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24 January 2020

The tax revolution: Anti-BEPS is coming up

On 16 January 2020, the Verkhovna Rada (Ukrainian parliament) adopted the Law “On Amendments to the Tax Code of Ukraine on Improving Tax Administration, Removing Technical and Logical Discrepancies in Tax Legislation” (the “Law”), which establishes new rules of the game and introduces essential amendments to the existing approaches to taxation in Ukraine.

The Law is aimed at large-scale implementation of the provisions of the BEPS (Base Erosion and Profit Shifting) Action Plan in Ukraine, ensuring of tax transparency in Ukraine, de-offshorization, and ensuring of the principle of substance over form.

The next step, which is a logical follow-up to the opted strategy of tax development, is to ensure the international automatic exchange of information between tax authorities of different states, which will be implemented in accordance with CRS (Common Reporting Standard).

In order to start this exchange of information, Ukraine still has to meet a number of special requirements, but the country is working towards this goal. As such, the question of when the automatic exchange of information under CRS will start in Ukraine is just a matter of time and it’s all about the “short run”. We expect that this could happen in 2021. And when automatic exchange starts in Ukraine, the tax authority will have all possible control instruments to ensure implementation of BEPS by Ukrainian residents.

To whom it may concern?

The new Law primarily concerns subsidiaries of multinational corporations operating in Ukraine, as well as domestic large and medium-sized businesses. It is particularly important for legal entities with a wide range of transactions with non-residents, as well as for businesses with business structure including companies registered in other jurisdictions.

The Law affects interests of beneficiaries who directly or indirectly (through a chain of companies) own assets situated in Ukraine, as well as legal or natural persons who apply provisions of double taxation treaties in their operations. Significant amendments affect businesses operating in Ukraine through permanent establishments.

The Law has been adopted by the Verkhovna Rada and is now waiting to be signed by the President. Its final text is not yet available to the general public, so we will keep you updated and informed in case of any changes or clarifications.

What to do next?

The most sensitive and “painful’ amendments, envisaged by the Law, will be introduced gradually.

For instance, taxation of controlled foreign companies and implementation of 3-level system of transfer pricing reporting are expected from 1 January, 2021. Taxation of Ukrainian assets at the level of foreign holdings (which may take place in some cases) will start from 1 July 2020.

This means that there is a “transition” period during which business may review the existing schemes of work and revise them in the light of the new reality without “pain and tenderness”

If not, we believe that as existing business models become more than irrelevant and expensive, they could become toxic. The price of a “head in the sand” tax strategy is too high. After all, when all new provisions of the Law come into force, and when the international data exchange system becomes effective (and that will happen), the cost of delay will be additional tax assessments, penalties and reputational damage, which is not easy to restore.

The TOP 10 changes introduced by the Law

1. Implementation of Taxation of Controlled Foreign Companies (“CFC”)

To whom it may concern?

  • Ukrainian residents (individuals and legal entities) holding or controlling foreign companies
  • Ukrainian residents who purchase or dispose shares of foreign companies

Effective date

  • 1 January 2021

According to the new Law, individuals or legal entities which are residents of Ukraine and hold (at least 50% or in some cases – 10%) or actually control a foreign company, shall pay tax in Ukraine in relation of CFC profit. If tax is paid by the individual, the tax rate amounts to 19.5% (18%+1.5%).

Individuals or legal entities are responsible for calculation of CFC profit to tax and the amount of tax which should be calculated in accordance with respective provisions of the Tax Code of Ukraine. Thereafter individual and legal entities shall submit an annual CFC report, which must be accompanied with certified financial statements of CFC and pay tax.

In some cases, residents of Ukraine may be exempt from taxation of CFC. For example, when at the end of the year total net income of all CFCs which belong to a Ukrainian resident does not exceed 2 million euros. Nevertheless, in such cases, the Ukrainian resident is still obliged to submit a CFC report and confirm that he is exempt from the tax.

From now on, residents of Ukraine will be obliged to notify the Ukrainian tax authorities about their purchase or disposal of shares in foreign companies, in cases where, based on the results of such transactions, they become or cease to be “controlling” persons. They are also obliged to notify about establishment or liquidation of CFC without legal entity status.

2. Amending of transfer pricing rules

To whom it may concern?

  • Persons and companies conducting controlled transactions from the perspective of Article 39 of the Tax Code of Ukraine
  • Permanent establishments

Effective date

  • Effective date for most of changes is the day following the day of publication of the new Law
  • Establishment of tax authorities powers to request the Master file – 1 January 2021

The Law provides for a 3-level TP reporting system, which includes:

  • report on controlled transactions
  • master-file
  • country-by-country report (“CbC report”)

Alongside the report on controlled transactions, companies are obliged to submit notification on participation in the Multinational Enterprise’s Group (MEG). Deadline for submission is the same – 1 October of the year following the reporting year. The list of requirements for transfer pricing documentation was supplemented one more time.

A Ukrainian company may receive a special request to provide a Master-file if aggregate consolidated net income of its MEG for the financial year is equal to or greater than 50 million euros.

