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PEs and Transfer Pricing: what should be known?

29 May, 2019 Newsletters

Since 2018 Ukrainian transfer pricing (TP) rules cover transactions of non-residents with their permanent establishments (PEs) in Ukraine. The implications of such changes will become visible starting from the first deadline set for submission of the Report on Controlled Transactions by PEs, i.e. from October 01, 2019.

This novelty has all chances to change the taxation regime of PEs in Ukraine drastically. More details in our newsletter “Why will everything change from October 1 for representations of non-residents”.

The application of TP rules to PEs is quite complicated topic and a lot could be written about it.. Just take, for example, the OECD Report on Attribution of Profits to Permanent Establishments1, set out on more than 250 pages.

In this newsletter we describe only key aspects, which in our view are worth to know for a PE’s management at the stage of organizing processes aimed at fulfillment of new legislative requirements.

1. What new reporting requirements are introduced for PEs?

Extension of TP rules on transactions of non-residents with their PEs in Ukraine implies that in case PEs carry out controlled transactions they are obliged to:

1) prepare and submit a Report on Controlled Transactions;

2) prepare and retain TP documentation.

A Report on Controlled Transactions shall be submitted to the tax authority in electronic form by October 01 of the year, next to the year, when the controlled transactions took place.

In other words, PEs with controlled transactions in 2018 shall submit reports on such transactions by October 01, 2019.

The Report shall contain basic characteristics of controlled transactions as well as some information about the way taxpayer opted to check compliance of such transactions with TP requirements.

TP documentation shall be submitted upon request of the tax authority. Such request may be provided after October 01, in other words – not earlier than the deadline set for submission of the Report. TP documentation shall be submitted within 30 days after receipt of the request by the PE.

The considerable part of TP documentation contains descriptive information. The core of documentation comprises functional and economic TP analysis, which documents procedures of checking the compliance of controlled transactions with the arm’s length principle.

In other words, in the context of PEs, in such part of TP documentation it would be necessary to outline the TP analysis procedures and results in terms of establishing whether proper portion of non-resident’s profit was allocated to the PE in Ukraine.

2. What will happen if these requirements are not fulfilled or fulfilled with delay?

The nonfulfillment of requirements on submission of TP reporting will result in penalties, which may prove to be material.

Thus, for non-submission of the Report on Controlled Transactions for 2018 the tax authorities can apply penalty in the amount of UAH 528 600. In case of omission of some transactions in the Report, such penalty will amount to 1% of the amount of such transactions with upper limit capped at UAH 528 600.

The penalty for non-submission of TP documentation for 2018 upon the request of tax authority will amount to 3% of the amount of transaction for which the TP documentation was not submitted with upper limit capped at UAH 352 400.

The penalties for delayed submission of the TP documentation reporting are also envisaged. There are also specific penalties, which are applied if the tax authority has already imposed penalty for non-submission of the Report, and the PE does not submit the Report within 30 days after the deadline set for payment of the penalty.

More information on penalties for non-reporting of controlled transactions may be found in our newsletter “Transfer pricing penalties 2019: onwards and upwards”.

Against the risk of material penalties, it is worth taking formal requirements on reporting seriously. Moreover, the first thing tax authorities are expected to control in terms of TP is due and timely fulfillment of formal requirements by a PE.

3. Which transactions conducted by PEs may fall under TP rules?

The general rule is that business transactions conducted by a taxpayer, which can impact the profit tax object, namely influence expenses or revenues, may be regarded as controlled transactions for TP purposes, provided that further requirements (party, volume thresholds) are met.

According to amendments in force from 2018, in terms of PEs TP control may cover transactions between non-resident and its PE in Ukraine. By amendments, effective from 2019, it was further specified that such transactions include internal settlements.

Transactions between non-residents and their PEs are separately indicated amongst the list of controlled transactions due to the fact that from legal standpoint PE and non-resident are single entity. Therefore, the civil-law relations between them cannot arise. By specifying such transactions among “controlled transactions” the legislator extended the TP rules to the intra-organizational relations of non-resident with its separate subdivision.

What kind of transactions are these?

Obvious “transactions” of non-resident with its PE in Ukraine is the transfer of material resources – monetary funds, equipment, goods.

But this list is not over yet.

There can be other “transactions” which are not obvious. The OECD in its recommendations on attribution of profits to PEs introduces the concept of “hypothetical” transactions between non-resident and its PE. This concept covers wider list of cases which should be considered in determining the part of non-resident’s profit, that should be taxed at the level of PE.

In this aspect lies the main difference between the application of TP rules to transactions between non-resident and its PE and usual TP practice related to transactions conducted between separate entities.

The issue is that relations between PE and other parts of the non-resident’s enterprise are as a rule not documented.

