Wages in envelopes: grey salaries in Russia and Ukraine

In both Russia and Ukraine, companies are able to navigate the fiscal system to their benefit by dividing salaries into white (taxed) and black (untaxed) segments via any number of grey payment schemes.

White payments are the salaries declared in an employee’s contract. Black payments escape documentation entirely, often coming in the form of illegal cash payments “in envelopes,” or “v konverte,” as the Russian saying goes. Ultimately, many companies end up paying grey salaries—a combination of the two.

Struggling to exert influence in a market dominated by state-supported giants, start-ups and SMEs are more likely to adopt these shadow trends as they seek to escape crippling taxes, experts maintain. But larger companies, even those that are directly sponsored by or connected to state structures or politicians, are not above such practices. Recent evidence to this effect emerged in a December 2016 report by German publication Frankfurter Allgemeine Zeitung claiming that Ukraine’s 5 Kannel – a television station owned by President Petro Poroshenko – by depositing its employees’ salaries onto accounts linked to two separate debit cards.

The most common grey salary scheme involves paying a small white salary (usually equal to minimum wage) through bank transfers and supplementing it with black payments in cash. Sometimes, when bank employees are willing to turn a blind eyes, employers desposit these black payments directly into bank accounts. But black payments often end up in bank accounts regardless of how workers receive receive them, as banks cashiers (and ATMs) across Russian and Ukraine accept cash deposits .

Another grey salary scheme involves registering employees as individual entrepreneurs – a special category that makes both employers and employees eligible for lower taxes rates. Another scheme, a remnant from the 1990s, involves registering employees as shareholders and paying regular dividends in addition to white salaries.

Yet another grey salary scheme occurs when “one-time” extra payments, such as untaxed bonuses or compensatory remuneration, become fixed monthly wages on top of taxable salaries. In Russia, bonuses for “services” must legally be written into contracts and declared, as they are seen as taxable measures of “encouragement.” But bonuses given “just because” (for instance on birthdays or holidays) are immune to taxation. Some companies exploit this by paying “just because” bonuses on a regular basis. (This particular grey salary scheme is slightly more difficult to execute in Ukraine, where employers are obligated to pay a tax on all wages, including those given as premiums for services, unless these premiums are “gifts” – in which case, any portion of the gift beyond 50 percent of one monthly minimum wage is taxed at 15-17 percent.) The most complex examples of this particular grey salary schemeoften occur in larger companies, whichsometimes createseparate banking structures to service them exclusively and process the payments in a manner that does not appear suspicious.

“[Grey salaries are] a collaboration agreement between an employer and employee. In principle, many employers want to save on taxes and on severance pay, so employers have created a scheme in which you have a small official salary and another [payment] called a premium which is paid depending on how well you do. So, ordinarily the way it works is your official salary is white, and the premium is grey or even black,” said independent analyst Maxim Kvasha in an interview with KYC360.

As economists Margarita Perova and Evgeniy Perov noted in their December 2015 article “Dynamics of Shadow Economy in Russia”: “the main reason for hidden wages is the intention of the employers to avoid payments of consolidated social tax and other taxes. This allows them to raise wages of the employees and to reduce the costs of production, making [themselves] more competitive.” In adopting the grey salary system, companies are able to get away with paying taxes only on the official white salary stipulated in an employee’s contract. As a result, a significant amount of money is saved for other corporate uses. This is what is known as “salary optimisation” in the post-Soviet space. Very often, companies are able to offer employees higher salaries precisely because, having circumvented taxes, they can afford to be more generous.

It is even possible for premium-based grey-salary schemes to exist in government-owned corporations. “I suspect that state-owned corporations actually save money by keeping federal funds to themselves,” said Kvasha. “For instance, a company has a budget of 1 billion rubles. It can give a fixed portion of this back as taxes, or it can say ‘no’, give back just a bit of it in taxes, and distribute the rest as bonuses to its directors so that they [can] buy themselves a house in France.”

In a September 2016 study, the Ukrainian branch of employment website HeadHunter revealed the results of its survey on grey salaries in Ukraine, according to which 48 percent of the country’s employees earned white salaries in 2016 (compared with 38 percent in 2014), 30 percent earned grey salaries (compared with 38 percent in 2014), and 22 percent earned black salaries (compared with 24 percent in 2014). The sharp decrease in shadow payments since 2014 could possibly be attributed to Ukraine’s increased efforts at eliminating corruption since the Euromaidan.

A survey conducted two years earlier by headhunting website Rabota.ru suggested that Russian salaries were moving deeper into the shadows. According to the survey, 59 percent of Russian salaries were grey in 2014, compared to 35 percent in 2013. This development coincided with, or was likely a direct consequence of, Western sanctions and Russian counter-sanctions. The Perova and Perov study maintained that “the share of hidden wages rises along with the overall share of taxes, the share of net taxes on production and imports … and a decrease in GDP per capita.” Russia’s GDP per capita has indeed fallen notably from a high of $15,543.70 in 2013 to $9,057.11 in 2015.

