On 21 May 2020, the President of Ukraine finally signed the Law of Ukraine "On Amendments to the Tax Code of Ukraine Purposed to Improve the Administration of Taxes, Eliminate Technical and Logical Inconsistencies in the Tax Legislation" ("Anti-BEPS Law").
On 23 May 2020, the Anti-BEPS Law became effective with certain provisions being phased out.
The Anti-BEPS Law introduces a number of fundamental novelties aimed at combating tax base erosion and profit shifting practices, improving transparency, tax compliance and administration, formally instituting the substance-over-form principle and other important anti-avoidance rules, generally modernizing the tax framework of Ukraine in vein with the OECD-driven initiatives. This new piece of tax legislation also fine-tunes numerous definitions, extends the range of penalized tax offences, and amends a large body of the Tax Code provisions that govern various taxes and procedures.
The new rules substantially alter the tax landscape for both Ukrainian individuals and legal entities as well as for non-residents that carry on business in Ukraine.
At the same time, with the Anti-BEPS Law being in force now, there are provisions that already call for the extension of their entry into force or elaboration thereof. Certain further legislative developments in this regard may be reasonably expected.
Separately, the President of Ukraine referred to the Cabinet of Ministers with a number of recommendations purposed to enhance the Anti-BEPS Law concerning, inter alia, the CFC Rules, protection of data reported by taxpayers and obtained from the foreign jurisdictions.
Key Tax Developments
Controlled Foreign Companies
► Effective 1 January 2021, the CFC Rules introduce taxation of income of controlled foreign entities ("CFCs") at the hands of Ukrainian "controlling" persons (individuals / companies).
► The CFC Rules will target Ukrainian individuals and companies with an ownership interest in a foreign entity of (i) more than 50%, or (ii) more than 10% (25% and more in 2021-2022) provided Ukrainian individuals (companies) jointly own a share 50% and more, or (iii) in case of established de facto control over a foreign entity.
► Notably, the CFC Rules also extend to arrangements that include foreign trusts, foundations and transparent entities, while granting certain exemptions for, say, irrevocable discretionary trusts.
► Ukrainian "controlling" persons would be responsible for, inter alia:
- annual reporting and taxation in Ukraine of undistributed CFC's income pro rata to their stakes in the CFC;
- annual reporting of existing CFCs, irrespective of whether there is any reportable income;
- control, as well as the establishment / liquidation of trusts or other transparent entities.de factoreporting of acquisition / alienation of shares in the CFCs or discharging other
► CFC's income would be out of Ukraine's tax scope if, inter alia, the total income for the reporting period of all CFCs of a taxpayer does not exceed EUR 2 million. At the same time, reporting obligations will remain in force regardless of an applicability of a CFC tax exemption.
► Otherwise, the undistributed income of CFCs would be subject to 18% Personal Income Tax ("PIT") at the level of Ukrainian "controlling" persons-individuals. In comparison, dividends distributed to private individuals would continue to be taxed at 9% PIT rate.
► Generally, Ukrainian individuals should also enjoy 5% PIT rate applicable to dividends distributed from Ukrainian companies to CFCs. Practical implementation of this novelty, however, remains to be established.
► Notably, the Anti-BEPS Law provides for a tax-free liquidation of CFCs effective until 31 December 2020 with no tax applicable to the liquidation proceeds. In addition, the value of such proceeds - if reinvested - creates cost basis for tax exemption of future capital distributions within immediate family members.
► However, with the Anti-BEPS Law being effective now, the provisions governing the tax-free liquidation already call for the timeline extension. We may, thus, reasonably expect some further legislative developments in this regard.
► The actual effect of the implementation of the CFC Rules will significantly depend on Ukraine joining the network of countries that automatically exchange tax and financial information. To this end, the Ukrainian Government committed to join the Common Reporting Standard (CRS) on automatic exchange of information on financial accounts by the end of 2020. The first exchange of information for 2020 is expected to take place in 2021.
► Importantly, as a part of the earlier FATCA implementation procedures, the applicable law was amended in December 2019 to include specific provisions on lifting bank secrecy, broaden reporting obligations and tighten mandatory KYC procedures for Ukrainian financial institutions, laying thereby grounds for a smoother introduction of the CRS rules.
