ACTUAL INFORMATION

TAX REFORM 2020 IN UKRAINE – 7. July 2020 OVERVIEW OF CHANGES IN

On May 23, 2020, the Law of Ukraine No. 466-IX of 16 January 2020 on enhancement of administration, removal of technical and logical inconsistencies in tax legislation became effective. This law introduced many changes to the provisions of the Tax Code of Ukraine (Tax Code) related to international taxation. The overview of the key changes is provided below. ACTUAL INFORMATION 7. JULY 2020

1. Changes in Taxation of Transactions with Nonresidents

 The principal purpose test was introduced as a condition for the application of reduced withholding tax rates and exemptions from tax under double tax treaties. Such benefits will now be available only if obtaining of the treaty benefits was not the principal or one of the principal purposes of the transaction with a nonresident and granting these benefits would be in accordance with the object and purpose of the provisions of the international treaty of Ukraine (Sec. 3 Par. 103.2 of the Tax Code).

 A “look-through” approach was implemented for the purposes of application of the double tax treaties, if the immediate recipient of Ukrainian-source income is not the beneficial owner of the income. For the application of the treaty with the country of which the beneficial owner is a resident, the recipient of the income and the beneficial owner must file applications and provide documents confirming the status of the beneficial owner (e.g. licenses, agreements, letters of competent authorities) (Sec. 4 Par. 103.2, Sec. 5 Par. 103.3 of the Tax Code).

 The “beneficial owner” definition was updated (Par. 103.3 of the Tax Code). A person qualifies as the beneficial owner, if such person has the right to receive such income and to actually receive the benefit of the income concerned. An agent, nominee or a person performing intermediary functions is not considered as the beneficial owner. A person is presumed to be acting as an intermediary, if:

(i) a person does not have sufficient authorities or, as may be evidenced by the facts and circumstances, does not have a right to use and to dispose of such income, and/or (ii) a person passes the income or most part of the income received to other person, regardless of how such income transfer is executed, and such person does not perform significant functions, does not use significant assets and does not assume significant risks in such transfer transactions, and/or (iii) a person does not have appropriate resources (qualified personnel, own or leased fixed assets, adequate equity capital), necessary for the actual performance of functions, use of the assets and management of the risks connected with receipt of respective income type, which are only formally performed (used, assumed) by such person in connection with the transfer transaction.

 A limitation on deduction of expenses in transactions with nonresidents which lack business purpose was introduced (Subpar. 140.5.15, Par. 14.1.231 of Tax Code). Transaction is assumed to have no business purpose, if, among others:

(i) the principal or one of the principal purposes and/or outcome of the transaction is non- payment (reduced payment) of tax and/or decrease of taxpayer’s taxable profit; (ii) in comparable conditions a person would not be willing to purchase (sell) works (services), intangible assets, other items different from goods, from unrelated persons.

The burden of proof that a transaction lacks business purpose rests on tax authorities.

 A new tax adjustment was introduced which requires increasing financial result before tax by 30% of the value of goods (works, services) sold to nonresidents from low-tax jurisdictions (the list of such jurisdictions is approved by the CMU Resolution No. 1045 of 27 December 2017) and to nonresidents who are not paying in their home countries (the list of legal forms of such nonresidents is approved by CMU Resolution No. 480 of 4 July 2017 and includes, among others, a German GmbH & Co. KG). The taxpayer may not increase the financial result before tax, if respective transaction is not a controlled transaction and the taxpayer can demonstrate that the amount of income received from sale of goods (works, services) complies with “arm’s- length” principle (Subpar. 140.5.51 of the Tax Code). This tax adjustment also does not apply to taxpayers whose annual income is below UAH 40 million, net of VAT, and who opted not to adjust the financial result for the tax adjustments.

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 From 1st January 2021, thin capitalization rules are changed. According to new rules, the limitation on tax deductibility of interest expenses will apply to interest paid on a loan from a nonresident lender, whether related or not. The amount of non-deductible interest will be determined with the reference to the taxable profit (taking into account all tax adjustments, except for loss carry-forward and interest expenses of current period), increased by the amount of financial expenses and depreciation allowances. The amount of interest which may not be deducted in the current period will be the interest amount exceeding by 30% the taxable profit of current period (Par. 140.2 of the Tax Code).

