Business splitting through sole proprietors: tax authorities step up control

Tax evasion through artificial “splitting” of business into sole proprietors has ceased to be a grey area: the tax service, the Bureau of Economic Security and financial monitoring bodies openly state that they treat such models as deliberate tax evasion with a high risk of additional assessments and criminal liability.

What is business “splitting” via sole proprietors?
The scheme works by artificially dividing a large or medium‑sized business into dozens or even hundreds of sole proprietors on the simplified tax regime who do not exceed their income limits; instead of a single legal entity paying corporate income tax and VAT, all operations are routed through a network of related entrepreneurs, often de facto employees of the same company.
By doing so, the company:

• avoids registration as a VAT payer;
• pays the single tax instead of corporate income tax;
• reduces payroll tax burden by disguising employment as civil‑law contracts.
  The tax authorities clearly state that such structures have no genuine business purpose and are used solely to minimise tax liabilities, and therefore are treated as tax evasion.

How the tax authorities detect splitting schemes
Over the past year, the State Tax Service has publicly reported uncovering splitting schemes in a number of major retail chains — from electronics and clothing to food. In some cases, the potential budget losses were estimated in hundreds of millions or even billions of hryvnias of VAT and other taxes.
Key analytical red flags monitored by the tax service and financial intelligence include:

• artificial division of a single business into many sole proprietors with the same type of activity;
• trading under a single brand with one signboard, marketing strategy and pricing;
• identical IP addresses, common registration addresses, the same retail outlets and staff;
• use of one payment terminal or cash register for several sole proprietors;
• gradual “on‑boarding” of new sole proprietors as previous ones approach their income limit;
• concentration of revenue from one or a few major customers, with no own resources, warehouses or staff.
  On‑site inspections confirm the analytics: inspectors record situations where identical goods in one store are sold on behalf of different sole proprietors, receipts do not match the real transaction, and the business is managed centrally.

What risks business splitting entails
For companies using such constructions, the consequences go far beyond extra single tax assessments:

• additional VAT and corporate income tax with re‑qualification of transactions and loss of simplified regime;
• fines and interest for underpaid taxes over the entire period the scheme operated;
• re‑classification of civil‑law contracts as employment, with extra PIT, social contributions and labour‑law fines;
• initiation of criminal proceedings under Article 212 of the Criminal Code of Ukraine (tax evasion) where significant budget losses are involved;
• for “nominal” sole proprietors — the risk of personal tax debts, frozen accounts and liability for participation in sham schemes.
  In public cases, the state stresses that the fight against splitting is not an attack on small business, but a response to large chains and companies that disguise themselves as sole proprietors to save on VAT and corporate income tax.

Where is the line between optimisation and evasion?
Cooperation with sole proprietors is lawful as long as they remain independent entrepreneurs rather than “tax conduits”.
Signs of a safer model include:

• the contractor has several clients and its own resources (office, equipment);
• the contract sets a market‑level price and a real scope of work;
• there is no full dependence on a single client in terms of schedule, workplace and managerial control (no de facto employment).
  For family businesses, kinship between sole proprietors is not a violation in itself, but a shared brand, tills, staff and counterparties taken together point to artificial splitting.
  In the IT sector, regulators increasingly recommend using more transparent special regimes such as Diia.City instead of mass engagement of contractors as sole proprietors.

How to reduce risks for businesses working with sole proprietors
In practice, a “safe” cooperation model with sole proprietors requires a systemic approach to structuring business processes. Experts advise to:

• limit the number of sole proprietors, especially where the business operates under one brand and in the same locations;
• document the economic substance of each contract with a sole proprietor, including their own resources, clients and risks;
• avoid sharing cash registers, POS terminals and bank accounts between different entities;
• carry out internal tax audits to ensure the model reflects genuine business activity rather than a tax‑evasion scheme;
• keep track of court practice and public positions of the tax service and the Bureau of Economic Security, as risk criteria are constantly being refined.
  For many large businesses, using dozens of sole proprietors no longer justifies the risk: potential additional assessments, penalties and criminal exposure outweigh any tax “savings”.
  If you have questions or issues related to your tax model involving sole proprietors, possible signs of business splitting or the risk of additional assessments and criminal liability, seeking qualified legal and tax advice will help you restructure your business in time and protect it from claims by supervisory authorities.

Author – Yuliia Popadyn, attorney of the tax and housing law practice at the Law Firm “Winner Legal Company”.