The Cabinet of Ministers adopted the list of legal forms of non-residents that do not pay profit tax and/or are not tax residents in the countries of their registration
The Cabinet of Ministers adopted by the Resolution No. 480 as of July 4, 2017 the List of legal forms of non-residents that do not pay profit tax (corporate tax), including income tax received outside the country of such non-residents’ registration, and/or are not tax residents of the country where they are registered as legal entities (hereinafter – the List).
Why has the new list been developed?
The List has been developed in pursuance of subpara. «g» of subpara. 18.104.22.168. of Art. 39 of the Tax Code of Ukraine (hereinafter – TC of Ukraine), added by the wording of Art. 39, which came into force on January 1, 2017. This subparagraph establishes the rule on the qualification of transactions as controlled for the purposes of transfer pricing (hereinafter – TP) with non-residents that do not pay income tax and/or are not tax residents in the country of their registration.
The List includes the legal forms from 26 countries, including such countries as the USA, Great Britain, Germany, Poland and even Japan. Such a wide geography of the countries that mainly do not occur in the media as offshores has caused some alert amongst taxpayers. There were warnings that the number of the controlled transactions will grow significantly due to such list introduction.
What is the purpose of the introduction of the new criterion of controlled transactions?
The principal target of the new criterion is the business that avoided TP control with the use of structures, the key link of which were non-residents that do not pay income tax and/or are not tax residents in the countries of their registration.
Thus, with the introduction of the TP control for transactions with non-residents from the “low-tax” list, the share of transactions with so-called “fiscally transparent” persons in countries that are not considered as low-tax countries, has increased dramatically. By “fiscal-transparent” we mean the persons who are created in legal forms, taxed at the level of participants and exempt from taxation of foreign incomes. That is, if participants are non-resident in the country of registration of the entity, and all income is from foreign sources, the tax will not occur in the country of registration of the “fiscally transparent” person.
For example, non-resident in the form of a Limited Liability Partnership (LLP) created in the UK, where partners are companies from Belize and Panama, who purchases and resells wheat from Ukraine, will not pay tax in the UK.
The tax result of sale via such non-resident is the same as sale through Belize and/or Panama, but without TP control. Thus, the Ukrainian seller and the partnership from UK are not related entities, or at least the difficulties of the information exchange do not provide the opportunity to prove the opposite.
The new criterion of the qualification of transactions as controlled is aimed at preventing the use of such structures. And in this light, the work on the list legal forms seems to be justified. It is clear that now fiscally transparent entities from Japan are unlikely to be widely used. But if to put under control only British partnerships, the demand for the Ukrainian export products may soon also appear among the Japan’s sleeping partnerships.
Is it possible to justify the lack of grounds for control, even if the legal form of the non-resident has appeared in the List?
The second part of subpara. “g” of subpara. 22.214.171.124 of the Art. 39 of the TC of Ukraine provides for such opportunity.
Thus, transaction is not subject to control if a non-resident counterparty, whose legal form is included in the List, paid the corporate tax in the reporting year. Of course, if other criteria of qualification of transactions as controlled are not met.
The question is only in the form of confirmation of such payment: will the fiscal authority of the non-resident country issue a certificate with sufficient information, which will be accepted by the fiscal authorities of Ukraine?
As practice shows, the lack of clear provisions regarding the form of confirmation of certain facts, as a rule, does not work in favor of taxpayers.
When do transactions with non-residents in legal forms included in the List start being controlled?
Paragraph 41 of Subsection 10 of the Transitional Provisions of the TC of Ukraine provides that transactions with non-residents in the legal forms included in the List are recognized as controlled from the date when the List comes into force.
However, the second paragraph clarifies that the scope of value criterion of qualification of transactions as controlled is calculated in 2017 as per results of the reporting (calendar) year.
That is, if the transactions with the counterparty after the List came into force were made for UAH 10 thousand, and before that for UAH 10 million, transactions for UAH 10 thousand will be recognized as controlled.
At least we understand the transitional provisions in this way.
Definition at the regulatory level of the list of legal forms of non-taxpayers in the country of their registration has wider consequences than the new criteria of the transactions’ controllability for the TP purposes.
Thus, in this case, there is also question about the application of the advantages of agreements on the avoidance of double taxation to payments in favor of such non-residents.
Such questions about partnerships arose earlier. After the appearance of the list, we expect the increase of such questions.
But this is the subject of a separate special review.
So, what are the conclusions?
With the adoption of the List the parameters of the new criterion of qualification of the transactions as controlled have been finally determined. The new parameter of the qualification of transactions as controlled is aimed at the specific structures whereby TP control was bypassed. Therefore, the law-abiding taxpayers are unlikely to feel significant changes.
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.
Transfer pricing penalties: general overview
The list of legal forms of non-residents who do not pay income tax (corporate tax), including tax on income received outside the state of such non-residents’ registration, and /or are not tax residents of the state in which they are registered as legal entities