{"id":6500,"date":"2017-05-18T11:59:00","date_gmt":"2017-05-18T09:59:00","guid":{"rendered":"https:\/\/kmp.ua\/?p=6500"},"modified":"2018-02-19T16:17:16","modified_gmt":"2018-02-19T14:17:16","slug":"ukrainian-customs-regime-of-inward-processing","status":"publish","type":"post","link":"https:\/\/kmp.ua\/en\/analytics\/exclusive\/ukrainian-customs-regime-of-inward-processing\/","title":{"rendered":"Ukrainian customs regime of inward processing: Is there a need of \u201ccrush-test\u201d for the applied business model?"},"content":{"rendered":"

Why are we talking about the risks?<\/strong><\/p>\n

Ukrainian customs regime of inward processing is widely used in business today. It is not surprising, because this regime has obvious advantages. It allows importing raw materials for processing with relief from the customs duties and VAT on condition that the finished products are exported from the customs territory of Ukraine within established terms.<\/p>\n

Yet, as is usual in economics, the benefits go hand-in-hand with the risks. Thus, regime of inward processing, if canceled, would result in significant tax charges \u2013 actually all customs payments on raw materials, brought under relief. Moreover, the fiscal authorities may cancel this regime during the post clearance audit.<\/p>\n

The fact that such risks actually exist in practice has been recently confirmed in practice. Thus, in 2016, the fiscal authority applied record assessments as per results of post-clearance audit of Ukrainian company of the renowned manufacturer of tobacco products. Based on public statements of representatives of the State Fiscal Service (hereinafter \u2014 “the SFS”), the overall amount of additional charges, expressed by ten-digit number, was caused by the alleged violation of conditions of application of Ukrainian customs regime of inward processing.<\/p>\n

Is this a call for business about the need to check existing models of production in Ukraine using the customs regime of inward processing? What features of the model would require special attention?<\/p>\n

Let us try to find out.<\/p>\n

 <\/p>\n

<\/p>\n

What is known about the arguments of fiscal authority and whether are they lawful?<\/strong><\/p>\n

As for the position of the fiscal authority in the abovementioned \u00a0notable case, as for now the only available information is the information, publically provided by representatives of the fiscal service and the company during public events.<\/p>\n

Following the available information, the fiscal authorities decided that taxpayer was not eligible to conditional relief under Ukrainian customs regime of inward processing on the customs territory of Ukraine on the basis of the several positions, which, in view of the fiscal authorities witness the violation of complex of interrelated rules, which regulate respective regime. Herebelow we consider these positions (at least the principal positions mentioned by representatives of the SFS):<\/p>\n

1. The absence of the Processing Agreement<\/em><\/p>\n

The first and the main argument is the statement, that the contracts, which arranged the relations between Ukrainian manufacturer and its foreign customer, are supply contracts while there is no processing agreement as such. Namely, Ukrainian manufacturer purchased the raw material for manufacturing of finished products and then sold finished products to non-resident customer.<\/p>\n

According to the auditors, this fact demonstrates the absence of inward processing on the customs territory of Ukraine, making it impossible to apply the customs regime of inward processing. Despite the fact that on the basis of respective contracts and other documents, the customs office grunted the permission to apply the regime and accomplished the customs\u2019 clearance.<\/p>\n

From the legal standpoint, this position is groundless and caused by the incorrect narrowing of processing to works on processing under the instructions of the customer. Thus, the position of the fiscal authority, in fact, means is that the the customs regime of inward processing may be applied exclusively in the case when there are contact works on processing and not in case of purchase of raw material for processing.<\/p>\n

However, the legislation does not provide grounds for such narrow interpretation. Thus, part 1 of Art. 332 of the Civil Code of Ukraine defines the processing as follows:<\/p>\n

“Processing shall mean the use of one thing (material), resulting in creation of the new thing”.<\/div>\n

The purchase of material and the manufacturing of new thing out of this material fits into this broad definition.<\/p>\n

The Customs Code of Ukraine also does not give reasons for the conclusion that the regime of inward processing on the customs territory of Ukraine may be applied only in case of contract works.<\/p>\n

Thus, according to Art. 147 of the Customs Code of Ukraine:<\/p>\n

“1. Inward processing is the customs regime under which foreign goods are subject to processing in accordance with legislation without application of the non-tariff regulation of foreign economic activity on condition of further re-export of processed products”.<\/div>\n

