Wednesday, April 6, 2011


This is an article on the application of the business purpose test while doing tax planning in Ukraine. To tell you the truth, although the article is not a fresh one (published in August 2009), it still carries weight in explaining how the business purpose test has established itself in the Ukrainian tax law. As a tax litigator I can assure you that the Ukrainian tax authorities do often refer to this test to charge taxpayers with extra tax liabilities.


The recent trends in court practice related to tax issues demonstrate that the concept of business purpose already widespread in other jurisdictions is gradually implanting itself in Ukraine. Under this concept even if in terms of its execution an operation aimed at obtaining certain tax benefit (e.g. increasing gross expenses or input VAT, gaining a tax privilege, etc) fully complies with the law, but does not have reasonable economic or other kind of causes, a taxpayer will have to be deprived of the respective tax benefit.

It is possible to talk about the implementation of the concept of business purpose in Ukraine based on the analysis of the Administrative Chamber of the Supreme Court of Ukraine’s decisions related to VAT refund (the resolution of April 24, 2007 in case No 07/92, the resolution of June 10, 2008 in case No 21-281во08, the resolution of April 01, 2008 in case No 08/91, the resolution of October 02, 2007, to name a few). In the course of these cases, the Supreme Court of Ukraine held that the absence of reasonable economical or other kind of causes (business purpose) constitutes a basis for rejection of VAT refund. Particularly, the Supreme Court of Ukraine detected the lack of business purpose in the case where the taxpayer was systematically selling goods for the price significantly lower than one for which they were bought by such a taxpayer and in the case where one taxpayer passed to another taxpayer the same equipment both into lease and storage simultaneously and with essential difference in the amounts of lease and storage payments.

It should be noted that the effective Ukrainian legislation does not contain any precepts of law enabling either tax or court authorities to directly apply the concept of business purpose (except for a few Double Taxation Treaties). For instance, the Double Taxation Treaty between Ukraine and the Netherlands of October 24, 1995 and the Double Taxation Treaty between Ukraine and Greece of November 06, 2000 state that their provisions governing the tax assessment of interest shall not be applicable if the debts on which interest is payable have been either created or transferred by a taxpayer primarily with the view to benefit from these provisions rather than to attain lawful commercial purposes.

The lack of legal regulation forces court and tax authorities to appeal to the Ukrainian civil law’s provisions regulating the invalidation of agreements, especially to Article 228 of the Civil Code of Ukraine (the Civil Code) stipulating the legal implications of agreements being voided as against public policy.

It is worth mentioning that pursuant to section 2 of Article 228 of the Civil Code the agreement breaching public policy is deemed null but not disputable, i.e. such an agreement is considered to be void automatically, without the relevant court decision. Consequently, having analyzed an agreement the tax authorities may, on their own, infer that the agreement breaches public policy and thus is deemed void, determine additional tax obligations and tax fines by issuing the respective tax notification-decision and send this tax notification-decision to a taxpayer for the reconciliation of tax obligations.

If the taxpayer does not agree with the tax authorities’ inference regarding the nullity of the agreement he may challenge it in court by brining a legal action aimed at the cancellation of the tax decision-notification and only now the reasonableness of the tax authorities’ inference is being verified by court. Though, the reasonableness of the tax authorities’ conclusion regarding nullity of the agreement can also be verified by court on the tax authorities’ initiative. This is the case when the tax authorities decide to file a lawsuit to recover all property received by a taxpayer under the economic obligation that has been recognized invalid on the ground that it had been executed for the purpose deliberately contradicting the state’s and society’s interests in the state’s ownership. Such a lawsuit can be brought by the tax authorities based on section 1 of Article 208 of the Economic Code of Ukraine (the Economic Code) establishing the possibility to recover all property received under the economic obligation that has been recognized invalid on the ground that it had been executed for the purpose deliberately contradicting the state’s and the society’s interests into the state’s ownership.

It should be noted that in the light of the Higher Economic Court’s stance included in paragraph 21 of information letter of July 04, 2008 No 01-8/211 that the Economic Code’s provisions governing the invalidity of economic obligations can not be applied given their contradiction to the Civil Code’s provisions regulating the invalidity of agreements, the application of section 1 of Article 208 of the Economic Code seems to be highly doubtful. However, the ruling of Lviv Administrative Court of Appeal dated September 16, 2008 (the State Tax Inspection in Chernivtsi vs. Private Enterprise “Tayis”) in accordance with which the funds received by the taxpayer under the nullified agreement were transferred into the state’s ownership based on the said legal provision should not be disregarded.

Notwithstanding the fact that the above-indicated practice is primarily concerned with VAT refund cases, there are no obstacles preventing its expansion on other kinds of tax disputes. The said is confirmed by the adoption of the Tax Authorities’ Methodological Recommendations (Approximate Algorithm of Actions) Concerning the Elimination of Tax Evasion Schemes and the Collection of Evidence in Cases Related to the Recovery of Funds Received under Nullified Agreements (the letter of the State Tax Administration of Ukraine of February 02, 2009 No 2012/7/10-1017) not being limited in the respect of its applicability to certain tax disputes.

In sum, it is quite advisable for taxpayers to modify their existing tax planning schemes allowing for the concept of business purpose. In order to mitigate the risk that the agreements involved in the scheme are nullified and all received under such agreements property is transferred into the state’s ownership, a tax planning scheme should be perfect not only from the perspective of legal execution but also from the perspective of the justification of business purpose in any agreements concerned.