The tax revolution: Anti-BEPS has come up

President of Ukraine has signed the Law No. 466-IX “On Amendments to the Tax Code of Ukraine to Improve Tax Administration, Eliminate Technical and Logical Discrepancies in Tax Legislation” (the “Law”).

The Law entered into force on 23 May 2020, however, many of its key provisions will come into effect later.

The Law significantly changes the current approach to taxation, in a number of instances being a total gamechanger for businesses and individuals. Its main purposes are de-offshorisation, ensuring tax transparency, and a large-scale implementation of the BEPS Action Plan in Ukraine.

Who is affected by the Law?

The Law primarily concerns multinationals operating in Ukraine, as well as domestic large and medium-sized businesses.

It is particularly important for the Ukrainian companies involved in a wide range of transactions with non-residents, as well as for the businesses structured with the extensive use of business vehicles in other jurisdictions.

The Law affects interests of the beneficial owners with direct or indirect (through a chain of companies) ownership of Ukrainian assets, as well as legal entities or individuals relying on double tax treaties. Businesses operating in Ukraine through permanent establishments are also significantly affected.

Finally, the Law introduces a brand new tax instrument for the Ukrainian residents with business or investments abroad – the rules on controlled foreign companies (“CFC”).

Next steps

The Law entered into force on 23 May 2020. However, the most profound and “painful” changes provided by the Law will be gradually introduced over time.

Thus, taxation of the sale of Ukrainian assets at the foreign holdings level will take effect on 1 July 2020, while taxation of CFCs and a three-tier transfer pricing reporting – on 1 January 2021. Besides, in few cases the Law promises a release from fines for violating the new tax rules, committed in 2021 and 2022.

This means there is a “transition period” during which businesses can review and restructure their existing operating models to comply with the new rules relatively easy. However, due to the delayed signing of the Law (four months after it was adopted by the Parliament), there is very little time left for the “transition”, moreover so given the impact of the COVID-19 pandemic.

When the Law is fully effective, the usual business structures will become not only ineffective and expensive, but also toxic. This is the case when strategies of “leave as is” and “wait and see” are mostly not working, with significant tax cost, penalties and lost reputation being the price of procrastination.

We will be happy to help you develop the optimal strategy of action in the changing circumstances and to answer your questions.

Future Events

Simultaneously with the signing of the Law, President proposed to the Government to develop a number of “additional” bills that should detail and improve provisions of the Law, as some of them were criticised by experts.

The parameters of these bills have not been announced, but we are aware they will concern the rules on CFC, the tax collection policies, and the liability for tax violations. It is also possible that the bills may postpone enforcement of certain provisions of the Law due to the COVID-19 pandemic.

In addition, President announced the bill on tax amnesty, which should be drafted by the Government in next three months.

Another event that could be a logical continuation of the country’s chosen tax strategy, would be a launch of a full-fledged automatic exchange of information under the Common Reporting Standard (“CRS”). Experts agree that automatic exchange is only a matter of time, and will be effected in the foreseeable future (2021 or 2022). Automatic exchange will provide the tax authorities with the access to the information on foreign accounts of the Ukrainian residents, which in turn will help them ensure the effective implementation of many provisions of the Law.

Overview of the most significant changes introduced by the Law

1. Taxation of the controlled foreign companies (“CFCs”)

Who shall be interested?

  • Ukrainian residents (companies and individuals) with ownership of or control in the foreign companies
  • Ukrainian residents who acquire or dispose shares in foreign companies

What is the effective date?

  • 1 January 2021. However, we do not exclude that the date may be postponed considering the bills proposed by President (see above).

Under the Law, a company or an individual Ukrainian resident who owns or controls a foreign company in any jurisdiction, with a few exceptions will have to pay tax on its profits to the Ukrainian budget. For individuals, the tax rate reaches 19.5% (18.5%+1.5%).

The tax obligation occurs if the Ukrainian resident’s share in a foreign company exceeds 50%; however, if there are several Ukrainian residents in the company’s ownership structure, a lower threshold can apply (i.e. 25% in 2021-2022 or 10% from 2023). Besides, a person who actually controls a foreign company is considered to be its 100% owner regardless of their formal participation.

