On May 21, the President signed the Law No. 466, or Bill 1210 “On Amendments to the Tax Code of Ukraine regarding the improvement of tax administration, elimination of technical and logical inconsistencies in tax legislation,” which introduces many changes to the Tax Code.
The Law provides for several amendments aimed at improving and simplifying the tax administration system and its harmonization with international standards. Its goal is to introduce international standards of tax control for all participants in international trade. The Law provides for significant changes in tax rules for working with foreign companies. And this will significantly affect the IT-industry of Ukraine.
In the newspaper “Golos Ukrainy” No. 84(7341), the Law was published on May 22, 2020, and on May 23, 2020, it came into force. It is useful to learn about the novelties from lawyers, experienced and beginner business people.
The Law is very long, difficult to read, and even harder to understand. The text contains many new concepts: “legislation on controlled foreign companies (CFC)”, “place of effective management”, “constructive dividends”, “rules of thin capitalization”, “tax resident”, etc. Let us talk about them.
CFC is a foreign company controlled by the owner from Ukraine.
Place of effective management – headquarters – apartment, where all strategic and management decisions are made, as well as bank account management.
Constructive dividends – various payments, which are disguised as business operations and are, in essence, payment of dividends. For example, in Estonia, when a company pays a founder under a contract for services or buys a house or pays for education, such payments are considered hidden dividends. The primary purpose of such transactions is to avoid paying taxes on profits to individuals because the revenue is not lost under taxation. The concept of constructive dividends is successfully applied in many countries, such as the USA, Ireland, Germany, Estonia, Switzerland, etc.
Thin capitalization rules are rules that regulate the attribution to expenses of a company’s debt payment, where the amount of funds borrowed exceeds its charter capital. For example, in Ukraine, if a company borrows from a foreign company, it pays interest on the loan and thus reduces its taxable income. And if the authorized capital of the company is 3.5 times less than the size of the loan, special restrictive rules are applied, the so-called laws of excellent capitalization.
A tax resident is a taxpayer at the principal place of declaration and payment.
Let’s get acquainted with the new rules, which will affect the IT industry:
The first rule
Everyone who works through a foreign company, where the owner or founder is a taxpayer in Ukraine (tax resident), must:
- Submit an annual report on such companies to the tax office.
- Pay tax actually at the rate of 19.5%, if the company is passive (i.e., does not operate actively, providing services or do not receive income from fees and publishers for the product), or registered in countries with low or zero taxes: Cyprus, Estonia, UAE, Hong Kong, Malta, Ireland, the full list here.
To prepare a report on such a company, you will need to hire qualified lawyers and financiers/auditors. They have experience working with foreign companies, banks and know the rules of international taxation and Ukrainian taxes.
If trust and funds have been created in the business structure, they will also fall under the same requirements.
Also, the tax office may request a transfer pricing report (TCO-report) for such company, if it has transactions within its group of companies and which fall under the criteria of Ukrainian TCO (company’s income for the year – UAH 150 million and more, the number of transactions with the controlled company, from UAH 10 million per year).
Transfer pricing establishes rules under which the prices in transactions between their companies or with companies that are registered in countries with low or zero taxes are the same as in the market.
- Relocation to the country where the company is registered and registration there as a tax resident. But remember that you should spend 183 days, not in Ukraine, but the country of registration and/or meet the rules of tax residency of the country where you want to be. The laws of 183 days and the center of vital interests are the main ones. If you had an FLP opened in Ukraine, you should close it. You can also rent a place of registration. If you have a family – you need to move it to the country of your tax residence and move the business interests of the company there. All this is necessary to ensure that your “center of vital interests” is not in Ukraine.
- Close the company by July 2020 without paying taxes and withdraw money to your account, starting to work through Ukrainian legal entities.
- Stay in Ukraine and restructure your business so that there are no passive companies in the structure, at the same time create a functioning office, pay utility bills, have employees who build the product for existing companies, submit reports on the CFC in Ukraine, but do not fall on taxes. Passive companies are companies that receive income in the form of dividends, royalties, and interest, except when royalties are income from fees or a publisher and have their headquarters in the country of registration.
- Optimize structure, file reports, and pay taxes.
As for risks, the CFC legislation is not a unique invention of Ukrainians. When you come to another European country or the USA, you will face similar requirements.
The risks of our country are that we do not have the Rule of Law and business interests are not protected. For example, it is difficult to defend the rights of intellectual property, real estate, money, because as long as there is no fair and independent court, on one day it may become someone else, and it is difficult to prove otherwise.
Also, confidential and personal data of the payers can be readily available for misuse, cyberattacks, and so on.
The second rule
All foreign companies that have an account in a Ukrainian bank must be registered with the tax office.
This does not apply to companies that have a transit account in Ukrainian banks, from which money is then redistributed to FLP accounts. Since this rule is designed directly for business operations of a foreign company, and the transit account is not such.
The third rule
There is a risk that a foreign company will be recognized as a payer of income tax because it has a valid place of management in Ukraine. This may happen when management decisions are made in Ukraine, or when a bank account or staff is managed from Ukraine. Or when accounting and management reporting is done in Ukraine.
There is also a risk that a company will be recognized as a profit taxpayer based on the signs of a permanent establishment in Ukraine. For example, if a person uses the corporate mail of a foreign company, or on behalf of an international company in Ukraine, the representative signs cooperation agreements with FLP, or if on the instructions of a non-resident, third parties lease premises to someone.
- Hire auditors/accountants abroad for accounting purposes.
- Please do not enter the online banking from the Ukrainian IP address and think over the policy of payments and other banking operations in the company so that they were conducted not from Ukraine.
- Structure HR and recruiting functions, drag and drop of trackers, emails, internal communication channels abroad, essential product or service product relay in the R&D domain. Essentially, this means that HR managers, leaders/team managers must work from the country of registration, tasks for contractors must be set from there (the same work with a distributed team).
The fourth rule
All those who bought or sold, all or part of a foreign company must notify the tax office.
The fifth rule
Sale of real estate, which “hangs” on a foreign company, will be taxed in Ukraine if the ownership structure is created by such a scheme: a foreign company owns a Ukrainian company, the share capital of which is formed by real estate. If such an international company is sold to another one, the tax should be paid in Ukraine.
The sixth rule
The subtle capitalization rules have been changed, under which the law “3.5 times” will apply to any loans, not only taken from “their” companies.
If let’s say, you took a loan from a foreign company (its own or someone else’s) for a business in Ukraine, now the interest that you pay to an international company can be attributed to the expenses, not in half the amount, but only 30%, and in another way to consider the number of costs in connection with this for tax purposes (so-called capitalization of interest).
The seventh rule is quite positive
The limits of the volume of income of the payer of the third group of single tax were increased to UAH 7m.
Although the law was passed, and many of the rules in it are still difficult for people who are far from Law and audit, this is a step forward for Ukraine towards civilized business: paying taxes in the country, creating added value, preventing the most common schemes of tax evasion.
For all Ukrainian business, it is a movement and growth, albeit through the pain.