Abolishing of the VAT exemption for the simplified tax system

The reform of the simplified tax system (STS) has become a priority in the context of Ukraine’s cooperation with the IMF under the Extended Fund Facility. This policy study examines the proposed removal of the mandatory VAT registration exemption for STS taxpayers and assesses its potential economic impacts. 

Based on 2024 data, the simplified tax system covers approximately 1.5 million private entrepreneurs who generate around UAH 2.5 trillion in reported turnover. The regime is predominantly utilized by businesses in wholesale and retail trade, which account for 38% of all STS participants and generate nearly half of the total STS turnover.

While initially designed to support genuinely micro-scale businesses, the STS has evolved into a structural enabler of tax avoidance and evasion. The highest concentration of business fragmentation is observed primarily in the trade sector, HoReCa, and manufacturing. Prevalent practices include the artificial splitting of businesses, concealed turnover, and grey imports, which distort competition and weaken consumer protection.

Removing the VAT exemption through a single mandatory registration threshold is considered the most balanced option for addressing these economic distortions. VAT registration converts implicit taxes into an input VAT credit, restoring the core function of VAT as a neutral tax on value added. Empirical evidence confirms that the effective impact of this approach is concentrated precisely in sectors with the highest incidence of abuse, rather than among genuine small businesses.

To ensure effectiveness, the study suggests calibrating the mandatory VAT registration threshold to UAH 2.5 million to protect small businesses from disproportionate compliance costs. Additionally, the reform should be accompanied by administrative simplifications, such as the cash accounting method, and a reconfiguration of the STS that merges Groups 1 and 2 and links payments to actual turnover.

This study evaluates how the proposed introduction of VAT would affect business operations, economic activity of STS actors, and their integration into VAT supply chains.

Check the full policy study for detailed statistical evidence, group-by-group impact assessments, and comprehensive implementation recommendations.

This publication is produced by the German Economic Team, which is financed by the Federal Ministry for Economic Affairs and Energy and implemented by Berlin Economics, in cooperation with the Centre for Economic Strategy.