Ukraine Imposes 20% VAT on Import of Drugs and Medical Devices and 7% VAT on Supplies of Domestic Products

[April 04th, 2014] Ukraine Imposes 20% VAT on Import of Drugs and Medical Devices and 7% VAT on Supplies of Domestic Products, Arguably in Violation of GATT

On March 27, 2014, as part of the tax legislative package to prevent financial disaster, [1] Verkhovna Rada, the parliament of Ukraine, revoked VAT exemption for import of drugs and listed medical devices manufactured outside of Ukraine. As a result, import of drugs and medical devices shall be subject to 20% VAT in Ukraine from April 1, 2014. Any subsequent sale of imported drugs and medical devices, which used to be exempt from VAT, shall be subject to VAT at the rate of 7%..

Likewise, any sale of drugs and medical devices manufactured in Ukraine, which used to be exempt from VAT, shall be subject to VAT at the rate of 7% from April 1, 2014.

We do not exclude that 20% VAT on import of drugs and medical devices might have been an oversight, while the intention could have been to impose 7% VAT both to sales of drugs and medical devices and their import to Ukraine. However, for the time being 20% VAT rate applies to imports under the Tax Code as amended.

A. PRICE REGULATIONS

This tax measure will result in increase of prices of imported drugs and medical devices, because 7% VAT on their resale in Ukraine would eventually be borne by consumers.

As prices of drugs and medical devices are regulated in Ukraine, international pharmaceutical companies operating in Ukraine should consider the following possible repercussions of 20% import VAT / 7% supplies VAT for their operations:

1. Because drugs and medical devices used to be exempt from VAT in Ukraine, domestic and foreign manufacturers were not entitled to recover any input VAT incurred in Ukraine, including material amounts of input VAT incurred in respect of marketing and promotion of their product in Ukraine. From April 1, 2014 domestic manufacturers shall be entitled to recover or refund their input VAT because they would be engaged in VAT-able sales (supplies) of drugs and medical devices (at 7% rate). Foreign manufacturers, to be capable of competing with domestic producers on the same footing, might need to reconsider their distribution channels so that their Ukrainian subsidiaries or branches (commercial offices) are capable of crediting (recovering) input VAT on marketing, promotion and other expenses in Ukraine. Presently, many foreign pharmaceutical companies recover marketing and promotion expenses incurred by their Ukrainian subsidiaries through services charges, subject to VAT in Ukraine, or by other means, which do not permit recovering input VAT.
2. Because prices of domestic and imported drugs and medical devices (both on wholesale and retail levels) or for state or municipal procurement purchases are regulated in Ukraine, introduction of 20% VAT on imports and 7% VAT on supplies of drugs and medical devices from April 1, 2014 would most probably require reconsideration of the existing pricing arrangements with wholesale dealers in Ukraine.
3. Moreover, existing state or municipal procurement contracts do not account for 7% VAT, which would result in material losses of revenues. Foreign manufacturers and their dealers should, therefore, examine whether they could demand increase of the procurement prices.
4. 20% VAT on import of drugs and medical devices (exceeding 7% VAT on their resale in Ukraine) may put many importers in a VAT refund position. Because VAT is refunded in Ukraine with great delays and subject to many issues, 20% import VAT will have negative cash flow consequences for importers and may require additional financing.
5. VAT on import of drugs and medical devices may result in increasing attention of the customs authorities to customs valuation of imports, especially if drugs and medical devices are imported by subsidiaries of foreign manufacturers, which may give grounds to the tax authorities to question customs value of the products imported in related-parties transaction and declared under the first method (contract price). It is common for the customs authorities to question customs values in related-parties transactions based on different customs values of same products imported directly by wholesale dealers.

B. GATT

20% VAT on import of drugs and medical devices, arguably, discriminates foreign manufacturers of such products in violation of Ukraine’s obligations under the GATT 1994. Under Paragraph 2 of Article III of the GATT 1994, Ukraine undertook that:

“the products [drugs and medical devices] of territory of any contracting party imported into the territory of any other contracting party [Ukraine] shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind [20% import VAT] in excess of those applied, directly or indirectly, to like domestic products [7% VAT on domestic supplies]”. (Clarification in brackets by us)

The government apparently favors domestic production by levying 20% VAT on “import” of drugs and medical devices manufactured outside of Ukraine, while supplies of drugs and medical devices manufactured in Ukraine are subject to 7% rate.

If 20% VAT rate on import of drugs and medical devices is retained in Ukraine, foreign manufacturers may consider the following actions to protect their interests:

1. To approach individually or collectively through business associations (e.g., EBA, ACC) the government of Ukraine to communicate discriminatory nature of 20% import VAT in violation of Paragraph 2 of Article III of the GATT 1994 and to request the government to extend 7% VAT to import of drugs and medical devices; and/or
2. To approach their respective authorities responsible for international trade and WTO relations (e.g. the EU Commission in the EU and the US Trade Representative in the USA) to communicate this issue and the apparent breach by Ukraine of its obligations under Paragraph 2 of Article III of the GATT 1994 and to request official consultations to be held with Ukraine to revoke this tax measure (20% import VAT) or to extend 7% VAT to import of drugs and medical devices to Ukraine.

We will keep you updated on further developments.

If you have any questions, please do not hesitate to contact MarchenkoDanevych Law Firm:

Oleh Marchenko, Partner
oleh.marchenko@marchenkodanevych.com

Leonid Cherniavskyi, Associate
leonid.cherniavskyi@marchenkodanevych.com

[1] Law of Ukraine “On Prevention of Financial Disaster and Establishment of Pre-Conditions for Economic Growth” dated March 27, 2014 (“Law”), which enters into effect on April 1, 2014.

Source: MarchenkoDanevych Law Firm