Due to this fact, OECD recommends using so-called “two step” analysis of relations between PE and non-resident. The first step is functional and factual analysis of PE. On this step economically significant functions of the PE should be determined, as well as assets and risks arising in the non-resident’s activity and attributable to the PE.

Such analysis will provide the basis for informed conclusion about relations between the PE and non-resident, that might form separate transactions (supply of goods, works, services, capital etc.) should such relations were in place between separate enterprises.

Would tax authorities adhere to such approach? We shall see. In general, TP rules in Ukraine follow the approaches, outlined in relevant documents of the OECD. Therefore, it is likely that the authorized by OECD approach would be also applied to PEs.

Therefore, the safest, although not the easiest, approach would be to follow OECD recommendations.

Separate question arises with respect to relations of PE with another non-resident being a member of relevant international group apart from non-resident that created PE.

We highly recommend paying attention to such transactions (if they were conducted) and assess their compliance with the criteria for recognition of such operations as controlled. It is advisable not to omit transactions conducted before 2018.

4. What to keep in mind during examination of transaction’s amount?

The value threshold, after which the non-resident’s transactions with their PEs in Ukraine would fall under TP control, is set at UAH 10 million per year.

The annual income criterion, which is applicable for transactions conducted by legal entities, is not applied to transactions between non-resident and its PE.

The amount of transactions is determined according to the accounting rules. However, it should be noted that in 2018 the legislator added the rule, according to which the amount of transactions for TP purposes shall be determined under prices, which are at arm’s length.

It is not clear yet, how this legal provision will be applied in practice. It is evident only that this rule had not added to legal certainty in determination of a range of controlled transactions.

We recommend PEs, which transaction’s scope approximates UAH 10 million, but does not exceed it, to pay special attention to this rule.

As an illustration, let us consider the following example.

According to accounting data the scope of income transactions between the PE and non-resident makes UAH 9,4 million. Net profit ratio (operating profit divided by income) of the PE makes 1%.

Based on the benchmarking analysis of the independent companies engaged in similar activity the tax authority determined that market profitability range starts from 10%. It means that to ensure market profitability PE’s income should be raised by at least 9%.

By simple calculation tax authorities may identify the amount of transaction, calculated at arm’s length prices, which would make UAH 10,246 million. (UAH 9,4 million according to accounting data increased by 9%).

And in that way transaction that seemingly fall outside TP control transform into transactions deemed controlled for TP purposes. And if the Report on such transaction was not submitted, the penalty for non-submission of the Report may be applied.

5. What should be done first – submission of the Report or preparation of the TP documentation?

TP documentation will not be requested till the deadline set for submission of the Report on Controlled Transactions.

However, it should be considered that information about approach to TP analysis should be also indicated in the Report. In particular, information on opted ways to aggregate transactions for TP purposes, applied TP method as well as profit ratio in controlled transactions (if profitability based method was used).

Therefore, the usual recommendation is to perform the economic TP analysis before submission of the Report.

It allows avoiding discrepancies between the Report and approaches applied to economic TP analysis. And in case if after examination it is necessary to adjust tax reporting, such self-adjustment may be implemented without respective penalties.

In terms of transactions between non-resident and PE without prior examination of functions and actual circumstances, there is a risk to qualify incorrectly or even omit controlled transactions.

To conclude, the TP documentation, which complies with all and any formal requirements, may be prepared after submission of the Report. However, we advise to conduct the examination of PE’s transactions according to TP rules before submission of such a Report.

6. What are the specific features of economic TP analysis for PEs?

What makes TP analysis of transactions between non-resident and its PE different is that all such transaction in fact happen within single legal entity. And the main task here is to allocate part of the profit which should be taxed in Ukraine at the level of PE.

In case of PEs the role of functional analysis, which is the determination of the distribution of functions, assets and risks between PEs and other parts of the enterprise, is significantly higher. Moreover, this task is more complicated in comparison with separate legal entities, since respective relations are usually not properly documented which makes it difficult to understand the substance of such relationship.

As for TP methods, given that the task is to allocate the part of profit to PE, it seems that usually profit-based methods would be the choice in the TP analysis.

Yet, it depends on specific case. One cannot exclude that in some specific cases comparable uncontrolled price method may be applicable as well.


As we outlined above, the TP rules related to PEs have their own features and peculiarities. And these special features arise already at the stage of determining the list of controlled transactions and their proper qualification. Therefore, we recommend not to delay and start getting prepared for TP reporting in the nearest future. The time runs fast and October 01 approaches quickly.

Need professional assistance in transfer pricing?

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Or sign up for free introductory discussion by phone with leaders of TP practice of the company WTS Consulting/KM Partners, by sending your contact information and preferable time for discussion to our email address admin@wts.ua.

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.


12010 Report on Attribution of Profits to Permanent Establishments.

Kind regards,

© WTS Consulting LLC, 2019

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