Tax Practice

Counsel, GOLAW

Partner, GOLAW

In Difficult Footsteps

Disputes on transfer pricing will become even more difficult, and requirements for preparation of documents will get stringent.

We can call the rules of transfer pricing (TP) "a sore point" of Ukrainian tax legislation. Provisions that can be usually found in numerous recommendations and guidelines of the Organization for Economic Co-Operation and Development and international conventions, are set out in one article of the Tax Code (TC) in Ukraine, which cannot but affect the correctness of its interpretation. Moreover, annual reports on controlled transactions should be submitted under the permanent changes, which one should adapt to.

In view of the brevity of Article 39 of the Tax Code of Ukraine, consideration of a case by a court is the only way to shed light on a disputable transaction.

Information provided by public authorities of the counterparty's country is important for the courts. The internal orders, constitutional documents of the counterparty, corporate correspondence, can be forcible arguments. Since one should have time to obtain such evidence, and the Code of Administrative Legal Proceedings of Ukraine will be amended regarding the terms of evidence, it is necessary to record their preparation in advance.



One of the criteria for recognizing transactions as controlled is the counterparty's registration in a low-tax jurisdiction, determined by order No. 977-р of the Cabinet of Ministers of Ukraine dated September 16, 2015 which is constantly being amended. The country  can be changed during performance of a contract, and there are two questions: how should the scope of transactions be counted, and will the transaction be controlled? Judicial practice has developed ambiguously in this respect.

For example, the Odesa Administrative Court of Appeal in case No. 821/2091/16 took the side of the payer in full, having noted that formation of the report on controlled transactions should occur in cases, provided by legislation, at the time of reporting. Pursuant to  case materials, Switzerland was excluded from the list of the Cabinet of Ministers of Ukraine at the time of reporting, though the taxpayer had managed to conduct transactions to the sum of over 44.7 million UAH for the previous period.

At the same time, the Kyiv Administrative Court of Appeal recognized, in a similar case, No. 810/830/17, the transactions as controlled, since the country of registration of the counterparty was included in the list of the Cabinet of Ministers of Ukraine when these transactions were conducted.

Finally, in case No. 821/1345/16, the Supreme Administrative Court of Ukraine (SACU) concluded that transactions will be deemed controlled for the period until such country has been taken off the list, and, respectively, the extent of transactions will be taken into account for the period until removal of such country from the list.

There have also been cases in judicial practice when the taxpayer had to prove that the jurisdiction of his counterparty to the transaction is not a low-tax one, even though it is included in the list of the Cabinet of Ministers of Ukraine. Thus, considering case No. 823/2039/16 in the Kyiv Administrative Court of Appeal, the State Fiscal Service appealed against the fact that Georgia is included in the list as a state, where income tax is 5 or more percentage points lower than it is in Ukraine. The payer, on his part, provided a letter from the Embassy of Georgia in Ukraine to the court, confirming that the difference is three, not five percentage points, as well as a letter of the Revenue Service of Georgia, which states that the profit of this counterparty is taxed at a rate of 15%. The court found such evidence more forcible than the country's presence on the list.



Paragraph of Article 39 of the Tax Code of Ukraine provides that transactions on the purchase or sale of goods/services through the non-resident commission agent shall be deemed controlled. However, the representative body of the non-resident can perform the function of mediation. At the same time, the provision on a representative body can contain the obligation to represent the main company to third parties, or an agreement of similar content can be signed between the main company and representative body. What is the risk of recognizing transactions with such a representative body as controlled?

Pursuant to the materials of case No. 820/1734/17, considered by the Kharkiv Administrative Court of Appeal, a resident of China (the buyer) bought goods from an unrelated Ukrainian manufacturer (the seller) through a representative body registered in Panama. The buyer and his representative body concluded the exclusive representation agreement enabling the latter to buy goods on behalf of the buyer, using his means for this. All payments under the agreement were made between the buyer's representative body in Panama and the seller from Ukraine. The State Fiscal Service reasoned that, first, Panama is classified as a low-tax jurisdiction, and, second, the agreement, concluded between the buyer and the representative body, is, in fact, a commission agreement.

Surprisingly, the court found the payer's arguments more forcible and concluded that transactions were made within the exclusive representation agreement and the resident of Panama performed his representative functions. The court decided not to explain the difference between a commission agreement and an exclusive representation agreement. The court also took into consideration the evidence of final delivery of goods to China (customs declarations, consignment notes). A cassation proceeding has now been opened with regard to this case, and if the Supreme Arbitration Court of Ukraine stands in full solidarity with the court of appeal, we will get a precedent. However, since the courts often specify that, according to paragraph 14.1.122 of Article 14 of the Tax Code of Ukraine, representative bodies are also "non-resident", the Supreme Arbitration Court of Ukraine might not support the decision of the appeal.



According to paragraph of Article 39 of the Tax Code of Ukraine, the payer may use any publicly accessible sources to compare prices in transactions. In letter No. 517/G/99-99-12-03-07-14 dated January 16, 2017, the State Fiscal Service specifies that the tax authority may not independently establish, from what sources data should be used, and such circumstances may be discovered only during tax control, but the State Fiscal Service recently provided several explanations as to what sources should be deemed acceptable. This list includes: commercial databases of enterprises such as Bureau Van Dijk (Orbis, Amadeus, RUSLANA), Interfax (SPARK), ThomsonReuters, Bloomberg; information on prices on the exchange and exchange quotes; tender documentation of open tenders; reports of estimating entities.

Since all transfer pricing documents are based on the chosen source, it is desirable to be guided by the most profitable and, at the same time, optimum indicators from the sources that are acceptable for the State Fiscal Service.



Today, the majority of judicial transfer pricing disputes relate to either recognition of transactions as controlled, or the formal aspects of  reporting: terms, correctness of filing and so forth. There are only a few cases to date of judicial practice connected with the contents of transfer pricing reports.

In case No. 815/3424/17, the Odesa District Administrative Court recognized it as wrong to compare prices for exported goods in controlled and uncontrolled transactions by the State Fiscal Service in accordance with the net margin method: first, only one source of  prices (data on the agrarian exchange) is used and the highest indicators are taken; second, the terms of delivery, extra charges and discounts, resulting from the marketing policy of an enterprise, are not taken into account. The court noted the following: if the tax authority used several sources of information to compare prices, it would obtain objective data on fair market prices. In addition, using a source of information other than a source of the taxpayer, the State Fiscal Service should provide evidence why this data should be used.

The Kharkiv Administrative Court of Appeal also declared in case No. 816/515/17 that the actions of the State Fiscal Service to be il­legal regarding the check on compliance to the "arm's length " principle, since data on prices that do not provide comparability of transactions by indicators of functions of the parties and their business strategy, economic conditions of transactions, terms of delivery and practice of their carrying out are used. Moreover, this data was taken not on the date of the contract’s conclusion, which also violates paragraph of Article 39 of the Tax Code of Ukraine.

Judicial practice shows potential points of conflict in a situation with the contents of transfer pricing reporting. Therefore, it is important to study qualitatively the arguments on the use of indicators, sources and methods in controlled transactions to increase the chances of successful settlement of a dispute. However, even today it is clear that transfer pricing disputes will become even more complicated, and the requirements for preparation of documents will become stringent, including in connection with obligations undertaken by Ukraine to implement the BEPS plan.