Significant Ukrainian tax changes for multinational companies
23/10/20
In brief
The new laws introducing significant changes in the area of international taxation and transfer pricing (TP) mostly related to the implementation of some BEPS Initiatives into Ukrainian tax legislation, entered into force.
A variety of new concepts, terms and obligations await Ukrainian businesses and Multinational Enterprises (“MNEs”). Existing financing/corporate structures may appear inefficient under the new rules. Non-compliance might result in material fines for the businesses.
The takeaway
For MNEs and Groups that have business in/with Ukraine it is advisable to adopt immediate measures to ensure compliance with the new rules and still retain the efficiency of the business:
- Make an assessment of the current corporate structures to conclude whether they comply with the new tax law and remain efficient;
- Identify if the activities of the Group create any taxable presence in Ukraine (either through a Permanent Establishment or PoEM) and take possible mitigation measures;
- Assess whether all transactions have a business purpose, i.e. are aimed at receiving certain economic benefits;
- Assess whether the Group can enjoy double-tax treaty benefits under the new rules and prepare a defense file, if needed;
- Identify if there is any Ukrainian controlling person in the Group (either an individual, tax resident of Ukraine, or a Ukrainian legal entity) and there are any controlled foreign companies (“CFCs”) subject to reporting and taxation in Ukraine at the level of such a controlling person, assess the related tax implications and assist in ensure compliance;
- Develop the transfer pricing (“TP”) policy for commodities, as well as for calculating the permanent establishment(s)’ (“PEs”) income, which corresponds with the arm's length principle;
- Appoint a person responsible for the gathering and preparation of the information to comply with the new TP reporting requirements.
For a deeper understanding of how this issue might affect your business, please contact our Ukrainian office.
In detail
- Taxation of controlled foreign companies (CFC)
- Application of double tax treaties (BO, PPT, LTA)
- Capital gain from the alienation of corporate rights
- Taxation of permanent establishments (PE)
- Dividend and deemed dividend payments
- Place of effective management (PoEM)
- Changes to the “thin capitalisation” rule
- Three-tiered TP documentation
- Justification of business purpose
- Transferring functions abroad
- New TP rules for commodities
Taxation of controlled foreign companies (CFC)
Law #466 introduces CFC rules into the Tax Code: a Ukraine resident company/individual may be taxed on a proportion of the profits of certain foreign entities that are owned or controlled by such Ukrainian residents. The profits of a CFC are included into the taxable income of the controlling person and are taxed at standard income tax rates. There are specific tax rates for individuals.
An entity is deemed to be a CFC if it is not a Ukrainian resident for tax purposes or PE in Ukraine, but it is controlled by a Ukrainian tax resident. Foreign establishments without the status of a legal entity (such as partnerships, trusts, funds, foundations, etc.) are also equated to such an entity for CFC purposes.
A controlling person of a foreign company is a person who
- holds a share of more than 50%, or
- owns more than 10% (25% for years of 2021 and 2022), provided other Ukrainian residents hold 50% and more of shares, or
- exercises actual control over the foreign company.
Control is determined based on an ownership share and other criteria and may be established directly or through a chain of indirect ownership.
The Law provides for specific rules and adjustments for calculating a CFC’s taxable profits. It must be apportioned among the Ukrainian controlling persons in proportion to their interest(s) in the CFC. The profits of the CFC may be exempt from taxation in Ukraine if certain criteria are met.
The CFC rules in Ukraine come into force on 1 January 2021.The first report should be submitted in 2022 for the year of 2021.
Application of double tax treaties (BO, PPT, LTA)
Similarly to the provisions of the Multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting (“MLI”), the Tax Code of Ukraine requires the application of the principal purpose test (“PPT”) to transactions with non-residents. The tax benefits provided by the relevant double tax treaty (“DTT”) will not apply if the principal purpose of the relevant business transaction with a non-resident was to directly or indirectly obtain that benefit.
The concept of the beneficial owner of income was amended. A legal entity or individual will not be regarded a beneficial owner of income, but rather an agent for such income if such person, for example:
- does not have enough authority to use and dispose of such income;
- transfers the received income or most of it to another person;
- is only a formal recipient of income, etc.
The possibility of applying the “look-through approach” was introduced. Ukrainian taxpayers could apply the provisions of DTT with a country whose resident is the beneficial owner of income, and not with a country whose resident directly receives payment.
These provisions became effective from 23 May 2020.
Capital gain from the alienation of corporate rights
Starting 1 July 2020, indirect alienation of corporate rights, shares, stakes or other similar corporate rights in a Ukrainian company by a non-resident shall be subject to 15% withholding tax in case:
- at least 50% of the value of the non-resident company being sold by another non-resident consists of corporate rights in the Ukrainian company at any moment during the 365 days before alienation, and
- at least 50% of the Ukrainian company’s value consists of real estate located in Ukraine at any moment during the 365 days before alienation.
Starting 8 August 2020, direct alienation of corporate rights, shares, stakes or other similar rights of a Ukrainian company by a non-resident shall be also subject to 15% withholding tax if at least 50% of the Ukrainian company’s value consists of real estate located in Ukraine at any moment during the 365 days before alienation.
Taxation of permanent establishments (PE)
The concept of PE was clarified and expanded to follow the PE definition from the OECD Model Tax Convention, but with a stronger agency test.
