The practice of international companies regarding relocation of expatriate management abroad started a long time ago since COVID-19 times. Sometimes it was the case when one person could hold the position of director in companies located in different countries. After the beginning of the russian federation\u2019s full-scale war against Ukraine, such practice has been widely adopted not only by international companies. When the management relocation became more prevalent, foreign tax authorities began to raise questions as to acquiring of residence status by Ukrainian companies in these countries. And such questions pertain not only to corporate income tax but sometimes also to value-added tax.<\/p>\n
The above brings up the question to owners of Ukrainian companies: are they aware of the potential risks and implications which may be caused by such relocation? Please find below the key points in respect of corporate income tax.<\/p>\n
Place of management is a self-sufficient condition for residency recognition<\/strong><\/p>\n Bilateral international agreements of Ukraine on avoidance of double taxation contain similar provisions of Article 4 regarding determination of the company\u2019s tax residency and one of the criteria for determining the tax residency status is the place of the company\u2019s management1<\/a><\/sup>. If according to the place of management criterion the company is a resident of both States, then it shall be deemed to be a resident of the State in which its actual managing body is located.<\/p>\n Let us reiterate, that the tax residency status under the place of management criterion may occur if the relevant provisions are stipulated in the domestic legislation of the respective country. Accordingly, Ukrainian companies should verify whether according to the local legislation of another country they have a tax obligation in connection with the relocation of their management personnel to such country.<\/p>\n Please note, that recognition of tax residency in the country where the company\u2019s management is located does not depend on whether permanent establishment is created in that country or not.<\/p>\n What is the \u201cplace of management\u201d?<\/strong><\/p>\n The international bilateral agreements of Ukraine on the avoidance of double taxation do not provide a clear definition of what exactly is meant by the \u201cplace of management\u201d. Therefore, for better understanding, it is advisable to refer to the Commentary of the Organization for Economic Co-operation and Development (the \u201cOECD\u201d) on model Convention for the avoidance of double taxation2<\/a><\/sup>.<\/p>\n Thus, in the Commentary on Article 4 of the Model Convention on the avoidance of double taxation, the OECD noted that double residency of legal entities is not a widespread phenomenon and is more relevant to specific industries, especially for transport. Therefore, the formulation of preference criterion for entities other than individuals was considered in connection with the taxation of income derived from shipping, inland waterway and air transport. A number of conventions for the avoidance of double taxation on such income accord the taxing power to the State in which the \u201cplace of management\u201d of the enterprise is located. In contrast, other conventions attach importance to its \u201cplace of effective management\u201d while other focus on the \u201cfiscal domicile of the operator\u201d.<\/p>\n After discussions of various approaches, the \u201cplace of effective management\u201d has been adopted as the preference criterion for entities other than individuals. The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity\u2019s business are in substance made. Typically, the place of effective management is a place where the senior manager or group of managers (e.g. the board of directors) adopt the decisions determining the business entity\u2019s general actions. However, there is no definitive rule and all relevant facts and circumstances must be examined to determine the place of effective management. Although an entity may have more than one place of management, but only one place of effective management may exist at any time.<\/p>\n In view of the above comment, we believe that for determining the \u201cplace of management\u201d it is possible to use the features of the \u201cplace of effective management\u201d given by the OECD. Thus, according to the OECD, when determining the \u201cplace of effective management\u201d<\/em> certain factors should be considered:<\/p>\n Despite the growing practice of the remote work, in various countries as well, the OECD has not substantially updated its recommendations in this part. It is especially felt the outdated recommendation on the place of storage of accounting documents in the context of the active use of electronic document flow by business.<\/p>\n As a consequence of applying the OECD position, only the relocation of the Ukrainian company\u2019s management to another country is sufficient for raising the questions on recognition residence status by the country where the management is located. The risk of recognition as a resident is increasing for the companies having the sole managing body (director), who has moved abroad and works remotely.<\/p>\n As mentioned above, the crucial factor in determining the place of management will be the legislation of the specific country. In this regard, for example, we will consider below how this issue is resolved according to the legislation of Ukraine.<\/p>\n First we should refer to Article 28 of the Law \u201cOn Limited Liability and Additional Liability Companies\u201d which defines that the bodies of the company are the general meeting of participants, the supervisory board (if any) and the executive body. The company may have a sole executive body (\u201cdirector\u201d unless\u00a0otherwise\u00a0is provided\u00a0by the Charter) (Article 39). The Charter may stipulate the existence of the collegial executive body of the company and determine its quantitative composition. The name of the collegial executive body is \u201cboard of directors\u201d and its head member is a \u201cgeneral director\u201d, unless\u00a0otherwise\u00a0provided\u00a0by the Charter. The Law provides that the competence of the executive body of the company includes the solution of all issues related to the management of the company\u2019s activity.<\/p>\n The above provisions confirm that the relocation of director (or board of directors) only, even without other key employees, changes the location of the managing body from Ukraine to the respective foreign country.