministry and then up to the president."
Yanukovich – who entered office vowing to fight corruption - could
not be reached for comment.
Oleksandr Klymenko, who was head of the tax authority under
Yanukovich, said in a statement to Reuters: "It is shameful and just
plain wrong that some of my country's new crowd of bureaucrats are
so desperate to distract the public from the alarming economic
conditions which they should be working hard to solve (as I did my
best to do), that they duplicitously try to explain their own
failures by casting blame on my popular successes by fabricating
groundless charges."
Tomas Fiala, president of the 900-member European Business
Association, said many companies were targeted by corrupt officials
and had little choice but to participate in tax avoidance and other
illicit schemes just to conduct ordinary business. "Definitely more
than half of the companies working in Ukraine overall were forced to
pay bribes," he said.
About 100 of the EBA’s members currently face criminal cases against
executives alleging tax evasion, according to its executive
director, Anna Derevyanko.
"THEY USE THAT AS BLACKMAIL"
For French food group Danone SA, troubles began with Ukraine’s tax
authorities in 2011, the year after Yanukovich took office. Dario
Marchetti, Danone Dairy Ukraine’s general manager at the time, said
the subsidiary had agreed to pay a local tax on royalties it was
paying the parent company to license its dairy products.
But after paying the tax to the tax office, Danone Ukraine was
audited by Ukraine’s customs office. According to Marchetti, customs
authorities determined the tax was owed to customs, not the tax
office, and the company was required to pay the tax again – plus a
penalty for non-compliance. The amount demanded by customs came to
about $725,000, he said. Worse, the tax office refused to refund
Danone’s previous payment of more than $500,000.
"I personally went to the guys investigating us, and they said,
‘Look, we have a target, and you have two options. You can pay us
either 20 or 30 percent of what is owed, or we will go after you.’"
Marchetti said Danone rejected the demand – which it considered a
bribe. He said Ukrainian authorities then filed a criminal complaint
against Danone Ukraine’s chief accountant, a single mother with two
children, accusing her of participating in tax evasion. "They use
that as blackmail," he said.
"In the end, we ended up paying customs, we ended up paying twice
just to save our employee," said Marchetti, who is now general
manager at Danone Dairy Brazil. "For a business that went through
the 2009 crisis and had low margins, this was a huge hit."
Mikhailo Noniak, deputy minister for revenue and duties at Ukraine’s
tax agency, said of Danone’s past problems: "This doesn't happen
now, but it happened very often before. Tax police, tax inspectors
would start checks, investigations, they would go after firms like
Danone, they would try to find something, and say something they had
done did not correspond to the law.
"To be honest," Noniak said, "at most firms they could find
something that did not meet the legal requirements, and they would
do the checks and they would either demand a fine, or open a
criminal case, and then they would say, ‘We will not launch a case
if you pay.’"
Businesses such as electronics retailer Foxtrot say Ukraine’s
consumer protection agency employed similar tactics.
Nestle SA’s local subsidiary, Nestle Ukraine LLC, had a run-in about
three years ago with the consumer protection agency. Gennadiy
Radchenko, local head of corporate communication and corporate
affairs for the Swiss food titan, said the agency halted the sale of
50-gram packages of Nescafe in southern Ukraine. It claimed the
product had a bad smell.
He said the allegation made no sense, since the agency found no
problem with 100-gram packages of Nescafe, even though the coffee
came from the same factory in Brazil. "How could one package be bad
and another good?" Radchenko asked. "It’s clear they wanted a
bribe."
Nestle declined to enter discussions and filed a lawsuit against the
agency, he said. The company initially lost the case but eventually
won on appeal, a process that lasted two to three months, he said.
Radchenko said Nestle’s experience was not at all unusual in
Ukraine. "This is routine," he said.
In a statement to Reuters, Olha Sokolova, the consumer agency’s
recently appointed acting head and previously its deputy chief, said
she had no information on Radchenko’s allegations. Separately, she
defended the agency’s legal actions against Foxtrot, and said she
had no information about the retailer’s charge that officials tried
to extort bribes.
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BLACK SALARIES
According to the tax agency and interviews with business people,
officials from other government offices frequently shook down
companies. The government has 70 different bodies with licensing
authority, including 40 with the power to shut down a business, the
tax agency said.
Said Danone’s Marchetti: "It was so hard to get an export license
without paying bribes that I had to give up exporting."
Government officials partly attribute the widespread bribery in
Ukraine to the low salaries paid to civil servants. The average pay
for tax inspectors, for example, is about $145 a month, according to
the tax agency. The head of a regional state tax office earns about
$350 a month.
"Bribes are how you make your ends meet," said Jorge Zukoski, who
headed the American Chamber of Commerce in Ukraine for 15 years
until stepping down in January. "Your government paycheck does not
put food on the table. It’s not a living wage."
In the private sector, many Ukrainian businesses pay their employees
partly in cash – known as "black" salaries - to avoid
social-security contributions that average about 38 percent. The
government loses additional revenue because employees typically do
not pay income tax on the secret cash portion of their salary.
"Many analysts single out the payroll tax as being exceptionally
high and the main reason why shadow wage payments remain common in
Ukraine," the Office of the U.S. Trade Representative stated in a
2012 report. The social-security tax for employers in Ukraine is
more than 2.5 times the average paid by companies in the 34-nation
Organization for Economic Co-operation and Development.