The model of work, in which the processor buys the materials for processing, produces and exports its products outside of the customs territory entirely corresponds to this definition. It should be noted, that the materials, purchased by Ukrainian manufacturer, do not change the status of foreign goods, because such status may change only by customs clearance according to the customs regime of importation for free circulation in Ukraine.<\/p>\n

The list of restrictions for the application of the regime (part 3 of Art. 148 of the Customs Code of Ukraine) also does not contain provisions that indicate on the impossibility of purchase by Ukrainian manufacturer of raw materials\/materials for processing.<\/p>\n

With respect to the permit for the inward processing regime part 1 of Art. 149 of the Customs Code of Ukraine envisages as follows:<\/p>\n

“1. Placing of goods under the customs regime of inward processing is permitted on the customs territory of Ukraine with the written permission of the fiscal authority upon the application of the owner of the goods or his authorized representative”.<\/div>\n

In case of contract works scenario, non-resident customer will be the owner of the goods imported for processing. Yet, the general rule (Art. 265 of the Customs Code of Ukraine) establishes that in the case of moving the goods according the foreign economic agreement, concluded by resident, such resident should act as declarant.<\/p>\n

Hence, it is possible to say that the rule on the application of inward processing is elaborated rather for the scenario when the material for processing is purchased by Ukrainian entity rather than received from the customer. We still believe that the regime of inward processing may be applied to contract works. Yet, in order to comply with the requirement that the resident should act as the declarant it would be necessary to ensure formal authorization of the Ukrainian manufacturer on submitting the application on behalf of the non-resident owner of material for processing.<\/p>\n

Yet, there is no clear instructions, how to provide this authorization. Hence, the model with the purchase of the material for processing is more certain.<\/p>\n

It is noteworthy that the list of documents, which should be submitted with the application for processing on the customs territory of Ukraine (part 2 of Art. 149 of the Customs Code of Ukraine), also does not mention the processing agreement. Instead, according to the list it is necessary to submit, inter alia,<\/p>\n

“…foreign economic contracts or documents that replace them, on the basis of which the processing of the goods will be carried out…”<\/div>\n

As regards the further sale of the finished goods to the non-resident, we note that according to part1, of Art. 331 of the Civil Code of Ukraine:<\/p>\n

“1. The ownership of the new thing that is manufactured (created) by the person shall belong to this person, unless otherwise is provided by contract or law. A person, who produced (created) thing from its own material under the contract shall be the owner of the thing”.<\/div>\n

Hence, the finished products, made from materials purchased by Ukrainian manufacturer, is the property of manufacturer and the ownership in such finished products needs to be transferred e.g. by sale.<\/p>\n

As a separate note, interpretation, according to which the regime of inward processing applies exclusively to the contract works, would discriminate independent Ukrainian manufacturers. Why independent Ukrainian manufacturer is not entitled to purchase raw materials abroad, bring them to Ukraine under the inward processing relief and use this material for productions of goods aimed for selling abroad? The application of this regime in such cases is a common practice in the world and to deprive the Ukrainian companies from this possibility is not in the economic interests of the state.<\/p>\n

To conclude, set-ups when inward processing relief is applied without the presence of the processing agreement as such are in line with the regulatory framework of inward processing regime. The challenges from the fiscal authorities, at least in this respect, seem to be groundless.<\/p>\n

However, notwithstanding our legal opinion, it is premature to ignore the possibility of the challenge in respect of similar set-ups of inward processing. According to the information from public sources, the dispute at this point is already considered in the court. This means that the SFS of Ukraine confirmed such approach.<\/p>\n

At the same time, we believe that there are risk mitigation opportunities by way of improving agreements without change of the applied model by substance.<\/p>\n

2. The absence of separate accounting of goods imported in the regime of inward processing<\/em><\/p>\n

Another point, mentioned as the basis for challenging the regime, was the absence of separate accounting of goods imported in the regime of inward processing. In view of the fiscal authorities, the fact that the manufacturer did not conduct separate accounting of the cost of finished goods, manufactured under the regime of inward processing, as well as of other costs, evidences the absence of such accounting.<\/p>\n

As we understand, such statement is related to para. 201.14 of Art. 201 of the Tax Code of Ukraine, which establishes the requirement of separate accounting for the purposes of VAT:<\/p>\n

