Implementing the steps of the BEPS Action Plan for Ukraine is a prerequisite for the liberalization of currency regulation, which is in line with the country’s obligations under the Association Agreement with the EU. To this end, on December 3, 2019, in the first reading the Verkhovna Rada of Ukraine approved the bill #1210 with the long title “On amendments to the Tax Code of Ukraine on improving the administration of taxes, eliminating technical and logical inconsistencies in tax legislation”.

The draft law, among other things, provides significant changes to the regulation of transfer pricing, permanent representation status, determination, and taxation of the income of controlled foreign companies and the application of double taxation treaties.

According to the project, it is planned to introduce taxation of CFC – foreign companies, registered in a foreign country and controlled by a resident of Ukraine. Thus, the CFC’s profit may be included in the total annual taxable income of the beneficial owner – natural or legal person (the controlling entity (henceforth referred as СE) and is taxed at the rate of 18%, 9% or 5%, depending on the fact of distribution and the number of other conditions. The relevant CFC report will have to be submitted at the same time as the annual income statement and income tax or corporate income tax return. Besides, the notice period of the acquisition/alienation of a stake in the CFC will also be determined within 30 days.

The bill also provides the conditions under which the CFC’s profit may not be included in the total annual taxable income of the CE. Such conditions would include, for example, the size of the total combined income of all CFCs of one controlling entity, the existence of a double tax avoidance agreement (with the country in which the CFC is registered), certain CFC activities and others.

The project also introduces a ban on the use of international treaties on avoidance of double taxation, if the main or predominant purpose of the respective business transaction is to obtain tax benefits.

This requires, among other things, the conditions under which the beneficial (actual) and nominal income recipient is determined and, if the non-resident is a direct income recipient with a source of origin from Ukraine, is not a beneficial (actual) recipient (owner) of such income, during the time of payment of such income shall be the subject to the provisions of the international agreement of Ukraine with the country of residence of the relevant beneficial (actual) recipient (owner) of such income.

In general, there is a number of other important changes to be made regarding tax administration as a whole, identification of related parties and permanent representation, regulation of transfer pricing and other significant developments.

On the whole, the draft law seems to be in line with established EU practices and standards, but the devil, as always, is in the detail. The draft is legislated in such a way that it is very difficult to say how the tax will work and how it will apply the provisions of the Law in every correct case. This creates the risk that it may recognize companies as related or controlled even when they are not such (in particular, when truly unrelated companies engage in active economic activities with each other). It follows that a person may be recognized by the CE with respect to companies that have no relation to it.

On the whole, the draft law seems to be in line with established EU practices and standards, but the devil, as always, is in the detail. The draft is legislated in such a way that it is very difficult to say how the tax will work and how it will apply the provisions of the Law in every correct case. This creates the risk that it may recognize companies as related or controlled even when they are not such (in particular, when truly unrelated companies engage in active economic activities with each other). It follows that a person may be recognized by the CE with respect to companies that have no relation to it. Moreover, based on a literal reading of the draft, it can be assumed that the tax will be able to determine at its sole discretion when to apply the double taxation conventions and when not. This may be the case, for example, when it appears to the company that it is applying such a convention “predominantly” for the purpose of “obtaining tax benefits”.

Another very insidious provision is the project norm that a company’s profits may not be included in the total taxable income of the CE, provided that such a company receives passive income within the scope of its principal economic activity. This fact raises the question of whether or not this definition falls within the scope of the activities of a conventional holding company. In case it’s not, a business which corporate rights in trading companies are concentrated in one or more holdings will be obliged to completely revise its corporate structure.

However, this draft is still being prepared for a second reading and could be substantially amended by the time it is approved, so we hope that the above risks or inaccuracies in the wording would be eliminated.

If you would like to get more information, please contact the VigoLex team for additional advice at the e-mail addresses provided on the site.