 The definition of “dividends” was amended. Starting from 1st January 2021, the following amounts shall be considered as dividends with respective taxation in Ukraine (Sabpar. 14.1.49 of the Tax Code):

(i) payments to nonresidents for securities (corporate rights) in controlled transactions in excess of the “arm’s-length” price; (ii) the value of goods (works, services) purchased from a nonresident in controlled transaction which exceeds the “arm’s-length” price; (iii) the value of goods (works, services) sold to a nonresident in controlled transaction which is below the “arm’s-length” price; (iv) a cash or in-kind payment to a nonresident shareholder (participant) in connection with decrease of charter capital, buyback of corporate rights in own charter capital, exit of participant from the company or other similar transaction between the company and its participant resulting in decrease of retained earnings of a legal entity.

The payments in mentioned in items (i) - (iii) above shall be considered as dividends, if such transactions are performed between a taxpayer and related nonresident persons, nonresidents from low-tax jurisdictions and nonresidents which do not pay corporate in their countries of registration.

 An obligation of tax registration in Ukraine was introduced for a nonresident buyer of the shares (corporate rights, participation interests) in a foreign company purchased from a nonresident seller, except for shares listed on stock exchange approved by the Cabinet of Ministers of Ukraine, if at any time during the 365-days period preceding the sale (alienation) 50% or more of the value of the shares (corporate rights, participation interests) in the foreign company is derived from the shares (corporate rights) in a Ukrainian company, and at any time during the same period the shares (corporate rights) in a Ukrainian company derive 50% or more of their value from owned or leased immovable property situated in Ukraine. The non-resident buyer is liable for withholding and paying the tax on capital gain realized by the nonresident seller in Ukraine (Subpar. 141.4.2 of Tax Code).

 The definition of income from sources in Ukraine which is subject to tax in Ukraine was extended. The income from alienation of rights on extraction and development of deposits of mineral resources, mineral springs and other natural resources and the capital gain from the alienation of shares, participation interests, corporate or other similar rights in foreign companies were added to the list. The capital gain from the alienation of shares (participation interests, corporate or other similar rights) in foreign companies is considered as Ukrainian- source income, if at any time during the 365-days period preceding the sale (alienation) 50% or more of the value of the shares (participation interests, corporate or other similar rights) in the foreign company is derived from the shares (corporate rights) in a Ukrainian company, and at any time during the same period the shares (corporate rights) in a Ukrainian company derive 50% or more of their value from owned or leased immovable property situated in Ukraine (Subpar. 14.1.54, Subpar. 141.4.1 of Tax Code).

 The obligation to deduct and remit to state budget withholding tax from nonresident’s income was extended to resident individuals registered as private entrepreneurs, individuals carrying on

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independent professional activities, as well as legal entities and individuals which are subject to simplified tax system (Subpar. 141.4.2, 141.4.4, 141.4.5, 141.4.6 of the Tax Code).

 The mutual agreement procedure implementation mechanism was added to the Tax Code (Article 1081 of the Tax Code). Both resident and non-resident taxpayers may initiate the mutual agreement procedure, if there are grounds for initiating the procedure and respective provisions are contained in the double of Ukraine. The mutual agreement can be initiated no later than within 1095 days after the tax liability assessed during the tax audit, including the audit, became final. The request for the initiation of the mutual agreement procedure can be rejected, if there is an ongoing administrative or judicial proceeding related to the same matter (Article 1081 of the Tax Code).

2. Changes in Taxation of Permanent Establishments

 The rules for determination of profits of have been changed. Under the new rules, the profits of the permanent establishment shall be determined on a general basis (using the direct method) in accordance with the “arm’s-length” principle. The profits of permanent establishment shall correspond to the profits of an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment (Par. 141.4.7 of the Tax Code).

 The use of the direct method can be advantageous for the nonresidents which have been using the indirect method to determine the profits of permanent establishments. The profits determined under the direct method in accordance with the “arm’s-length” principle can be lower compared to the profit determined under indirect method which supposes 30% profit margin of the permanent establishment. It should be noted that the double tax treaties allow deducting expenses which are incurred for the purposes of the permanent establishment, whether in or outside of Ukraine. This possibility is especially important for the nonresidents engaged in construction or other projects in Ukraine and which incur project-related expenses not only through their permanent establishments in Ukraine, but also outside of Ukraine.

