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Partner, Attorney-at-Law, Arzinger
Changes in the Foreign Trading Structures of Ukrainian Business Due to TP Amendments
In recent years it has become a tradition in Ukraine to adopt significant amendments to tax laws at the very end of the year and, what is more, to make such amendments effective right at the start of the coming year. The year 2016 was no exception. In particular, the rules of the Tax Code of Ukraine regulating transfer pricing were substantially modified, which, in our opinion will have a major impact on the trading structures traditionally utilized by Ukrainian companies.
The aim of this article is not to analyze the adjustments to the methods of determination of the arm’s length price of transactions; rather the purpose is to study the amended list of controlled transactions and to define the potential impact of recent (and anticipated) amendments in transfer pricing regulations on the trading structures of Ukrainian businesses.
Previous and Present Regulations
Before 1 January 2017 the list of controlled transactions included the following:
1) transactions with related non-residents;
2) foreign economic transactions on the sale of goods with the use of non-resident commissionaires;
3) transactions with non-residents registered in so-called low-tax jurisdictions.
The list of low-tax jurisdictions was approved by the Government of Ukraine based on either of: a) the general corporate tax rate in such jurisdiction being five percentage points or more below the corporate tax rate in Ukraine; and/or b) such jurisdiction has not concluded an international treaty with provisions on exchange of tax information with Ukraine.
Furthermore, a transaction has not been recognized as controlled if the following criteria have not been simultaneously met: a) the total annual income of Ukrainian taxpayer has exceeded UAH 50 million (about EUR 1.7 million); and b) the total volume of the above transactions with one such non-resident party has exceeded UAH 5 million (around EUR 170,000).
Starting from 1 January 2017 the above thresholds were increased to UAH 150 million (close to EUR 5.1 million) and UAH 10 million (approx. EUR 340,000), respectively.
Moreover, the list of controlled transactions has been altered and supplemented. At the same time, the list does now include the following transactions:
1) transactions with related non-residents;
2) foreign economic transactions on the sale and/or purchase of goods and/or services with the use of non-resident commissionaires. Thus, any transaction involving the sale or purchase of goods or services is considered as controlled by itself if performed through a non-resident commissionaire, irrespective of whether or not such commissionaire or another party to a transaction is a related party or a resident of a low-tax jurisdiction;
3) transactions with non-residents registered in low-tax jurisdictions. The criteria to put a jurisdiction into the “low-tax list” have been supplemented with the following: a jurisdiction, the competitive authorities of which do not provide a full and timely exchange of tax and financial information upon queries from the Ukrainian tax authorities;
4) transactions with non-residents of Ukraine which do not pay taxes in jurisdictions of their residence (including from income obtained abroad) and/or which are not tax residents in the jurisdiction where they are registered as legal entities. Oddly enough the Government of Ukraine should issue a list of legal forms of such entities by each jurisdiction and not the list of instances where this criterion should be taken into account (where a purpose to avoid paying taxes exists).
Potential Recognition of High-Tax Jurisdictions as Low-Tax to Qualify Transactions as Controlled
Recent amendments show that the purpose of the Government of Ukraine was to exclude relevantly small Ukrainian companies from the burden of preparation and submission of transfer pricing documentation; at the same time, the Government has broadened the base. It has determined as controlled the transactions which are used, or could be used, to avoid transfer pricing requirements. However, the extension of the list of such transactions must have been carried out with consideration not to catch the completely lawful economically substantiated structures and not to place an unjustifiable TP burden thereon.
In particular, inclusion of such a ground for the Government of Ukraine to recognize a low-tax jurisdiction as non-cooperation in exchange for tax and financial information with Ukraine seems rather hasty. The reasons why many jurisdictions (including countries like the Netherlands, UK and Switzerland) do not provide tax information to Ukraine is either due to groundless queries by the Ukrainian tax authorities and/or inability of Ukraine to ensure safe storage and confidentiality of the data received. It is also unclear how many denials to provide respective information or untimely/inaccurately provision thereof must be considered by Ukrainian tax authorities to recognize the jurisdiction as non-cooperative and low-tax — hence such discretion on the part of the Government to decide on the list of jurisdictions seems unreasonable.
