Implementation of BEPS Action Plan in Ukraine: Limited Tax Reform or Fundamental Game-Changer?

The last few years have seen Ukraine make significant progress in the implementation of key anti-avoidance concepts into its national tax legislation. The transformations launched in 2014 culminated in adoption of Anti-BEPS law 466-IX in January 2020, introducing a number of new tax doctrines in Ukrainian tax legislation and significantly revising existing ones.

Some of these tax doctrines are completely new to Ukrainian legal realities, such as CFC rules, place of effective management, the Look Through Approach and “constructive dividends” concepts. The others, have been significantly revised and require new approaches to their application, among them PE, RE — clause, and beneficial ownership concepts.

In addition, ratification of the FATCA Agreement with the USA in October 2019 along with the adoption of accompanying laws have paved the way for subsequent introduction of the AEI (automatic exchange of information) regime, which will be implemented in Ukraine soon.

New Tax Concepts Implemented into Ukrainian Tax Legislation by Anti-BEPS Law

CFC Rules

There are no doubts that the most revolutionary change introduced into Ukrainian tax legislation recently is the CFC (controlled foreign companies) regime.

New Article 39² of the Tax Code of Ukraine, which deals with CFC rules, will come into effect from 1 January 2022.

It is designed to catch the income of foreign companies which are under the control of either individual or corporate tax residents of Ukraine, exercised in legal, economic or factual form. Legal control is in place when the controlling person owns a share in a CFC exceeding 50%, or when the controlling person and other individuals or legal entities — tax residents of Ukraine with shares in a CFC, exceeding 25% (to be further reduced to 10% from 2023 year) each, jointly own 50% or more in such CFC.

Factual control implies exercising decisive influence of a controlling person over the activities of a CFC: to conclude agreements, manage assets and profits, manage CFC bank accounts, etc.

Persons who own a CFC shall submit reports about the activities of such CFC to the Ukrainian tax authorities on an annual basis.

Apart from that, such persons will also notify Ukrainian tax authorities about any significant changes in exercising (gaining or losing) control over CFC.

The annual profit of a CFC, calculated according to special rules, is subject to taxation in Ukraine at the hands of its controlling person (proportionate to its share in CFC) unless the following exceptions apply:

•  the effective corporate tax rate of a CFC equals or exceeds 13% (in case there is DTA or TIEA in place between Ukraine and the jurisdiction where the CFC is registered)
•  the share of the passive income of a CFC does not exceed 50% in overall CFC revenues (in case there is DTA or TIEA in place between Ukraine and the jurisdiction where the CFC is registered)
•  the total consolidated income of all CFCs under the control of a controlling person does not exceed the equivalent of EUR 2 million
•  the CFC is a public company and its shares are bought and sold on a stock exchange

The CFC tax base is calculated in line with financial standards of the jurisdiction where the CFC is incorporated, adjusted according to specific rules, applicable in Ukraine.

Ukrainian legislation provides for the possibility of a tax-free liquidation of existing foreign companies, controlled by Ukrainian tax residents, without paying personal income tax, in case such liquidation starts no earlier than 1 January 2020 and ends no later than 31 December 2021.

Place of Effective Management

Ukraine had, until recently, been applying the place of incorporation as the major criteria for determining the tax residency of legal entities. Respectively, all companies, registered in Ukraine have been treated as tax residents of Ukraine while companies registered in other jurisdictions as tax residents of such jurisdictions not taxable in Ukraine, unless their presence in Ukraine creates PE.

This has changed with Law 466-IX amending the list of Ukrainian taxpayers with those meeting the new criteria: legal entities, established according to the legislation of other states (foreign companies), which have a place of effective management on the territory of Ukraine.

The criteria for determining the place of effective management follow the OECD–based approach, reflected, inter alia in the OECD Model Convention on Income and on Capital and include the following conditions, which might trigger tax residency status:

•  meetings of the executive body of a foreign company are held more regularly in Ukraine than in any other country;
•  management decisions and other current (operational) activities of a foreign company by its officials are carried out in the main from Ukraine;
•  the actual management of the activities of a foreign company is mainly carried out from Ukraine, regardless of whether such persons have formal (legal) powers for such management.

