Wednesday, April 29, 2015

Out-of-Court Recovery of Tax Debt: Devil is Not So Fearful as He is Painted

One of the hardly noticeable changes brought by the tax reform 2015 was a right vested in the fiscal authorities to recover tax debts in some cases without a court order.

The relevant rules are provided for by para 32 of Chapter XX "Transitional Provisions" of the Tax Code of Ukraine.

This is a temporary measure being in force until 1 July 2015.

A very important point here is that out-of-court recovery is possible in respect of tax debts based on self-assessed tax liabilities only (for example, a taxpayer files its corporate income return, but fails to remit the tax specified in the return to the state revenues).

Another no less important point is that even the recovery of tax debts arising from self-assessed tax liabilities is limited to certain cases. The Tax Code of Ukraine lays down two conditions that must be simultaneously met to make out-of-court recovery possible:

- The amount of the tax debt is more than UAH 5 million;

- There is no debt owed by the fiscal authority to the taxpayer (excessively paid taxes), which can be set off against the tax debt to be collected.

Out-of-court collection of tax debts is carried out on the basis of a decision taken by the head of the local unit of the fiscal authorities. Taxmen can have the debt recovered by means of both cash money and funds held in bank accounts.

In the case of funds held in bank accounts a decision to collect the tax debt is sent to a bank. The bank just withdraws money from the account of the taxpayer. The National Bank of Ukraine has already managed to confirm this possibility (the letter dated 27 January 2015 No 25-110 / 4833).

If cash money is at issue, the decision on debt collection goes directly to the taxpayer. “Severe” taxmen come to the taxpayer’s premises and seize the available cash. The procedure for the seizure of cash money is set out by the legislation (the Cabinet of Ministers’ resolution of 29 December 2010 No 1244). Hopefully, “lawlessness" should not occur.

The recourse to out-of-court collection does not mean that the fiscal authorities are exempt from general procedural constraints related to recovery of tax debts. For instance, before a decision on out-of-court collection is made, the fiscal authorities must fully comply with general procedure requirements, namely they are supposed to forward to the taxpayer a formal request on the repayment of the tax debt and wait 60 calendar days after the sending of such a request.

Below are some comments on the actual purpose of the amendments and their possible impact on taxpayers.

There are some articles in the press intimidating taxpayers with massive seizure of their "sweat earned" money "without any trial". My best advice is to be sceptical of such threatening articles, as they significantly exaggerate the actual state of affairs.  

Not all is that bad, indeed. The change will be felt only by the small number of taxpayers. It will primarily affect taxpayers having serious liquidity problems (so-called pre-bankruptcy entities). The change may also touch upon those whom we "affectionately" call "shams".

An "average" taxpayer should not be affected by the change. For a viable business it is a paranormal situation to be where it records its tax liabilities and then does not have enough funds to discharge them.

What was the rationale behind the change is a good question. Unfortunately, an answer to this question cannot be extracted from an explanatory note to the relevant Bill on amending the Tax Code of Ukraine.

It seems that the change was made to facilitate the recovery of tax debts from distressed companies. The procedure for obtaining a court judgment authorizing the recovery, especially given a possible appellate review, may take up to a year. Over this time, money can just “evaporate” from the bank accounts of the distressed enterprises. The money will go to other creditors or can be taken out by means of “fake nature” transactions. The fiscal authorities will go into bankruptcy proceedings and eventually collect nothing, just because the money has been already gone.

The amendments do improve the chances of the fiscal authorities to emerge victorious from the battle for the assets of a "drowning" taxpayer. This is due to the shortening of debt recovery time and ensuring "surprise effect" in the tax debt collection.

Friday, April 10, 2015

Recast Transfer Pricing Rules

In the scope of the tax reform of 2015 the transfer pricing (“TP”) rules incorporated in the Tax Code of Ukraine have been completely restated. The new TP rules have been in operation since 1 January 2015. However, taxpayers report in 2015 for the year of 2014 according to the old TP rules. The new TP reporting requirements will first apply in the year of 2016 when the taxpayers report for the year of 2015.

