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Why will everything change from October 1 for representations of non-residents?

20 May, 2019 Blog

Ivan Shynkarenko_

Ivan Shynkarenko

Partner, Ph.D. in Economics

Since 2018 Ukrainian transfer pricing (TP) rules apply to transactions of non-residents with their permanent establishments (PE) in Ukraine. It is a novelty in Ukraine.

PEs have met this news without great anxiety. And the reason for this is obvious. In fact, the first time when PEs will get in touch with the new rules would be filing of the Report on Controlled Transactions. And the deadline for submission of such Report regarding transactions of 2018 (already subject to TP rules) is set on October 1st, 2019.

Yet, time is running fast and the deadline for submission of the Report on Controlled Transactions is approaching. And it is high time to get acquainted with the new rules. Thus, they have every chance to change the playing field for PEs dramatically.

The category of PEs has been included to Ukrainian tax law long ago. It is a tax category that was taken to the national law from Double Tax Treaties. It has been introduced for the purpose. Namely, for distinguishing cases:

1) when foreign company deriving income from Ukraine (supplying goods, services, works) is not subject to taxation in Ukraine;

2) when foreign company should pay the tax in the source country of income, namely Ukraine.

It is worth noting that PE is not just a representative office as a remote division of non-resident company in Ukraine. It is a broader tax concept designating business-presence of foreign company in Ukraine. Such business presence may be in the form of registered office, employees staying in Ukraine for some time for business purposes, residents that are engaged in the activity generating income for non-resident.

From the first years of work in the profession I started dealing with PE-related issues. This work covered consulting projects as well as tax disputes where tax authorities reclassified “non-commercial” representative offices into PEs.

And during this work I always had the feeling that some “piece of the puzzle” is missing in the system of control over PEs in Ukraine.
Thus, practical application of the PE concept in most cases needs two questions to be answered:

1. Whether according to criteria in Ukrainian legislation and applicable DTT a PE of non-resident in Ukraine is triggered or not?

2. If the answer is “yes” then what portion of non-resident’s Ukraine-sourced income should be taxed in Ukraine? The so-called problem of allocating profit to PE.

An answer to the first question is often clear, although there are cases challenging already at the stage of defining if there is a PE.
Yet, an answer to the second question usually created serious problems. Ukrainian law lacked relevant tools for making grounded decisions on what part of the profit should be allocated to PE.

For example, the Tax Code of Ukraine envisages the dependent agent PEs, which are residents that provide agency, trust, commissioner and other similar services on selling or purchase of goods, works, services at the expense and for the benefit of a sole non-resident.

Let us assume that we have identified such dependent agent PE. And what is next? What additional taxes from non-resident’s profit should be payable in Ukraine?

Tools of tax control over PEs did not provide the answer to this question. In other words, there was the rule of law but no clear mechanism of its practical application.

In general, the control over PEs in Ukraine is often limited to the amounts passing through the bank accounts of PEs. There was no other legal mechanism of establishing “fair” portion of profit subject to tax in Ukraine.

This is bound to change since October 1st of this year, when PEs will have to submit first Reports on Controlled Transactions under TP rules.

Why the status of control over PEs will change? Because instruments of TP were the “piece of the puzzle” which was missing. Without TP it was not possible to ensure full-fledged tax control over PEs in Ukraine.

In other words, extension of TP rules to transactions of non-residents with their PEs should not be regarded as merely extra administrative burden in the form of additional reporting.
In fact, everything is likely to change for PEs from the standpoint of tax regime in Ukraine.

Therefore, I advise not to ignore the new rules but to prepare in advance. There are good reasons why significant share of TP disputes in countries with developed TP control frameworks are related to the issues of profit allocation to PEs.

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