The Ministry of Finance and NBU have recently issued a legislative draft aimed to made amendments to the Tax Code of Ukraine (hereinafter - TCU) with a view to implementing several Actions of BEPS plan - steps 3, 4, 6, 7, 8-10, 13. It is planned that most of the changes envisaged by this legislative draft will come into force already from 2019 (although we note that the legislative draft itself contains an erroneous reference to 2020). In addition, it is not registered in the Verkhovna Rada of Ukraine yet and so it is too early to estimate the chances of its adoption. If amendments still are made, what business should be prepared for?
Basic rules
These amendments, if adopted, will significantly change the approach to taxation and reporting in Ukraine. Therefore, for the first time among these changes, we introduce the main rules for controlled foreign companies (hereinafter - CFC). This is Action 3 BEPS.
The mentioned above rules are already in force in the United States and in a number of European countries (in particular, some of them it is only planned to implement within the framework of the European Anti Tax Avoidance Directive (ATAD). It should be noted that CFC in Ukraine is different from CFC in Europe. Thus, ATAD suggests that CFC generally does not affect individuals, extending only to the companies. Ukrainian CFCs are applicable to individuals. But now first things first.
What is a controlled foreign company?
The published legislative draft contains its broad definition. These are legal entities (at the same time, for the purposes of CFC they will be equated with establishments without the status of a legal entity, in particular, trusts, funds, etc.) that are under the control of an individual - resident of Ukraine. Signs of such a control will be also named in the TCU. They include:
- ownership by an individual of the share in a foreign legal entity in the amount of 50% or more, or
- ownership by an individual of the share in a foreign legal entity in the amount of 25% and more, provided that several individuals - residents of Ukraine own shares in a foreign legal entity, the aggregate amount of which is 50% or more; or
- separate or together with other residents of Ukraine (for some reason at that point the legislative draft does not specify that such residents should be only individuals) exercises actual control over a foreign legal entity. What should be considered as actual control is disclosed in the legislative draft. The signs of such control are quite extensive. This is an opportunity to give binding instructions to the governing bodies of the legal entity, negotiating and agreeing on the essential conditions of such agreements (which will only be formally approved by the management bodies of the legal entity), the presence of a power of attorney for the execution of substantial transactions, issued for a term longer than 1 year and does not provide for preliminary agreement of terms of such agreement by the management bodies of a legal entity, etc. Despite the volume of such a listing, according to our estimates, there is still a gap to acquire ownership of the company so that the SFSU could not prove the presence of control.
In itself, such a control will not always create tax consequences in Ukraine. A role will be played by the registration/location of a foreign company. Thus, there will be no tax consequences if
1) between Ukraine and the jurisdiction where the foreign company is registered/located, there is a current double taxation treaty and
2) this jurisdiction is not included in the list of low tax, and any of the following requirements is met:
- such a foreign company actually pays the income tax at an effective rate (determined by dividing the cost of the income tax/corporate tax on the amount of income before tax according to the financial statements), which is less than the basic rate of the income tax in Ukraine, no more than by 5 percentage points;
- the share of passive incomes of such a company makes no more than 50% of the total income of such company from all sources.
Also, there will be no tax consequences if the income of all controlled foreign companies of one person at the end of the reporting year will not exceed EUR 1 million (that is, if they are inactive or very insignificant), or such a foreign company is public, and its shares are listed on the stock exchange.
As for the controlling person, it is only an individual - resident of Ukraine, who is considered to be the final beneficiary in the sense of the legislation on combating the legalization of proceeds from crime. In other words, these are not the beneficiaries for the purpose of applying international double taxation treaties, and the so-called ultimate beneficiary owner (UBO). As a rule, they are specified in the registers of beneficiaries (and in Ukraine - in the USR).
How to tax within CFC?
A taxpayer within the limits of the rules of the CFC is the mentioned above individual - resident, acting as the controller of the corresponding foreign company. In some cases, payers can be at once several individuals - controllers of CFC. Therefore, in fact, it is a question of paying PIT and the war tax (while the legislative draft only mentions PIT, but the subject for PIT, according to the general rule, is also the subject for the war tax).
The subject for taxation will be a part of the adjusted income of a foreign company, not all, but proportional share owned (or controlled) by such an individual. If the dividends are distributed by such a company in favor of an individual, special rules will be in force to prevent double taxation of the PIT within the limits of CFC and dividends received.
At the same time, such adjusted income is determined on the basis of the financial statements for the calendar year in accordance with the accounting rules used by the foreign company. That is, it may be IFRS or other rules, such as GAAP, and if the law of the jurisdiction of a foreign company does not provide financial statements, the controlling individual is required to ensure that such statements are prepared in accordance with IFRS.
In addition, please note that the financial results thus determined before tax are subject to adjustments based on rules similar to those currently applied to the income tax (in particular, regarding the limitation of accounting for interest, bad debt, deductions, etc.).
Moreover, the legislation draft requires to determine the income/expenses of a foreign company in transactions with related parties, with non-residents from low tax jurisdictions, as well as with non-residents registered in low-tax organizational and legal forms, according to the arm’s length principle, that is, in essence, taking into account the usual prices determined by the rules of transfer price formation (TPF) (and SFSU, among other things, can oblige the controlling individual to provide the TPF with the documentation of relevant company).
For the purpose of applying these rules, an individual must submit a report on CFC, in addition with declaration of PIT (that is, before May 1 of the year following the reporting period). The composition of the information that should contain such a report is disclosed in the legislative draft, and it is very detailed. In addition, to some extent we can say that these rules are something like TPF, only for individuals. Fines of their size exactly correspond to the TPF. Here are just a few of them:
- for failure to submit a report on the CFC, the fine will amount to 1 000 minimum wages on January 1 of the reporting year for each such a fact. Therefore, on the basis of the minimum wage on January 1, 2018, it is UAH 3 723 000;
- for the non-reflection of information about foreign companies subject to the requirements of CFC, a fine of 3% of the amount of transactions of controlled foreign companies, or 25% of adjusted income of such companies for the year that are not reflected in the report, whichever is greater, but not more than 3 000 minimum wages established on January 1 of the reporting year. On the basis of minimum wage on January 1, 2018, then it is UAH 11 169 000.
In view of the above, if these corrections are made to the TCU, individuals-owners of foreign companies will significantly increase the PIT base, which may lead to a restructuring of the business model (for example, it will be necessary to abandon the tax residence of Ukraine, transfer the controlled companies to other jurisdictions, etc.). If they come to terms, in any case they will be required to incur additional losses not only for the payment of PIT within the limits of CFC rules, but also for the administration of this payment (determination of the amount of tax, preparation of a report, etc.).
