The majority of the latest tax changes in Ukraine are based on the best tax experience throughout the world, especially on the BEPS Plan which Ukraine undertakes to implement. The Tax reform prescribes novelties to transfer pricing rules; new rules for preventing from double tax treaties abuse; new rules for preventing from avoidance of the status of permanent establishment and taxation of permanent establishments; etc.
It is still not clear how certain provision will work on practice and when such provisions will take effect. However, it is already clear that certain practices that the business used to take advantage of will not work anymore. Based on our experience the following areas of business activities will be definitely subject to close attention of the tax authorities.
Business relations with non-residents
1) It is highly recommended to make an internal audit of all economic transitions with non-residents, especially those related to payment for the services or for the goods if such activities are not subject to Transfer Pricing Rules.
From May 2020 all business transaction with non-residents shall have a “sound economic reason” otherwise Ukrainian company’s expenses will not be deductible for the tax purposes.
It is worth noting that if the main purpose of the transaction is optimizing tax burden or reduce the tax obligation than such transaction will not meet the “sound economic reason” principle. In this regard we advise to prepare the grounding proving existence of the economic reasons of the transaction in advance. Also it is advisable to review or even paraphrase the wordings of the agreements or change the price to avoid possible disputes with the tax office in the future.
2) Review the license, lease, loan or any other contracts with non-resident where the Ukrainian company pays passive income to non-resident (royalty, interests, dividends).
Tax reform changes the notion of the “beneficial owner” of the income as well as introduce the “principal purpose test” (PPT) of the business transaction with non- resident. PPT will apply only if the company would like to refer to Double Tax Treaty (DTT) with the foreign country and reduce the withholding tax rate (WHT). PPT is very similar to the “sound economic reason” principle and means that the reduced WHT will be denied if the main purpose of the transaction if avoid tax payment.
Also in order to apply to reduced WHT the non-resident recipient of the income shall be the beneficial owner of such income. It means that non-resident shall enjoy the full authority to dispose of the income, determine its future distribution and such authority shall not be limited by any contractual or non-contractual obligations. The following criteria will help to prove the beneficial status of the non-resident: a company has sufficient resources and personnel, it is not an intermediary, which transfers the obtained income to third parties, the non-resident bears significant risks, and it has no rights to use such income at its own discretion.
The good news is that Ukrainian company has the right to use the “look through” approach if it definitely knows that the non-resident contractor passes the receive income to another non-resident company. Such approach allows Ukrainian company to apply DDT with the real beneficial owner of the business that may also allow reducing WHT.
3) Analyze the business activity for risks of appearance of non-resident’ permanent establishment in Ukraine.
The new definition of the “non-resident permanent establishment” will substantially change the previous approach that is specifically relevant for the pharmaceutical, agro and IT industries. If Ukrainian subsidiary helps its parent non-resident company to promote its products in Ukraine and for example acts as a legal department of the parent company (review and approve the contracts with the Ukrainian customers) such activity may be treated as a permanent establishment of non-resident in Ukraine.
Another example is private entrepreneur IT specialist who develops software for non-resident with its further sale to Ukrainian customers. Such activity may also be treated as a permanent establishment.
However, it shall be noted that Tax Code of Ukraine does not prohibit the general commercial relations of Ukrainian companies with non-residents. Such activity is not necessarily leads to the permanent establishment of non-resident in Ukraine. In majority of cases, minor restructuring of the business model or paraphrasing of the contract with non-resident will help to avoid tax risks in the future.
For those pharmaceutical companies that have representative offices or permanent establishments in Ukraine, special attention shall be paid on the new rules of the profit calculation. As of May 2020 the profit of PE shall be calculated according to arm’s length principle and be taxed according to the general rules of the Tax Code.
4) Proper preparation for the tax audit.
New rules of the Tax code expand the rights of the tax inspectors, provides for new grounds of the tax audit and what is most important introduce the notion of “guilt” and “willful intent” to commit tax offence.
In certain cases it may be better for tax payer to reveal the tax violation by itself that will allow reducing the tax fine by 50% in comparison with the situation where such violation will be identified during the tax audit.
To prevent abusing by the tax inspectors of its rights during and tax audit and imposition of the fines we recommend preparing for the tax audit in advance and engaging the professional lawyer to the process at the stage of the inspection.
The aforementioned recommendation are the minimum practices that we may recommend business to implement in the course of preparation to the new tax rules. Tax reform introduce changes to many other aspects of the business activity that shall be taken into account depending of the type of business and industry.
Partner at GOLAW, Head of Tax practice, Restructuring, Claims and Recoveries practice, Attorney at law