► While being not a part of the Anti-BEPS Law, the CFC regime is expected to be complemented with the contemplated Voluntary Disclosure (Tax Amnesty) relief. Under the proposed Tax Amnesty Draft Law, Ukrainian tax residents would be pardoned for tax offences disclosed by such residents voluntarily. The disclosed qualifying income is proposed to be taxed at PIT rates varying from 2.5% to 10%.
► To this end, the President urged the Cabinet of Ministers to prepare and submit the Tax Amnesty Bill for the Parliament’s consideration within the next three months.
► Finally yet importantly, the introduction of the CFC regime does not contemplate the introduction of "balancing" Exit Tax or a similar tax regime.
Corporate Income Tax
► Earning Stripping Restriction: Presently, the restriction on deductibility of interest at 50 percent of EBITDA applies to debts owed to non-resident related parties provided the debt-to-equity ratio exceeds 3.5:1 (10:1 for financial institutions and leasing companies).
Effective 1 January 2021, the threshold of interest deductibility would (1) be lowered to 30 percent of EBITDA, (2) apply if a debt-to-equity ratio exceeds 3.5:1, and (3) extend to loans from any non-resident lender regardless of the "relation" status.
No earning stripping restriction, however, would apply to financial institutions and leasing companies.
► Business Purpose: Albeit the Tax Code of Ukraine formally permitted the tax office to probe transactions on the subject of their economic (business) purpose, in enforcement practice this legal tool lacked efficient application due to the absence of a clear-cut guidance and framework for the application thereof.
Effective as of 23 May 2020, the principle of "reasonable economic purpose (business purpose)" is considerably refined, suggesting its wide employment by the tax office while analyzing transactions. The new approach suggests that transactions with non-residents should be deemed to lack business purpose if, inter alia:
- the principal or one of the principal purposes of a transaction is found to be tax evasion or underpayment;
- under comparable conditions, a taxpayer would not be able to purchase/sell same services/works from/to an unrelated party.
Should the cross-border transaction fail to meet the reasonable economic purpose test, no deduction will be allowed in such a case. Should a transaction purpose be challenged, the burden of proof will rest with the tax office.
► Principal Purpose Test: Although the principal purpose test (PPT) - in line with the BEPS Action 6 - was introduced in the covered Ukraine's double tax treaties via the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS as of 1 January 2020, Ukraine resolved to transpose this concept into its domestic legislation.
Effective from 23 May 2020, Ukraine will be in a position to deny the application of double tax treaty benefits to transactions where it will be reasonable to conclude that "obtaining the benefit was one of the principal purposes" of the arrangement or transaction.
► Beneficial Owner: Effective from 23 May 2020, Ukraine amends the definition of "beneficial owner".
In particular, the recipient of an income should not qualify as the beneficial owner but rather as an agent, nominee or intermediary with respect to the income when:
- the recipient does not have the right to dispose such income; and/or
- the recipient merely forwards the income further along the chain and performs no substantial functions in the transaction; and/or
- the recipient has no relevant resources (personnel, fixed assets, sufficient equity, etc.) necessary to perform the functions and manage the risks of the transaction.
Moreover, effective from 23 May 2020, Ukraine introduces a "look through" approach to cases when there is a foreign intermediary between the Ukrainian payer and the foreign beneficial owner of the income. In brief, the tax benefits under the treaty with country of the intermediary’s residence should not apply. Instead, the tax treaty with the country of residence of the beneficial owner should govern. At present, the mechanism for the realization of this provision is yet to be clarified.
► Capital Gains: Previously, Ukraine had no effective legal mechanism to tax capital gains arising from the sale of real estate rich companies deriving their value from immovable property located in Ukraine. This will change effective 1 July 2020, with the introduction of a specific set of rules addressing such a transaction.
In particular, capital gains from the alienation of shares/participatory interest in a foreign company that directly or indirectly owns a Ukrainian real estate rich company would be subject to taxation in Ukraine, if for any period during the last 365 days:
- the foreign company's shares/participatory interest derive more than 50% of the value from the capital in the Ukrainian company; and
- more than 50% of the value of the Ukrainian company was generated by real estate located in Ukraine.
The non-resident buyer of the foreign company would be required to register with the Ukrainian tax office and withhold capital gains tax from the non-resident seller at the rate of 15%.