“Taxpayers are obliged to keep separate accounting of transactions for the supply and purchase of goods\/services that are subject to taxation and which are not subject to taxation and those exempt from taxation under this section”.<\/div>\n

In addition to that part 13 of Art.149 of the Customs Code of Ukraine establishes that:<\/p>\n

\n

“13. The ability of determing of the availability of imported goods in products of inward processing is not required for the admission of goods for inward processing on the customs territory of Ukraine if:<\/p>\n

1) these products can be identified by presenting the detailed data on the expenditure of resources and manufacturing of products of the inward processing or through customs control during inward processing…”.<\/p>\n<\/div>\n

At the same time, according to part 9 of Art. 149 of the Customs Code of Ukraine, the permission for inward processing can be revoked, inter alia, if the company, granted with such permission, does not comply with the provisions of the Customs Code of Ukraine and other legislation of Ukraine on customs.<\/p>\n

We are not aware about the actual circumstances of the case, in particular, how and in what form the accounting was conducted by Ukrainian manufacturer of goods, brought to Ukraine under the customs regime of inward processing. Therefore, we are not in the position to provide legal judgment about the challenge by the fiscal authority.<\/p>\n

However, the above position evidences that the fiscal authorities interpret this requirement as the need for separate accounting of inward processing transactions and providing the availability of separation of costs of the company, incurred in connection with the processing. Separate accounting in some internal accounting system may be considered insufficient.<\/p>\n

Hence, at this point it is advisable to pay attention to the accounting of inward processing operations and if necessary take measures to reduce the risks.<\/p>\n

3. Transfer pricing<\/em><\/p>\n

According to the fiscal authorities, they are planning the comprehensive transfer pricing audit of the Ukrainian manufacturer.<\/p>\n

It is worth investigating the risks that may arise in this context.<\/p>\n

In the analyzed set-up, Ukrainian processor performs limited functions and bears limited risks. Thus, the customer sells the materials for processing at the pre-agreed price and purchases the finished products. The customer takes care about further selling of the finished products.<\/p>\n

From the economic point of view, it is generally accepted that in this case the profitability of operations of manufacturer should be lower compared with the profitability of the independent manufacturer, which sells by himself, bears the risks of changes in prices of materials etc.<\/p>\n

However, most likely that during the audit the compliance with the arm\u2019s length principle would be checked with the application of the net margin method. In practice, this method implies comparing the net margin, earned by taxpayer in controlled transaction, with net margin of comparable independent companies engaged in similar business activity. The data is available generally in respect of general financial results of such enterprises. At the same time, when it comes to manufacturers, it is almost impossible to determine whether this manufacturer operates as an independent person (i.e. performs a full set of functions and bears the risks) or is the contractor or the limited risk manufacturer.<\/p>\n

In the set-up, when there is no processing agreement but only supply contracts, there is no evident formal differences, which would allow distinguishing such set-up from standard activities of an independent manufacturer. There is no separate remuneration for processing as such (as in the case of separate payment of processing works). The corresponding element of remuneration should be included in the profit that Ukrainian manufacturer earns when sells the finished products to the customer.<\/p>\n

In view of the above again arises the question of separate accounting of transactions under the inward processing regime. If there is no such accounting, the cost and other operating expenses, incurred in connection with such transactions, will likely be determined by calculation (pro rata to the revenue from such activity). This could lead to the inclusion of costs that are not related to the processing transactions as such. For example, the expenses for promotion of the products, supplied to the independent customers within the ordinary business activity of the manufacturer (advertising etc.). This will further reduce the profitability of the inward processing transactions.
\nTo conclude, we can expect that the fiscal authorities will compare the profitability of transactions under the inward processing regime with the profitability of comparable independent manufacturers. Therefore, it is advisable to check whether the profitability of Ukrainian manufacturer, engaged in processing, is at the proper level.<\/p>\n

So what are the conclusions?<\/strong><\/p>\n

The set-ups of goods\u2019 manufacturing with the application of the regime of inward processing are at risk.<\/p>\n

We recommend checking the selected model and its documentary arrangement. The notable positions taken by the fiscal authorities in challenging the regime (particularly in the recent notable dispute) may serve as indicators of what should be checked in the first place. At the same time, we do not advise to limit such self-check to highlighted aspects, since there may be other grounds for cancellation of the regime.<\/p>\n

