Transfer pricing: An overview of litigation practice and disputes with the State Tax Service

Functional analysis is an important step in TP. It involves determining the functions, risks and assets of each party to controlled transactions (‘CTs’), which are then critical for identifying the most appropriate TP method and the tested party.

However, the approach to interpreting facts and circumstances may give rise to disputes between taxpayers and tax authorities, particularly in case of complex value chains.

For example, in case #320/30311/24, tax authorities challenged, among other things, the appropriate functional analysis performed by the taxpayer and the resulting selection of the TP method and the tested party. In particular, the tax authorities insisted on changing the tested party arguing that the counterparty performs fewer functions, bears fewer risks, and has internal comparable transactions. Meanwhile the taxpayer argued that the choice of itself as the tested party in CTs was appropriate due to the more complete information available about its own operations and limited information (including financial statements) commonly available on the companies whose operations are comparable with the business of the non-resident.

The court supported the taxpayer's position, arguing it was important to consider all factors for the analysis and reasonable selection of the tested party.  

This case is a good example that a high-quality and well-supported functional analysis is the key to the taxpayer's ability to successfully sustain its position in any disputes with the regulators.

Ukrainian TP regulations, whilst based on the international OECD guidance, set minimal requirements for comparability of transactions. Whilst providing a degree of freedom to taxpayers, this makes room for various interpretations and differences from the stance taken by tax authorities.

In addition, information on certain industries may be insufficient (limited number of companies operating in the industry), complicating the search for a sample of comparable transactions to support prices in CTs. The limited data available may make businesses rely on details of transactions that are not fully comparable or reference data for other countries. This enhances the risk that tax authorities may challenge the findings of the taxpayer’s tested arm’s length range.

For example, in case #420/19747/21, tax authorities challenged the final samples of comparable companies and attempted excluding certain companies from that sample, thereby increasing the arm’s length range and assessing additional tax liabilities. However, the Supreme Court (‘SC’) ruled against the tax authorities as the latter failed to provide sufficient arguments for the following: why, treating the tested party as a ‘large business’, they excluded certain ‘mid-size business’ while including others, what information and for what companies was missing to support comparability, etc. 

As such, due to the lack of clear requirements and challenges in finding information, taxpayers should carefully select comparable transactions and be prepared to sustain their position. 

Even pre-war, taxpayers engaging in transactions with commodities, struggled to support the arm’s length basis of prices for such commodities in controlled transactions. These days, many taxpayers still have their chosen source of quoted prices or comparability adjustment methodology challenged, as a result, having to revise or justify their chosen approach. 

Case #440/2924/24 is a good example where the tax authority attempted applying Agrus and Refinitive sources of information to exports of corn and soybean during 2017. The court of second instance ruled in favour of the taxpayer arguing that:

• these sources did not become the recommended sources of information until 2021 and had not appear earlier un either the regulations effective in prior reporting periods or in general tax advice;
• during 2017, Agrus did not publish any information relevant to agricultural produce pricing;
• neither Agrus no Refinitive methodologies determine any related party criteria for parties to the transactions and disclose any related party identification techniques, thereby distorting the sample of potentially comparable transactions;
• evidence provided to tax authorities is not appropriate and acceptable.

Therefore, taxpayers engaging in commodity transactions should carefully choose the information sources relied upon in pricing their transactions and be prepared to justify their choice to the controlling authority. 

Intangible assets, such as patents, trademarks, know-how and software, have become an increasingly important source of value creation for many businesses. However, their valuation for TP purposes is extremely complex. The cost of intangible assets is often difficult to determine objectively as it depends on a wide range of factors, including the asset’s unique nature, its potential contribution in the company’s profitability, market environment, and legal restrictions. 

Tax authorities tend to scrutinise transactions with intangible assets as they could be used to move profits to low-tax jurisdictions.

Case #0740/860/18 focused on know-how and the disputed issue was the classification of the transaction to return the intangible assets to the counterparty as a controlled transaction. 

The taxpayer purchased a number of intangible assets totalling USD 620,700 and EUR 695,000 from related parties. Subsequently, the parties agreed to terminate the contracts signed and return the know-how obtained under such contracts as they were unable to implement the originally anticipated business projects that the assets were purchased for. The supervisory authority concluded that the return of such assets represents a controlled transaction, claiming that the taxpayer had failed to disclose the CT relating to such return in its report.   

The Supreme Court ruled in favour of the taxpayer, having determined that the return of assets has no impact on either an increase or a decrease of the taxable amount if the counterparties agree to terminate their contracts. 

Proving the business rationale of such CTs is another complex area related to intangible assets in TP. 

The result of such transactions does not always have a clear financial dimension or an immediate impact on profit, thereby complicating the substantiation of the business rationale. At the same time, tax authorities may challenge the deductibility of expenses from such transactions, resulting in significant additional tax assessments. Our team has a broad experience in developing methodologies for substantiating the business rationale of transactions in relation to intragroup services, royalties, etc., and will be happy to help you strengthen your TP documentation with a credible analysis.

The reality of the full-scale war and the resulting economic crisis have radically transformed the approaches to making business in Ukraine. Among others, taxpayers face new TP challenges. Today, it is critical for the businesses engaging in related party transactions to consider these challenges and be prepared to justify their position to tax authorities or even in court.