A CbC report shall be submitted if consolidated revenue of MEG exceeds 750 million euros and Ukrainian taxpayer meets at least one of special criteria established by the Law, e.g. taxpayer is a parent company of the group; or parent company of the group authorizes Ukrainian taxpayer to submit CbC report; or there is no effective mechanism of CbC reports in the jurisdiction of the parent company’s registration (the list of such jurisdictions will be adopted separately).

The Law provides for special rules of arm’s length principle application for transaction with commodities (based on quoted prices).

The threshold for recognition of parties as related for transfer pricing purposes was raised to 25% which is in line with international standards of TP methodology.

The taxpayer may apply a special self-adjustment mechanism on preferential terms not only when controlled transactions are not at arm’s length, but also when controlled transactions performed under conditions that do not have a reasonable economic purpose (business purpose). The Law stipulates the mechanism for a proportional tax adjustment if the taxpayer’s counterparty in a controlled transaction has adjusted the results of controlled transactions in its jurisdictions

3. Introduction of economic (business) purpose criteria

To whom it may concern?

  • All residents of Ukrainian and non-residents conducting operations in the territory of Ukraine

Effective date

  • Day following the day of publication of the Law

The Law establishes the definition of “economic (business) purpose”, which provides for increase (preservation) of taxpayer’s assets or their value, or creation of conditions for such a future increase or preservation. A reasonable economic purpose (business purpose must be present in each business transaction.

The Law establishes criteria under which any transaction (even if such transaction is duly documented) could be qualified as transactions without economic purpose (business purpose). For instance, if one of the main purposes of a transaction and/or its results is tax avoidance; or if under similar conditions the counterparty would not be able to buy (sell) such works (services), assets, other object of transaction from non-related party.

If the tax authority proves that a transaction has no economic (business) purpose, the taxpayer is obliged to increase its result before taxation in line with the amount of expenses incurred in such transaction.

4. Changes in procedure of DTT application. Amending the definition of “beneficial owner”

To whom it may concern?

  • Taxpayers applying tax preferences under international agreements
  • Taxpayers paying interests, dividends, royalties

Effective date

  • Day following the day of publication of the Law

From now on, the Tax Code of Ukraine stipulates that tax preferences established by DTT should not be applied if the main or preferential purpose of taxpayers’ transaction was to obtain such tax exemptions or application of a reduced tax rate.

However, the wording of provisions included in DTT shall prevail including in questions of qualification of “beneficial (actual) recipient (owner)”.

The definition of “beneficial owner” for the purposes of application of reduced tax rate for interest, dividends and royalties was broadened. Now, the Tax Code provides that a person that receives income (interest, dividends, royalties) and wants to apply the reduced tax rate under DTT shall receive benefits from such income, which means that such person shall be entitled how to manage such income.

The Tax Code also envisages a non-exclusive list of criteria that indicate that the person is not a beneficial owner of income.

The Law allows for the application of “look – through” approach if income is paid from Ukraine to a non-beneficial owner of income. This means that provisions of DTT between Ukraine and the jurisdiction of actual recipient of the income (who is not a beneficial owner) will not be applied. At the same time, the taxpayer may apply DTT between Ukraine and the jurisdiction where the real beneficial owner is registered in case the non-resident provides evidence that he is beneficial owner of the income.

5. Introduction of taxation of capital gains within cross-border M&A with Ukrainian assets

To whom it may concern?

  • Taxpayers that dispose shares (corporate rights) of foreign company and whose shares derive ≥ 50% of their value from shares of Ukrainian legal entities, and ≥ 50% of their value from immovable property located in the territory of Ukraine

Effective date

  • 1 July 2020

Rules for taxation of capital gains (income from disposal of shares, stocks, corporate and other similar rights of international company) were introduced if the following conditions are simultaneously met:

  • at any time period during 365 days preceding alienation value of shares, stocks, corporate and other similar rights of foreign company deriving more than 50% of their value from the shares of Ukrainian legal entity, which are owned (directly or indirectly) by this foreign legal entity, and
  • at any time period during 365 days preceding such alienation, value of shares, stocks, corporate and other similar rights of foreign company deriving more than 50% of their value from immovable property located in the territory of Ukraine and owned by such Ukrainian legal entity or are used by such Ukrainian legal entity under terms and conditions of long-term lease agreement, finance leasing or other similar agreement

6. Definition of “permanent establishment” is significantly expanded

To whom it may concern?

  • Non-residents operating in Ukraine through a commercial or non-commercial permanent establishment

Effective date

  • Day following the day of publication of the Law

The new Law expands the concept of “permanent establishment” and introduces additional criteria which shall be used to determine permanent establishment in Ukraine.
In particular, a permanent establishment is situated in case of provision of services by non-residents (including consulting services but excluding provision of personnel) through employees hired for such purposes, if such activity is performed in Ukraine within the period or periods with total duration of more than 183 days in any 20-month period.
Permanent establishment is also situated in case of individual’s activity, if such individuals in accordance with agreements or other legal instruments, are entitled and usually exercise their right to negotiate the essential terms of agreements, as a result of which non-residents conclude such contracts without essential amending of its terms, and/or if such individuals are entitled to conclude agreements on behalf of a non-resident, if the abovementioned activity is carried out on behalf of and at the expense and/or for the benefit of only one non-resident or non-residents, related to such non-resident.