The tax base for calculating such a tax will be the positive difference between the sale value and the documented costs of acquiring such an asset borne by the non-resident seller. At the same time, if the non-resident seller fails to provide the non-resident buyer with documents confirming the acquisition costs, the full purchase value would constitute the tax base in such a case.
► Constructive Dividends: Earlier unknown in Ukraine, a new concept of "constructive dividends" will be introduced starting 1 January 2021.
Effectively, if the value of a transaction with designated counterparty - that is, foreign related entity or non-resident incorporated in a “low-tax” jurisdiction or fiscally transparent entity - were to be found to be not at "arm's length", the difference would be re-classified into dividends and taxed accordingly in Ukraine.
The same treatment would apply to cash or non-cash pay-outs by Ukrainian companies to non-resident shareholders in the case of (1) charter capital decrease, (2) shares buyouts, (3) shareholder's withdrawal from the company, (4) other similar transactions that effectively decrease the retained earnings of the Ukrainian company.
Personal Income Tax
► The Anti-BEPS Law specifically excludes investment profit, e.g., foreign-sourced capital gains, from the definition of income derived from foreign sources. This amendment allows private individuals to report and have taxed foreign-sourced capital gains on a net basis.
► The three-tier approach to the transfer-pricing documentation will be introduced in Ukraine: (i) Local File, Report on Controlled Transactions and Notice of Participation in an International Group of Companies, (ii) Master File and (iii) Country-by-Country Report ("CbCR").
► The tax office can request the Master File from the Ukrainian taxpayer, if consolidated annual revenue of the relevant international group of companies amounts to at least EUR 50 million. The Country-by-Country Report can be requested if (i) consolidated annual revenue of the relevant international group of companies exceeds EUR 750 million and (ii) the Ukrainian taxpayer is an ultimate parent entity or there is lack of effective CbCR exchange mechanism with a jurisdiction of an ultimate parent entity.
► Such changes affects multinational enterprises the most, for they will be ultimately required to comply with an additional set of rules, which may require allocation of additional professional resources.
► Separately, the threshold used for recognition of companies as related entities will increase from 20 to 25 percent.
► The vast majority of transfer pricing amendments shall enter into force on the next day following the official publication of the Anti-BEPS Law. At the same time, for example, the tax office will be in a position to request a Master File only for the financial year ending in 2021.
► Moreover, the Government of Ukraine has declared its intention to sign and implement into law the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports ("CbC MCAA") by the end of 2020. Once effective, the CbC MCAA would enable an automatic exchange of CbCR information.
► Effective from 23 May 2020, the definition of permanent establishment ("PE") was elaborated and detailed in line with the OECD's recommendation as per the BEPS Action 7.
► The key change concerns the methods of PE taxation, introducing the Authorized OECD Approach (AOA). The AOA suggests applying the transfer pricing methods for determining the profits that would be deemed earned by the PE as if it were an independent local company rendering / selling the same or similar services / goods on the same or similar terms.
► Harsh penalties are envisaged for carrying out business activities in Ukraine without formal tax registration as a PE.
► The royalty payable for production of:
- ferrous (except iron ore) and non-ferrous metals is increased to 6.25% (previously 5%);
- iron ore is increased to 12% if the mean price of iron ore per index IODEX 58% FE CFR China, as published by Platts, during the reporting period was ≥ USD 70, or to 11% if the mean price was below USD 70 (previously, the single rate of 8% applied).
► The list of natural resources and operations eligible for adjusting coefficients applicable to royalty rates was amended.
► The chart of royalty rates for production of timber resources was restructured to reduce the timber categories.
► The list of radio frequency bands, the use whereof is subject to royalties, was extended to include three additional bands.
► Wholesale suppliers of electricity power are now exempt from the excise tax.
► The definition of "excise tax payer - producer of electricity power" was fine-tuned.
► The excise tax will not apply to sale/transfer of electricity power within the single enterprise.
► The list of excisable goods was extended to include tobacco-carrying products designated for electric heating.
► Formally determined the terms "electronic cigarettes" and "liquids used in electronic cigarettes" and subjected such products to the excise tax.
► Mutual Agreement Procedure ("MAP"): The Anti-BEPS Law introduces a procedural mechanism enabling the Ukrainian tax office and the relevant foreign authority to resolve controversies regarding the application of provisions of the relevant double tax treaty. The MAP was also introduced in the covered Ukraine's double tax treaties via the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS.
