Things don’t work the first time or following a “hot trail” of transfer pricing report
The Law of Ukraine “On Amendments to the Tax Code of Ukraine regarding transfer pricing” of 01.09.2013 imposed an obligation on the taxpayers to submit the report on transactions, recognized controlled for the transfer pricing (TP) purposes. In accordance with sub-para. 39.4.2 of the Tax Code of Ukraine TP report (hereinafter “Report”) was to be submitted until May 1, 2014.
However, on May 13, 2014 the Verkhovna Rada of Ukraine has introduced amendments into these new TP rules, which set October 1, 2014 as the new deadline for submitting the first Report. It is obvious that most of taxpayers have submitted the Reports before May 1, 2014, since belated shifting of the deadline was unexpected.
Submission of the Reports following requirements of then effective rules was a kind of “rehearsal”, which allowed determining the weaknesses and inconsistencies of the reporting procedure. There is no specific rules on the status of already submitted Reports and hence they will have all legal implications of the Reports although submitted earlier of the deadline.
There is no special procedure provided for amending/correcting of the submitted Reports. However, based on the established form of the Report (and the second paragraph of para. 39.4.2 of the Tax Code), according to the current form the Report may be submitted as adjusting report. Hence, the adjustment of the Report is allowed.
In this material, we focus on the principal issues, which arose when composing the Reports in practice. Such experience may be useful for the taxpayers, who have not submitted their Reports as well as for the taxpayers who are going to revise their approaches and amend the Reports submitted.
An issue with detailing of data in the Report
One of the first questions, which arose while filling the Report, concerns the extent of detailing the transactions, indicated in the Report. Is there any possibility of grouping the periodic transactions?
Paragraph 4.20 of the Order November 11, 2013 No. 669 of the Ministry of Revenues and Duties, which establishes the form of the Report and Procedure of its filling (hereinafter the “Order”), allows indicating consolidated information regarding the controlled transactions in a single line. This option is available in case if a contract provides for the periodic transactions during the reporting period with constant terms of supply and other indicators in columns 2 – 14, 17, 19 – 20, 23 – 26 of section “Information on controlled transactions” of the Report remaining unchanged through the period.
In other words, this option is available only in case the transactions, conducted during a period, are different only in quantity of supplies, currency rates and total value of transaction. The transactions meeting these criteria may be grouped without stipulation of each transaction separately in the Report.
However, it is not clear how to deal with the situations of supplying the hundreds of different goods within a single delivery.
Based on the Report’s form each transaction on each item shall be indicated separately, since these transactions differ from each other in subjects, amounts and other terms.
At the same time, quite often transactions imply delivery of hundreds and thousands of items with different names and prices within a scope of a single supply (under the single customs declaration, for example). Indicating of each such item separately in the Report requires huge efforts from a taxpayer and in some cases is not possible at all. Such detailing is especially problematic in case the software, applied for filling the Report, does not allow automatizing the process, which happened quite often.
Therefore, the bravest taxpayers opted to apply the mechanism of transactions’ grouping, provided for in p. 4.20 of the Order, by the analogy. Namely, the various items were grouped and indicated in the single line of the Report under a generalizing name, for example, spare parts of a machine. This approach allowed saving the efforts while filling the Report.
We do not exclude that such approach may result in additional request for the information by tax authority in order to receive confirmation of price level. At the same time, we do not identify any other risks in case of such approach. It cannot be deemed to constitute non-identifying certain transactions in the Report as far as the total value of controlled transactions, reported, and general amount of controlled transactions shall be similar.
An issue with indicating the arm’s length price per unit in case of grouping
The Order stipulates that the mark “X” shall be indicated in column 21 of the Report, which discloses the information about the currency rate as on the date of transaction, in case the grouping option was used.
Hence, the question arose in practice how to determine the arm’s length price per unit in Hryvnia in case the contractual price is in foreign currency and exchange rate is not available due to the grouping option.
In practice, such situations were resolved by way of computing the arm’s length price of the unit by using the available data on total value of the transaction (column 22) and quantity of units (column 18). We believe that such approach is correct.
