Changes in the tax sphere effective from January 1, 2021
Provisions of the Law No. 1117-IX dated December 17, 2020 “On Amendments to the Tax Code of Ukraine and Other Laws of Ukraine on Ensuring the Collection of Data and Information Necessary for Declaring Certain Objects of Taxation” (hereinafter the “Law 1117”), which have already come into force, introduce a number of amendments to the Tax Code of Ukraine (hereinafter the “Tax Code”). These amendments take effect form January 1, 2021.
The Law 1117 not only introduced a number of new provisions, but also postponed the effective date of implementation of certain provisions of the Tax Code, which were earlier introduced due to adoption of the Law No. 466 dated 16 January 2020 “On Amendments to the Tax Code of Ukraine on Improving Tax Administration, Elimination of Technical and Logical Inconsistencies in Tax Legislation” (hereinafter the “Law 466”).
An overview of the main changes is provided below.
Controlled foreign companies
The Law 1117 postponed the enactment of rules on controlled foreign companies (hereinafter “CFCs”). In particular, Art. 392 of the Tax Code, which defines the CFCs taxation rules, is supposed to become effective from January 2022.
In view of the amendments, para. 54 of Sub-section 10 of Section XX of the Tax Code stipulates that the first reporting (tax) year for CFCs report will be 2022. In other words, a person will be obliged to report on acquisition of control or withdrawal from the CFC starting from January 1, 2022. At the same time, the law permits to submit the first report together with the controlling person’s annual declaration for 2023.
For the years 2022-2023, the Law establishes a transition period, during which penalties and fines for violations of Art. 392 of the Tax Code shall not apply. During the same period administrative and criminal liability shall not be applied for any violations connected with the application of Article 392 of the Tax Code. Besides, the information and/or documents, received by a controlling authority based on the results of 2022-2023, constitute the information with restricted-access and may not be demanded by and/or disclosed to law-enforcement authorities. Moreover, such information may not be regarded as evidence in the criminal proceeding.
Changes were also introduced to the provisions on the “tax-free” liquidation of CFCs, namely to para. 170.13-1 of Art. 170 and para. 14 of Sub-section 1 of Section XX of the Tax Code. In particular, the amendments clarify the conditions under which income, received in result of the CFC’s liquidation, shall not be included into taxable income of natural persons. They are the following:
- liquidation must begin no earlier than January 1, 2020 and be completed no later than December 31, 2021;
- the taxpayer must submit, together with the tax return, the application for the exemption of such income from taxation;
- the foreign entity must be incorporated or registered no later than May 23, 2020;
- when the income is received, in compliance with all the conditions above, by the beneficial owner (controller) from the nominee holder (nominee). In this case, the beneficial owner must additionally provide documents confirming the receipt of such income from the nominee due to the liquidation of the foreign legal entity.
Thin capitalization rules
The Law 1117 clarifies the “thin capitalization” rules.
It was expected, in particular, that with the adoption of the Law 466, since January 1, 2021 for the purposes of calculation of the amount of adjustment of financial result (provided that there are debt obligations to non-residents on credits, loans, and lease agreements and such obligations exceed the equity capital by more than 3.5 times) all interest on credits, loans, and other debt obligations accrued in accounting records should be taken into account, regardless of whether they arose from transactions with non-residents or residents (para. 140.2 of Art. 140 of the Tax Code).
The Law 1117 limited the amount, which shall be included for the purposes of calculation of the amount of adjustment, to the amount of interest on credits, loans and other debt obligations arising only from transactions with non-residents.
In addition, the Law 1117 expanded the list of cases in which the thin capitalization rules do not apply. Thus, except for the amount of interest deemed inconsistent with the “arm’s length principle” according to Art. 39 of the Tax Code, adjustments do not apply to the amount of interest accrued in favour of certain international financial institutions on credits (loans), the fulfilment of which is secured by state or local guarantees, as well as the amount of interest accrued in favour of foreign banks.
The “business purpose” test
The Law 1117 somewhat narrowed the scope of the “business purpose” test.
In particular, the Law 1117 excluded the provision of the Tax Code (namely para. 140.5.15 of the Tax Code) which provided, for the purposes of taxation, adjustments of the financial result for the amount of expenses incurred in respect of transactions with non-residents if such transactions have no business purpose. It is worth reminding that para. 140.5.15 of the Tax Code, introduced by the Law 466 and applied from May 23, 2020 (the date of entry into force of the Law 466), stipulated that the business purpose test should be applied to all transactions with non-residents without exception.
