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Project finance entails a number of issues requiring a
response from a tax lawyer. This article deals with long-term contracts
taxation.
Project finance always involves construction. Even if
in the focus is not a new transnational gas pipeline or a power plant of
unprecedented scale, but a modest 10,000 square meters shopping centre in
one of the regional (oblast) centres of Ukraine, no one can dispense with
the knowledge of long-term contracts taxation.
It should be borne in mind that the law provides a
special taxation regime for long-term contracts (concluded for a term exceeding
one year). The special regime relates to both "heavyweights" of
the Ukrainian taxation system – corporate income tax and VAT.
The special regime for the taxation of long-term
contracts had also existed before the Tax Code of Ukraine came in force. However,
the present regime appears to be quite different from the previous one. In
addition to technical distinctions relevant to the calculation of taxes, it should
be noted that the special regime for the taxation of long-term contracts became
obligatory. It is no more at the discretion of taxpayers to use it or to
refrain from its use.
First of all, it will be expedient to outline the
coverage of the special taxation regime. The special regime extends to cases
where the relevant contract (i) provides for producing goods, performing works
or rending services within a long-term (more than one year) technological cycle
and (ii) does not provide for their interim (stage by stage) acceptance by the
customer (paras 137.3 and 187.9 of the Tax Code of Ukraine).
In the "realm" of corporate income tax, the
special regime affects a taxpayer-contractor (as regards project finance – the
contractor being in charge of the construction project) only. The transactions
on the part of the customer (real estate developer) are taxable under general
rules.
The special taxation regime seems to be nothing, but
the government’s care about its tax revenues during the discharge of long-term
contracts. Had not this special procedure subsisted, the accrual method would
have been applied and the income corporate tax would not have fallen due until
the handling over of the result of the works to the customer. Just this very
event triggers the recognition of income by the taxpayer-contractor (para 137.1
of the Tax Code of Ukraine).
The special taxation regime is an exception from the accrual method. The taxpayer being the contractor under a long-term contract
must show income in each tax period (quarter) notwithstanding that the results
of the works are not yet passed to the customer (developer). The income is to
be computed according to the degree of the completion of the works, which is
determined (i) by the ratio of the expenses incurred in the tax period to the
total expected amount of such expenses and/or (ii) by the ratio of the services
rendered in the tax period to the total expected volume of such services. Since
the latter mechanism of calculating income is regarded with service provision
contracts, it is unlikely to be extended to construction works.
As for the expenses, the taxpayer-contractor is
allowed to deduct expenses associated with the performance of the works under
the long-term contract concurrently with the recognition of the above income.
Upon the results of the works are transferred to the
customer, the contractor makes adjustments to his income. If the actually
received income exceeds the amount of the income accrued in each preceding tax
period concerned, the surplus is attributable to the income of the ongoing tax
period. If, on the contrary, the actually received income is less than the
amount of the previously accrued income, the deficiency reduces the income of
the current tax period.
The "realm" of VAT also faces an exception. The
special taxation regime for long-term contracts lays such contracts outside the
well-known rule of "first event". Input VAT/output VAT arises at the
date of transferring the results of the works under a long-term contract. This
special regime seems to be favourable for the contractor, as it allows him to
adjourn the recognition of the output VAT to the final stage of the performance
of the contracts. However, when it comes to the customer (developer), things
turn out to be the opposite. The customer appears to be placed in an extremely
disadvantageous position. Despite the advance payments made by the customer in
favour of the contractor, the former is not able to qualify for the input VAT
deduction for a long period of time.
It is difficult to figure out what purpose the
government pursued while putting long-terms contracts beyond the operation of
the “first event” rule. Perhaps, by doing so it intended to protect the state
budget from VAT refund claims of the customers (real estate developers). Had
the "first event" rule been in effect, such customers would have been
able to claim VAT refund out of the input VAT accumulated in the course of the
construction (the advances paid to the contractor under long-term contracts). Albeit
our system of the VAT administration diminishes the chances of getting the VAT
refund in this situation almost up to the minimum, the government decided to
save itself once again.
Apparently, the special taxation regime for long-term
contracts is not the thing that taxpayers can undoubtedly benefit from. Sometimes
it makes sense to frame a contract to the effect that it will not be treated as
long-term one for tax purposes (say, to incorporate the interim (stage by
stage) acceptance of the works into the contract).
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