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Anti-avoidance Measures Bring Tax Risks to Foreign Investors
Ukraine adopted a new Tax Code on 2 December 2010 and its key sections will be effective from 2011. A considerable portion of the Tax Code represents current tax rules transformed into the code format. Whilst the tax code provides for reduction of the corporate profits tax rate from 25% to 23% (from April 2011), it includes several controversial measures aimed at combating tax avoidance schemes. Taxand Ukraine provides a summary of key changes to the tax system focusing on anti-avoidance measures that are relevant to multinationals operating in Ukraine or having business interests in Ukraine.
The effective date for the Corporate Profits Tax section is 1 April 2011. Key changes in tax rules that will impact foreign businesses and cross border transactions include the following:
The beneficial ownership definition is introduced from 1 January 2001. It follows from the beneficial ownership definition that an intermediary entity cannot qualify as a beneficial owner even if it is legally entitled to receive relevant income. It may be expected that the tax authorities will further develop rules for testing beneficial ownership criteria while applying double taxation treaties.
Permanent establishment rules
The permanent establishment definition is amended to catch service provision activities. From 2011, a permanent establishment will arise for a non-resident entity if it supplies services in a territory of Ukraine via its personnel (or other individuals hired for provision of service) for period(s) of at least 6 months within any 12 month period. This rule explicitly does not apply to personnel provision agreements. Construction or assembly sites, and supervisory activities related to such sites, create a permanent establishment for a non-resident contractor if activities last over six months.
Limits for deductibility of cross border service fees
Restrictive deductibility requirements are introduced for cross border arrangements in respect of
(i) consulting, marketing, advertising fees;
(ii) engineering fees and
(iii) license fees / royalties
The key condition for deduction is that the recipient of fees does not qualify as an "offshore" (blacklisted) entity. In addition, the following limitations are established.
- For consulting, marketing, advertising fees paid to non-resident service providers (either related or non related party), the allowable deduction cannot exceed an amount computed as 4% of entity revenue for the previous reporting year.
- For engineering fees the allowable deduction is 5% of the customs value of respective equipment imported to the country. The recipient of fees should qualify as beneficial owner of engineering fees.
- For royalties the allowable deduction is computed as 4% of revenue of the previous reporting year. This limit should not apply to movie distributors and entities that operate in the sphere governed by the Broadcasting Law. There are also other conditions that should be met in order to ensure deduction. For instance, no deduction will be allowed if royalties are not subject to tax in the recipient's home country.
Black listed jurisdictions
The general limitation for deductibility of expenses incurred on purchases from entities that are located in a tax haven (blacklisted) jurisdictions will continue to apply (85% of which actual expense can be deducted). The Cabinet of Ministers of Ukraine is supposed to re-approve the current list of tax haven jurisdictions by 30 March 2011.
Investors operating in Ukraine via subsidiaries may suffer from unfair tax treatment as no deduction for respective service fees will be available in the first year of subsidiary operations in Ukraine or where a subsidiary has no sufficient revenues in the year preceding the reporting one. In addition, there is a risk of uncertainty and disputes with the tax authorities due to lack of clarity in the new rules (e.g. there is no definition of the term "consulting services").
Investors that receive interests, royalties, dividends and services fees from Ukrainian sources via intermediate structures will face risks of treaty benefits scrutiny.
The amended definition of permanent establishment exposes non-resident service providers to oblige with Ukrainian compliance requirements (e.g. registration, tax filings).
In order to determine and manage risks investors are advised to review prior to 1 April 2011:
(i) Intra-group service arrangements with Ukrainian subsidiaries;
(ii) various service arrangements with Ukrainian customers/partners and take corrective measures, if required.
Your Taxand contact for further queries is:
T. +380 44 492 8282