In the case if there are risks, it is worth taking measures to mitigate them. This may be improvement of agreements arranging the processing or financial terms. Such measures would reduce the probability of dispute or, at least, enforce the position of the taxpayer in case of challenge by the fiscal authority.<\/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.<\/strong><\/em><\/p>\n

 <\/p>\n","protected":false},"excerpt":{"rendered":"

\u0427\u043e\u043c\u0443 \u0433\u043e\u0432\u043e\u0440\u0438\u043c\u043e \u043f\u0440\u043e \u0440\u0438\u0437\u0438\u043a\u0438? \u0420\u0435\u0436\u0438\u043c \u043f\u0435\u0440\u0435\u0440\u043e\u0431\u043a\u0438 \u043d\u0430 \u043c\u0438\u0442\u043d\u0456\u0439 \u0442\u0435\u0440\u0438\u0442\u043e\u0440\u0456\u0457 \u0423\u043a\u0440\u0430\u0457\u043d\u0438 \u0441\u044c\u043e\u0433\u043e\u0434\u043d\u0456 \u0434\u0443\u0436\u0435 \u0448\u0438\u0440\u043e\u043a\u043e \u0432\u0438\u043a\u043e\u0440\u0438\u0441\u0442\u043e\u0432\u0443\u0454\u0442\u044c\u0441\u044f \u0431\u0456\u0437\u043d\u0435\u0441\u043e\u043c. \u0406 \u0446\u0435 \u043d\u0435 \u0434\u0438\u0432\u043d\u043e, \u043e\u0441\u043a\u0456\u043b\u044c\u043a\u0438 \u0442\u0430\u043a\u0438\u0439 \u0440\u0435\u0436\u0438\u043c \u043c\u0430\u0454 \u043e\u0447\u0435\u0432\u0438\u0434\u043d\u0456 \u043f\u0435\u0440\u0435\u0432\u0430\u0433\u0438. \u0412\u0456\u043d \u0434\u043e\u0437\u0432\u043e\u043b\u044f\u0454 \u0432\u0432\u043e\u0437\u0438\u0442\u0438 \u0441\u0438\u0440\u043e\u0432\u0438\u043d\u0443 \u0434\u043b\u044f \u043f\u0435\u0440\u0435\u0440\u043e\u0431\u043a\u0438 \u0437\u0456 \u0437\u0432\u0456\u043b\u044c\u043d\u0435\u043d\u043d\u044f\u043c \u0432\u0456\u0434 \u043e\u043f\u043e\u0434\u0430\u0442\u043a\u0443\u0432\u0430\u043d\u043d\u044f \u043c\u0438\u0442\u043e\u043c \u0442\u0430 \u041f\u0414\u0412 \u0437\u0430 \u0443\u043c\u043e\u0432\u0438, \u0449\u043e \u0433\u043e\u0442\u043e\u0432\u0430 \u043f\u0440\u043e\u0434\u0443\u043a\u0446\u0456\u044f \u0432\u0438\u0432\u043e\u0437\u0438\u0442\u044c\u0441\u044f \u0437\u0430 \u043c\u0435\u0436\u0456 \u043c\u0438\u0442\u043d\u043e\u0457 \u0442\u0435\u0440\u0438\u0442\u043e\u0440\u0456\u0457 \u0423\u043a\u0440\u0430\u0457\u043d\u0438 \u0443 \u0432\u0441\u0442\u0430\u043d\u043e\u0432\u043b\u0435\u043d\u0456 \u0441\u0442\u0440\u043e\u043a\u0438. \u0410\u043b\u0435 \u0437\u0430 \u0437\u0430\u043a\u043e\u043d\u0430\u043c\u0438 […]<\/p>\n","protected":false},"author":280,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11],"tags":[79],"class_list":["post-6500","post","type-post","status-publish","format-standard","hentry","category-exclusive","tag-duty"],"_links":{"self":[{"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/posts\/6500"}],"collection":[{"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/users\/280"}],"replies":[{"embeddable":true,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/comments?post=6500"}],"version-history":[{"count":13,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/posts\/6500\/revisions"}],"predecessor-version":[{"id":9040,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/posts\/6500\/revisions\/9040"}],"wp:attachment":[{"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/media?parent=6500"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/categories?post=6500"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/kmp.ua\/en\/wp-json\/wp\/v2\/tags?post=6500"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}