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Partner, Head of Tax, Attorney-at-Law EVRIS Law Firm
Ukraine: International Taxation 2018
Ukraine is continually improving its domestic tax legislation so as to adequately respond to international tax challenges and increase the attractiveness of Ukraine to foreign investors and creditors. The Ukrainian Government intends to implement minimum BEPS standard in the near future. Automatic exchange of tax information, common reporting standard and country-by-country reporting are also under way.
In this article we have briefly summarized the most important Ukrainian tax implications pertaining to transactions involving foreign businesses.
The standard WHT rate in Ukraine is 15%. Reduced WHT rates apply to freight services (6%) and insurance premiums (0%, 4%, 12%).
Interest payable to foreign creditors resident in high-tax jurisdictions can be exempt from WHT provided that certain conditions are met. The conditions include placement of debt securities on designated stock exchanges to raise funding for Ukrainian borrowers and actual provision of loans by 31 December, 2018. Interest in respect of such loans extended after this date shall be subject to 5% WHT rate.
Ukrainian tax laws also provide for WHT exemption in relation to interest and income (discount) on state securities and municipal bonds, or debt securities secured by the state or municipal guarantees, other income payable by the Ministry of Finance in relation to state securities, as well as interest payable in relation to state or municipal loans envisaged in the State Budget, municipal budgets or National Bank of Ukraine’s estimate, as well as in relation to interest on loans extended to business entities and secured by the state or municipal guarantees.
Importantly, the Ministry of Finance of Ukraine intends to introduce a distributed capital tax replacing corporate income tax and withholding tax. If introduced, the distributed capital tax will be due on account of Ukrainian businesses. Accordingly, businesses would remit the full amounts of income due to foreign recipients without reduction of Ukrainian WHT.
Double Taxation Treaties
Ukraine is a party to over 70 double taxation treaties. The Ukrainian Government is working on improving existing taxation treaties and further expanding the DTT network. Specifically, amendments have been introduced to DTTs with the UK, Turkey and Cyprus. New DTTs with Luxembourg and Malta have been in force since 2018.
As a rule, WHT can be mitigated or even eliminated based on the applicable DTT. There is no need to pre-approve application of the DTT and reduced WHT rate with the Ukrainian authorities. A duly formalized tax residency certificate from the foreign income recipient serves as the basis for the Ukrainian paying company to apply the DTT.
As far as syndicated loans are concerned, Ukrainian borrowers are entitled to apply the DTTs with the jurisdictions of tax residence of participants of the syndicate of creditors irrespective of whether the interest is payable to them directly or via an agent.
The Ukrainian tax authorities are becoming more knowledgeable and sophisticated in challenging the WHT reduction or elimination based on DTTs. The beneficial owner and principal purpose test are currently the primary focus of their attention as far as royalties, interest and dividends payments are concerned. Therefore, international structures with companies lacking substance are no longer efficient and are likely to trigger the risk of material tax assessments.
Specific attention is also being paid to representative offices of foreign companies with a view to their re-classification into permanent establishments. There are, however, few attempts by the Ukrainian tax authorities to establish de-facto permanent establishments of foreign businesses in the absence of their registered presence or real estate in Ukraine.
Ukrainian transfer pricing rules follow the OECD TP guidelines.
Transactions by Ukrainian businesses with foreign related companies, companies registered and/or resident in low-tax jurisdictions specified in the relevant Government list, should be performed at arm’s length, provided that the TP thresholds are met. This rule also applies to transactions involving Ukrainian businesses with entities incorporated in specific organizational forms that are exempt from corporate income tax (corporate tax) and/or do not qualify as tax residents in the jurisdictions of their registration.
TP thresholds for 2018 are as follows:
— Total annual income of a Ukrainian company, being a party to a transaction with a foreign company/entity, should exceed UAH 150 million (circa EUR 4,483 thousand); and
— A transaction of a Ukrainian company with a specific foreign company/entity exceeds UAH 10 million (circa EUR 299,000).
From 2018 transactions between foreign companies and their Ukrainian permanent establishments reaching UAH 10 million (circa EUR 299,000) are also subject to TP rules.
