AP IMPACT: Wide scale Ukrainian scam intercepted billions in taxes using fake companies

The Associated Press

In this May 23, 2014, photo, Ukrainian protesters hold banners outside the tax ministry in Kiev. They say that their country’s new government isn’t doing enough to fight tax fraud, which is thought to have squeezed billions of dollars out of their country’s budget. Tax officials acknowledge that some corruption remains in place but say their limited in terms of how quickly they can move. (AP Photo/Sergei Chuzavkov)

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By MARIA DANILOVA and RAPHAEL SATTER, Associated Press

KIEV, Ukraine (AP) — On paper, the Ukrainian trading firm known as Mistral dealt in management consulting and research, doing millions of dollars' worth of deals before going bust after Ukrainian President Viktor Yanukovych was chased out of office earlier this year.

But when police recently tried to visit Mistral's Kiev office at No. 12 Saperne Pole Street, they found a huge hole in the ground, the foundation of an apartment complex to be completed next year. There was no trace of Mistral, whose name refers to a type of wind.

A receptionist at No. 5 on that street said there used to be a wine warehouse at the site, but it was cleared when construction began in 2011. Apartment numbers now jump from 9 to 22.

Officials tasked with cleaning the country's corruption-scarred tax system say the company didn't merely enter the wrong address. They say Mistral may never have existed in the first place — one of scores or even hundreds of phantom firms suspected of squeezing a total of 130 billion hryvnias ($11 billion) from Kiev's coffers over the past three years. The country's total tax revenue amounted to 210 billion hryvnias ($17.8 billion) in 2013.

Some 30 investigations are now underway, and a handful of companies have been raided, but the country's top tax official contends his predecessors were part of the fraud, which is why many phantom firms acted with impunity.

"They didn't care about the police, the security services. Nobody was checking," Deputy Tax Minister Ihor Bilous told The Associated Press in an interview at his Kiev office last month. "That's why this cancer ... spread over the whole country."

Outside experts support Bilous' claims, and documents reviewed by the AP — including tax records, a list of alleged phantom companies drawn up by a Ukrainian anti-corruption group, and data from the business intelligence website Arachnys — echo his description of a wide-ranging scheme.

Bilous' assertions are "very hard not to agree with," said Anna Derevyanko, the director of the Kiev-based European Business Association. "Basically whatever field you are touching, it was corrupt in the territory of Ukraine."

Tax fraud has long been a problem here, and reforming the country's revenue system is a key challenge faced by the newly elected administration of Petro Poroshenko, who was sworn in Saturday as Ukrainian president. For now, Ukraine's budget is being held together with the help of a $17 billion IMF loan package; Bilous says he's proposing a series of changes to the country's parliament in a bid to put the country on a firmer financial footing.

The success of those reforms may hinge on whether the country can exorcise its phantom firms, fake companies which have long been used by legitimate businesses to reduce their tax bills.

According to officials and insiders, here's how it worked: A business pretended to buy goods or services from the phantom firm but, instead of delivering on the deal, the fake company secretly returned the money in cash, reducing the real company's tax liability in return for a cut of the money.

Some 1,700 legitimate businesses were in on the scam, according to the ministry, which flushed them out by identifying 100 to 120 phantom companies and tracking who was at the other end of their deals.

Getting in on the scam slashed tax bills dramatically. One home appliance importer used phantom partners to whittle its tax obligations down to $85,000 a month, according to ministry figures. Once it dropped the tactic, its payments jumped tenfold.

Those behind the phantom firms stood to make huge amounts of money; one tax document reviewed by AP showed that a company purporting to be a Kiev-based trading firm drew in $190,000 in sales per month — with only a single employee on a monthly salary of just $110.