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Ukraine: The tax office insists that a EUR 2 million CFC exemption threshold applies to revenues, not profits

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In brief

On 1 January 2022, the CFC rules became effective in Ukraine. For the novelty of the concept and the imperfections of the underlying legislation, many provisions of the applicable CFC rules call for clarification, elaboration, or further guidance.

In this context, on 2 May 2023, the Parliament of Ukraine passed – in the first (of typically two) readings – Bill No. 8137 “On Amendments to the Tax Code of Ukraine with respect to Enhancement of the Taxation of Controlled Foreign Companies” (“Amending Bill“), aimed at addressing most pressing issues pertaining to the application and interpretation of the CFC rules. Since then, however, the Amending Bill has seen very little progress.

Rather, with its Information Letter No. 3/2024 of 17 April 2024 (“Letter“), the State Tax Service of Ukraine offered its guidance as regards the application of some of the CFC rules. The Letter is being issued in less than two weeks before the CFC reporting deadline.

Key takeaways

With the Letter being largely aimed at offering guidance on the CFC rules provisions, it prescribes that:

  • The CFC’s financial statements are not required to be translated to Ukrainian, apostilled, or otherwise legalized in a foreign jurisdiction.
  • The EUR 2 million threshold for the CFC tax exemption should apply to CFCs’ revenues rather than profits.
  • Ukrainian “controlling” persons should not be subject to penalties for the late reporting of acquisition/alienation of shares in the CFCs.

In more detail

Controlled Foreign Companies

  • The CFC rules, which introduce taxation of income of controlled foreign companies (CFCs) at the hands of Ukrainian “controlling” persons (individuals/companies), entered into force on 1 January 2022.
  • The CFC rules 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 are responsible for, inter alia:
    • Annual reporting of, and paying tax in Ukraine on, 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 not be subject to tax in Ukraine if, inter alia:
    • “The total comprehensive 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.
    • CFC is a charity organization, which does not distribute profits.
    • 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 remain intact even if CFC’s income is exempt from taxation in Ukraine.
  • The first CFC reporting period was 2022. At the same time, Ukrainian “controlling” persons were allowed to file the CFC report for 2022 along with their income tax return for 2023.
  • Ukrainian individuals-“controlling” persons shall file the 2023 income tax returns by 1 May 2024.

Amending Bill

  • Reporting of existing CFCs would be shifted to a second year following the reporting one.
  • The company’s CFC status would be determined as of 31 December of the reporting year.
  • The ownership threshold would be amended. The CFC Rules would target Ukrainian individuals and companies with an ownership interest in a foreign entity of (i) 50% and more, or (ii) 10% and more 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.
  • A Ukrainian “controlling” person is currently deemed to own a share in the CFC if his/her related parties own such share. The list of related parties would be amended and limited to a spouse, a minor child, and a ward.
  • The rules for the calculation of the Ukrainian “controlling” person’s indirectly owned share in the CFC would be amended and clarified.
  • The rules for the accounting and reporting of CFCs’ transactions with securities would be amended and clarified.
  • The restriction on deductibility of interest (Earning Stripping Restriction) at the CFC’s level would be amended and clarified.
  • The EUR 2 million threshold for the CFC tax exemption would be amended from the total comprehensive income to a net revenue.
  • The immediate taxation of CFC’s dividends derived from its Ukrainian subsidiaries (so-called look-through dividends) at the level of the Ukrainian “controlling” person would be abolished.

Tax Office’s Guidance

  • Notably, the Letter elaborates on the tax office’s interpretation of the CFC rules, namely:
    • Ukrainian “controlling” persons are responsible for annual reporting of existing CFCs and filing the financial statements of their CFCs to the tax office.
      The tax office confirmed that they would not expect such financial statements to be translated to Ukrainian, apostilled, or otherwise legalized in a foreign jurisdiction.
    • Under the Tax Code, the CFC tax exemption is available to a taxpayer, so long as QUOTE the total comprehensive income UNQUOTE for the reporting period of all his/her CFCs does not exceed EUR 2 million.
      The tax office has expressed a rather fiscal position insisting that the total comprehensive income should be understood to be a CFCs’ revenue.
      While this interpretation is being proposed to be made into law through the Amending Bill, until the latter is voted into law, however, there are strong reservations to such approach, given the interpretation of the “total comprehensive income” definition under the International Financial Reporting Standards and/or the National (Ukrainian) Accounting Standards.
    • As noted, Ukrainian “controlling” persons are responsible for reporting of acquisition/alienation of shares in the CFCs within 60 days.
      The tax office confirmed that the taxpayers should not be penalized for the late filing of such notices.
    • Ukrainian “controlling” persons who relocated abroad and acquired foreign tax residence shall remain responsible for reporting their CFCs in the periods when they still were tax residents of Ukraine.
    • In the event of CFC tax exemption being applied, Ukrainian “controlling” persons shall still disclose their CFCs’ transactions with related parties, non-residents from low-tax jurisdictions, and non-resident fiscally transparent entities.

Actions to consider

The CFC rules significantly affect most international corporate structures as well as available structuring alternatives. 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, identify CFCs, which are subject to Corporate Income Tax, and assess the feasibility of crediting corporate taxes paid by CFCs against Personal Income Tax obligations of the Ukrainian “controlling” person.
  • Assess the soundness of the business purpose in your CFCs transactions with non-residents.
  • Consider the tax efficiency of the existing structure and the potential for restructuring.
  • Assess functions and economic substance of your CFCs.
  • Consider changing the tax residence of your foreign companies to Ukraine with the view to avoiding their qualification as CFCs.
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Author

Hennadiy Voytsitskyi heads Baker McKenzie's Tax Practice Group in Kyiv, which was named Ukraine Tax Law Firm at the International Tax Review's 2016 European Tax Awards. He has more than 20 years of experience practicing in Ukrainian and international tax law. Mr. Voytsitskyi is named among the best legal professionals by Legal Experts Europe, Middle East & Africa 2012-2015, one of the leading practitioners of tax law by Legal 500 Europe, Middle East & Africa 2011-2015, and among the Leading Individuals 2012-2015 Band 2 according to the Chambers Europe 2012-2015. He is among the top 100 tax lawyers in Ukraine according to Client's Choice 2010-2015, based on a Yurydychna Gazeta survey of in-house counsel from 2,000 major companies in Ukraine. Mr. Voytsitskyi participated in a working group led by the National Bank of Ukraine on development of draft legislation for the introduction of controlled foreign companies and implementation of BEPS Actions.

Author

Roman Koren is an Associate in Baker McKenzie, Kyiv office.

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