Ukraine to face its 'graft culture' under aid plan

KIEV, Ukraine -- A hairstyling business closes four salons rather than deal with crooked officials. An independent salesman hustling paint from the trunk of his car faces a $5 million tax penalty. A humble crafts stall gives up after taxes increase ten-fold overnight.

That's the world of small business in Ukraine -- a tangled thicket of bribe-hungry government inspectors and complicated, unpredictable regulations.

Reducing graft and red tape are set to be part of the conditions Ukraine will face in exchange for an international financial rescue package. Officials in Kiev are expected to wrap up talks with the International Monetary Fund as soon as Tuesday.

Yet it will take some doing. Ukraine's culture of corruption and bureaucracy is deeply entrenched.

Take the story of Aleksey Antonyuk, who runs a hairstyling, marketing and publishing company in Kiev.

He was part of the first wave of Ukrainian entrepreneurs in the waning days of the Soviet Union, setting up a hair salon with one stylist. He expanded that to a company that employed 200 people at its peak. He branched out into media, publishing a stack of glossy magazine on hair and makeup, and offered marketing services, training courses and hairstyling competitions.

The trouble began when his business grew large enough to register as a limited liability corporation. That means he needed to install cash registers -- and with those came government inspectors eager to find evidence of rule-breaking.

"It's like honey for flies," said Antonyuk, a tall, slim 48-year-old, in an interview at his offices in a nondescript Soviet-era building away from the bustle of Kiev's city center.

The inspectors found something wrong at every turn -- a register a few coins short, the safe in the wrong place. It was either a large fine -- or bribe to ensure a smaller one. The going bribe rate is the equivalent of $100 for small, recurring matters, and $2,000 for yearly inspections.

Meanwhile, competitors had a simpler model: renting salon chairs to independent stylists, who didn't declare any income at all.

"I was competing with the black market," he said. "And you can't compete against the black market. I lost."

Antonyuk shut down four salons, keeping just two, and went back to the simpler form of business registration, as a sole proprietor.

"If I lived in another country, I'd have 100 salons, and I'd have sold them, and I'd being doing something else."

The hope of a better-governed country was one of the motivations for those who fought to get Ukraine closer to the European Union. Their protest movement helped drive out pro-Russian President Viktor Yanukovych, triggering a conflict with Moscow that resulted in the annexation of Ukraine's Crimea region.

Antonyuk was part of the pro-EU protest encampment on Independence Square in Kiev and spent a cold night on the square Dec. 10 when there were fears it would be cleared violently by police. His phone is full of video of the protests. Though the demonstrations closed his downtown business for days, he says it was worth the trouble: "If there's no change, there won't be any business."

On a country-wide scale, corruption and bureaucracy are keeping people poor. As companies fail to grow or shut down, the government -- which is almost broke -- misses out on valuable tax revenue. And good jobs are lost that could raise the per-capital income of just $7,400 per year, even adjusted for the lower cost of living.

The World Bank cites "pervasive" corruption and the burdens on small business as primary reasons why Ukraine has seriously lagged its neighbors economically since it gained independence at the breakup of the Soviet Union in 1991. The country of 46 million is poorer on a per-capita basis than other former parts of the Soviet Union such as the Baltic states of Latvia, Lithuania and Estonia -- now EU members -- and it even lags Russia and Belarus.

Making business laws simpler to navigate and more transparent is likely to be among the IMF's goals. Sudden changes to laws and taxes can make companies unviable overnight.

Dmitry Zimin, in the northeastern Ukrainian town of Sumy, had to close down his stand selling embroidery supplies at the central market when the tax code was amended in 2010. His social contributions rose 10-fold, eliminating his profits.

He's currently making do with odd jobs while he tries to build up a new business, a network of farms and homestays that offer ecotourism holidays. But even there, growth is hindered by uncertainty. The members of his ecotourism network are struggling to get financing -- banks concerned about the unpredictable nature of doing business in Ukraine demand annual interest rates of 30 percent or more on loans.

Another key issue the IMF is likely to look into is Ukraine's outdated system of tax inspections, which involves lots of face-to-face contact between bureaucrats and businesses -- an open invitation to extorting bribes. Modernizing the system, so that businesses can do more of their paperwork over the Internet, for example, could help.

A more difficult aspect to change, some say, is a historical mistrust of entrepreneurs that has carried over from Soviet times, when businesspeople were denounced as speculators and prosecutors reigned supreme.

"For us, the prosecutor is tsar and god," said Vladimir Solodkov, a former small business owner in the town of Armyansk.

Local officials in general remain a class by themselves who can't be called to account for their behavior, he said. Police, prosecutors and tax officials hang out together and the system protects its own.

Solodkov used to sell paint wholesale, taking supplies on consignment from a factory -- until the local tax inspector decided he had violated tax rules. Solodkov was given an option -- pay a bribe of $40,000 or a fine of a bit more than $5 million.

The inspector, he says, had been too greedy: "If it had been 40,000 hryvnia [$4,000] it would have been different."

He challenged the fine in the courts. The case is still pending after four years.

What will happen to the case is unclear. Armyansk is in Crimea, just 2 1/2 miles inside what Russia now claims is its territory. The civil part of Solodkov's case is in Ukraine; a related criminal investigation, in Crimea.

In any case, he has forgotten about opening a business again.

"The second I open something, they'll land on me," he said.