On 23 May 2020, 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“) became effective with certain provisions being phased out.
At the same time, certain provisions of the Anti-BEPS Law have called for the extension of their entry into force or elaboration thereof.
To this end, on 14 July 2020, the Parliament of Ukraine passed Law of Ukraine No. 786-IX “On Amendments to the Tax Code of Ukraine with respect to Functioning of the Electronic Cabinet and Simplification of Work of Private Entrepreneurs”, which entered into force on 8 August 2020.
In addition, on 17 December 2020, the Parliament of Ukraine adopted the Law of Ukraine “On Amendments to the Tax Code of Ukraine and Other Laws of Ukraine to Ensure the Collection of Data and Information Required for Reporting of Certain Income Subject to Taxation” (“Amending Law“).
On 1 January 2021, the Amending Law became effective.
With the Amending Law being largely aimed at extending the entry into force or elaboration of the Anti-BEPS Law provisions, it prescribes that:
- The CFC rules are delayed and would enter into force on 1 January 2022.
- The enhanced permanent establishment rules would apply starting from 1 January 2021.
- The application of the Business Purpose Test is delayed until 1 January 2022 and limited to (i) transactions with non-residents from low-tax jurisdictions and non-resident fiscally transparent entities, and (ii) payment of royalties to non-residents.
- Effective 1 January 2021, the mechanism of taxation of capital gains arising from the offshore sale of real estate rich companies deriving their value from immovable property located in Ukraine is amended with the view to taking into account the recognition of Ukrainian real estate as assets.
In more detail
Controlled Foreign Companies
- The CFC Rules, which introduce taxation of income of controlled foreign entities (“CFCs”) at the hands of Ukrainian “controlling” persons (individuals / companies), would enter into force on 1 January 2022.
- 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 2022-2023) provided Ukrainian individuals (companies) jointly own a share of 50% and more, or (iii) in case of established de facto control over a foreign entity.
- 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;
- reporting of acquisition / alienation of shares in the CFCs or discharging other de facto control, as well as the establishment / liquidation of trusts or other transparent entities.
- 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;
- CFC is a public company listed on a recognized stock exchange. In this connection, on 16 December 2020, the Cabinet of Ministers of Ukraine adopted the list of recognized stock exchanges.
- CFC is a charity organization, which does not distribute profits; or
- CFC is a resident of a jurisdiction, which Ukraine has a double tax treaty with, and CFC pays Corporate Income Tax at the effective tax rate of 13% or more or CFC’s passive income constitutes 50% or less.
- At the same time, reporting obligations will remain regardless of an applicability of a CFC tax exemption.
- The first CFC reporting period would be 2022. At the same time, Ukrainian “controlling” persons would be allowed to file the CFC report for 2022 along with their income tax return for 2023.
- Notably, the Amending Law elaborates the rules for a tax-free liquidation of CFCs, namely:
- The tax-free liquidation would be effective until 31 December 2021 with no Personal Income Tax applicable to the liquidation proceeds, including those obtained through the nominal shareholders.
- The tax-free liquidation would not apply to CFCs established after 23 May 2020.
- Despite the Amending Law being initially aimed at exempting the liquidation proceeds from 1.5% Military Tax, such a provision was not sustained in the course of the oral debates on the Parliament’s floor.
- According to the Anti-BEPS Law, 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.
- The Amending Law postpones the application of the enhanced PE rules until 1 January 2021.
- Non-residents carrying out business activities in Ukraine through a non-registered PE must register such a PE with the tax office by 1 April 2021.
Corporate Income Tax
- Business Purpose. The application of the Business Purpose Test would be restricted to:
- transactions with non-residents from low-tax jurisdictions and non-resident fiscally transparent entities; and
- payment of royalties to non-residents.
The Amending Law delays the application of the Business Purpose Test until 1 January 2022.
- Earning Stripping Restriction. Effective 1 January 2021, the restriction on deductibility of interest at 30 percent of EBITDA would apply to debts owed to non-residents provided the debt-to-equity ratio exceeds 3.5:1.
No earning stripping restriction, however, would apply to (i) financial institutions and leasing companies and (ii) loans obtained from international financial institutions and foreign banks.
- Place of effective management. The application of the concept of a place of effective management concept, which allows foreign legal entity to be considered a tax resident of Ukraine if the place of effective management of such an entity is established to be in Ukraine, would be delayed until 1 January 2022.
- Capital Gains. Effective 1 January 2021, a set of rules addressing the sale of real estate rich companies deriving their value from immovable property located in Ukraine would be amended.
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 50% or more of the value from the capital in the Ukrainian company; and
- 50% or more of the value of the Ukrainian company was generated by real estate located in Ukraine, either owned or used under a long-term lease, financial lease, or similar agreement. In this connection, such a use should be recognized as an “asset” by the Ukrainian company, including the “right-of-use asset”, under the Ukrainian national accounting standards or the International Financial Reporting Standards.
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 nonresident 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.
- Tax Audits. The Amending Law limits the maximum tax audit period for the payroll taxes from 2555 days (seven years) to 1095 days (three years)
Actions to consider
The Anti-BEPS developments will significantly affect most international corporate structures as well as domestic companies. In light of the already effective and 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;
- assess contemplated restructuring against the novelties of the Anti-BEPS Law;
- assess the soundness of the business purpose in your transactions with non-residents;
- 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.