The Law No. 63-VIII as of December 25, 2014 “On amending of the Tax Code of Ukraine regarding aspects of adjustment of corporate profit tax and value added tax liabilities in case of applying tax compromise” has been promulgated on January 16, 2015 (hereinafter “the Law on tax compromise” or “the Law”). The Law comes into force starting from the next day after the day of its promulgation, i.e. on January 17.
What is the tax compromise according to this Law?
The Law defines tax compromise as a regime of exemption of taxpayers and/or their officials from legal responsibility for understatement of tax liabilities on the corporate profit tax (CPT) and/ or value added tax (VAT) for periods till April 1, 2014 within term limits (1095 days), providing that (according to the procedure established by this Law) 5% of the amount of understated tax liability is to be paid to the budget.
According to the definition tax compromise shall be applied only to the understatement of CPT or VAT liabilities. Correspondently, it does not cover, for example, overstatement of negative value of CPT or VAT, overstated budgetary VAT refund and other possible controversial issues in relations with tax authorities.
It is worth mentioning that tax compromise regime envisages paying 5% of additional “tax liabilities”. This definition is prescribed in subpara. 14.1.156 of the Tax Code and covers only payment of tax or duty as such, i.e. without penalties, fines. In particular, the Law defines that either penalties or fines are not charged under the tax compromise regime.
In what cases may tax compromise regime be applied?
- The taxpayer has tax “wrongdoings” for periods till April 1, 2014 which have not been identified by tax authorities yet, but which may cause additional CPT and VAT liabilities.
- The taxpayer has already received the tax notification-decision regarding indicated periods with additional CPT or VAT liabilities, but these liabilities are not agreed and the procedure of court or administrative appeal is still in progress.
- Documentary audit has been initiated or the act has been filed in result of such audit (however, unadjusted tax notification-decisions have not been issued yet).
How shall tax compromise be applied?
The case (2) when there is a tax notification-decision available in the dispute is the most simple.
Tax compromise may be achieved on the basis of the taxpayer’s statement of intention to reach tax compromise, which shall be submitted in written form to the controlling body. In such case the Law does not require acknowledgement of the tax authority’s position. Therefore, the statement may comprise the information that the taxpayer has decided to accept tax compromise based on pragmatic reasoning (for example, closing of dispute which takes time and money to hire lawyers), but herewith the taxpayer remains of the same opinion as for the subject of the dispute. The day of submission of such statement is considered to be a day of agreement of tax liability defined in tax notification-decision. 5% of such liability shall be paid to the budget within 10 calendar days after the day of liability’s agreement.
We would like to underline that according to the definition the tax liability, 5% of which shall be paid to reach tax compromise, is actually the amount of additional liability of tax or duty. It does not include the entire amount which the taxpayer was supposed to pay, i.e. tax liability including penalties.
According to the Law, when paying such amount within the regime of tax compromise the rest 95% of the liability amount has been considered as satisfied (herewith it is not included to the income of the taxpayer as “forgiven debt”), fines and penalties are not applied (i.e. in such case they are to be written off by the tax authority).
As follows this is a closing procedure of the dispute at the stage of administrative appeal under the Law.
The court disputes additionally require the formally completed procedure of amicable settlement that may take additional efforts.
In case (3) it is easier to wait for transition to case (2) (if only terms allow) and then close the dispute as described above. Otherwise the procedure will be similar to case (1).
In case (1), i.e. when “wrongdoings” for previous periods have not been identified during audits or have not been the subject of the audits, the procedure is the following:
- the taxpayer submits adjustment calculations where the overstated amount of tax expenses and/ or tax credit is defined. We would like to note that exactly the expenses and the tax credit are meant, in case of understated income or tax liabilities tax compromise is not applied;
- within 10 days after the submission of adjustment calculation the tax authority takes a decision regarding relevance of unscheduled documentary audit related only to issues of tax compromise;
- the tax authority either notifies that the audit is not required (in such case the amount of declared liabilities is considered as adjusted), or takes a decision to carry out an audit. According to the results of the audit the tax authority delivers a notification-decision (5% of liabilities shall be paid under such decision), or draws a document confirming declared liabilities;
- the taxpayer shall pay adjusted liabilities (5%) within 10 calendar days. Tax notification-decision may be appealed, but in such case tax compromise shall not be applied.
