The Parliament adopts BEPS based tax reform

On 16 January 2020, the Ukrainian parliament adopted the tax Law (hereinafter, the “Law”) containing significant changes to the tax legislation, including long-debated recommendations based on the OECD base erosion and profit shifting (BEPS) plan.

The new rules include the introduction of the three-tier transfer pricing reporting requirements, new fixed ratio rule that limits the amount of interest expenses that may be deducted, general anti-abuse rules (GAAR), new controlled foreign company (CFC) rules, mutual agreement procedure (MAP) and amendments to the definition of a permanent establishment (PE).

The Law now is waiting for the President’s approval, and it will be enacted after publication in the official media.

The provisions of the Law will come into force in phases over the period from 2020 to 2023 (please see the effective dates for separate provisions below).

This alert summarizes the most important tax rules from the Law that affect cross-border business transactions.

I. Corporate income tax and transfer pricing

1. Introduction of three-tier transfer pricing reporting in accordance with BEPS action 13

In addition to a local file, multinational enterprises (MNEs) would be required to prepare a master file and a country-by-country (CbC) report. Proposed revenue thresholds are in line with OECD recommendations (i.e., EUR 50 million for master files and EUR 750 million for CbC reports). The first reporting year for master files and CbC reports would be 2021 (but not earlier than the date when Ukraine joins the OECD Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports (CbCR MCAA)).

Effective date: 2021 – first reporting year for master file and CbC report.
 

2. Repeal of the thin capitalization rules and introduction of a fixed ratio

The Law repeals the current thin capitalization rules and introduces a fixed ratio rule in accordance with BEPS action 4:

• The new rule would apply to transactions with related and unrelated persons (whether or not resident in Ukraine) if the debt is greater than 3.5 times the company’s equity. Debt attributable to all non-resident creditors would be compared with the relevant entity’s equity (currently, only debt with related non-resident entities is considered).
• If the debt-to-equity ratio is exceeded, the relevant entity’s deductions for all interest, (and economically equivalent payments) would be limited to 30% of tax EBITDA (rather than the current rule of 50% of financial EBITDA).
• Interest expenses above the limit could be carried forward and be deducted in computing corporate income tax. The non-deductible interest expense could be carried forward indefinitely but it would be subject to an annual 5% disallowance.
• Banks and finance leasing institutions (as debtors) would not be subject to the new interest deduction limitation rules.

Effective date: 1 January 2021.

3. 30% upward adjustment (increase of taxable base) on sales to residents from low-tax jurisdictions and fiscally transparent entities

Resident companies would be required to increase their taxable base for corporate income tax purposes by 30% of the value of goods and services sold to residents of low tax jurisdictions and foreign entities having special legal forms (partnerships or similar fiscally transparent entities).

Effective date: the day following the day of publication of the Law.

4. Introduction of GAAR

The Law introduces the anti-abuse rules, including:

• “business purpose test" in transactions with non-residents for corporate income tax and transfer pricing purposes. The business purpose test has been already applied by Ukraine’s tax authorities in practice, whereby tax deductions are disallowed for expenses that lack a genuine business purpose. The new law would codify the existing practice; and
• domestic GAAR to prevent the granting of tax treaty benefits where one of the principal purposes of a transaction is to claim the relief at source or a lower withholding tax rate in Ukraine under the relevant tax treaty.

Effective date: the day following the day of publication of the Law.

II. Transactions with non-residents

1. Dividend-equivalent payments

Transfer pricing adjustments and certain other payments to non-residents (payments for buyout of shares and certain types of divestment) would be treated as dividend-equivalent payments subject to 15% withholding tax.

Effective date: 1 January 2021.

2. Principal purpose test and beneficial ownership rules for tax treaty purposes

The following amendments were introduced as regards claiming benefits under Ukraine’s tax treaties:

• “Look-through approach” for beneficial ownership purposes, according to which if the immediate recipient of Ukraine-source income is not the beneficial owner of such income, the tax treaty with the jurisdiction of the beneficial owner may apply in Ukraine; and
• “Principal purpose test”, according to which the tax treaty would not apply if the main purpose of the arrangement or structure is to obtain tax treaty benefits.

Effective date: the day following the day of publication of the Law.

3. Taxation of indirect transfers of shares in asset-rich companies

15% withholding tax would apply to gains derived by non-resident companies in transfer of shares that directly or indirectly derive their value from real estate situated in Ukraine (including leased property).

Effective date: 1 July 2020.

4. Permanent establishments (PEs) of non-resident companies

The domestic definition of a PE is amended to align with the updated definition under the 2017 OECD model tax treaty.

New administrative procedures would be introduced to scrutinize non-residents that carry on business operations in Ukraine that rise to the level of a PE where the non-resident fails to register its PE and pay taxes in Ukraine.

Effective date: the day following the day of publication of the Law.

III. Changes in administrative procedures affecting non-residents

The tax authorities would be empowered to initiate tax inspections of non-resident companies that operate in Ukraine through a PE without registration and fail to report and pay taxes in Ukraine.

Non-residents would be able to file claims against the actions and decisions of Ukraine’s tax authorities related to withholding taxes levied in Ukraine and tax assessments made by the tax authorities in relation to PEs of foreign companies.

Effective date: 1 July 2020 for new registration rules and 1 January 2021 for new tax inspection rules.

IV. Controlled foreign companies

The Law introduces the CFC rules to tax the undistributed profits of CFCs at the level of their Ukrainian tax resident owner (controlling shareholder) being an individual or legal entity. A CFC is defined broadly to include corporate entities, as well as certain transparent entities (e.g., trusts, investment funds, partnerships etc.). However, there are some exemptions for trusts, etc.

The CFC’s income is taxable in Ukraine unless an exemption applies. If a resident controlling shareholder meets the minimum control threshold, the respective share of the CFC’s income shall be attributed to such shareholder.

For CFC taxation purposes, the reporting period is a calendar year or another fiscal year as the CFC may follow the financial reporting requirements in the jurisdiction of its tax residence. The taxable income of each CFC would be included in the annual income of its controlling shareholder for Ukrainian personal or corporate income tax purposes, and reported in the annual tax return.

18% personal income tax shall apply to the undistributed income of a CFC calculated under the applicable tax laws. The distributed income of a CFC could be subject to either 18% or 9% rate depending on the period of distribution. The lower 9% rate would apply if the CFC’s income is distributed by the CFC to the resident controlling shareholder as dividends, provided that the distribution is made by the CFC before filing the CFC report in Ukraine or by the end of the second calendar year that follows the reporting year. An 18% rate would apply if distribution is made at a later date.

Effective date: CFC rules shall be introduced in phases over the period from 2021 to 2023. For instance, the first CFC report shall be filed in 2022 for the reporting year 2021.

V. Mutual agreement procedure

The MAP for resolving tax disputes under tax treaties would be introduced into domestic law (as current tax laws do not provide for this type of procedure).

Both residents and non-resident taxpayers who believe that actions or decisions of the tax authorities (both Ukrainian and foreign) have resulted or will result in taxation not in accordance with the relevant tax treaty could file MAP requests with Ukraine’s Ministry of Finance.

Effective date: the day following the day of publication of the Law.

Comments

The changes are expected to lead to a substantial overhaul of Ukraine’s tax legislation, with a particular focus on cross-border transactions. Tax authorities shall have more power to scrutinize the activities of multinational enterprises. Taxpayers should consider reviewing their cross-border structures and transactions to assess the potential impact of the new legislation and take appropriate step to comply with the rules.

We will be happy to provide you with the advisory support on all issues you may have in relation to the aforementioned legislative changes.