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Extension of transfer pricing control to PEs of non-residents

author: Ivan Shynkarenko

source: WTS CEE Newsletter "Tax Bridge", #1/2018

10 May, 2018 Press

The Ukrainian law “on the amendment of the Tax Code and some other legislative acts to balance budget revenues for the year 2018” amended the Tax Code in such a manner that TP control applies to PEs in Ukraine starting from 1 January 2018.

As such, transfer pricing rules may now apply, inter alia, to transactions between a non-resident entity and its permanent establishment, and, possibly but not definitely, to transactions between permanent establishments inside Ukraine.

Both documented and non-documented transactions or deemed transactions are subject to TP control. This means that although from a civil law point of view there are no transactions between the PE and non-resident as such, “deemed” transactions between the PE and its non-resident are identified for TP purposes.

Legal basis for TP control of PEs

Such an approach follows the principle of distinct and separate taxpayers, as envisaged in paragraph. 141.4.7 of the Tax Code of Ukraine. In accordance with this principle, a PE for tax purposes is deemed to be a taxpayer, which conducts its own business activity separately from the non-resident.

For instance, Article 7 of the Double Taxation Treaty (DTT) between Ukraine and Germany of 3 July 1995 envisages a similar approach. Paragraph 2 establishes that a PE for the purposes of attributing profits should be treated as “…a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment”.

Alongside supplementing the list of business transactions for TP purposes the law also added the special valuation threshold for recognising controlled transactions between the PE and the non-resident entity (paragraph 39.2.1.7 of Article 39 of the Tax Code).

According to this rule, transactions between the PE and the non-resident fall under TP control provided that the annual value of such transactions exceeds UAH 10 million (around EUR 386,000 at the current exchange rate).

Moreover, the recent amendments of TP rules also envisage the established value threshold being calculated not just based on accounting records but taking into account the arm’s length value of transactions, including deemed transactions.

For the purposes of TP control, “deemed” transactions between the PE and non-resident shall be determined which may include (1) functions of the PE in Ukraine conducted for the benefit of the non-resident and (2) support from the non-resident to the PE.

Such functions of PE/support from non-resident would be considered “deemed” transactions between the PE and its non-resident for TP purposes, irrespective of whether they are documented as a transaction or not.

Based on current legislation and previous practice we conclude that the transactions between PEs are not yet considered to trigger TP control in Ukraine, yet this may still change.

Implications of new TP rules for PEs

In general, the introduction of TP control for PEs in Ukraine triggers the need for PEs to comply with Ukrainian TP rules, which means conducting a TP analysis, preparing and submitting the Report on Controlled Transactions and the TP Documentation detailing the TP analysis.

In the absence of official guidelines regarding TP analysis for the PEs, we tentatively conclude that the authorised OECD approach on the attribution of profits to PEs may be applied. Thus, the purpose of extending the TP rules to PEs is to ensure the fair attribution of profits to the PEs.

As such, TP analysis would require identifying all the functions of the PE in Ukraine and attributing the proper amount of profit for such functions applying the TP tools.

During the process of TP analysis we expect it would be necessary to define the functions of the PE and use TP tools compute the arm’s length remuneration of such functions.

For the sake of completeness, the Tax Code of Ukraine contains special rules for calculating the taxable profit of PEs of non-residents (paragraph 141.4.7 of the Tax Code). Thus, there are options for such a calculation:

  • direct calculation;
  • if the non-resident does not calculate the PE profit, a separate balance sheet of activities via the PE should be drafted subject to approval of the fiscal service;
  • if such an estimate of PE profit is not possible, then “deemed” profit is calculated as 30% of the revenue of the PE.

Alignment of new rules with rules on profit taxation of Pes

These rules of the Tax Code were amended in connection with extending TP control to PEs. According to these amendments, starting from 1 January 2018 the above calculations of PE profits should be done with due consideration of TP rules, as set forth in Article 39 of the Tax Code.

However, we tend to conclude that the existing rules (as well as the regulations detailing the procedure of profit tax reporting by PEs) are not entirely aligned with the new approach that relies on TP principles and rules.

This conclusion is also confirmed by representatives of the State Fiscal Service, who stated that changes to these rules are expected.

We will monitor the possible changes and follow up with updates. At the same time, since the above-mentioned provisions are new and there is little real experience on the matter, it is highly recommended to start such an analysis now, as soon as possible, in order to ensure respective PEs located in Ukraine are compliant with the new Ukrainian requirements.

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