Ensuring financial stability not just nationally, but also globally, is the number one task for all civilized countries. Over the past year, Ukraine has taken significant steps in this direction. And business should be preparing now for the implementation of the BEPS Action Plan into Ukrainian legislation
World-wide tax globalization might reach Ukraine earlier than many expected.
Over the past three years, in order to reduce the number of so-called forum shopping cases aimed at reducing the tax burden on Ukrainian companies by paying passive income to foreign companies, protocols to Double Taxation Treaties were signed on behalf of Ukraine. In addition, Ukraine joined the Multilateral Instrument (MLI) in 2018, the purpose of which is to simultaneously amend existing Double Taxation Conventions with countries that have also expressed a wish to make amendments to the conventions together with Ukraine.
However, none of the signed protocols, as well as the MLI were ratified by the Ukrainian Parliament. Nevertheless, work on reducing the attractiveness of the profit shifting by Ukrainian companies with the use of foreign companies, continued. Submission to Parliament of the presidential draft law on the tax on exiting capital was one of the outcomes of such work. The Ministry of Finance and the National Bank of Ukraine developed the draft law "On Amendments to the Tax Code of Ukraine for Implementing the Plan on Base Erosion and Profit Shifting" (Draft Law), and the amendments are made in excess of Ukraine’s obligations for the BEPS Action Plan implementation. Thus, there is a high probability that the "traditions" of amending tax legislation at the end of the year and their coming into force from January 1, 2019, will be observed by the Ukrainian Parliament.
These steps, among other things, include rules on the taxation of controlled foreign companies (CFC), constructive dividends and taxation of the indirect sale of Ukrainian real estate items through foreign companies. Particular attention is paid to transfer pricing (TP) and issues related to the application of tax conventions.
Taxation of CFC
Introduction of CFC taxation aimed at implementing mechanisms to counteract the withdrawal of capital with the use of the international structuring of business processes is the highlight of the draft law.
The basic principle of CFC taxation proposed by the draft law is that the profits of a CFC belonging to Ukrainian residents-individuals will be subject to taxation in Ukraine in proportion to the share of participation of such individuals in the capital of a CFC. Moreover, if the annual revenues of all CFCs exceed EUR 2 million, their profits will be adjusted according to the special rules provided for by the draft law.
At the same time, the rules of taxation of CFC profits will not apply to all foreign companies. CFC profits registered in countries with which valid tax conventions are signed and which are not on the "offshore" list, will not be subject to taxation in Ukraine. To get such an exemption, a CFC should actually pay income tax at an effective rate of no less than 13%, or 50% of the CFC profit shall be active and comply with the relevant definition proposed by the draft law.
If the annual income of all CFCs belonging to a Ukrainian individual resident does not exceed EUR 1 million, there will be no supplementary taxation in Ukraine.
The draft law suggests introduction of special reports on the activities of CFC and provides for fines for failure to submit the aforementioned reports. In view of the planned changes, it is obvious that the costs of maintaining and conducting business through a CFC will increase due to the need to comply with tax rules in Ukraine. In some cases, holding a CFC or accumulating cash in it may become unprofitable due to a higher rate of taxation of CFC income compared to paying dividends directly to the Ukrainian business owner.
Emergence of the concept of constructive dividends should be noted among the possible innovations. The difference between the amount of interest, royalties, or the amount paid for the supply of goods/services to a "qualified" non-resident and the price corresponding to the arm’s length approach will be equal to the payment of dividends with the corresponding obligation to pay an advance tax on corporate profits and non-residents income tax. The same rule will be applied when selling goods/services to non-residents at prices inconsistent with the arm’s length approach.
As previously mentioned, special attention in the draft law is given to the topic of TP. The changes will affect both the criteria determining coherence of the parties, expansion of the number of taxpayers, growing list of controlled transactions, and reporting that will need to be submitted by Ukrainian companies.
It is supposed to introduce the doctrine of a business goal in transactions with non-residents to the Tax Code. Even if the transactions are not controlled for the purposes of TP, expenses in favor of non-residents without a business goal will increase the amount of taxable profits and the results of controlled transactions will not be taken into account in the absence of a reasonable commercial ground for their implementation. The same consequences will occur if a transaction does not provide for an increase in the assets of the taxpayer, or if the tax authority considers that one of the main goals of controlled transactions is tax evasion. We can but hope that the tax authorities will not abuse these provisions and that the reasons for additional charges based on the aforementioned provisions will not be absurd. At the same time, of course, the number of tax disputes in connection with this innovation will increase.
The draft law also provides for the introduction of a three-tier reporting for the purposes of TC which will include documentation on transfer pricing (Local File), global documentation (Master File) and a country-by-country report. It should be noted that there is some discrimination in Ukrainian business, that is, in Ukraine the country-by-country report shall be prepared at lower turnovers (EUR 50 million) compared to foreign businesses (EUR 750 million). In connection with significant penalties for failure to submit TP reports, business should take the new rules very seriously.
Application of tax conventions
If the draft law is adopted, those companies cooperating with companies from jurisdictions the tax conventions with which do not contain beneficial owner clauses, can catch a break. The State Fiscal Service will not be able to charge them additional obligations in connection with the "non-beneficialness" of the income earner.
But if there is a beneficial owner clause in the tax convention, the rules become stringent. At the legislative level, it is planned to bring requirements to the beneficial owner, videlicet: the performance of essential functions, no further profit transfer, availability of appropriate resources for the use of assets and risk coverage. This, in turn, will affect the already well-established judicial practice regarding the "beneficialness" of sublicensors with exclusive licenses, and will provide a regulatory background for the actions of tax authorities aimed at challenging the legality of application of tax conventions.
It is likely that the draft law placed in the public domain for public discussion will undergo significant changes. However, the vector chosen by the Ukrainian authorities to counteract profit tax base erosion will unequivocally entail additional expenses for business in the form of paying tax and/or tax administration. Even if the BEPS Action Plan is implemented more softly in Ukraine, it is high time to think about the impact of the draft law on existing business structures and to prepare for possible changes or complete the planned transactions before introduction of new tax rules.