An issue regarding possibility of using foreign language in the Report
According to the Order, the description of controlled transactions shall be indicated in column 3 of the annex to the Report. Such description shall be provided according to the primary documents. The Report often contains the information about contracts with non-residents and the primary documents regarding such contracts contain description in a foreign language.
There is no strict obligation for the taxpayer to fill the report (including indication of goods items) only in Ukrainian language. Thus, the only requirement, established by para. 4.8 of the Order, is to describe the subject of transaction in accordance with the primary documents.
Therefore, in practice taxpayers have indicated description of the transactions in foreign language.
We agree with such an approach. It is in line with position of the Ministry of Revenues and Duties of Ukraine expressed with respect to the filling VAT invoices (Order # 127 dated 16.02.2012). We believe that this clarification may be applied by analogy also in the discussed case.
Impossibility to indicate the price of transaction in a form other than monetary
According to current form of the Report price per unit of a transaction only in monetary form may be indicated. Yet, there are transactions, in which the price is determined as a percentage applied to certain base. For instance, such situation is often in case of royalties for the use of trademarks. In such cases, it would be more correct to indicate the percentage rather than the amount of monetary funds, paid, since such amount depends on the base and percentage used for computation and is hardly informative by itself.
Yet, the form of the Report requires stating the price only as certain amount of monetary funds. Therefore, in practice for the cases when the amount of payment was determined based on percentage, taxpayers indicated in column 17 “price per unit” of the Report the amount of monetary funds paid and copied the same amount in column 22 “total value of the transaction”.
An issue with indicating measurement units
Column 19 of the Report indicates the information regarding measurement units in respect of controlled transaction described. In accordance with para. 4.23 of the Order in this column a taxpayer shall indicate a code of the measurement unit under the Classifier of notification system of standard measurement units, adopted by the Order of State Committee of standardization, metrology and certification of Ukraine # 8 dated January 8, 1997.
As evident even from the date of adoption of this order, the Classifier is somewhat outdated. Therefore, in practice, especially in case of non-standard transactions, it was often impossible to find exactly relevant code in the Classifier.
The taxpayers used different approaches to resolve this issue. For instance, we are aware of cases when the literal indication “service” was used in complex classification cases while the other approach implied indicating the closest possible alternative, found in the Classifier, or even ignoring this column at all.
It is difficult to say, which approach is the most appropriate in this case. In our opinion, where it is impossible to identify a code under the Classifier, a word description would be an advisable way for avoiding controversial interpretation of the Report.
An issue with rounding of monetary indicators
Another issue concerning “technical” side of filling the Report, which arose in practice, is related to the necessity to specify all monetary indicators in Hryvnia without kopeks (Ukrainian cents) with appropriate rounding in accordance with common rules, including monetary indicators of unit price and currency rate used in calculations. This requirement is established by para. 1.6 of the Order.
Pursuant to the Order, a taxpayer shall indicate in column 22 of the Report the total amount of transaction, which is calculated as follows: “total amount of transaction” = “unit price” * “quantity” * “currency rate”. Specification of all the above monetary indicators with appropriate rounding under para. 1.6 of the Order results in difference between the total amounts of the transaction, calculated in the Report, and indicated in the primary documents.
In such situation the choice is between filling the Report in accordance with the Order with appropriate rounding, which could result in the necessity to provide additional explanations regarding the differences, or to ignore requirement of rounding and to mention actual amounts in line with primary documents.
In our opinion, there is no legal grounds for non-acceptance of the Report or applying of any other sanctions by the reason of non-fulfillment of requirement on rounding the figures in the Report. Furthermore, the existing software, used for filling the Report, in some cases does not provide technical possibility to indicate the rounded figures.
In practice, some taxpayers have decided to mention monetary indicators with rounding, while others have not rounded the figures in the Report. We believe that there is no considerable risk in any case because rounding is in line with requirements of the Order while non-rounding ensures compliance with the figures in the primary documents.
Method of price determination in controlled transactions
In the Report, a taxpayer shall provide the information regarding the method of determining the price in controlled transaction and the source of information, used in the calculations proving the price.
