Business Splitting & Fictitious Sole Traders: DPS Red Flags

When a single business is formally broken up into several sole traders (FOP — fizychna osoba-pidpryiemets, an individual entrepreneur) or small companies, yet in practice operates as one whole, Ukraine’s State Tax Service (Derzhavna podatkova sluzhba, DPS) does not see “a group of independent entrepreneurs.” It sees one taxpayer that has artificially kept itself on the simplified tax system. In my expert practice, the fiercest disputes with the tax authorities and the Bureau of Economic Security (BEB) are fought exactly along this line — between lawful optimisation and artificial splitting. Below is how such an arrangement gets classified as tax evasion, and what genuinely protects a business.

What business splitting is and why the DPS cares

Business splitting (droblennia biznesu) is the division of what is really a single economic activity among several entities — most often sole traders or small limited-liability companies on the single tax — not for a genuine business need, but so that each of them separately stays within the limits of the simplified system and avoids moving to the general system, with its VAT and corporate profit tax.

The most common motive is staying within Group 3 of the single (unified) tax: its annual income ceiling is tied to the minimum wage (1,167 times that amount as of 1 January of the tax year, under Article 291 of the Tax Code of Ukraine). As real turnover approaches this ceiling, the owner is tempted to “seat” the revenue across several persons. Formally, each entity remains a single-tax payer at 5% (without VAT) or 3% (with VAT), yet together they serve one and the same business.

Where the line of legality runs

The key point: the law does not prohibit owning several businesses or working with sole traders. What it prohibits is doing so without a reasonable economic reason (business purpose) — a concept fixed in the Tax Code (subparagraph 14.1.231). If the only sense of the structure is a tax advantage, the DPS has grounds to treat the split as artificial and to assess taxes as though a single entity had carried on the activity under the general system.

So the question is never “how many sole traders do you have,” but always “why exactly this way, and what would happen if the tax advantage did not exist.”

Signs of artificiality: what the DPS and BEB look at

During audits and pre-trial investigation, tax officers and BEB detectives collect markers indicating that the “separate” entities are in fact run from a single centre. No single marker is a verdict on its own — what decides the matter is their combination.

Group of signs	What is checked specifically
Shared management	same beneficiaries, family ties, shared directors or accountants, powers of attorney granted to the same people
Shared resources	one premises, warehouse, equipment or machinery, without separate lease agreements
Personnel	employees “move” between entities, perform the same functions, report to a single manager
Digital traces	shared IP addresses for filing reports and for the client-bank, one phone, e-mail, website, cash registers
Finances and accounting	shared bookkeeping, transit transfers between entities, mutual settlements not at market prices
Market	the same suppliers and buyers, a single brand, signage, logistics, contracts with one counterparty

Separately, the DPS assesses economic independence: could each entity survive on the market on its own, or does it exist only as a “wallet” for part of the main business’s turnover? Transit transfers between related parties can also draw the attention of the State Financial Monitoring Service (Derzhfinmonitoring) — at which point a financial dimension is added to the tax one.

Fictitious sole trader or real employment

The other side of the problem is registering actual employees as “independent” sole traders. Instead of an employment contract, the business signs a services agreement and pays the salary as “payment for an entrepreneur’s services.” The aim is to avoid paying, in full, personal income tax (PDFO), the military levy and the unified social contribution (YeSV) for that person.

When payments to a sole trader are reclassified as wages

Both the tax service and the State Labour Service (Derzhpratsi) look at substance, not the form of the contract. Actual employment is indicated by:

• a fixed monthly “fee” not tied to any specific result;
• work on a set schedule and at the client’s premises;
• subordination to internal rules and to a manager;
• performance of a permanent job function rather than a one-off service;
• a single client from which the sole trader earns virtually all of their income;
• equipment, materials and workwear supplied by the client.

Where the signs of employment prevail, the payments may be reclassified as wages, with PDFO, the military levy and YeSV assessed on top, plus penalties for using the labour of an unregistered worker under the Labour Code (Kodeks zakoniv pro pratsiu, KZpP; Article 265). In such a situation the “saving” on taxes turns into a sum many times larger than what was saved.