Recognition of a foreign entity as a tax resident of Ukraine in accordance with Place of Effective Management in Ukraine criteria may be performed by the respective company voluntarily at its own discretion or upon a decision adopted by the Ukrainian tax authorities.

Importantly, a foreign entity, recognized as having place of effective management in Ukraine and, thus, being a Ukrainian tax resident, is taxed only with respect to income sourced inside Ukraine.

Though this creates different tax treatment among various types of Ukrainian tax residents, some taxpayers consider this mechanism as creating interesting opportunities for tax structuring.

“Constructive” Dividends

As a general rule, a dividend is a payment made by legal entity for the benefit of the owner of a share in such legal entity as a distribution of profit (full or partial) gained by such a legal entity.

Law 466-IX has extended the definition of dividends to the difference between the contractual price of goods or services and their fair price calculated according to transfer pricing rules in controlled transactions with low tax jurisdictions.

Such difference shall be taxed with Ukrainian corporate income tax and additionally with a withholding tax of 15% as deemed (implied) or “constructive” dividend unless otherwise stated in the DTA.

Concepts revised by Anti-BEPS Law

PE Concept

With regard to PE provisions, Ukraine has updated them according to OECD approaches reflected, in particular, in Articles 12-15 of the MLI, which imply revision of agency PE rules, counteracting artificial avoidance of PE status through specific activities’ exemptions and splitting-up of contracts.

RE — Clause

Having amended some of its DTAs with a “real-estate clause” earlier, Ukraine finally fixed the respective rules in its Tax Code on a more general basis, stating that any transaction with respect to the sale or purchase of the corporate rights of a Ukrainian company, deriving its value from real estate, located in Ukraine, will be taxed in Ukraine.

Look Through Approach in the Context of Revised Beneficial Ownership Rules

Beneficial ownership rules have already been in place in the Tax Code of Ukraine for quite a long time and provide for the possibility to apply a reduced withholding tax rate to passive payments in accordance with double taxation treaties only in case the recipient of such funds is their beneficial owner, i.e. a person eligible to determine the economic destiny of such income.

Now, in order to be qualified as a beneficial owner, additional rules have been introduced: a non-resident should also prove it performs significant functions with respect to such income and possesses respective resources (qualified personnel, fixed assets, etc.).

At the same time, it is also now possible to apply the reduced withholding tax rate according to a double taxation agreement with the jurisdiction where the real beneficial owner resides.

What to Expect Next?

Apart from introduction of CFC rules in January 2022, the other two significant initiatives to be expected in coming months are the “tax amnesty” and automatic exchange of information.

“Tax Amnesty”

“Tax amnesty”, or the voluntary disclosure program, is currently under consideration by the Ukrainian Parliament and the chances of its adoption are quite high.

The respective draft bills provide that any Ukrainian tax resident, who possesses assets acquired with violation of tax, currency control or antimonopoly legislation of Ukraine, may “legalize” such assets subject to payment of a special contribution calculated as a share of the value of the declared assets.

Preliminary rates of special contribution vary from 2.5% to 9%.

The tax amnesty is expected to start on 1 July 2021 and to last one calendar year.

FATCA and Automatic Exchange of Information

Ukraine is among quite a few countries that has not yet introduced an automatic exchange of information.

Certain steps in this direction were made in autumn 2019 when Ukraine ratified the Foreign Account Tax Compliance Act agreement with the USA and changed its laws, enabling the collection and exchange of financial information received from banks and depository institutions.

It is expected that the first exchange of information under the FATCA agreement will take place in 2022 and Ukraine will join the AEI either in 2021 or 2022.

To sum up, the next few years will bring a lot of changes into the Ukrainian taxation system, which will have an impact on business models of both international and Ukrainian companies. Hopefully, there is still enough time to face these changes and make the necessary preparations for these new realities.