Law No.466-IX, or the BEPS law, that introduced numerous changes to the Tax Code caused a real stir among businesses back in May 2020. The main block of changes concerned working with non-residents.
From May 2020, amendments came into force regarding the income taxation of non-residents in Ukraine, the application of conventions for the double taxation avoidance, permanent missions, transfer pricing rules and the business purpose concept.
From January 1, 2021, among other things, changes will come into force regarding the recognition of foreign companies as residents of Ukraine, the main purpose test, "constructive" dividends and some transfer pricing nuances.
So who, for what and how to prepare in 2021?
Who should prepare?
Companies and Ukrainian beneficiaries who own or cooperate with non-residents.
What to prepare for?
Let's say a Ukrainian beneficiary owns a holding in Cyprus, and the latter owns an operating business in Ukraine. In Cyprus it is a "paper" company without a real office and employees, with nominee directors who sign formal documents. Let's consider the main nuances that should be paid attention to.
About the main purpose test
If the main purpose of the operation is to optimize taxation, the Convention for the double taxation avoidance (Convention) does not apply—this is a short summary of the main purpose test.
By the way, the main purpose test is now provided at the level of national legislation as a requirement for the Convention application, unless otherwise provided by international treaties. Among international treaties, the main purpose test may be provided for in the Convention or in the MLI Convention.
That is, if the latter do not require the main purpose test application, then the reduced tax rate of the Convention can be applied without such a condition.
From 1 January 2021 the Convention with Cyprus applies the main purpose test according to the MLI Convention. If a Ukrainian company pays dividends to Cyprus, it is necessary to prove not only the beneficiary of the income recipient, but also the compliance with the main purpose test.
The existence of a company in Cyprus should be conditioned not only by obtaining tax advantages, but also by economic viability. Without a real office and employees, the test will be almost completely failed. As a result—15% tax on repatriation.
An office and a few employees are also not a panacea because economic viability is a broader concept. Tax officials are looking at the need for such a company to exist in the structure as a whole. Therefore, one cannot do without transferring real management functions to this level.
And these are qualified managers on board with the corresponding costs for their salaries, and making strategic decisions on the subsidiaries activities, etc.
So, beneficial owners should consider whether it is really worth continuing to work with a foreign holding company. If so, significantly enhance the functionality of such a company and ensure its full-fledged work in the jurisdiction.
About the place of effective management
If, in fact, a company in Cyprus is managed by a Ukrainian beneficiary who provides instructions to nominee directors, manages a bank account, or generally acts on behalf of the company under a power of attorney, the Cyprus company has every chance of becoming Ukrainian for tax purposes. You will have to register with the tax office and pay income tax in Ukraine.
This makes it possible to implement the place of effective management concept that takes effect from January 1, 2021.
Of course, the practice of applying such a rule and any clarifications are still lacking, but it is already clear that a company without a real economic presence, that is actually headed by a resident of Ukraine, is likely to have effective management in Ukraine and be taxed here.
Among the advantages is the following: a foreign company registered as a resident of Ukraine will not be considered a controlled foreign company (CFC), and when paying income from a Ukrainian company to such a foreign company, the repatriation tax will not be applied.
If the Ukrainian beneficiary owns a Cypriot company, most likely, the beneficiary will be recognized as the controlling person, and such a company is a CFC. As a result, based on the results of 2022, the beneficiary must submit reports and pay tax on the adjusted profit of the CFC.
The postponement of the CFC until 2022 was a "New Year present" for the beneficiaries—the corresponding Law 1117-IX was published on December 31, 2020.
About re-qualification of paid income
- Here you have to be careful with the concept of "constructive dividends". If a Cypriot holding company reduces the authorized capital in a Ukrainian company, or leaves the membership of a Ukrainian company and receives a payment for this, then such a payment can be considered dividends and be taxed like the rest.
- The bad news is that such a payment will be subject to a 15% repatriation tax. The good news is that it can most likely be reduced to 5% or 10% by applying the provisions of the Convention.
But do not forget about the protocol to the Convention with Cyprus, the proof of the income recipient’s beneficiary, as well as the application of the main purpose test before such conventions, starting from January 1.
About transfer pricing
- With the transfer pricing rules (TP), you must always set up sail to every wind. Legislation in this area is constantly being improved (read—it becomes cruel). Thus, in 2021, a three-tier documentation structure will already come into effect, additional reporting for international groups’ companies, updated sanctions and numerous other innovations.
- By the way, the TP rules will now be linked to the CFC rules.
How to prepare?
The risks that may apply to transactions with non-residents starting from 1 January 2021 should be identified. Further, depending on the situation:
Answer the question—are the risks and costs related to the non-residents' existence in the structure proportionate to the functions that these non-residents perform? Due to the updated legislation, some businesses find it more profitable to work through Ukrainian companies.
- Assess your own transactions for the risks of being recognized as having no reasonable business purpose and be prepared to justify it.
- Pay attention to the advantages of the foreign company Ukrainian residence. As a tax resident of Ukraine, a foreign company can apply the benefits of foreign personal law and not be recognized as a CFC.
- Organize an economic presence if appropriate. In this way, the risks related to the place of effective management, CFC taxation, and the main purpose test can be minimized.
- Seize the opportunity of a CFC tax-free liquidation—if the CFC maintenance is not viable. There is a chance to receive the CFC property after liquidation without tax consequences, subject to certain conditions.
- Consider changing the tax residency of the beneficiary, but before doing so carefully assess the requirements and consequences.
- Viktoriya Fomenko, partner at INTEGRITES
- Viktoriia Shvydchenko, junior associate at INTEGRITES
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