E.g. cases such as #300/2375/24, #500/5563/23 and others have shown that neither the war nor even the taxpayer's location in occupied territories may prevent tax authorities from imposing a late reporting penalty unless the taxpayer has submitted an application reporting its inability to ensure tax compliance.

This is yet another proof that companies need to have a clear legal position to mitigate the risk of challenges by tax authorities, whilst also being able to adequately protect themselves should such challenges arise.

Using commissionaires or limited risk distributors (LDRs) is a common practice for multinational groups operating in international markets. However, tax authorities carefully monitor such structures to make sure they are not used for artificial profit allocation.

In case #813/3451/16, the Supreme Court ruled that sales of products to a resident of a low-tax jurisdiction via a resident commissionaire must be treated as controlled transactions. 

The taxpayer entered into export transactions with a non-resident domiciled in a low-tax jurisdiction through a resident commissionaire. Tax authorities insisted that these transactions should be treated as controlled transactions and that the taxpayer should have disclosed such transaction in its CT report. However, the taxpayer disagreed arguing that the transactions were with a resident of Ukraine under a commission agreement and that it had no relationship with the non-resident.

Having heard the case, the Supreme Court ruled in favour of the tax authorities arguing that the taxpayer operated through a commissionaire acting on its behalf. The court also considered that the selling price of the products for sales to the non-resident through the commissionaire was effectively controlled by the taxpayer by signing relevant addenda to contracts. 

This case shows that taxpayers should carefully review terms and conditions of the commission agreements and plan their supply chains using commissionaires as the legal lack of direct relationship with a non-resident does not exempt such transactions from TP control.

Financial transactions such as loans, guarantees and treasury services between related parties are another area of common disputes with tax authorities. Determining a market interest rate on an intragroup loan or a guarantee fee may be a complex task as terms and conditions of such transactions often differ from those that would be offered by independent parties. This has become increasingly relevant to Ukrainian businesses since the beginning of the full-scale war as benchmark interest rates on domestic borrowings have radically changed.

Besides proving the arm's length basis of such transactions, a question may also arise which of these transactions will be treated as controlled transactions for TP purposes. 

Despite the fact that TP has existed in Ukraine since 2013, this matter is still debated, even in a recent case, #826/3462/18. The Supreme Court ruled in favour of the taxpayer agreeing that the repayment of debt does not meet the definition of a controlled transaction as it does not represent a business transaction to buy/sell goods and generates no revenue for the claimant. As such, the taxpayer was under no obligation to disclose these transactions as controlled transactions.

Therefore, particular attention should be paid to consideration of whether financial transactions meet the definition of controlled transactions, taking into account both the position of tax authorities and the existing court practice. Our team monitors the most recent practice and will be happy to support you in any controversial TP matters. 

Identifying the profits to be allocated to the permanent establishment (PE) of a non-resident is another complex area of TP. The concept of a permanent establishment determines when a company has to pay taxes in the country it operates in, event when it is not incorporated in that country. Allocation of profits between the company’s head office and the PE requires a careful analysis of functions, assets and risks related to activities of the PE.

When a company carries on business activities through the representative office or engages in other actions that may indicate that such activities are ‘business’ or ‘commercial’ in nature, the representative office constitutes a permanent establishment and must pay income tax on the income originating from Ukraine. For permanent establishments, existence of CTs become an important matter. 

E.g. in case #2а-16434/12/2670, the Supreme Court ruled in favour of tax authorities agreeing that activities of the representative office may not be treated as supporting or preparatory as the nature of such activities matches the activities of the non-resident and represents providing services to third party, rather than the non-resident, for the purpose of generating profit. As a result, the court ruled that the representative office was required to pay income tax as a separate business entity. 

As the example shows, not paying sufficient attention to analysing the activities of a representative office may have grave tax implications. 

As a reminder, the only financial criterion for classification of transactions as controlled transactions applicable to a permanent establishment in Ukraine is that the total amount of such business transactions (identified using accounting rules) must exceed UAH 10 million for the respective reporting year, therefore they have higher chances of being subject to TP requirements.

It is fair to say that the frequent changes in legislation, the limited TP enforcement practice in certain areas, and the inconsistent court practice in TP-related cases remain the major factors making life difficult for businesses.  This contributes to the uncertainty, making the process of disputing any decisions of tax authorities a real challenge.

As the treatment of TP nuances by tax authorities may differ from that of the taxpayer, the outcome will strongly depend on how clearly and consistently the company will be able to prepare ahead and support its position. In addition, courts of various instances - and sometimes even courts of the same instance - may make conflicting rulings in cases with similar factual circumstances and legal matters. It is also common for courts of higher instances to overrule conclusions and rulings of courts of the first instance. Even if the court of the first instance ruled in favour of the taxpayer, this does not guarantee a similar outcome in the court of appeal or cassation. 

With this in mind, secure your protection through the monitoring of law and court practice, ensuring legal compliance on time, clearly understanding all the details of your position and your ability to sustain it if necessary. PwC Tax and Legal team is always here to support you even in the most challenging of situations.