What should NGOs take into account while working with Sole Proprietors (FOP) in Ukraine

As we promised in the previous article, we keep on introducing NGO activities to you, their peculiarities in accounting, and in relations with other business entities on the market of Ukraine. Today we will speak about the cooperation of NGOs with sole proprietors - (FOP). We will focus on what needs to be taken into account when ordering services/goods from sole proprietors - (FOP), and what risks might arise in accounting/tax accounting while cooperating with sole proprietors - (FOP).

We, actually, provide services for NGOs in audit, keeping financial records and accounting, HR - administration and payroll, and preparing all types of records, including tax. Do not hesitate to contact us via the link here.

Sole Proprietors: who they are according to Ukrainian legislation

We will briefly outline who sole proprietors  - (FOP) are, which tax system they may be on, the main groups, and the main prerequisites of being included in them.

According to Ukrainian legislation, the Sole proprietor (FOP) is an achieved status with state registration, which allows an individual to engage in entrepreneurial activity at their own risk and bear the responsibility for their actions with all their property. Concerning the tax systems, these are simplified and general taxation systems. Mainly, Sole proprietors (FOP) register for the simplified taxation system, if the volumes and conditions of stay allow. This system is much simpler and economically beneficial for Sole proprietors themselves.

The following groups are distinguished on the simplified system:

• Group 1 – individuals, marginal income is 167 minimum wages, established by the law on January 1 of the tax (reporting) year, the monthly flat tax rate is 10 % of the living wage, without hiring employees. The types of activities are mainly trade in the market and household services to the population.
• Group 2 – individuals, marginal income is 834 minimum wages, established by the law on January 1 of the tax (reporting) year, the monthly flat tax rate is 20 % of the living wage, hired workers – not more than 10 persons. The types of activities are restaurant business, providing services only to the population and single taxpayers, and the possibility of selling goods to legal entities on the general taxation system.
• Group 3  – individuals and legal entities, marginal income is 1167 minimum wages, established by the law on January 1 of the tax (reporting) year, the tax rate is 3% + VAT or 5 % of the amount of income received, and the number of hired workers is unlimited. The types of activities embrace all types apart from a certain category (see clause 291.5 of the Tax Code of Ukraine), the possibility of selling goods to legal entities on the general taxation system and providing services to them.
• There exists Group 4, but it mainly concerns activities in agriculture.

As you can see, the main differences between the above-mentioned groups are marginal income and tax rate, consequently, the possibility to hire employees and carry out certain activities. In 2023, one more requirement was added: the mandatory use of a cash register (payment terminal, POS).

So as we can see, when it comes to cooperation with NGOs, mainly Sole proprietors of Group 3 may be involved. It may also partly concern Sole proprietors (FOP) of Group 2 in terms of purchasing necessary goods and Sole proprietors (FOP) on the general tax system.

Advantages and risks of NGOs concluding contracts with sole proprietors

When it comes to one-time tasks, it is not always reasonable to hire the necessary specialist as a member of personnel. You may refer to self-employed persons or Sole proprietors (FOP). According to Ukrainian legislation, there is no direct prohibition to collaborate with Sole proprietors. That is why NGOs can conclude contracts with Sole proprietors (FOP).

The advantages are as follows:

• no need to hire a staff member, when the work (services) is provided by Sole proprietors (FOP). Consequently, it is about the reduction of personnel work regarding registration of acceptance/dismissal and vacations.
• reduction in tax burden as NGOs are not tax agents for Sole proprietors (FOP) and they do not have to pay taxes if compared with paying salaries to employees. Sole proprietors pay their own taxes.
• sole proprietors are interested in rewarding and implementing their tasks in the shortest possible time and with the best result for the client.

However, there are some caveats regarding the involvement of sole proprietors:

1. Long-term collaboration with Sole proprietors (FOP) with monthly payments of equal amounts may be recognized as hidden employment by the Tax Office. Especially when Sole proprietors fulfill the same tasks / provide the same services as the hired worker who is provided for in the staffing schedule. If acknowledged as labor relations, the Tax Office will add all payroll taxes. Moreover, they will also add fines for unofficial employment. For example, the fine for admitting an employee to work without signing an employment contract is equal to 30 minimum wages (in 2023 it is  201000 UAH). There is no statute of limitations for these fines. It means that the employer (owner) can be prosecuted at any time.
2. As mentioned above, not all Sole proprietors can provide services/goods to NGOs. Basically, if a sole proprietor (FOP) from a different group provides services to the NGO, there will be more tax risks for this Sole proprietor themselves. However, we cannot exclude the possibility of tax inspectors putting the blame on the NGO for not fulfilling the function of a tax agent in paying the money to Sole proprietors (FOP) on the basis of clause 177 of the Tax Code of Ukraine. There were also cases when state bodies recognized such transactions (legal acts) as invalid in general (see Court orders of the High Administrative Court of Ukraine of May 18, 2017, in case № К/800/13843/16*) and of September 27, 2016, № К/800/12450/15).
3.  If Sole proprietors have direct relations with the founders, members, members of management bodies, and other individuals of the NGO, there is a probability that it can be equated to profit sharing (distribution). With non-profit status, there is a ban on the distribution of the received income (profit) for founders, members, members of management bodies, and other individuals related to the NGO (paragraph 133.4.1 clause 133.4 article 133 of the Tax Code of Ukraine), which might refer to Sole proprietors (FOP) involved in the activities.