More about application of tax compromise (only in cases of expenses and tax credit?)
The question is whether it is possible to apply tax compromise in case (2) when liabilities under tax notification-decision related to definition of additional income or VAT liability are not agreed.
Adjustment which is prescribed by the Law [i.e., in cases (1) and (3)] shall be applied only to overstated expenses or VAT tax credit. In case (2) such limits are formally not established. Therefore, it can be said that in such case tax compromise may be applied to additional CPT and VAT liabilities irrespective of grounds for their additional charging, their relation to “troubled” expenses or incomes, liabilities or VAT credit.
However, the restrictive interpretation on the part of tax authorities cannot be excluded. According to this interpretation exactly the overstated expenses/ tax credit is meant even in case of unadjusted liabilities. It seems that tax authorities tend to such interpretation in practice.
Herewith, practical questions have been arising on how to act in cases when additional liabilities are charged under one tax notification-decision both for removal of expenses and for understatement of incomes.
What are the time limits for tax compromise application?
The time for application of tax compromise is limited: taxpayers have the right to submit respective adjustment calculations or statements within 90 calendar days from the day after the effective date of the Law, i.e. since January 17, 2015.
How application of tax compromise may influence contractors?
The Law contains general norm which provides that adjustment of tax liabilities using tax compromise does not influence tax liabilities of contractors.
Such wording is quite general and does not contain direct prohibition of reviewing tax liabilities during tax audits. It may be interpreted as follows: adjustment of indexes by other taxpayer as such does not influence liabilities of contractors. It is clear enough without special prescription.
However, in case of supply chain the issue of contractors’ tax liabilities is entirely important. Eventually, when one of the participants of the supply chain admits the transaction as “troubled”, deciding to apply tax compromise, it may cause problems for other contractors. It is subject to expenses and tax credit of supply chain contractors, who, for example, resell goods purchased from the third parties, as well as to expenses/ tax credit of contractors purchasing goods from the taxpayer who admits troubled expenses/ tax credit.
Thus, according to the fiscal approach all the contractors of the supply chain, where the “compromise” taxpayer appears, fall upon the risk.
In other words, if all the contractors of the supply chain do not voluntarily adjust 5% payment to the budget, after 90 days of effect of tax compromise regime they may face penalties or additional charges.
Thus, in case of supply chain we have something like turnover tax in the amount of 5% from tax liabilities of all participants of supply chain where one of them has reached a compromise.
Hence, we recommend to control the adjustment processes of contractors in the supply chain as far as possible in order to avoid risks of disclaiming tax report indexes on real activity of bona fide taxpayers by tax authorities only proceeding from the fact that respective participant of the supply chain has admitted the overstatement of expenses/ tax credit. In particular, the adjustment may be elaborated including explanations that the tax compromise is attributed only to respective transactions which are not related to reselling of goods to contractors, and afterwards cannot put in doubt all other transactions in the supply chain.
We would like to mention that when tax compromise is reached, the liabilities may not be appealed and their amount cannot be changed, whereas tax audits regarding CPT or VAT related to adjusted transactions shall not be carried out in the next periods.
Tax compromise is not a multipurpose “act of grace”
According to the Law the action made by the taxpayer or its officials which has caused understatement of its tax liabilities, only if such liabilities have been adjusted under the procedure of tax compromise and paid to the budget, is not considered, ad verbum, as intentional evasion of payment of taxes and duties (mandatory payments).
Respective changes regarding absence of responsibility are introduced to Article 1631 of the Code on Administrative Offences (violation of the procedure of tax administration) and Article 212 of the Criminal Code of Ukraine (tax evasion).
However, elimination of responsibility falls only within the abovementioned specific regulations. Thus, the attempts of bringing to responsibility on other grounds in case of tax compromise should not be completely excluded. Such grounds may be, for example, under Article 366 “Employment Fraud” of the Criminal Code, namely, intentional introduction of false information to official documents (for example, tax report) by the officials (as it may be considered in practice with regard to tax compromise).
Thus, one must be prudent while accepting tax compromise and arrange it with written statement that such decision has been taken based rather on pragmatic reasoning than acknowledgement of “cheating” in previous periods.
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.