► Tax Audits: the Anti-BEPS Law:
- grants the tax office additional authorities to enforce the permanent establishment rules on non-residents that fail to properly register while conducting business activities in Ukraine. The automatic registration and possible penalties are now available in the tax office's toolkit.
- extends the maximum tax audit period for the CFC, transfer pricing rules, and Payroll Taxes from 1095 days (three years) to 2555 days (seven years).
- effective 1 January 2021, introduces the concept of "guilt", a new essential element for the purposes of tax evasion offences and other tax incompliance matters. There are certain exceptions to this rule (e.g. sale of property that is under tax lien).
- places the burden of proof on the tax office in tax offence matters, obliging the latter to demonstrate that, in violation of the tax rules, the offender acted "unreasonably", "dishonestly", and with the lack of "due prudence", none of which concepts - each requiring to be proved - is much known as matter of present-day practice. Doubts, if any, should, as previously, be interpreted in taxpayer's favor.
- introduces the concept of "willful intent" which, if proved by the tax office, would qualify an offence by a taxpayer to a higher degree of financial liability.
- revamps the legal framework of electronic (virtual) cabinet of taxpayer, permitting to limit "human factor" in communication between the tax office and the taxpayer.
- enables - if requested by the tax payer which request can be called back once a year - the tax office to send documents, inter alia, notifications and tax assessment notices in electronic form to the taxpayer`s electronic (virtual) cabinets, which in such a case will be deemed to be duly delivered to the taxpayer.
- effective 1 January 2021, substantially expands the contents of the form of tax assessment notices;
- effective 1 January 2021, establishes a unified registry of tax assessment notices to provide up-to-date information regarding the status thereof.
- specifies that the "act" of tax audit should not per se be viewed as a legal ground for initiating criminal prosecution procedures.
- excludes a ruling of an investigative judge from the legal grounds for initiating unscheduled tax audits. At the same time, the tax office now has two new formal grounds for unscheduled auditing a taxpayer: (i) the receipt of information regarding tax offences from foreign official authorities, and (ii) the receipt of information of a non-resident conducting business activities in Ukraine without being formally registered as a PE.
► Tax Penalties: The Anti-BEPS Law also significantly extends the list of the existing tax penalties, widens their application, and revises some of the penalty rates as follows:
- CFC. Generally, penalties under the CFC Rules would include fines for the violation of the reporting obligations of Ukrainian "controlling" persons (e.g., non-submission of the CFC Report would result in a fine of 100 times of the subsistence level (to exemplify, based the subsistence level in 2020, the fine would be UAH 210,200 - c. USD 8,400)).
- Transfer Pricing. Transfer Pricing penalties are mainly supplemented by the fines for the violation of the requirements to the newly introduced types of the transfer-pricing documentation (e.g., non-submission of CbCR will be punishable by a fine of 1000 times of the subsistence level (to exemplify, based the subsistence level in 2020, the fine would be UAH 2,102,000 - c. USD 84,000)).
- Permanent Establishment. Presently, there are no financial penalties for non-resident entities conducting business in Ukraine without formal registration of a PE. Effective from 23 May 2020, failure to register a PE may result in the non-resident being fined for UAH 100,000 (c. USD 4,100).
Actions to consider
The enactment of the Anti-BEPS Law will significantly affect most international corporate structures as well as domestic companies. In light of the upcoming changes in taxation, you may wish to consider the following actions to mitigate possible transition stress:
- review your corporate structure and identify entities that may be recognized as CFCs in Ukraine;
- assess the soundness of the economic (business) purpose in your transactions with non-residents:
- test the "look-through" approach within your international corporate structures, financial or IP arrangements, management or services agreements, and assess the potential for corporate migration;
- prepare for new reporting obligations;
- review the current model of attribution and taxation of profits, if you have a PE in Ukraine, and adjust the model to address the new requirement to determine PE's profits under the "arm's length" principle;
- consider the tax efficiency of the existing structure and the potential for restructuring if necessary;
- assess contemplated restructuring against the novelties of the Anti-BEPS Law;
- assess the PE risks, if you act through a dependent agent or have individual contractors working in Ukraine;
consider establishing corporate presence to align your activities in Ukraine with the new tax rules.