Ukrainian businesses are required to maintain transfer pricing documentation in relation to transactions controlled for TP purposes and file annual transfer pricing reports before October 1 of the year following the reporting year.
There is currently no established tax jurisprudence on the substance of transfer pricing disputes. The majority of TP-related disputes boil down to qualification of transactions as subject to TP rules and obligation of the taxpayer to submit TP reports or provide TP documentation to the tax authorities. Only a limited number of TP disputes relate to challenging the TP methods applied by taxpayers and/or correctness of application of selected methods. However, given the increasing number of TP audits, the number of such disputes is likely to increase in the near future. If the distributed capital tax is introduced, TP assessments are likely to become one of the primary sources of collecting the tax for the State Budget.
There are no CFC rules in Ukraine. However, there is a draft law on this topic. We do not expect this draft law to be voted on by the Ukrainian Parliament in 2018.
Gains realized by foreign investors upon disposal of shares in Ukrainian companies are subject to 15% WHT. This WHT can be eliminated based on the majority of DTTs, provided that the shares do not derive the greater part of their value from real estate located in Ukraine. DTT with Cyprus still provides for tax exemption with respect of gains received on such shares.
The Tax Code of Ukraine provides for a 20% tax due upon remittance of service fees for production and/or placement of advertising to foreign service providers. This tax is not withheld from the service fees due to foreign recipients and is payable by Ukrainian businesses at their expense. It can be argued that this tax does not comply with non-discrimination clauses of DTTs and there are tax jurisprudence positives for taxpayers on this matter.
The tax base for Ukrainian corporate income tax is determined as profits based on the financial statements of taxpayers adjusted for tax differences. Formally, there are no CIT deductibility limitations as such. However, certain expenses increase the tax base, thus making specific payments effectively non-deductible. In this article under “non-deductible” or “disallowed for deduction” we mean expenses increasing the CIT base.
Specifically, 30% of the cost of goods and/or services purchased from foreign companies / entities registered or resident in low-tax jurisdictions included into the Government’s list are disallowed for deduction. The same relates to transactions with entities incorporated in the specific organizational forms that are exempt from corporate income tax (corporate tax) and/or do not qualify as tax residents in the jurisdictions of their registration.
Royalties payable to foreign recipients in excess of 4% of net income of a Ukrainian company (except for TV and radio companies) for the previous reporting year are also disallowed for deduction.
The above-mentioned limitations can be side-stepped if the transactions are made at arm’s length, as supported by the relevant transfer pricing documentation.
However, in certain cases, royalties payable to foreign companies are disallowed for deduction in full. For example, royalties are non-deductible in full if:
— paid to a foreign recipient other than the beneficial owner of such royalties (except for royalties payable for audiovisual content), unless the beneficial owner granted the right to third parties for them to receive royalties;
— paid to a foreign recipient in respect of intellectual property initially registered to a Ukrainian resident;
— the recipient of royalties is not subject to tax in respect of the royalties received from a Ukrainian company.
If the debt-to-equity ratio of a Ukrainian company in relation to loans from foreign related companies exceeds 3.5:1 (10:1 for financial institutions and leasing companies), interest in excess of 50% of profits, financial expenses and depreciation for the relevant reporting period is disallowed for deduction for corporate income tax purposes. Such interest can be deducted (reduce the CIT base) in subsequent periods subject to the same limitation. The non-deducted portion of interest that can be potentially deducted in subsequent periods (subject to thin capitalization limitation) is reduced by 5% per annum.
To sum up, Ukrainian national tax laws provide for a set of specific tax rules to be observed as far as transactions with foreign businesses are concerned. Historically, transactions involving Ukrainian businesses with foreign companies have always been in the focus of the Ukrainian tax authorities. Internationally-known tax disputes in relation to application of double taxation treaties and international transfer pricing assessments encourage the Ukrainian tax authorities to apply the same fiscal principles during tax audits of Ukrainian companies. Given this, treaty shopping and use of foreign structures lacking substance are likely to result in material tax assessments. Special attention should be paid to the correct tax structuring of transactions with foreign business partners and subsequent application of double taxation treaties, transfer pricing rules and so-called deductibility limitations.