On 21 May 2020, the President of Ukraine finally signed the Law of Ukraine 'On amendments to the tax code of Ukraine purposed to improve the administration of taxes, eliminate technical and logical inconsistencies in the tax legislation' ('Anti-BEPS Law').
On 23 May 2020, the Anti-BEPS Law became effective with certain provisions being phased out.
The Anti-BEPS Law introduces a number of fundamental novelties aimed at combating tax base erosion and profit shifting practices, improving transparency, tax compliance and administration, formally instituting the substance-over-form principle and other important anti-avoidance rules, generally modernizing the tax framework of Ukraine in vein with the OECD-driven initiatives. This new piece of tax legislation also fine-tunes numerous definitions, extends the range of penalized tax offences, and amends a large body of the Tax Code provisions that govern various taxes and procedures.
The new rules substantially alter the tax landscape for both Ukrainian individuals and legal entities as well as for non-residents that carry on business in Ukraine.
At the same time, with the Anti-BEPS Law being in force now, there are provisions that already call for the extension of their entry into force or elaboration thereof. Certain further legislative developments in this regard may be reasonably expected.
Separately, the President of Ukraine referred to the Cabinet of Ministers with a number of recommendations purposed to enhance the Anti-BEPS Law concerning, inter alia, the CFC Rules, protection of data reported by taxpayers and obtained from the foreign jurisdictions.
Key Tax Developments
Controlled Foreign Companies
- Effective 1 January 2021, the CFC Rules introduce taxation of income of controlled foreign entities ('CFCs') at the hands of Ukrainian 'controlling' persons (individuals/companies).
- The CFC Rules will target Ukrainian individuals and companies with an ownership interest in a foreign entity of (i) more than 50%, or (ii) more than 10% (25% and more in 2021-2022) provided Ukrainian individuals (companies) jointly own a share 50% and more, or (iii) in case of established de facto control over a foreign entity.
- Notably, the CFC Rules also extend to arrangements that include foreign trusts, foundations and transparent entities, while granting certain exemptions for, say, irrevocable discretionary trusts.
- Ukrainian 'controlling' persons would be responsible for, inter alia:
- annual reporting and taxation in Ukraine of undistributed CFC's income pro rata to their stakes inb the CFC;
- annual reporting of existing CFCs, irrespective of whether there is any reportable income; reporting of acquisition/alienation of shares in the CFCs or discharging other de facto control, as well as the establishment/liquidation of trusts or other transparent entities.
- CFC's income would be out of Ukraine's tax scope if, inter alia, the total income for the reporting period of all CFCs of a taxpayer does not exceed EUR 2 million. At the same time, reporting obligations will remain in force regardless of an applicability of a CFC tax exemption.
- Otherwise, the undistributed income of CFCs would be subject to 18% Personal Income Tax ('PIT') at the level of Ukrainian 'controlling' persons-individuals. In comparison, dividends distributed to private individuals would continue to be taxed at 9% PIT rate.
- Generally, Ukrainian individuals should also enjoy 5% PIT rate applicable to dividends distributed from Ukrainian companies to CFCs. Practical implementation of this novelty, however, remains to be established.
- Notably, the Anti-BEPS Law provides for a tax-free liquidation of CFCs effective until 31 December 2020 with no tax applicable to the liquidation proceeds. In addition, the value of such proceeds - if reinvested - creates cost basis for tax exemption of future capital distributions within immediate family members.
- However, with the Anti-BEPS Law being effective now, the provisions governing the tax-free liquidation already call for the timeline extension. We may, thus, reasonably expect some further legislative developments in this regard.
- The actual effect of the implementation of the CFC Rules will significantly depend on Ukraine joining the network of countries that automatically exchange tax and financial information. To this end, the Ukrainian Government committed to join the Common Reporting Standard (CRS) on automatic exchange of information on financial accounts by the end of 2020. The first exchange of information for 2020 is expected to take place in 2021.
- Importantly, as a part of the earlier FATCA implementation procedures, the applicable law was amended in December 2019 to include specific provisions on lifting bank secrecy, broaden reporting obligations and tighten mandatory KYC procedures for Ukrainian financial institutions, laying thereby grounds for a smoother introduction of the CRS rules.
- While being not a part of the Anti-BEPS Law, the CFC regime is expected to be complemented with the contemplated Voluntary Disclosure (Tax Amnesty) relief. Under the proposed Tax Amnesty Draft Law, Ukrainian tax residents would be pardoned for tax offences disclosed by such residents voluntarily. The disclosed qualifying income is proposed to be taxed at PIT rates varying from 2.5% to 10%.
- To this end, the President urged the Cabinet of Ministers to prepare and submit the Tax Amnesty Bill for the Parliament’s consideration within the next three months.
- Finally yet importantly, the introduction of the CFC regime does not contemplate the introduction of 'balancing' Exit Tax or a similar tax regime.
Corporate Income TaxTax Code Overhaul in Ukraine
- Earning Stripping Restriction: Presently, the restriction on deductibility of interest at 50 percent of EBITDA applies to debts owed to non-resident related parties provided the debt-to-equity ratio exceeds 3.5:1 (10:1 for financial institutions and leasing companies).
Effective 1 January 2021, the threshold of interest deductibility would (1) be lowered to 30 percent of EBITDA, (2) apply if a debt-to-equity ratio exceeds 3.5:1, and (3) extend to loans from any non-resident lender regardless of the "relation" status.
No earning stripping restriction, however, would apply to financial institutions and leasing companies.
- Business Purpose: Albeit the Tax Code of Ukraine formally permitted the tax office to probe transactions on the subject of their economic (business) purpose, in enforcement practice this legal tool lacked efficient application due to the absence of a clear-cut guidance and framework for the application thereof.
Effective as of 23 May 2020, the principle of 'reasonable economic purpose (business purpose)' is considerably refined, suggesting its wide employment by the tax office while analyzing transactions. The new approach suggests that transactions with non-residents should be deemed to lack business purpose if, inter alia:
- the principal or one of the principal purposes of a transaction is found to be tax evasion or underpayment;
- under comparable conditions, a taxpayer would not be able to purchase/sell same services/works from/to an unrelated party.
Should the cross-border transaction fail to meet the reasonable economic purpose test, no deduction will be allowed in such a case. Should a transaction purpose be challenged, the burden of proof will rest with the tax office.