<\/p>\n In accordance with Article 93 of the Civil Code of Ukraine, the location of a legal entity is the actual place of its activity or office location, in which the daily managing activity of the company (mostly in which the top management is located), as well as implementation of managing decisions and accounting are executed. In case of management relocation abroad, the business activity continues to be conducted in Ukraine, accounting remains in Ukraine as well. Therefore, despite the change in the location of the executive body, according to Ukrainian legislation the legal entity’s location remains in Ukraine, which means that Ukraine will continue to consider such an entity as its resident.<\/p>\n In such a case, the States in which the company\u2019s residence status occurs, should conduct a mutual agreement on avoidance of double taxation.<\/p>\n Mutual agreement<\/strong><\/p>\n The issue of tax residency should be resolved by two States through the mutual agreement procedure provided for in the relevant article of the international bilateral agreements of Ukraine on the avoidance of double taxation and Article 108-1 of the Tax Code of Ukraine (the \u201cTax Code\u201d).<\/p>\n In particular, pursuant to the provisions of Article 108-1 of the Tax Code, the taxpayer considering that he\/she is subject to double taxation as a result of a decision of the state authorities of Ukraine or a foreign State, which contradicts to the provisions of the relevant agreement on the avoidance of double taxation, may apply to the competent authority for initiation of the mutual agreement procedure.<\/p>\n That is, it is possible to apply for the initiation of such a procedure when the relevant taxpayer has on hand a respective decision inducing the double taxation.<\/p>\n In the case under consideration, it might be the decision of the State of residence of top management stating that the relevant Ukrainian company is subject to taxation in such a State as a resident due to the relocation of the top management to such a foreign state.<\/p>\n As a rule, as stipulated by the bilateral agreements between Ukraine and other countries on the avoidance of double taxation, the Minister of Finance or its authorized representative is considered to be such a competent body authorized to communicate with the States for the purposes of the Convention.<\/p>\n Upon completion of such a mutual agreement procedure, the States should determine such rules of taxation of the respective taxpayer in Ukraine and in the foreign State where its top management is located, which will eliminate the double taxation.<\/p>\n In case of change of the tax residency of the Ukrainian taxpayer to the foreign State, the taxpayer in Ukraine shall acquire the status of a non-resident, in particular, for the purposes of payment of corporate income tax \u2013 only income originated from Ukraine will be subject to taxation. In the foreign State (as a new country of residence) the taxpayer shall comply with:<\/p>\n Risk of double taxation <\/strong><\/p>\n We are not aware of any practical cases when Ukrainian taxpayers initiated the mutual agreement procedure. Therefore, it is difficult to predict whether in practice the Ukrainian tax authority will agree with the change of the taxpayer\u2019s residency and what will be the real requirements for this. Considering bureaucratic delays and tax authority\u2019s approach for preparing formal non-substantiative replies, there is a significant risk that the mutual agreement procedure will be dragged on and the taxpayer will be in a situation where both countries consider him as double taxation resident. Why does this risk exist?<\/p>\n First, we do not exclude that as a result of the mutual agreement procedure the taxpayer may receive only general recommendations on taxation.<\/p>\n For example, a few years ago in Ukrainian tax legislation appeared the concept of the \u201cplace of effective management\u201d<\/em> by analogy with international agreements on the avoidance of double taxation, introduced for the purpose of qualification of companies as CPT taxpayers\u00a0\u2013 residents<\/strong> of Ukraine under Law No. 466-IX as of January 16, 2020<\/a>.3<\/a><\/sup><\/p>\n However, the Tax Code stipulates the mentioned rules only for foreign legal entities having a place of effective management in Ukraine.<\/p>\n At the same time, the Tax Code does not contain provisions that would regulate the tax implications for Ukrainian companies whose top management relocated to another State and who were initially tax residents of Ukraine from the moment of their registration. Accordingly, how exactly the tax authorities will recognize the Ukrainian companies as non-residents? Will they de-register them as residents? We do not exclude that companies will have to spend a lot of time and efforts for such technical issues.<\/p>\n Second, the international agreements of Ukraine on the avoidance of double taxation do not establish any deadlines for States for reaching any agreement upon results of the mutual agreement procedure.<\/p>\n Therefore, since this procedure involves communication at the level of authorized state bodies and each case of double taxation requires a separate procedure (i.e. case-by-case analysis), the procedure potentially may take years and years. Moreover, the agreements do not stipulate that States shall achieve any specific result in principle.<\/p>\n The approach of European countries to relocated Ukrainian top management was discussed in the newsletter by the link<\/a>.<\/p>\n Consequences of ignoring the actual change of the country of residency<\/strong><\/p>\n If the taxpayer ignores the requirements of the tax legislation of the State where the top management is located, then in case of detection by that country of changing \u00a0the place of effective management and, accordingly, tax residency:<\/p>\n What can be done right now to mitigate the risks?<\/strong><\/p>\n <\/p>\n First of all, we would advise taxpayers, whose management temporarily stays abroad, to estimate the number of such individuals and countries in which they are located: to analyze in which country he (they) resides, to check if there is a respective agreement on the avoidance of double taxation between Ukraine and that (those) country (countries), what are the provisions and approaches of local legislation to the recognition of companies as residents.<\/p>\n If after analysis it appears that there is a high risk of the Ukrainian company being recognized as a resident of another country, the following actions may be considered:<\/p>\n If the proposed above solutions are not suitable, in order to mitigate the risk the management may transfer the maximum scope of its authorities to other employees who continue to stay in Ukraine<\/p>\n 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.<\/em><\/strong><\/p>\n Footnotes:<\/em><\/p>\n 1<\/a><\/sup>Since according to the UNHCR data, the largest number of Ukrainian refugees was recorded in Germany, let\u2019s consider an example of\u00a0the Agreement between Ukraine and the Federal Republic of Germany on the avoidance of double taxation with respect to taxes on income and capital\u00a0as of July 3, 1995.<\/em><\/p>\n\n
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