A company liquidation or “Ukrainian offshore”: What to do with CFCs in light of Law No.466-IX
Last week, the President of Ukraine signed Law No.466 (draft law No.1210). Among other things, this means that the rules for controlled foreign companies (CFCs) will be adopted in Ukraine.
Although the current version of the rules envisages many options for tax exemption of retained earnings of CFCs, the preparation of reporting documents can be a challenging and costly process. Moreover, many business owners see a great number of confidentiality and data protection risks associated with the disclosure of such information and an obligation to report any changes.
In addition to the cases when CFCs are exempt from tax (without exemption from CFC reporting obligation), the legislator has provided for two more attractive options for the Ukrainian business owners, which should be considered separately.
1. Liquidate CFC, notify the Ukrainian tax authorities about it, and receive tax exemption in Ukraine.
Following the second reading, a new provision was added to the draft law, which exempts from taxation income of individuals received from liquidation of a foreign company. Presently (before this provision enters into force), personal income is taxed at 19.5% (18% PIT and 1.5% military levy).
To avoid tax consequences that may arise from liquidation of a foreign company, a number of conditions should be met, in particular:
- The term for finalizing the liquidation process after the respective decision is made. As a general rule, liquidation should be started not earlier than 1 January 2020 and finalized not later than 31 December 2021. At the same time, the legislator provides for exceptions when the liquidation process may be finalized later.
- Filing of tax return and notifying tax authorities about liquidation of a company without tax consequences. A company owner (an individual who is tax resident of Ukraine) should, simultaneously with filing of tax return, apply for tax exemption of income received, by submitting an application prepared in any format. The application should contain information about the characteristics of property received and liquidated company. Along with the application, it is required to submit documents that present information about the value of property received according to financial statements of a company.
The possibility of liquidating a foreign company without tax consequences arising in Ukraine may offer an effective solution for some Ukrainian owners of CFCs. For example, if such CFCs are “half-abandoned” companies located in once-popular island jurisdictions or companies that no longer perform essential functions, then efforts to comply with CFC rules (including the preparation of financial statements and audit opinions) are more significant than the amount of money spent on liquidation of such companies.
2. Make CFC a tax resident of Ukraine, after which a former CFC will be turned into “Ukrainian offshore”.
Another interesting option for the Ukrainian owners of foreign companies is the possibility of recognizing, on a voluntary basis, a foreign company as a tax resident of Ukraine (for income tax purposes). A foreign company may be recognized as a tax resident of Ukraine if the place of effective management is in Ukraine.
A foreign company that will take advantage of this opportunity will not be considered a CFC. In other words, such a company will not have to pay taxes in Ukraine on retained earnings and to prepare special purpose reports on CFC.
Moreover, income of a company that is sourced outside Ukraine will not be subject to taxation in Ukraine (i.e. such a company will be treated as a kind of “Ukrainian offshore”).
The indications suggesting that the place of effective management is in Ukraine are as follows:
- Meetings of a foreign company's executive body are held more regularly in Ukraine than in any other country
- A foreign company's officials in Ukraine take managerial decisions and carry out other current (operating) activities of a company
- An effective management of the foreign company's operations is performed mainly in Ukraine, regardless of whether the persons who perform such management functions have official (legal) powers to do so
If both Ukraine and another jurisdiction can be recognized as a place of effective management, then a number of additional criteria are applied (for example, bank account management is performed in Ukraine).
It is clear that the “Ukrainian offshore” option will be an interesting solution for some Ukrainian owners of CFCs. However, it is very unlikely that it will gain a broad appeal. The skeptic attitude of businesspersons to an option that seems too attractive to be true as well as well-grounded fears that tax rules may change again and render such an option ineffective is very likely to push many of them away.
For some it would be easier to liquidate CFC, for others – to turn CFC into the “Ukrainian offshore”. In any event, it is high time to carefully consider all the possibilities and requirements for controlled foreign companies, so that the option you choose is the most effective solution for your specific situation.