Ukraine: Businesses Need to Reshape Tax Planning Strategies Due to the Recent Ukrainian Tax Reform

Ukraine: Businesses Need to Reshape Tax Planning Strategies Due to the Recent Ukrainian Tax Reform

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On January 16, 2020, the Ukrainian Parliament passed a law launching anti-BEPS tax reform in Ukraine, among other legislative changes (the “2020 Tax Law”). The business community expressed opposition to most of its provisions.

Despite the controversy, the President signed the 2020 Tax Law in May. To sweeten the pill for business, the Government, after consulting with the business community, prepared a draft law amending the 2020 Tax Law, which was passed by the Parliament on July 14, 2020 (the “July 14th Law”) – in a version which did not include the majority of the business community’s proposals. The July 14th Law is currently awaiting the President’s signature. Some provisions of the 2020 Tax Law are already effective, while others – including the following – will become effective on January 1, 2021:

Implementation of the Business-Purpose Concept

Effective May 23, 2020, the tax authorities may deny the deductibility of the taxpayer’s expenses resulting from a transaction with any foreign counterparty where the cited business purpose is considered insufficient or unjustified.

A lack of business purpose may be claimed if the key aim or one of the key aims of the transaction (or its result) is to minimize the tax burden, or if, in comparable conditions, the taxpayer would not purchase or sell works, services, or other assets from or to non-affiliated parties. Although the tax office will bear the burden of proof in such cases, the business community claims that the implementation of the concept would increase the discretion of tax authorities and eventually the business-purpose test will be applied to all transactions with foreign companies, especially to those regarding non-material assets or services.

The July 14th Law has adjusted the business-purpose concept, which would now apply to operations with companies registered in low-tax jurisdictions, and to transactions involving royalty payments with any foreign company.

Principle Purpose Test

As of May 23, 2020, no exemption or lowering of Ukrainian taxes allowed under the double-tax avoidance agreement will be granted for payments of income from Ukrainian residents to foreign recipients if obtaining this tax benefit was the main purpose of the transaction. The Principle Purpose Test is incorporated into domestic legislation to fulfil the requirement of the MLI Convention effective for Ukraine from December 1, 2019.

Thin Capitalization Rules

As of January 1, 2021, new thin capitalization rules apply to all taxpayers whose debts to any non-resident (not only to an affiliated non-resident) exceed more than 3.5 times the company’s equity, except for financial institutions and companies engaged exclusively in leasing activities, acting as debtors.

The new thin capitalization rules will decrease the limit of interest expenses that can be deducted in the reporting period from 50% to 30% and the basis for its calculation. Instead of the 50% EBITDA that is applicable now, the new 30% limit will be calculated from the corporate income tax base plus the amount of financial expenses under accounting rules and tax depreciation. The new limit will apply to transactions with all counterparties (including residents). Interest that has been capitalized as part of the value of non-current assets shall be included to interest expenses proportionately to the depreciation of such assets for the respective reporting period. The business community proposed that these rules be limited to transactions with affiliated non-resident companies only. However, this proposal was denied in the July 14th Tax Law.

Constructive Dividends

Under the 2020 Tax Law, any payment for goods or services by a Ukrainian company to an affiliated foreign entity exceeding the arms-length price may be treated as a de facto distribution of dividends and subject to the standard 15% withholding tax or the lower withholding tax rate under the double-tax avoidance agreement. Constructive dividends can also include share buyouts, reductions of share capital, and similar transactions with a Ukrainian company. The business community urged that these provisions be eliminated, but this request was not supported by the Parliament. As the July 14th Law makes no important changes in favor of businesses operating in Ukraine, businesses need to verify their operations and reshape their tax planning strategies to conform with the new taxation rules. 

This list of changes is not exhaustive, and the 2020 Tax Law contains a lot of other provisions that should be carefully considered by Ukrainian taxpayers, especially those which are part of global business structures.

By Anna Pogrebna, Partner, and Sergiy Datsiv, Associate, CMS Reich-Rohrwig Hainz Kyiv

This Article was originally published in Issue 7.9 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.