 The time period upon expiry of which a permanent establishment in connection with activities on a building site, construction, installation or assembly project or related supervisory activities (within one or several related projects) is created was increased from 6 to 12 months (Par. 14.1.193 of the Tax Code).

 The rules for the calculation of the time period the expiry of which creates a permanent establishment were introduced. Upon calculation of the total duration of the activities, in addition to the consecutive or non-consecutive full calendar months of the duration of the project (or interrelated projects), performance of works or rendering of services in Ukraine, the following time periods shall be taken into account (Par. 14.1.193 of the Tax Code):

(i) the time of nonresident’s activities in Ukraine which are carried on during several consecutive or non-consecutive time periods each of which is less than full calendar month, but which exceed in total 30 days, and (ii) the time of activities carried on by related persons of such nonresident in Ukraine, if such activities are closely related to the nonresident’s activities.

 The criteria which give rise to existence of an agency permanent establishment were added to the Tax Code. In particular, an agency permanent establishment arises, if a person acting exclusively for one nonresident and/or for related nonresidents on the basis of an agreement, other deed or in fact has and habitually exercises an authority to negotiate essential conditions of the contracts that are routinely concluded by the nonresident without material modification, and/or to conclude contracts (agreements) on behalf of nonresident (Par. 14.1.193 of the Tax Code).

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 The circumstances indicating that a person has in fact authority to act for a nonresident were added to the Tax Code. Such circumstance are the following (Par. 14.1.193 of the Tax Code):

(i) a person receives mandatory instructions from nonresident (including by way of electronic communication means or transfer of electronic data carriers) and performs such instructions; (ii) a person has and uses electronic address of corporate e-mail of nonresident or related persons of such nonresident for communication with the nonresident and/or third parties with whom the nonresident has concluded or will conclude contracts or other deeds.

 The anti-fragmentation rule to prevent avoidance of permanent establishment status was introduced. Under this rule, a permanent establishment is deemed to exist in Ukraine, if the activities are carried out by several related nonresidents, provided that overall activity constitutes complementary functions of a cohesive business and goes beyond the activities of preparatory or auxiliary nature for such group of related nonresidents. In this case, the permanent establishment is deemed to exist for each nonresident (Par. 14.1.193 of the Tax Code).

 New tax registration requirements for nonresidents were introduced. A nonresident is required to register for tax purposes in Ukraine, in case such nonresident (i) acquires immovable property or the rights to the immovable property situated in Ukraine, (ii) opens bank account in Ukraine, and (iii) establishes a branch in Ukraine. The tax authorities are entitled to perform tax registration of a nonresident without nonresident’s application, and to impose UAH 100,000 penalty on nonresident in case of failure to register for tax purposes in Ukraine (Par. 64.5, 117.4 of the Tax Code).

 Nonresidents which are carrying on business activities in Ukraine and/or which have registered branches in Ukraine, including permanent establishments, and which have not performed the tax registration in Ukraine as of 1 July 2020, shall within three months (until 1.10.2020) perform the tax registration in Ukraine (Par. 60 of Subsection 10 of Section XX of the Tax Code).

3. Changes in Transfer Pricing Rules

 The scope of transfer pricing reporting has increased. In addition to report on controlled transactions, a taxpayer which is a member of an MNE group, must submit notification about participation in MNE group (Subpar. 39.4.2 of the Tax Code). The notification shall be submitted starting from 2021 for the reporting year 2020.