Other changes include: the broadening of anti-fragmentation rules and definition of dependent agent, as well as conferring more powers to the tax authorities. In case the non-resident performs activities on the territory of Ukraine without registration, the tax authorities now have the right to initiate a tax audit of this activity and make the mandatory registration of a PE (if that is the case).
Now, all PEs should calculate their taxable income in accordance with the “arm’s length principle”; other options were cancelled. TP analysis and developing a methodology for calculating the PE’s income will be required.
Passive income paid by a PE will be treated as income with the source from Ukraine.
These provisions became effective from 23 May 2020.
Dividend and deemed dividend payments
Starting from 1 January 2021, the concept of dividends will be expanded.The following transactions will be treated as deemed dividends:
- payment of dividends in non-monetary form;
- payments to the non-resident founder or participant in a Ukrainian company that decrease the retained earnings of the Ukrainian company, and are made in connection with:
- reduction of the Ukrainian company’s charter capital;
- redemption by the Ukrainian company of its corporate rights;
- withdrawal of a participant from the membership of a Ukrainian company;
- transactions with a non-resident related party and/ or resident of so-called “low-tax” jurisdictions and/ or non-residents who do not pay corporate profit tax on the amount of the:
- payment for securities and corporate rights in controlled transactions in excess of the the "arm’s length" principle;
- understatement or overstatement of the goods’ (works, services) value in controlled transactions compared the "arm’s length".
These payments will be subject to 15% Ukrainian withholding tax, unless otherwise provided by the relevant double tax treaty.
Place of effective management (PoEM)
From 1 January 2021, foreign legal entities which have an effective management in Ukraine, must pay corporate income tax in Ukraine on a general basis.
Ukraine should be treated as a PoEM of a foreign company if (i) bank accounts of a foreign entity are controlled from Ukraine, (ii) financial or managerial accounting, as well as (iii) personnel management are conducted in Ukraine.
The Tax Code contains a list of indicators of an effective management, including meetings of the executive body, making managerial decisions and performing actual control over the foreign entity, etc. The rule applies even if persons effectively managing an entity are not legally empowered for such actions.
Changes to the “thin capitalisation” rule
The Law No. 466 amended thin capitalisation rule. The ratio of debt to equity remains the same as now (3.5:1), but the debt should be calculated taking into account the liabilities before all non-residents, not only related non-residents, as was previously the case. Also, the calculation of tax differences and other aspects of the rule were changed.
The thin capitalisation rule will no longer apply to financial institutions and companies engaged exclusively in leasing activities.
The provisions come into force on 1 January 2021.
Three-tiered TP documentation
The core changes in TP are the implementation of a three-tiered approach to TP documentation for taxpayers with intercompany transactions, which are subject to TP control from the Ukrainian perspective, namely a Master file (further – “MF”), Local file (further – “LF”) and country-by-country report (further – “CbCR”).
The implementation of three-tiered TP documentation is associated with the following requirements for the Group members:
- Submission of a notification of participation in an international group of companies (further – “IGC”) by 1 October of the year following the reporting year. The first time a notification in IGC must be submitted no later than 1 October 2021 for the 2020 reporting year;
- Submission of the CbCR for the Group having a total consolidated group revenue of more than EUR 750 million during the fiscal year preceding the reporting fiscal year. The requirement is firstly applied to the financial year ending in 2021, but not earlier than the year in which the competent authorities joined the multilateral agreement on the automatic exchange of interstate reports (Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports). At this stage, there is no clarity when the Ukrainian authorities expect to join this agreement;
- Preparation of a MF – has to be submitted within 90 calendar days upon the request of the tax authorities in case the IGC's revenue exceeds EUR 50 million. The requirement is first applied to the reporting period 2021.
The list of penalties is extended. The penalties for non-compliance are as follows:
- for failing to submit a notification on participation in an IGC, 50 subsistence minimum wages (further – “SM”) (approx. USD 3,800);
- for failing to submit a CbCR, 1000 SM (approx. USD 75,000).
Furthermore, penalties are stipulated for providing inaccurate information in the CbCR and the notification on participation in an IGC.
Justification of business purpose
The application of the concept of "business purpose" to the corporate profit tax and TP was introduced. The TP documentation should contain a justification of the economic benefits resulting from the controlled transaction on charges related to service fees, intangible assets (including licences) and financing). Any expenses incurred in transactions with non-residents which do not have a business purpose (economic benefit) are disallowed.
The provision became effective from 23 May 2020.
Transferring functions abroad
The definition of business transactions for TP purposes is extended. The transfer of functions abroad without compensation can be a taxable event if they reduce the amount of income and / or profit of the taxpayer.
The provision became effective from 23 May 2020.
New TP rules for commodities
The new concept of quoted prices has been implemented into the Ukrainian TP rules. The taxpayer has an option to use the recommended list of sources of information for quoted prices for the application of the comparable uncontrolled price (CUP) method. The Cabinet of Ministers of Ukraine is responsible for the publishing of the mentioned list. At the moment, there is no available officially published list with quoted prices. As that, there is no clear roadmap available for the taxpayer. In this regard, we recommend developing and documenting the TP policy based on new rules to mitigate the risk of challenges from the tax authorities.
The provision became effective from 23 May 2020.