A controlling person must independently calculate the profit of CFC and the respective tax amount, taking into account the provisions of the Tax Code. Then a controlling person shall file a so-called CFC report together with the certified financial statements and pay the tax. If there are several controlled companies, the profit is calculated and the tax is paid for each company separately. Transfer of losses between controlled companies is not allowed.

A person may apply for a CFC exemption and not pay tax from all or some of their foreign companies: for example, if the total annual income of all its CFCs did not exceed EUR 2 million, or if the foreign company generates mostly active income. However, even in such case it is necessary to file a report on all of the CFCs to the tax authorities.

Ukrainian residents will also be required to separately notify the tax authorities about the acquisition or disposal of shares in a foreign company if as a result of such actions they become or cease to be a controlling person, as well as notify the tax authorities on setting up or liquidation of foreign companies.

2. Changes in the transfer pricing (“TP”) rules

Who shall be interested?

  • Taxpayers who carry out controlled transactions in the meaning of Article 39 of the Tax Code of Ukraine
  • Permanent establishments of foreign companies in Ukraine

What is the effective date?

  • Most provisions – from 23 May 2020
  • Provisions on master file – from 1 January 2021
  • First country-by-country report shall be filed for FY 2021, but the filing itself should not be made unless Ukraine enters into the CbC MCAA
  • First notification on participation in the international group of companies shall be filed in 2021 for the 2020 reporting year
  • We do not exclude that some or all of the above terms may be postponed considering the bills proposed by President (see above)

The main TP novel is the three-tier reporting which includes:

  • сontrolled transactions report and local TP documentation (so-called local file)
  • global TP documentation (master file)
  • country-by-country (“CbC”) report

The master file and the CbC report are relevant only for the companies which are a part of an international group of companies (the “group”). Taxpayers that carried out controlled transactions during a given year, shall inform the tax authorities whether they participated in a group.

Master file is submitted at the request of the tax authorities, which can only be issued if the total consolidated annual income of the group to which the taxpayer belongs has reached EUR 50 million.

The taxpayer must file CbC report without a request if the total consolidated annual income of the taxpayer’s group exceeded EUR 750 million, provided that at least one of the following conditions is met:

  • the taxpayer is a parent company of an international group
  • the parent company of the group authorises the taxpayer to file the CbC report in Ukraine
  • the parent company of the group is located in a jurisdiction that does not require CbC reporting and the parent does not authorise another group company to file it
  • there is no effective mechanism for exchanging CbC reports with the parent company’s jurisdiction (the list of such jurisdictions is to be adopted)

Other changes to the TP rules worth noting are essential revisions of the special rules for commodity transactions, an increase in ownership thresholds for recognition of the “related parties” from 20% to 25%, and a more detailed regulations of the corresponding adjustment rules.

3. Return of the business purpose

Who shall be interested?

  • Taxpayers who conduct business transactions with non-residents

What is the effective date?

  • 23 May 2020

Absence of business purpose in a business transaction will again become a ground for not counting expenses for the corporate income tax purposes, although now only for transactions with non-residents. Nevertheless, even before this change has been introduced, the tax authorities and courts widely applied the business purpose doctrine in their practice.

From now on, the Law explicitly states that the burden of proof the absence of business purpose rests with the tax authorities.

The Law also clarifies the definition of the business purpose concept and establishes criteria which indicate its absence, mainly:

  • if the main purpose or one of the main objectives of the transaction and/or the result thereof is non-payment or incomplete payment of taxes
  • if in comparable conditions, a person would not be willing to purchase (sell) the same services, intangible assets, or other items, other than goods, from/to unrelated persons

4. Changes concerning application of the tax treaties

Who shall be interested?

  • Taxpayers who pay income to non-residents (particularly, dividends, interest, and royalties)

What is the effective date?

  • 23 May 2020

The Law introduces the so-called principal purpose test: benefits under a tax treaty are not applicable if the main or the primary purpose of the transaction was to obtain such benefits directly or indirectly.

Notably, the most Ukraine’s tax treaties have their own definitions of the principal purpose test (mainly, the one used in the OECD Multilateral Convention). In case of discrepancies in the wording, the tax treaty definition prevails.