What is more, following Ukraine joining the automatic exchange of financial information based on the common reporting standard certain jurisdictions might expressly refuse to exchange financial information with Ukraine on the reasons envisaged by the CRS. Would this be grounds for the Government to recognize a really high-tax jurisdiction (e.g. Austria) as a low-tax one?
In any case, the good news is that transactions with the resident of such jurisdiction will be considered controlled only starting from 1 January of the year following the year when the respective jurisdiction is recognized as low-tax. Hence, tax planning opportunities due to the extension of the described criterion are narrowed but not eliminated.
Highly Suspicious Counterparties for the Purpose of Recognition Transactions as Controlled
The new criterion for the purpose of qualification of transactions as controlled implies that a non-resident counterparty is either not resident in the jurisdiction of its registration or it does not pay taxes in the jurisdiction of its residence. It seems that Ukraine treats such non-residents as suspicious, meaning that transactions with them are more likely to be used for the purpose of tax avoidance. However, there are some thoughts on why establishment of this criterion has been too rather a hasty decision.
First of all, transfer of residence is a completely normal adequate procedure which is allowed by laws of many jurisdictions and which is usually carried out mainly for commercial reasons and not for the sole purpose of tax avoidance. Of course, tax considerations are always taken into account when transferring tax residence but again when the tax planning is not its sole or its main purpose there is nothing illegal about following the procedure for changing the tax residence established by the laws of respective jurisdictions.
The analyzed provision could entail a situation when a law-abiding company resident of a respectable jurisdiction (even though primarily registered in another jurisdiction) paying taxes in such jurisdiction will be deemed suspicious by Ukraine and will, therefore, cause its Ukrainian counterparty to fall under the TP regime.
Secondly, the mere fact that a company does not pay taxes in the country of its tax residence does not by itself mean that such a company is established (and transactions are carried out with it) for the purpose of tax evasion.
Upon close examination of the wording of the analyzed provision, we can conclude that this criterion refers to non-payment of taxes in general irrespective of the presence of income whatsoever. Therefore, a wide approach to interpretation of this wording could allow Ukrainian tax authorities to bring under this provision (to recognize a transaction as controlled) any company which does not pay taxes (including companies which have obtained no income in the reporting period). Special attention should be given to the part of the analyzed provision referring to non-payment of taxes from income sourced outside of the jurisdiction of residence of such a company. We believe it to be a very controversial decision to consider as suspicious the residents of jurisdictions with a territorial system of taxation.
Taking into account the above conclusions and suggestions, we believe that a new criterion which is aimed at recognizing as controlled transactions with non-resident companies considered suspicious by Ukraine, might not work properly in practice. Inaccuracies in the wording of the criterion, as well as the large discretionary powers held by the Government to establish a list of organizational forms of non-resident companies (and the need for such a list is very debatable in principle) and of the tax authorities could lead to the recognition as controlled of transactions performed by fully independent companies with the necessary level of substance and other attributes of businesses that do actually operate.
Apart from the newly-adopted TP regulations, further amendments to the transfer pricing rules are anticipated. In particular, the following measures could be implemented in Ukraine:
— introduction of the obligation to submit country-by-country reports in Ukraine as well as group master files;
— imposition of rules on disclosure of information on taxpayers’ related parties involved in the sale of goods chains (up to the first unrelated counterparty);
— imposition of special rules for intra-group services rendered within a group as well as some other measures.
In view of the stated, the “anti-BEPS” Draft law amending the tax laws of Ukraine is expected to be adopted by the end of 2017, and its main provisions will come into operation no earlier than 2018 (except for certain urgent measures). However, no specific time frame has yet been announced by Parliament or the Government.