So, generally, there are no direct sanctions for collaboration with Sole proprietors. The main point is to follow the requirements concerning the groups of Sole proprietors (FOP) as well as requirements on the use of funds to finance expenses for their maintenance within the approved norms for certain types of NGO forms (we have discussed this here), implementation of the goal (tasks) and directions of activity that are defined by the founding documents (paragraph 133.4.2 clause 133.4 article 133 of Tax Code of Ukraine). While collaborating with Sole proprietors (FOP), NGO managers have to carefully consider all advantages and drawbacks and make a balanced decision taking into account all the features.

NGO worker as sole proprietor

It happens quite often that an individual, say an employee, draws up not a labor contract with the NGO, but cooperates with the NGO as a sole proprietor on a permanent basis. We have touched upon such a format of collaboration above. It has its own advantages as well as risks due to the attitude of state bodies.

It might happen that an individual cooperates with the NGO as a worker and provides additional services as a sole proprietor. It is possible to conclude a contract for the necessary work/services with an employed employee who is registered as a sole proprietor. At the same time, you need to be careful with the execution of such an agreement and to ensure that the functional duties of the employee do not coincide with the types of services/works he/she provides as a sole proprietor (FOP), to take into account the work schedule, etc. Such cautions stem from the definition of "self-employed person" (paragraph 14.1.226 of the Tax Code of Ukraine).   

So, when concluding a contract with a sole proprietor it is worth making sure that the service or product is specified in the contract, not the process of providing or manufacturing them, price, payment procedure, and terms of execution are clearly defined as well as the possibility of concluding additional agreements on new types of services/works, etc. (articles 903, 905 of the Civil Code of Ukraine). Our experts can help you with this, click here.

Settlements (payments) between NGOs and Sole Proprietors

Nowadays the vast majority of all current settlements of enterprises, including NGOs, take place in non-cash form using the modern bank system via any gadget, which fits in the palm of your hand. With the liberalization of the legislation, opening an account takes about as long as you have been reading this text. At certain banking institutions, you can open an account without even leaving your home.

However, not all economic entities have such an advantage. For example, the conditions for opening NGO accounts for non-residents are slightly different. We will definitely touch upon this issue in our next articles.

So, cash settlements with Sole proprietors (FOP) mostly take place on their accounts opened precisely for Sole proprietors, but not for individuals (it should contain the digits UAxxxxxxxx..2600..), which is easier than paying with cash and you do not have to deal with a cash register. If a sole proprietor still uses the account of an individual to carry out activities, firstly, this is considered a violation.

Secondly, the Tax office may recognize the NGO as a tax agent and, consequently, they will have to pay taxes as in the case of operations under Civil Law contracts. Obviously, all necessary documents confirming the fact of performance of works (service provision) are drawn up, namely, Contract, expense invoice/ act of completed works.

Conclusions

 To sum up, the NGO can cooperate and carry out mutual settlements with Sole Proprietors (FOP). At the same time, there are some points to pay attention to when collaborating with Sole Proprietors, namely:

• before establishing business relations, identify the counterparty for the relevance of registration in the UDR (Unified State Register), the system of taxation, the group chosen, NACE codes
• conformity of the services provided by Sole Proprietors to the areas of activity of the NGO defined in the founding documents.
• duties, and work schedule specified for the employee should not coincide with the obligations, and conditions under the contract with Sole Proprietors (FOP) (on the types of services/works). However, there might be objections from the side of the donors concerning the collaboration with Sole Proprietors. If it is agreed with the donor, then the main thing is to carefully draw up an agreement with a Sole Proprietor.  

Generally, the collaboration of NGOs and Sole Proprietors may have its peculiarities and requires an individual approach in each case. Therefore, it is worth getting individual tax advice or consulting with specialized experts.

Links and abbreviations used in the text

1. The Tax Code of Ukraine
2. The Civil Code of Ukraine
3. Labor Code of Ukraine  
4. NGO (Non–Governmental Organization)
5. (FOP) - Sole Proprietor.

Article authors

Natalya Lytvynenko  
Project manager        

Volodymyr Jyvun   
Expert