Limitations of interest accrued in favor of non-resident andeligible for deduction according to the Tax Code of Ukraine
In the same way as before, the provisions of the tax legislation, currently in force, stipulate limitations of deductible interest accrued in favor of non-resident, of whose 50 per cent or more statutory capital in which is owned or controlled by the non-resident.
Thus, according to para. 141.2 of Article 141 of the Tax Code of Ukraine (hereinafter referred to as “the Tax Code”):
“it shall be permitted to deduct the amount of interest under the loans, borrowings and other debt obligations in favor of the said non-residents and related persons in the amount which shall not exceed the amount of the income of such taxpayer obtained during the reporting period in the form of the interest from the placement of own assets increased by an amount equivalent to 50 per cent of the taxable profit of the reporting period except for the amount of such received interest.”
At the same time, Law of Ukraine “On Corporate Profit Tax” dated of 28.12.1994, No. 334-94/VR (hereinafter referred to as the “CPT Law”) contained the procedure of calculation the taxable profit, according to which it was clear, that the amounts of interest eligible for deduction in favor of non-resident were excluded from the amounts of gross expenditures for the purposes of calculation of “taxable profit” as it is mentioned in this rule. Currently the Tax Code does not contain clear directions, therefore there are three ways of calculating the “taxable profit” which we consider herebelow.
First of all, it is necessary to note that the Uniform tax database the following formula is suggested:
Portion_of_Interest_expenses = Interest_Income + (Taxable_Income – Interest_Income)/ 2, where:
- “Portion_of_Interest_expenses”– the amount of interest on loans, borrowings and other debt obligations accrued in favor of the non-residents and associated persons thereof that are allowed for consideration as expenses when assessing the corporate profit tax (line 06.4.18 “Expenses on operations with debt claims and securities” of the amendment ІВ (Other Expenses) to the Profit tax return, a form of which is approved by the Order of the Ministry of Finance of Ukraine dated of 28.09.2011 N 1213 (hereinafter referred to as Tax return), with the consequent transferring to the line 06.4 “Other expenses of the ordinary activities and other operating expenses” of the Tax return);
- “Interest_Income” stands for the amount of income of the taxpayer received during the reporting period in the form of interest payments for placement of the own assets (line 03.2 “Interest” of amendment ІД (Other incomes) to the Tax return with the appropriate transfer to the line 03 “Other income” of the Tax return);
- “Taxable_Profit” stands for the taxable profit of the reporting period (line 07 “Taxable base with respect to all the activities” of the Tax return).
In this explanation the tax authorities indicate that the “taxable profit” should be equal to the line 07 “Object of taxation” of the Tax return. In addition to that, the way how this object of taxation is calculated (with consideration of the interest accrued in favor of non-resident, without consideration or with its partial consideration within allowed limits) is not indicated.
Therefore, there are basically three main options to interpret the term “taxable profit” used in the rule: (1) such interest shall not be considered when calculating the “taxable profit” at all; (2) such interest shall be considered when calculating the “taxable profit” in full; (3) such interest shall be considered when calculating “taxable profit” taking into account the limitation of interest eligible for deduction (a kind of equation with the unknown).
We consider these approaches herebelow:
- This approach provides for the assessment of the “taxable profit” with exclusion of the interest accrued in favor of a non-resident during the reporting period. In this case, the amount of income (line 01 of Tax return) is decreased by the amount of expenses (line 4 of Tax return, but without inclusion of 06.3.1).
The above example is advantageous for the taxpayer, as it increases the amount of interest that can be attributed to expenses under the limitation. However, we do not see sufficient grounds for the application of this approach since para. 141.2 of the Tax code does not give grounds for such non-inclusion of interest. Yet, the indicated option was recommended in the magazine Tax Service Bulletin (№ 34 (654), p. 10).
- This approach provides for the assessment of the “taxable profit” with inclusion of the full amount of interest that has been accrued in favor of a non-resident during the reporting period. The specified option is the most conservative one, because it reduces at most the amount of interest which may be attributed to the expenses (unlike the example above, line 06.3.1 of Tax return, on the contrary, is included to the full extend without limitations).
- This approach provides for the assessment of the “taxable profit” with the partial inclusion of interest that equals the amount of interest eligible for deduction. The calculation is accomplished using the formula. For instance, some auditors suggest applying the following formula:
E % = (I % + TI – TE without %)/ 3, where:
E % – expenses related to the payment of interest;
I % – income received in the form of interest;
TI – all tax income;
TE without % – tax expenses excluding expenses related to the payment of interest.
The indicated formula uses the line 07 “Object of taxation”, which will be obtained in the case of using the line 06.3.1 with due regard to the established limitations. The option (3) most fully corresponds with the lines of the Tax return. It is also more favorable to the taxpayers, than the second option (described above). However, it is also based on interpretation, so may be challenged by the tax authority.
Taken into consideration the uncertainty of rules of the tax law regarding calculation of the amount of interest accrued in favor of non-resident and eligible for deduction, we suggest receiving the individual tax advice consultation on this issue.
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.