The Gambling Industry in Ukraine: Financial and National Security Threats

Shortly before Russia’s full-scale invasion of Ukraine, the country’s gambling industry was legalised. Due to weak initial policy decisions, the resulting state of affairs posed significant risks to the state's financial security and offered opportunities for enhanced Russian influence. Over the past year, Ukraine has come a long way in terms of de-risking the gambling business and increasing budget revenues from it – with the help of banking regulation, sanctions and parliamentary control.

Economists view gambling as an exemplary ‘demerit good’, a good or service whose consumption is considered unhealthy, degrading, or otherwise socially undesirable due to the perceived negative effects on consumers themselves – with negative externalities. It is also tricky to regulate – a challenge heightened by the increase in online gambling, facilitated by online payments and, more recently, cryptocurrencies.

Full prohibition does not work well with demerit goods. Gamblers shift to illicit gambling activities and other jurisdictions, which has become easier than ever with the spread of online gambling. Illicit gambling is also a valuable source of non-cash funds, which can be used for facilitating tax evasion in other sectors, financing organised crime and even counterintelligence and diversions.

The Ukrainian Experience

Soon after he was elected in 2019, Volodymyr Zelensky pledged he would legalise the operation of casinos in luxury hotels to drive investment in tourism. As a result, in 2020, after a 10-year ban, Ukraine legalised gambling.

The new law legalised a far broader spectrum of gambling activities than initially intended: casinos were allowed to operate in 4 and 5-star hotels, slot machine halls in 3- to 5-star hotels. The law also legalised online gambling and bookmaking as well as poker.

The law introduced a special regulatory body, the Commission, authorised to license operators on a set of conditions to limit the negative externalities of gambling. The law also envisaged the development and implementation of an online monitoring system which would facilitate the taxation of gambling and safeguard those suffering from gambling addiction.

Lawmakers stated that the legalisation would reduce illegal gambling, which operated under the disguise of lotteries, in murky slot machine halls, and in the rapidly growing illicit online gambling industry.

At the same time, some large owners of illegal gambling businesses expected to expand and attract investment or officially sell their businesses after legalisation. There is also evidence of heavy involvement of Russian businessmen and legal advisors linked to Russian oligarchs, Russian banking and the Russian gambling industry in designing the initial Ukrainian legislative base for the gambling industry, and even connected with the gambling regulator itself. One of the key alleged agents of Russian influence, Boris Baum, was expelled from the advisory body of the gambling regulator in July 2022 and fled the country.

By design, the gambling industry is subject to heavy taxation. Winnings and gross gaming revenue are subject to 18% tax, and on top of that, gambling operators are subject to a standard corporate profit tax of 18%. Furthermore, a significant annual licence fee for every approved activity, casino table and slot machine is also due.

In 2020 the regulator expected that licences alone would generate over UAH 7.5 billion for state budgets. However, in reality, licence fee income amounted to only UAH 1.6 billion in 2021 and UAH 1.2 billion in 2022 (the licence fees are paid at the beginning of the year, thus 2022 revenues were mostly collected before the Russian full-scale invasion).

Tax revenues were also disappointing for 2021 and most of 2022. After the beginning of the Russian invasion, there were spikes in tax revenue due to larger quarterly corporate profit tax payments (much of which consisted of contributions, voluntary or otherwise, in support of the war effort), even though revenues from personal income tax (PIT) on payouts – the direct measure of officially reported turnover – remained strikingly low. The average monthly PIT during the first three quarters of 2022, UAH 10 million, equated to a total monthly payout to gamblers of UAH 180 million – only a fraction of the monthly volume of UAH 12–15 billion estimated by the National Bank of Ukraine (NBU).

This trend began to change in November 2022, and revenues have increased sharply and sustainably in 2023 so far. Monthly PIT on payouts averaged UAH 347 million in Q2 2023 – 43 times more than a year before – and reached UAH 576 million in August. In total, gambling contributed UAH 5.6 billion in taxes to the Ukrainian budget in the first eight months of 2023.

Sources: Ministry of Finance of Ukraine, State Tax Administration, author's own calculations

So, What’s Changed?

Since the beginning of the Russian invasion, the Ukrainian government has scrambled for additional internal revenue sources. At the same time, the state security service and other investigative bodies have launched multiple investigations into Russian influence channels in Ukraine. In December 2022 the Temporary Investigative Commission was established by the Ukrainian Parliament to address economic crimes, with a focus on budget revenue loopholes. One of its first extensive hearings was dedicated to illicit gambling and tax evasion.

These investigations have revealed that illegal gambling is built into the wider financial infrastructure. For example, certain banks and non-bank financial institutions (NBFI) allowed bets to be masked using merchant codes that are unrelated to gambling. The dysfunctional nature of the financial monitoring and compliance systems of these banks and NBFIs meant they were being abused by gamblers, who channelled accumulated funds into salaries in retail businesses that avoided paying salary taxes. In exchange, gambling companies received unaccounted cash accumulated by retailers or swapped these funds with exporters, who accumulated the money in foreign banks, thus circumventing the capital controls introduced after the invasion. Other schemes included misuse of virtual terminals intended for non-gambling businesses.

The gambling regulator started revoking gambling licences for identified violations in September 2022. In March 2023 President Zelensky sanctioned over 400 individuals and legal entities related to Russian gambling businesses, including five Ukrainian gambling companies (two of which were major ones) and one NBFI.

The NBU acted by applying progressively larger fines and later revoking the licences of two banks and key NBFIs facilitating these gambling schemes, due to repeated breaches of anti-money laundering (AML) legislation identified by inspections. Other banks and NBFIs were fined, and halted or limited high-risk operations as a result.

The NBU has also reorganised the bank supervision unit in line with the IMF programme outline, with a focus on payment systems and related parties monitoring, improved AML and risk assessment procedures, as well as desk supervision and on-site inspection procedures. The regulator also took action to close certain technical loopholes and extensively communicated to the market the need to strengthen AML compliance measures, setting a strong tone from the top. Inspections of banks and NBFIs are ongoing and may result in further actions.

These steps significantly decreased the illegal gambling flows through unlicensed market players, as well as tax evasion by licensed gambling operators. They have also undermined Russian influence and revenues from the Ukrainian market.

This case illustrates how despite the ongoing full-scale war and the weakness of the Economy Security Bureau of Ukraine – the body charged with preventing and investigating economic crimes – the state can nevertheless rapidly and rather successfully address complex financial security risks with the help of a strong and proactive bank regulator, parliamentary control and targeted sanctions.

Yet to sustain these results in the long term and boost the integrity of the gambling industry, Ukraine needs to develop the institutional capacity of its gambling regulator and implement a long-awaited online monitoring system for gambling, which would enable continuous fiscal oversight, help protect vulnerable gamblers, and ensure Russian influence is addressed.

The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.

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