The DPS position and case law

The DPS consistently treats artificial splitting and fictitious sole traders as a tool for understating tax liabilities. Yet there can be no automatic assessment “on the mere fact of several sole traders” — the authority is obliged to prove the absence of a business purpose.

Case law of the Administrative Court of Cassation within the Supreme Court (KAS VS; its rulings are published in the Unified State Register of Court Decisions) has produced a balanced approach:

• the mere existence of related parties or shared features is not, in itself, sufficient proof of a scheme;
• the controlling authority must demonstrate a combination of circumstances and a real flow of assets to a single beneficiary;
• at the same time, the taxpayer is not relieved of the duty to explain the economic sense of the chosen structure.

Moreover, in an administrative dispute the law places the burden of proving the lawfulness of the challenged assessments on the controlling authority itself (Article 77(2) of the Code of Administrative Procedure, KASU). In practice, the dispute is won by whichever side more convincingly shows — or refutes — the presence of a business purpose, and that is a matter of evidence and expert economic analysis.

Consequences: assessments and criminal liability

A confirmed split entails several layers of consequences:

1. Additional tax assessments — VAT and corporate profit tax as though a single entity had operated under the general system; for fictitious sole traders — PDFO, the military levy and YeSV.
2. Fines and late-payment interest on the assessed amounts.
3. Criminal risk — where there is intent and evasion on a significant scale, the act is classified under Article 212 of the Criminal Code of Ukraine (KKU); investigating such proceedings falls within the competence of the BEB.

This is why the stakes are high: it is not only about money, but about potential criminal proceedings against a company’s officers or its beneficiary.

The role of forensic economic examination

The central question in any such dispute is whether a business purpose existed and whether the structure really operated as a single entity. That question is not legal but economic, and it is answered by a forensic economic examination (sudovo-ekonomichna ekspertyza).

An expert of the relevant specialisations (examination of accounting, tax-accounting and reporting documents; documents on the economic activity of enterprises and organisations; documents of financial and credit operations), working from primary documents, examines:

• the reality and independence of each entity’s business operations;
• whether prices in settlements between related parties are at arm’s length;
• the actual movement of funds and the identity of the ultimate beneficiary;
• whether the assessed amounts are justified — or not.

The examination is ordered within criminal proceedings (under the Criminal Procedure Code, KPK, rules on ordering an examination) or in administrative, commercial or civil proceedings under the respective procedural codes (KASU; the Commercial Procedure Code, HPK; the Civil Procedure Code, TsPK). The general framework is set by the Law of Ukraine “On Forensic Expert Activity,” while the procedure for ordering and conducting examinations is set by the Instruction approved by Order of the Ministry of Justice of Ukraine No. 53/5. Importantly, the expert’s conclusion can work both ways — it may confirm a scheme, or prove that the split had a real business purpose and the assessments are groundless.

How to document the rationale for your structure in advance

The most effective defence is not to “cover the tracks,” but to build a structure that withstands an audit and to document its logic before the DPS arrives.

• Business purpose in writing. Each entity should have a clear reason to exist: a separate line, market, product or risk — not “to stay within the limit.”
• Genuinely separate resources. Owned or arm’s-length-leased premises and equipment, separate bank accounts, separate staff with their own functions.
• Independent accounting and document flow. Separate primary records, separate reporting channels, different responsible persons.
• Arm’s-length terms between related parties. Settlements at prices that would pass the “as with an unrelated counterparty” test.
• Clean employment relationships. If a person actually works as a staff employee, sign an employment contract rather than disguising it as a sole trader.

Common mistakes

• one accountant and one IP address for all the “independent” entities;
• moving workers between sole traders without changing their actual functions;
• transit transfers and baseless “services” between related parties;
• a single website, cash register, phone number and brand with no separation at all;
• the absence of any documents explaining why the structure was built this way.

The worst scenario is when the rationale is “assembled” during the audit itself: such evidence looks unconvincing to both the DPS and the court.

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If you are assessing the risks of your own structure, or have already received a request or an audit report, it is wise to look at it in advance through the eyes of the person who will examine your documents from the other side. As a forensic economic expert, I help verify whether a business purpose exists and prepare a well-grounded position — before the question arises at the DPS or the BEB.