The Law also confirms the principle that has already been established in the practice of the Ukrainian Supreme Court, i.e. the “beneficial owner of income” test applies only if it is provided for in the relevant tax treaty. In most cases, this limits application of the test to dividends, interest, and royalties.

The definition of the beneficial owner of income has also been substantially clarified: from now on, according to the Tax Code the recipient of income must be the beneficiary and factually dispose of the income. For this purpose, the recipient must have relevant functions and a possibility to perform thereof, sufficient assets which they can use, as well as an ability to carry the relevant risks.

The Law allows “look through” approach to application of the tax treaties: when the immediate recipient of income is not its beneficial owner, provisions of the tax treaty of the actual beneficial owner’s jurisdiction may apply. However, the mechanism for implementing this provision seems burdensome.

5. Taxation of the sale of Ukrainian assets structured abroad

Who shall be interested?

  • Parties to the agreements providing for direct or indirect disposal of Ukrainian assets to the non-residents

What is the effective date?

  • 1 July 2020. However, we cannot exclude that this term may be postponed considering the bills proposed by President (see above).

The Law introduces taxation of capital gains derived by non-resident from the sale of shares in foreign companies, if both of the following conditions are met:

  • at any time during the 365 days preceding such sale, the shares in the foreign company derive more than 50% of their value from the shares in the Ukrainian legal entity, which are owned (directly or indirectly) by this foreign company
  • at any time during the 365 days preceding such sale, the shares in the Ukrainian company derive more than 50% of their value from the immovable property located on the territory of Ukraine and owned by such Ukrainian legal entity or is used by such Ukrainian legal entity under a long-term lease agreement, financial leasing or other similar agreement

6. Changes to the rules on permanent establishments (“PE”)

Who shall be interested?

  • Non-residents carrying out their activity in Ukraine through commercial or non-commercial representative office

What is the effective date?

  • 23 May 2020

The Law distinguishes different types of PE with more clarity and introduces additional criteria allowing to determine PE.

For instance, a so-called agency PE (i.e. a PE created by the persons authorised to negotiate essential terms of transactions on behalf of a non-resident) may have the following features:

  • non-resident provides instructions which are binding on the person and such person actually follows the instructions
  • the person has access to, and uses corporate e-mail of the non-resident and/or its related parties
  • the person exercises its authority to possess or dispose of goods or other assets of the non-resident in Ukraine based on the non-resident’s instructions
  • the person rents the premises in its own name for the storage of the assets purchased at the expense of the non-resident

The Law also provides that profits must be attributed to the PE on an arm’s length basis, i.e. the profits must correspond to the profits of an separate enterprise acting independently and engaged in the same or similar activities under the same or similar conditions.

Besides, the Law changes the procedure for tax registration of PEs and determines rules by which the tax authorities may conduct inspections of non-residents which have commercial activity in Ukraine but not registered as PEs. A penalty of UAH 100,000 (approx. USD 3,700) may apply for such violation (without taking into account penalties for underpaid taxes).

7. Changes to the taxation of the investment income by individuals

Who shall be interested?

  • Individual taxpayers performing transactions with investment assets (stock, shares, other corporate rights, bonds, other securities and derivatives)
  • Companies which incentivise their personnel by granting stock options to them

What is the effective date?

  • 23 May 2020

Under the Law, in case a resident individual disposes of an investment asset (stock, shares, other corporate rights, bonds, other securities and derivatives) to a non-resident related party or to a buyer registered in a “low tax” jurisdiction, he or she must calculate its income for the tax purposes in the amount not less than a fair market value of the asset. If a resident individual purchases investment asset from a non-resident related party or from a seller registered in a “low tax” jurisdiction, he or she must determine its expenses in such transaction in the amount not exceeding a fair market value of the asset.

The Law also eliminates uncertainty which existed in respect of taxation of investment income received abroad. The Law makes it clear that the tax is imposed on the investment profit, i.e. positive difference between the gross income and the expenses.

If a taxpayer purchases securities or derivatives from an issuer that has signs of fictitiousness, the cost of their acquisition shall not be taken into account when determination the taxpayer’s financial result. The list of the securities issuers with the signs of being fictitious is determined by the National Securities and Exchange Commission.