The practice of paying "black salaries" continues today. "I know our
local competitors are paying in cash in envelopes," Nestle Ukraine’s
Radchenko said. "I know from people in interviews who want to be
employed by Nestle."
Tax authorities estimate that cash payments for salaries total about
$17 billion a year, resulting in at least two million workers not
appearing on tax rolls. Another five million employees report
earning salaries that are below minimum wage, which authorities say
is a sign they are paid partly in cash. In all, more than a third of
Ukrainian workers are believed to receive "black" salaries.
To run this dodge, many businesses used so-called cashing services,
which offered - for a fee of about 8 percent to 12 percent - to
provide banknotes to pay "black" salaries and bribes, according to
the tax agency.
Tax officials say that during Yanukovich’s administration, there
were between six and nine "certified" cashing services that received
the agency’s blessing. There were also another 100 to 120 "transit
companies" used in the fraud to disguise transactions.
The officials declined to name any of the companies or the people
involved, but said more than 100 tax agency employees were directly
involved in the schemes.
PHONY PAPERWORK
In exchange for fees, the cashing services provided businesses not
just with bank notes, but also phony invoices showing purchases of
goods that never took place. Businesses used these fake expenses to
reduce their reportable profits and save on corporate income tax,
tax officials say.
Many companies also used the fake purchases to reduce the
value-added taxes they owed to the government by falsely claiming
that they had paid VAT on goods they never really bought.
For years, hundreds of firms offered such illicit services. But tax
agency officials say that in 2012 and 2013, Yanukovich officials
began pressuring companies to use the half-dozen or so "certified"
or "state program" firms. Tens of billions of dollars passed through
these firms, tax authorities say.
The biggest loss to the government was VAT revenue, a 20% tax on
goods and services that normally provides more than half the funding
of Ukraine’s budget, according to tax agency officials. They
estimate the treasury last year lost a quarter of its expected VAT
revenue through government-sponsored fraudulent schemes.
Ukraine’s treasury was so depleted that in recent years, companies
with legitimate claims for VAT refunds often couldn’t receive them.
Volodymyr Klymenko, president of the Ukrainian Grain Association,
whose 40 members account for about 90 percent of the country’s grain
exports, said that about 15 years ago, officials typically would ask
for a cut of one or two percent of VAT refunds. The kickback demands
later rose dramatically, he said.
In December, a Ukrainian subsidiary of U.S.-based agribusiness group
Archer Daniels Midland Co pleaded guilty in U.S. District Court in
Illinois to charges that between 2002 and 2008, it paid about $22
million in bribes to Ukrainian officials through vendors to obtain
more than $100 million in legitimate VAT refunds.
The improper payments, falsely recorded as insurance premiums or
other business expenses, "were generally 18 percent to 20 percent of
the corresponding VAT refunds," according to a lawsuit by the
Securities and Exchange Commission.
ADM and its subsidiary agreed to pay criminal fines and other
penalties of about $54 million. Calling the conduct "regrettable,"
chief executive Patricia Woertz said ADM had enhanced its internal
controls and terminated some employees.
A spokeswoman for ADM added: "While we owned 80% of the corporate
parent of the Ukrainian company, we did not control it at that
time."
Grain lobby chief Klymenko said the business of paying kickbacks to
receive VAT refunds "reached its height" after Yanukovich became
president in 2010. "You had to give up 40 to 50 percent of it," he
said. "They told you where to put it, in which bank to open a bank
account, where to transfer the money."
POLYGRAPH TESTS
In his statement, Oleksandr Klymenko, the previous head of the
tax authority and no relation of the grain lobby chief, said that
the amount of VAT refunds increased in 2013 under his leadership and
that he "radically" dealt with "VAT swindlers." His statement didn’t
address the issue of kickbacks.
Officials in the new government of President Petro Poroshenko have
taken steps to try to deter corruption. These include a plan
announced this week to slash the size of government and increase the
salaries of civil servants.
In the meantime, at the ministry of economic development and trade,
new chief Pavlo Sheremeta said graft is "a cancer that’s eating the
country from inside." Some of his reform efforts have met
resistance.
Sheremeta tried to cancel some of the huge fines leveled by the
consumer protection agency against retailers like Foxtrot. The
agency – which falls under his own ministry – responded by filing a
lawsuit against Sheremeta, arguing that the fines were legal. The
suit was dismissed.
The tax ministry, meanwhile, is trying to clean up the VAT rackets.
Noniak, the tax deputy, said the agency has opened 166 inquiries
involving allegedly fraudulent requests for VAT refunds totaling
about $76 million and another $4 million in illegal refunds. It also
has started a criminal case against state officials involved in the
suspect refunds.
The agency, Noniak said, plans to give polygraph tests to state
officials. It has opened 256 criminal cases against tax inspectors,
tax police and customs officials, including 18 cases of alleged
bribery. Another focus is hiring.
"We need to appoint new managers as soon as possible," said Noniak.
"We need normal, honest, reliable people who are ready to work for
the state, not for themselves."
Asked if he believed some tax agency employees are still on the
take, tax chief Bilous replied: "Of course. That’s our main
problem."
(Additional reporting by Natalia Zinets. Edited by Michael Williams)
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