One head is bad, three heads – even worse

Experience is a strange thing. Today, the press and Internet are dominated by the discussions of current challenges and issues that the state has to address – with or without our help.

However, if you remember the turbulent 90's or the shock-induced 2008, you know for sure that nothing lasts forever, and you have to decide in advance what your actions will be when the crisis is over. Better yet is to consider several scenarios of future developments.

We have all grown up and matured over the last 15 years, both in our entrepreneurship skills and experience in equity capital formation. The risks have also changed as compared to those faced during the previous crises. We already have some kind of wealth; sometimes it involves accounts abroad, and often – a foreign company or even a group of companies in different countries.

Although it is difficult for us to comprehend, but the hunting for our foreign structures and wealth has been opened already. We have become a target of a very dangerous three-headed dragon, with each head representing a specific risk exposure.

Head One

You have a business – a group of companies, including foreign ones. Do you have a consistent practice of making payments to non-residents (dividends, interest, royalties, sale of shares, freight, etc.)? If this is the case, before the infamous draft law No.1210 becomes effective (it has been awaiting signature by the President for two months now), you have to consider the OECD Multilateral Convention (MLI), which came into force in Ukraine almost four months ago.

Multilateral Convention is a complex document that provides for the simultaneous amendment of certain provisions of double tax treaties entered into by the signatories to the convention. One of the key changes is an obligation of the Ukrainian taxpayers to prove that the main reason for a non-resident transaction is to achieve a certain commercial goal, and not to reduce taxes – a so-called “principal purpose test”.

This usually entails the need to prove a “beneficial owner” status of a non-resident recipient. If the test is failed, your payments to a non-resident will be taxed at the base tax rate (15% or 6% for freight) instead of the preferential tax rates (0%, 2%, 5% or 10%).

While there is no sufficient practice or official position of tax authorities regarding the substantiation of the “principal purpose”, we know from our own experience and insist that at the time of the payment to a taxpayer it is required to prepare arguments to defend your standpoint and prove it to tax authorities. This requires a thorough preparation and time.

In addition, tax authorities also pay attention to the formal aspects of payments (for example, the date and form of tax residence certificates of non-resident recipients of payments from Ukraine). This relates especially to payments that are made, for example, to France (due to a convention that many are simply ignoring) and some other countries, in particular Cyprus, since there is a problematic position of the Supreme Court of Ukraine – the certificate should be issued on the date of the transaction, and not in advance (Resolution of the Supreme Court of Ukraine in case No.806/1213/15 dated 10 December 2019).

Head Two

You do not currently have any passive income payments to non-residents, but due to the quarantine you have postponed the consideration of corporate restructuring. In particular, this refers to a possible adaptation to the rules for controlled foreign companies (such rules may be adopted in Ukraine due to the draft law No.1210, while they have already been introduced in many foreign countries), as well as the requirements to economic substance of companies (office, actual directors, etc.), especially in offshore jurisdictions, disclosure of information under the EU DAC 6 Directive on Administrative Cooperation, transfer pricing rules, and many more.

We should not be surprised if, after the quarantine has ended and business activities have resumed, these aspects would suddenly be seen as highly relevant. After all, the unplanned health care costs, a catastrophic situation with the state budget execution and an ongoing economic crisis will inevitably lead to finding ways to speed up tax collection.

That is the reason why you should start analyzing the functioning of your business in all jurisdictions and developing a plan of action. It is necessary to divide the planned measures into those that can be resorted to during the quarantine, and those that can be applied after the cancelation of travel restrictions and return to full operation of structures across all countries – state bodies, registrars, notaries and other.

Head Three

You do not seem to have any international payments or an intention to make such payments, but you have not analyzed your finances and taxes as an individual from a critical perspective for a long time? Here I would like to quote a well-known saying: The cobbler always wears the worst shoes.

Even if the first two “dragon heads” are not posing a threat to you right now, you should be mindful of inevitable risks associated with the automatic exchange of information for tax purposes under the CRS standard (you should also remember about the possible amnesty of capital in Ukraine and plans to raise individual income tax rates).

There is no doubt that the Ministry of Finance of Ukraine and the State Tax Service continue working on the technical implementation of information exchange even during the quarantine. The information received about foreign accounts of Ukraine resident individuals and their controlled companies will be actively used by tax authorities in the future, especially if the above mentioned rules for controlled foreign companies are implemented. In addition, the Ukrainian taxpayers are in for many unpleasant surprises when they will start uncovering various “benefits” received from foreign companies (payment for goods, services, training, medical treatment, travel).

Therefore, it makes sense to check your personal files and accounts right now and make all the necessary changes (maybe even to submit or update your PIT return; this year the PIT return is to be submitted later than usual) instead of trying to eliminate personal risks at the last minute and at a rapid-fire pace. Especially when you already have enough worries with resuming your usual business activities and restoring business processes in the post-crisis period.

And many are doing just that. Perhaps they have an experience or know something.

Advice for dragon fighters: If you ask for help right now and plan everything properly, fighting a fairy-tale monster will require much less time and resources!