However, in view of the Law 1117, the business purpose test may be applied only to controlled transactions, and since January 1, 2022 also to such transactions with non-residents as:
- transactions for the purchase of goods (works, services) (subpara. 140.5.4 of para. 140.5 of Art. 140 of the Tax Code), as well as transactions for the sale of goods (works, services) (subpara. 140.5.51 of para. 140.5 of Art. 140 of the Tax Code) provided that the counterparties are non-residents registered in low-tax jurisdictions or in low-tax legal corporate forms (except for transactions subject to the transfer pricing rules, and except for interest in favour of non-residents subject to the “thin capitalization” rule according to para. 2 of Art. 140 of the Tax Code);
- royalties in favour of any non-residents (subpara. 140.5.5 of para. 140.5 of Art. 140 of the Tax Code) – regardless of whether they are low-tax or not (except for transactions subject to the transfer pricing rules).
Non-residents and their permanent establishments
Let us remind that the Law 466 has changed the approach to taxation of non-residents. In particular, non-residents were recognized as income tax payers instead of their permanent establishments (subpara. 133.2.2 of para. 133.2 of Art. 133 of the Tax Code). Moreover, the Law has obliged non-residents, carrying out business activity in Ukraine, to register with the controlling authorities of Ukraine until October 1, 2020 (para. 60 of Sub-section 10 of Section XX of the Tax Code, as amended by the Law 466). The audits of non-residents, that did not comply with these requirements, were supposed to start from January 1, 2021.
The Law 1117 provides for the postponement of deadline by which non-residents must be registered, as well as the start of inspections/audits of non-residents.
According to the amendments introduced by the Law 1117 in subpara. 1 and 2 of para. 60 of Sub-section 10 of Section XX of the Tax Code, non-residents, which have not registered with tax authorities, still have possibility to register until April 1, 2021. While the start of tax audits of non-residents, carrying out business activity in Ukraine, and which are meant to be registered, and of their separated branches, including permanent establishments, which have been already registered, was postponed until July 1, 2021.
It should also be mentioned that the Law 466 introduced new qualification criteria, according to which non-residents’ permanent establishments are recognized on the territory of Ukraine (para. 14.1.193 of the Tax Code). And the amended para. 141.4.7 of the Tax Code established new rules by which the profit of permanent establishments shall be determined for the purposes of taxation of non-residents carrying out their activities through permanent establishments.
At the same time, in view of the changes introduced by the Law 1117, the new criteria for the recognition of permanent establishment in Ukraine and the new rules for determining taxable income of permanent establishments shall apply only from January 1, 2021 (subpara. 1 of para. 60 of Sub-section 10 of Section XX of the Tax Code).
Until January 1, 2021 taxation of representative offices and non-residents, carrying out their activities through permanent establishments, shall be implemented according to the rules effective before the changes introduced by the Law 466.
Taxation of non-residents’ income from the sale of investment assets
The Law 1117 postponed the date from which the new rules of taxation of non-residents’ income from the sale of investment assets shall apply, and stipulated the mechanism of taxation of non-residents’ income from sale of such assets in Ukraine, even if the transaction is carried out between two non-residents (subpara. 14.1.54 (и) of para. 14.1 of Article 14 of the Tax Code, subpara. 141.4.1 (e), subpara. 141.4.2 of para. 141.4 of Article 141 of the Tax Code).
Based on the provisions of para. 602, para. 607, para. 608 of Sub-section 10 of Section XX of the Tax Code the respective taxation rules shall apply from January 1, 2021. Until January 1, 2021 subpara. 14.1.54 of para. 14.1. of Art. 14 of the Tax Code shall be applied in the version effective before the changes were introduced by the Law 466. This version does not provide for taxation of non-residents’ income received from alienation of investment assets in favor of other non-residents.
The Law also specifies that, in order to determine the share of immovable property in the assets of a Ukrainian company, for the purposes of taxation of income from the sale of investment assets, the leased property shall be considered, which is reflected in the accounting records of such entity as an asset, including asset by right of use, according to the requirements of National Accounting Standards or IFRS (subpara. 3-4 of subpara. 14.1.54 (и) of para. 14.1 of Art. 14 of the Tax Code and subpara. 5-6 of subpara. 141.4.1 (e) of para. 141.4 of Art. 141 of the Tax Code).
In addition, in para. 64.5 of Article 64 of the Tax Code the Law 1117 established the procedure for registration of non-residents acquiring ownership in the investment asset from another non-resident, alienating such property and having no permanent establishment in Ukraine. In particular, non-residents acquiring investment assets shall be registered with the controlling authority at the location of the Ukrainian legal entity, which shares, corporate rights form the value of the investment asset, which is the subject of such transaction. Such registration shall take place before the date of the first payment for the acquired investment asset.
Although earlier the Tax Code established the respective obligation for a non-resident aquiring investment asset to register with the Ukraininan tax authorities, the procedure for implementing such obligation had not been provided by the Tax Code.
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.
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