President of Ukraine has signed the tax reform law (hereinafter, the “Law”) containing significant changes to the tax legislation, including long-debated recommendations under the OECD base erosion and profit shifting (BEPS) project and changes to tax administration procedures, the president's website reported on 21 May 2020.

Measures in the Law include the introduction of the three-tiered transfer pricing reporting requirements, a new fixed ratio rule that limits the amount of interest expense that may be deducted, general anti-abuse rules (GAAR), new controlled foreign company (CFC) rules, and a mutual agreement procedure (MAP) and amendments to the definition of a permanent establishment (PE).

The Law will be enacted after publication in the official gazette. The provisions of the Law will come in force in phases over the period 2020 to 2023 (please see effective date of each provision below).

This alert summarizes the most important tax rules from the Law that affect cross-border business.

1. Corporate income tax and transfer pricing

1. Introduction of three-tiered transfer pricing reporting in accordance with BEPS action 13

In addition to a local file, multinational enterprises (MNEs) would be required to prepare a master file and a country-by-country (CbC) report. Proposed revenue thresholds are in line with OECD recommendations (i.e., EUR 50 million for master files and EUR 750 million for CbC reports). The first reporting year for master files and CbC reports would be 2021 (but not earlier than when Ukraine joins the OECD Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports (CbCR MCAA)).

Effective date: 2021 – first reporting year for master file and CbC report.

1. Repeal of the thin capitalization rules and introduction of a fixed ratio

The Law would repeal the current thin capitalization rules and introduce a fixed ratio rule in accordance with BEPS action 4: 

• The new rule would apply to transactions with related and unrelated persons (whether or not resident in Ukraine) if the debt is greater than 3.5 times the company’s equity. Debt attributable to all nonresident creditors would be compared with the relevant entity’s equity (currently, only debt with related nonresident entities is considered).
• If the debt-to-equity ratio is exceeded, the relevant entity’s deductions for all interest, (and economically equivalent payments) would be limited to 30% of tax EBITDA (rather than the current rule of 50% of financial EBITDA).
• Interest expenses above the limit could be carried forward and be deducted in computing corporate income tax. The nondeductible interest expense could be carried forward indefinitely but it would be subject to an annual 5% disallowance.
• Banks and finance leasing institutions (as debtors) would not be subject to the new interest deduction limitation rule. 

Effective date: 1 January 2021.

1. 30% upward adjustment (increase of taxable base) on sales to residents from low-tax jurisdictions and to fiscally transparent entities

Resident companies would be required to increase their taxable base for corporate income tax purposes by 30% of the value of the goods and services sold to residents of low tax jurisdictions and foreign companies having special legal forms. 

Effective date: day following the day of publication of the Law.

1. Introduction of a GAAR 

The Law would introduce anti-abuse rules, including: 

• A “business purpose test" in transactions with nonresidents for corporate income tax and transfer pricing purposes. The business purpose test already has been applied by Ukraine’s tax authorities based on case law, whereby deductions are disallowed for expenses in transactions that lack a genuine business purpose. The new law would codify existing practice; and
• A domestic GAAR to prevent the granting of tax treaty benefits where one of the principal purposes of a transaction is to claim relief at source or a lower withholding tax rate in Ukraine under a relevant tax treaty. 

Effective date: day following the day of publication of the Law.

1. Transactions with nonresidents 

1. Dividend-equivalent payments 

Transfer pricing adjustments and certain other payments to nonresidents (payments for buyout of shares and certain types of divestment) would be treated as dividend-equivalent payments subject to a 15% withholding tax. 

Effective date: 1 January 2021.

1. Principal purpose test and beneficial ownership rules for tax treaty purposes 

The following amendments were introduced in conditions for claiming benefits under Ukraine’s tax treaties: 

• “Look-through approach” for beneficial ownership purposes, according to which if the immediate recipient of Ukraine-source income is not the beneficial owner of the income, the tax treaty with the jurisdiction of the beneficial owner may apply in Ukraine; and
• “Principal purpose test”, according to which the tax treaty would not apply if the main purpose of the arrangement or structure is to obtain tax treaty benefits. 