The schemes can give ordinary workers a sense of autonomy in an unreliable system. In an interview with KYC360, Moscow-based Russian translator Anna Pylnaya said that grey and black salaries are “justified by the fact that the country has endured various different financial crises, including the crisis of 1998 when Russia’s Central Bank devalued the rouble and defaulted on its debt. As a result, all personal savings rapidly fell in value.

“This changed our mentality as a nation to the point where we stopped relying on the government as a stable entity that can protect us. Grey salaries allow us to have better control over our financial futures. Every man is on his own. This keeps you in shape,” said Pylnaya.

In an August 2016 interview with Business FM, Roman Terekhin, managing partner of law firm Business Fairway said that “while it is problematic to transfer the white salaries of longtime employees into the grey zone, this becomes more common when they are replaced or when new employees are hired.” New employees are more likely to be young people, who, according to Pylnaya are more willing to take financial risks (for example, as freelancers) to gain some control over their unpromising financial futures.

“Yes, I sometimes feel unstable, but this practice is entirely standard in Russia and I don’t have the impression that I’m committing some horrible crime, because many of my acquaintances do the same thing. They’ve lived this way for years, started families, raised children – and all without encountering any difficulties. So I don’t have a sense of guilt because of my grey salary,” said Pylnaya.

But the schemes are not free of complications and lend themselves to “a deformation of the employee-employer relationship,” warned Kvasha. As shadow transactions, not only are black salaries hidden from conventional monitoring systems, they are also very much dependent on an employer’s good will and decency. If an employee happened to do “poorly” one month or fall into disfavour, she might only be paid the white portion of her salary. She would have no legal means to prove that a regular – often larger – part of her monthly income had not been paid. Luckily, in practice, there have been many cases in which courts have taken the side of scorned workers over those of unethical employers, said Kvasha.

Most importantly, in agreeing to grey salaries, employees sabotage their own benefits, including social security, reimbursement for unused vacation time upon the termination of collaboration, unemployment payments upon being laid-off, eligibility for mortgages and other loans, maternity leave, and future pensions, which are determined based on tax contribution during one’s working life.

Grey workers, though still salaried workers with contracts and business relationships, sometimes end up not qualifying for pensions at all when official salaries are too small for money (or points) to accumulate as benefits, Kvasha said. A March 2017 article by Gazeta.ru revealed that a growing number of new pensioners from around Russia had not earned enough points to qualify for a pension.

But according to Pylnaya, many young people are simply not concerned about pensions. “In Russia, there’s this idea that it doesn’t really matter whether you invest into the pension fund or not. You still won’t get anything at all, nil. So, people understand that preparing for one’s retirement requires an individualized approach and intelligent investment on the side, because it’s futile to rely on the government.”I

Fiscal bodies have been developing methods by which to better identify employers with a foot in the shadow economy. Companies with“conveyer belt” contracts, for example, that stipulate the same base salaries (often minimum wage) for a wide range of employees regardless of position or station are likely to be compensating each employee under the radar with additional black payments.

In a March 2017 interview with TASS, IBS group president and Russian Union of Industrialists and Entrepreneurs boardmember Alexei Karachinsky said that finding out whether a company pays grey salaries is as simple as going online.

“Today, in the information age, you can easily analyse the average salary [paid by] an enterprise [and compare it to the] the average salary in the industry … If a person, for example, works as a builder and [earns a] salary that is 3-5 times less than the average, it means that he actually has a higher income.” Karachinsky believes that the entire country could be “forced to pay [white] salaries” after just two years of fiscal investigation.

Both Russia and Ukraine have sought to tighten reulations and fight grey salaries in recent years. Though such schemes are illegal and employers who entertain them can face serious consequences (including criminal charges) if discovered, people are undeterred, because the amount of money that can be saved is so significant, said Kvasha. The way the situation stands, change is not imminent.

But foreign pressure can have an effect, believes Kvasha. “This system that appeared nearly 30 years ago, amongst other things, for servicing corruption by means of both tax evasion and money laundering, has, from the very beginning, used the foreign banking system. Corrupt money appearing in Western banks is sent to [foreign] financial institutions legally,” said Kvasha.

“[The way it works] in Russia, [is that] today, you have money and tomorrow you won’t. Until there are real property rights, only foreign money will be considered real in Russia, which is why all money, whether it was earned legally or illegally, will appear in the West … [In fact], the only money that had ever been ‘real’ is that which is held outside of Russia.”

Banks and fiscal bodies continue to introduce stricter mechanisms to monitor grey salaries, but many Russian and Ukrainian workers have become disheartened in the face of what they see as the government’s unreliability. At least for now, grey salaries are here to stay, unless officials start tackling petty corruption from the top down.