The new Law envisages a list of criteria that may show that a person is entitled to perform activity on behalf of and at the expense and/or for the benefit of non-resident, which may be considered as activity that creates a permanent establishment. This list includes without limitations:

  • non-resident provides instructions (including by means of electronic communication or by transmission of electronic media), which are obligatory for an individual in Ukraine and such individual follows the instructions
  • individual has corporate e-mail of non-resident and/or its related parties and uses such e-mail to communicate with the non-resident and/or with third parties with whom non-resident has already concluded or is going to conclude agreements or other legal acts
  • individual exercises the right to own or dispose of stocks (goods) or other assets of the non-resident in Ukraine, or its significant part according to relevant instructions from non-resident
  • individual possess the premises, which he rents on his own behalf, to store property purchased at the expense of the non-resident or which belong to non-resident or which belong to third parties and have to be transferred to the third parties on instruction of the non-resident, or for other purposes determined by non-resident

7. Changes in accounting rules for investment income

To whom it may concern?

  • Taxpayers who purchase or sell investment assets from/to non-residents
  • Taxpayers who purchase securities, derivative securities

Effective date

  • Day following the date of publication

If the taxpayer sells or purchases investment assets from a non-resident related party or non-resident registered in a low-tax jurisdiction, special accounting rules for revenue and losses shall be applied. In particular, income from the sale of assets shall not be less than the usual price; in turn, expenses from the purchase of assets shall not exceed the usual price.

If the investment asset purchaser is CFC and vender is controlling person, CFC rules shall be applied during taxation of income within this transaction.

The National Securities and Exchange Commission compiles a list of emitters with fictitious features. If a taxpayer purchases securities or disposes securities of emitter included in this list, expenses incurred with respect to this acquisition shall not be taken into account during the determination of its financial result.

8. The definition of “dividends” is expanded

To whom it may concern?

  • Taxpayers distributing or receiving dividends
  • Taxpayers conducting controlled transactions defined in accordance with Article 39 of the Tax Code of Ukraine
  • Taxpayers who make payment in favor of non-resident in connection with decrease of charter capital, acquisition of corporate rights in own charter capital, withdrawal of a participant/shareholder, or conduct similar transaction between legal entity and its participant/shareholder for an amount that leads to a decrease of undistributed profit

Effective date

  • 1 January 2021

According to the Law, payments in non-monetary form in favour of participants or shareholders of the taxpayer in connection with net profit distribution are equal to dividends (previously exemption involving only payments in monetary form).

In addition, the part of price, which does not correspond to the arm’s length principle in the transaction with related parties or counterparty registered in “low-tax” jurisdictions, shall be qualified as dividends. In particular, the following transactions shall be deemed as “dividends”:

  • amount of income in the form of payments for securities (corporate rights) paid in favour of non-resident exceeding amount which complies with the arm’s length principle
  • value of goods/works/services (excluding securities and derivative securities) which are purchased from a non-resident that exceed in value that which is complies with the arm’s length principle
  • amount of the underestimated value of goods, works, services, that are sold to a non-resident within controlled transactions compared to the amount that complies with the arm’s length principle

Also “dividends” shall cover:

  • deemed payments (in non-monetary or monetary form) conducted by a legal entity in favor of its shareholder or participant which is non-resident of Ukraine, in connection with decrease of charter capital, acquisition of corporate rights in own charter capital, withdrawal of a participant/shareholder, or conduct similar transaction between legal entity and its participant/shareholder for an amount that leads to a decrease of undistributed profit

9. Changes in “thin capitalization” rules

To whom it may concern?

  • Taxpayers who apply tax differences related to financial operations

Effective date

  • 1 January 2021

New “thin capitalization” rules were established. In particular, financial result before tax shall be increased by exceeding amount of interest accrued under loans, credits and other debt obligations (except interest subject to capitalisation before putting into operation of an asset) calculated according to accounting rules exceeding 30% of the amount of the calculated CPT object during the period when interest accrued plus amount of expenses according to financial statement and amount of depreciation and amortisation of the same period. However, negative value of taxation object for previous periods shall not be taken into account.

New “thin capitalization” rules also take into account the situation when the amount of interest expenses exceeds amount of expenses complying with the arm’s length principle.

10. Limits for private entrepreneurs were increased

To whom it may concern?

  • Private entrepreneurs single taxpayers of 1st, 2nd and 3rd group

Effective date

  • Day following the date of publication

According to the Law limits of annual turnover are following:

  • for single taxpayer of 1st group – UAH 1 million
  • for single taxpayer of 2nd group – UAH 5 million
  • for single taxpayer of 3rd group – UAH 7 million

 

 

 

 

 

 

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