Effective date: day following the day of publication of the Law.

1. Taxation of indirect transfers of shares in asset-rich companies 

A 15% withholding tax would apply to gains derived by nonresident companies in transfer of shares that directly or indirectly derive their value from real property situated in Ukraine (including leased property). 

Effective date: 1 July 2020.

1. Permanent establishments (PEs) of nonresident companies 

The domestic definition of a PE would be amended to align with the updated definition under the 2017 OECD model tax treaty. 

New administrative procedures would be introduced to scrutinize nonresidents that carry on business operations in Ukraine that rise to the level of a PE but where the nonresident fails to register and pay taxes in Ukraine. 

Effective date: day following the day of publication of the Law.

1. Changes in administrative procedures affecting nonresidents 

The tax authorities would be empowered to initiate tax inspections of nonresident companies that operate in Ukraine through a PE without registration and that fail to report and pay taxes in Ukraine.

Nonresidents would be able to file claims against the actions and decisions of Ukraine’s tax authorities related to withholding taxes levied in Ukraine and tax assessments made by the tax authorities in relation to PEs of foreign companies.

Effective date: 1 July 2020 for new registration rules, 1 January 2021 for new tax inspection rules.

1. Controlled foreign companies 

The Law introduces CFC rules that tax undistributed profits of CFCs at the level of the Ukrainian tax resident owner (controlling shareholder) whether an individual or a legal person. A CFC is defined broadly to include corporate entities, as well as certain transparent entities (e.g., trusts, investment funds, partnerships etc.).

The CFC’s income would be taxable unless an exemption applies. If a Ukraine resident controlling shareholder meets the minimum control threshold, income would be attributed to that shareholder. The amount of income to be attributed to each controlling shareholder would be calculated by reference to their proportion of ownership. 

For CFC taxation purposes, the reporting period would be a calendar year or another fiscal year as the CFC may follow financial reporting requirements in the jurisdiction of its tax residence. The taxable income of each CFC would be included in the annual income of a controlling shareholder for income tax purposes and reported in the annual tax return. 

An 18% tax would apply on the undistributed income of a CFC calculated under the applicable tax laws. Distributed income of a CFC could be subject to an 18% or 9% rate depending on the period of distribution. The lower 9% rate would apply if CFC income is distributed by the CFC to the resident controlling shareholder as dividends, provided that distribution is made by the CFC before filing the CFC report in Ukraine or by the end of the second calendar year that follows the reporting year. An 18% rate would apply if distribution is made at a later date. 

Effective date: 1 January 2021. The new CFC rules would be introduced in phases over the period 2021 to 2023. For instance, the first CFC report shall be filed in 2022 for the reporting year 2021.

1. Mutual agreement procedure 

The MAP for resolving tax disputes under tax treaties would be introduced into domestic law (current tax laws do not provide for this type of procedure). 

Both residents and nonresident taxpayers who believe that actions or decisions of the tax authorities (both Ukrainian and foreign) have resulted or will result in taxation not in accordance with the relevant tax treaty could file MAP requests with Ukraine’s Ministry of Finance. 

Effective date: day following the day of publication of the Law.

Comments 

The changes brought about by the Law effectively would lead to a substantial overhaul of Ukraine’s tax legislation, with a particular focus on cross-border transactions. Ukraine’s tax authorities would have more power to scrutinize the activities of multinational enterprises and, in the process, would obtain more knowledge and skills in assessing such activities. Taxpayers should consider reviewing their cross-border structures and transactions to assess the potential impact of the new legislation and take appropriate step to comply with the rules.

We will be happy to provide you with advisory support on all issues you may have in relation to the aforementioned legislative changes.