VAT in construction financed from the state budget: how the state creates the problem and then punishes business

In recent years, a dangerous practice has been emerging in Ukraine, already hitting construction businesses working with public contracts.
It is a classic situation: the state first approves contract terms including VAT, and then, acting through the prosecutor’s office, tries to claw this VAT back as “damages”.
This is no longer theory — these are real court disputes backed by the position of the Supreme Court.

Essence of the issue:
The prosecutor’s office, acting in the interests of the state, files claims to:

• invalidate the construction contracts insofar as they include VAT;
• recover the VAT paid by the contractor as “unjustly received funds”.

Key argument:
the works were financed from the budget → Article 197.15 of the Tax Code applies → the transaction is exempt from VAT.

Where the real problem lies
On paper, it all looks simple.
In reality:

1. The contract is signed with VAT.
   The customer (a state body) approves:

• a price including VAT;
• work completion certificates including VAT;
• payment including VAT.
  So the state itself sets the rules of the game.

1. The business performs the contract in good faith.
   The contractor:

• performs the works;
• pays VAT to the budget;
• bears the tax burden.

1. A year later the prosecutor’s office arrives
   and says:
   “VAT should not have been charged here → return the money.”

What this means for business
This is not just a dispute about a tax.
It is a systemic risk:

❗ Double loss

• VAT has already been paid to the budget;
• the VAT registration limit has been reduced;
• now the same amount is being claimed back again.

❗ Changing the rules after the game
Business operates under an agreed contract,
→ and the state later changes its interpretation.

❗ Criminal risks
Such disputes often escalate into:

• Article 191 of the Criminal Code (misappropriation/embezzlement);
• Article 364 of the Criminal Code (abuse of office).

The legal problem is deeper than it seems
The issue is not only Article 197.15 of the Tax Code.
The real questions are:

🔹 Who is responsible for correct taxation?

• The customer?
• The contractor?
• The state as regulator?

🔹 Can what has already been fully performed be declared invalid?
Court practice is now clearly in favour of the state, even though judges themselves admit that it is absurd: once the works are completed, certificates signed and payment made,
this is economic reality, not a “mistake”, but despite saying so they still decide cases in line with the Supreme Court’s position.

🔹 Is VAT really “damage”?
This is the key question.
VAT is:

• paid into the state budget;
• not retained by the contractor.
  Therefore, calling it “damage to the state” is legally questionable.

Why this may become widespread
This is only the beginning.
Drivers include:

• budget deficit;
• increased activity of the prosecutor’s office;
• audits of public procurement;
• pressure on the construction sector.

What businesses should do now

1. Review all contracts with public customers.
2. Check whether Article 197.15 of the Tax Code should apply.
3. Formulate a VAT position before any dispute arises.
4. Properly document the tax consequences.

Most importantly — about recovering VAT
Here is what most people overlook:
👉 this VAT is not lost forever.

There are legal mechanisms such as:

• adjusting tax liabilities;
• revising input tax (VAT credit);
• claiming compensation from the state where VAT was mis-administered;
• restoring the economic balance through the courts.

A position that can already be defended
In short:
if the state itself created the VAT model,
→ it cannot simply “take the money back” without compensation mechanisms.

Conclusion:
The VAT situation in construction is not just a tax dispute.
It is:

• a risk of margin loss;
• a risk of criminal prosecution;
• a risk of ongoing systemic pressure on business.
  At the same time, it is also an entry point for a well-designed legal strategy.

Key points
👉 VAT can be recovered or compensated.
👉 There are workable legal models for doing this.
👉 Action must be taken now, not when the prosecutor’s office turns up.

And most importantly — we know how to do it, and we know how to do it effectively.

Yevhenii Murchenko – Head of Criminal Law and Litigation Practice at the law firm “WINNER”.