What follows is a brief account of the recast TP rules:

- The notion of “arm’s length principle” is now explicitly stated in the Tax Code of Ukraine. A transaction is considered to be in compliance with the arm’s length principle if its terms and conditions do not differ from those of comparable uncontrolled transactions carried out between independent parties.

- The new TP rules normally apply to the calculation of corporate income tax only. They do not generally apply for the purposes of the computation of VAT.*

- Domestic transactions (transactions between residents) are not normally viewed as controlled transactions anymore. Controlled transactions are only those involving non-residents.*

- The scope of controlled transactions involving non-residents has been significantly expanded. Nowadays, in addition to transactions with related non-residents and non-residents from low-tax jurisdictions, the following transactions with non-residents are caught:

1)    transactions of sale of goods through commission agents;

2)    transactions with residents in countries that do not make publicly available information on the ownership structure of their legal entities;

3)    transactions with residents in countries that do not have effective treaties with Ukraine enabling the exchange of tax information.

- Transactions involving artificially inserted intermediaries are now a separate type of controlled transactions. In order to determine whether an intermediary has been inserted artificially to lay the transaction outside the TP control, the functions, risks and assets of the intermediary are examined. Should those be insignificant, the intermediary will be most likely treated as artificially inserted one.

- The financial threshold for controlled transactions has been considerably remodelled. At present, it consists of two conditions that must be simultaneously met for a transaction to be considered as controlled. Those two conditions are as follows:

1)    Annual gross revenues of the taxpayer, taken along with those of all its related parties, in the current tax year exceed UAH 20 million; and

2)    Gross amount of all transactions conducted by the taxpayer/its related parties with any of their  counterparties in the current tax year exceeds either UAH 1 million or 3% of the  taxable income of the taxpayer.

- The new criteria of relationship have been introduced. First, taxpayers can be now recognised as related parties by means of debt-to-equity ratio (more than 10.0 times debt-to-equity ratio for banks, lease and financial companies, as well as more than 3.5 times debt-to-equity ratio for other taxpayers). Second, the state fiscal authorities can now claim “factual” relationship even where no one of the criteria of relationship set forth by the Tax Code of Ukraine is directly met. In this case, the state fiscal authorities should obtain a court order confirming “factual” relationship.

- The TP methods remain as earlier. Their description has been largely amended to fit in more closely with that of the OECD Transfer Pricing Guidelines.

- Taxpayers importing or exporting commodity exchange-traded products are supposed to apply comparable uncontrolled price method (method No 1) based on the price quotations of the commodity exchanges concerned. Such taxpayers may also apply other methods of TP, but subject to the full disclosure of their supply chains to the state fiscal authorities.

- There is no more division of informational sources to “official” and “non-official” ones. A taxpayer may use any informational source open to the general public.

- Further to a TP return, a new piece of TP reporting has emerged. This is a TP annex to a corporate income tax return that lists controlled transactions. The annex is mandatory and to be filed by all taxpayers having controlled transactions over the reporting year. As opposed to the annex, a TP return is not to be filed in all cases. It is to be filed only by those taxpayers whose amount of the controlled transactions with at least one of their counterparties exceeds UAH 5 million (excluding VAT).

Co-authored by Anton Babak
- The length of TP audit has been significantly prolonged. As for now, it may continue up to 30 months from its commencement.

- The maximum time for the issuance of TP-related tax assessments by the state fiscal authorities has been extended to 7 years.

- Penalties for TP-related violations have become much more severe. In particular, the failure to report a controlled transaction in a TP return can lead to a penalty of 5 % of the value of the non-reported transaction. The failure to provide TP documentation at the request of the state fiscal authorities can lead to a penalty of 3% of the value of the controlled transactions involved, but no more than 200  minimal statutory salaries (currently, UAH 243,600).

* - Due to the lack of clarity in the Tax Code of Ukraine, there is still the risk of the application of the TP rules in respect of VAT and domestic transactions in certain cases. This, in particular, may occur with reference to controlled transactions involving artificially inserted intermediaries. 

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