 A three-tiered structure of transfer pricing documentation was implemented (Subpar. 39.4.6, 39.4.7, 39.4.10 of the Tax Code):

1) transfer pricing documentation – the scope of this documentation corresponds to the local file which was prepared before the introduction of changes by the Law No 466; the local file shall be submitted within 30 calendar days upon tax authority’s request; 2) global transfer pricing documentation (master file) – this documentation contains information about activities of an MNE group as a whole; this documentation shall be submitted within 90 calendar days from receipt of request. The tax authority may request master file from a taxpayer which is a member of an MNE group with annual consolidated revenue for the preceding fiscal year equal to or exceeding equivalent of EUR 50 million. The master file can be requested not earlier than after expiration of 12 months and not later than before expiration of 36 months following the last day of fiscal (reporting) year. The master file can be requested for the first time with respect to the fiscal (reporting) year ending in 2021;

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3) country-by-country report – shall be submitted by a taxpayer which is a member of an MNE group with annual consolidated revenue for the preceding fiscal year equal to or exceeding equivalent of EUR 750 million, provided that one of the conditions set forth in the Tax Code is met (e.g., the taxpayer is the ultimate parent entity of an MNE group, the taxpayer was authorized to submit the CbC Report in Ukraine and other). The CbC Report shall be submitted for the first time for the fiscal year ending in 2021, but not earlier than in the year in which Ukraine joins the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports (CbC MCAA).

 The scope of transfer pricing documentation (local file) has increased. The local file must contain the following additional information (Subpar. 39.4.6 of the Tax Code):

1) information about taxpayer’s ultimate beneficiaries (if available); 2) description of supply chain (value creation) of the goods (works, services) in controlled transaction; 3) justification of economic substance and business purpose of transactions involving the purchase of works (services), intangible assets, other items different from goods; 4) copies of material intercompany agreements which affect the pricing in controlled transactions, copies of advance pricing agreements, tax rulings of competent authorities which apply in agreements between members of an MNE group, if the taxpayer is a member of an MNE group and Ukrainian tax authorities did not participate in the preparation of such documents; 5) a copy of auditor’s report with respect to the taxpayer’s financial statements for the reporting period (periods) for which the local file is submitted (if the audit of taxpayer’s financial statements is mandatory).

 The share of capital ownership to treat persons as related parties was increased from 20% to 25%. International financial institutions which enjoy privileges and immunities according to international treaties of Ukraine as well as companies in which international financial institutions hold 75% or more of the capital, are not considered as taxpayer’s related parties, regardless of the participation share in the taxpayer’s capital or the amount of credits (loans) granted to such taxpayer or guaranteed by such international financial institutions (Subpar. 14.1.159 of the Tax Code).

 The list of controlled transactions was extended and now covers business restructuring transactions. A transaction involving the transfer of taxpayer’s functions to other person, along with the transfer of assets (or without assets transfer), benefits, risks and opportunities, shall be treated as controlled transaction, if it leads to the decrease of taxpayer’s income and/or financial result and such transfer would not have been occurred between unrelated parties without compensation (Subpar. 39.2.1.4 of the Tax Code).

 The priority in the application of transfer pricing methods was abolished. The taxpayer may now apply any of the methods set forth in the Tax Code, which is the most appropriate method taking into account the facts and circumstances of a particular controlled transaction (except for commodity transactions for which the comparable uncontrolled price method is a priority method) (Subpar. 39.3.2.1, 39.3.3.4 of the Tax Code).

 The transactions involving intangible assets (royalties, licenses, payments for the use of patents, trademarks, know-how etc.) and business restructuring transactions can be analyzed using the comparable value approach which is based on the calculation of the present value (discounted value) of future cash flows (Subpar. 39.3.10 of the Tax Code).

 New penalties were added (Par. 120.3 of the Tax Code):

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1) 50 times the living minimum – for the failure to submit notification about participation in MNE group; 2) 300 times the living minimum – for the failure to submit global transfer pricing documentation (master file); 3) 1000 times the living minimum – for the failure to submit CbC Report.

 The mechanism of the proportionate adjustment procedure has been implemented. The proportionate adjustment can be made, if the taxpayer’s counterparty in controlled transactions has actually adjusted its tax liabilities in accordance with the arm’s-length principle and there is a double tax treaty in place between Ukraine and the country of which the taxpayer’s counterparty is a resident (Subpar. 39.5.5 of the Tax Code).

Roedl & Partner LLC Mykoly Pymonenka St. 13, building 1B, office 31 04050 Kyiv Ukraine T +38 044 586 23 03 www.roedl.net/ua/uk www.roedl.com

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