8. Constructive dividends

Who shall be interested?

  • Taxpayers conducting controlled transactions in the meaning of Article 39 of the Tax Code of Ukraine
  • Taxpayers with foreign shareholders

What’s the effective date?

  • 1 January 2021. However, we do not exclude that this term may be postponed considering the bills proposed by President (see above).

The Law equated the difference between the actual and the arm’s length price of the transaction to dividends for the tax purposes. This rule applies to certain transactions with non-resident related parties and counterparties registered in the “low tax” jurisdictions, namely:

  • sale or purchase of securities or corporate rights
  • sale or purchase of goods, works, and services

Besides, the dividend-like treatment applies to payments made to non-resident shareholder (irrespective of their jurisdiction) in connection with the decrease of the charter capital, acquisition of corporate rights in the own charter capital, withdrawal of a shareholder, or a similar transaction between a legal entity and its shareholder in the amount causing reduction of the undistributed profit (retained earnings).

The “constructive” dividends described above are subject to the same tax treatment as the “regular” dividends, i.e. advance corporate tax payment and dividend withholding tax may apply to them.

9. Change to the thin capitalisation rules

Who shall be interested?

  • Taxpayers borrowing from non-residents

What’s the effective date?

  • 1 January 2021. However, we do not exclude that this term may be postponed considering the bills proposed by President (see above).

The Law introduces the new thin capitalisation rules. In particular, financial result before tax shall be increased by the amount comprising any excess over 30% of the accrued interest under the loans, borrowings and other debt obligations (except for interest subject to capitalisation before putting into operation of the asset) above the amount of the corporation tax calculated during the period when the interest was accrued, and increased by the amount of expenses according to the financial statement and the depreciation and amortisation of the same period. However, negative value of taxation object for previous periods shall not be taken into account.

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

10. Introduction of the mutual agreement procedure

Who shall be interested?

  • Taxpayers applying tax treaties in their transactions with non-residents
  • Taxpayers conducting controlled transactions in the meaning of Article 39 of the Tax Code
  • Non-residents carrying out their activities in Ukraine through commercial or non-commercial representative offices

What’s the effective date?

  • 23 May 2020

The Law introduces a possibility to resolve tax disputes concerning application of the Ukrainian tax treaties through a mutual agreement procedure (“MAP”).

The Law envisages that the disputed tax notifications-decision are considered “not agreed” for the duration of the case consideration under the MAP. At the same time, the Law does not allow simultaneous consideration of the same case under the MAP and in an administrative or court proceeding. Also, MAP cannot be initiated if a court decision is available on the same dispute. Instead, if the taxpayer does not agree with the MAP outcome, they can appeal the decision in court (within the usual statute of limitation).

MAP is an instrument of tax dispute resolution that is usually available to taxpayers under a double tax treaty and is designed to resolve the cases when double taxation arises not in accordance with the treaty. As such, MAP provides to the governments a mechanism allowing to agree on the appropriate amount of tax that each is entitled to take in a given situation, at the same time eliminating or reducing the double taxation.

Around the world, MAP is a popular instrument for resolving disputes in the field of TP, PE taxation and other fields where the tax treaties apply.

Prior to adopting the Law, Ukraine did not have its national rules for MAP, which made it difficult to commence MAP in practice.

11. Changes to the rules on liability of taxpayers

Who shall be interested?

  • All taxpayers

What’s the effective date?

  • From 1 January 2021

A number of Tax Code provisions concerning liability for tax violations will be changed. In particular, the penalty rates for the underpayment of taxes shall be differentiated depending on whether the violation was intentional, namely:

  • 10% of the underpaid amount – for an unintentional violation
  • 25% of the underpaid amount – for an intentional violation
  • 50% of the underpaid amount – for an intentional violation committed repeatedly within three years

In a like manner, the existence of intent will affect penalties for some other tax violations.

Besides, the Law clarifies general provisions of financial liability of taxpayers: it defines the terms “guilt” and “intent” and provides for a list of circumstances which exempt from or mitigate liability. If at least one mitigating circumstance exists, the amount of penalty must be halved.

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