Thus, while under sub-para. 39.1.3 of the Tax Code the price in controlled transaction shall be deemed to be at arm’s length unless tax office proves otherwise, actually the taxpayer shall determine a method, according to which the price level is confirmed, and a source of information used before submission of the Report. In order to determine an appropriate TP method the taxpayer at least has to determine the concept of confirmation of the price before submission of the Report.
In accordance with para. 39.3 of the Tax Code : “A taxpayer shall use any method which is considered to be the most appropriate, but where there is a possibility to use both a comparable uncontrolled price method (analogue of sales) and any other method, a comparable uncontrolled price method shall be used”.
The importance of the comparable uncontrolled price method, assigned to it by the Tax Code, resulted in choosing this method by many of the taxpayer even without any preliminary study according to the rules of the Tax Code.
However, a taxpayer indicating this method should be prepared to provide the tax authorities (in case of the request) with the calculations and studies confirming the price level by applying such method. Thus, in order to prove the price by applying the comparable uncontrolled price method, the taxpayer shall determine market price range on identical (or similar in the absence of identical) goods (works, services) in comparable transactions. However, it may turn to be not easy (or even impossible) to obtain the necessary information on comparable transactions for such calculations.
In our opinion, in order to determine the most appropriate method for indicating in the Report a taxpayer shall consider the available information and (in case of international group) method and respective grounds for the price determination in similar transactions used by the other enterprises of the group.
Thus, in case of the request from the tax authorities, at least, it will be possible to confirm the price level in the transaction in accordance with the core TP documentation of the group. Providing such evidences would be useful, since in this case the tax office will have to prove why such grounding is not acceptable if they decide to challenge the pricing. While in situation with taxpayer, failing to provide necessary evidences of the data in the Report, the assessments would be relatively easier for tax authorities.
The source of information used in order to determine an arm’s length price
Annex 8 of the Order provides for the codes of information sources applied in determining the arm’s length price. The official sources of information regarding the arm’s length prices (in accordance with para. 18.104.22.168 of the Tax Code) are grouped under code “401”. There are other sources of information (with codes from “402” to “409”) as established in para. 22.214.171.124 of the Tax Code. These other sources may be used in case of absence or insufficiency of relevant information from the official sources.
In pursuance of sub-para. 126.96.36.199 of the Tax Code, the Cabinet of Ministers of Ukraine has adopted the Resolution of 23.10.2013, № 866-p “On the approval of the list of sources of information on market prices for the purpose of transfer pricing” (hereinafter – the “List”).
The form of the List is a table with specification of the names of the information sources and their publishers (holders of Internet resources). The names of the information sources, provided for in the List, evidence that all the “official” sources of information cover only some categories of goods and do not mention services at all. Thus, in case if there is a controlled transaction on rendering services a taxpayer will not have a possibility to use an official source of information due to the fact that any source provided for in the List does not contain the information regarding market prices on services.
Due to the limited availability of the official sources of information, in practice, most often the code of the information sources “404” was indicated in the Report. This code covers: “prices published in specialized commercial editions (including online publications) and publications (including electronic) and other databanks, reports and references of business departments in diplomatic agencies of Ukraine, informational programs used for the purposes of transfer pricing and other public information sources which are publicly available”.
The list of sources, available under this code, is not exclusive and may include a broad number of information resources. As far as there is no possibility to mention several codes of information sources, in our opinion, stating this code is advisable in most of the cases unless taxpayer has made his mind where to take the data for computations prior to submitting the Report.
Many issues arose when composing the Reports, submitted by the taxpayers before May 1, 2014, which was the deadline before the amendments of the Tax Code. The first experience of the Report submission has evidenced the serious drawbacks of the existing mechanism of TP controls in Ukraine and the main drawback is its excessive complexity for the taxpayers. There are also evidences that the tax authorities are not able to process the data from the Reports in full. Therefore, it is quite clear now that the system of TP controls should be revised taking into account that it has been elaborated by the previous government in order to create an additional instrument for “squeezing out” additional payments to the budget, which approach, hopefully, is not in line with new paradigm of Ukraine. We hope that during the period now available after transferring the first reporting date the lawmakers will introduce necessary changes to the Tax Code and/or the Report form and procedure of filling.
More information on taxation and transfer pricing in Ukraine may be found on our web-site http://www.km-partners.com/.
The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.
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