Tax losses of previous periods: resetting of securities accounting

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People who have had to deal with tax-related issues this way or another probably know about the long-lasting confrontation between taxpayers and tax authorities about the possibility/impossibility of carrying forward tax losses incurred before January 1, 2011.

The confrontation ended in May 2012, as amendments were made to the Tax Code (paragraph 3 of Chapter 4 of Part XX), whereby:

- taxpayers whose income in 2011 was below UAH 1 million, are permitted to carry forward such losses in full, based on the results of the first half of 2012;

- taxpayers whose income in 2011 equaled to, or exceeded UAH 1 million, are permitted to carry forward such losses by degrees: 25% following the results of the first half of 2012, 2013, 2014 and 2015, respectively.

Tax officers decided not to stop at what has been achieved and interpret the above amendments to the Tax Code to their maximum benefit (to raise additional public revenues).

This time, it hurt taxpayers that carry out securities transactions, mostly banks and securities dealers. In its letter No. 320/0/71-12/15-1217 “On Reflecting the Negative Financial Performance of Securities and Derivatives Transactions in 2012-2015”, dated 9 August 2012, the State Tax Service of Ukraine explained that the provision of the Tax Code related to the 25% partial carrying forward of tax losses incurred before January 1, 2011 in 2012, 2013, 2014 and 2015, is also applicable to the tax losses of securities and derivatives transactions carried out by taxpayers whose income in 2011 equaled to, or exceeded UAH 1 million.

Therefore, in the opinion of the State Tax Service of Ukraine, corporate profit tax payers whose income in 2011 equaled to, or exceeded UAH 1 million have the right to carry forward in 2012 only 25% of the amount of tax losses of securities and derivative transactions accumulated as of 1 January 2012. They will be entitled to carry forward the rest of such losses in 2013, 2014 and 2015 – 25% for each year, respectively.

The tax losses to which the above-mentioned provisions of the Tax Code (regarding the gradual carrying forward during 2012, 2013, 2014 and 2015) are applied, and the tax losses of securities and derivatives transactions are two completely different things. Consequently, taxpayers and tax lawyers/advisors unanimously state that it is groundless on the part of the tax authorities to apply the 25% restriction to securities and derivatives tax accounting.

Even the Committee of the Verkhovna Rada of Ukraine on Finance, Banking, Tax and Customs Policy made a comment regarding this issue. In its letter No. 04-39/10-990 of 10 September 2012, the Committee supported taxpayers and pointed out that it is groundless for the tax authorities to apply the 25% restriction to tax accounting of securities and derivatives transactions.

Be that as it may, the tax authorities stand their ground and actively implement the said letter of the State Tax Service of Ukraine. Under such circumstances, a large number of judicial disputes may arise between the tax authorities and taxpayers on applying the 25% restriction to securities and derivative tax accounting.

To date, some decisions related to the problem in question can be found in the Uniform State Register of Court Decisions (for instance, a case concerning the claim lodged by Subsidiary enterprise “Polygraphic combine “Zorya” to the District State Tax Service – the Central Office for Servicing Large Taxpayers, http://www.reyestr.court.gov.ua/Review/26237868). Unfortunately, in the above case the court did not analyze the lawfulness of applying the 25% restriction to securities and derivatives tax accounting, and refused to initiate proceedings, being governed solely by procedural rules.

No one knows how this story will end and what the court practice in cases on applying the 25% restriction to securities and derivative accounting will be like. Looking at the issue of carrying forward losses incurred by 1 January 2011, the court practice will hardly be unambiguous.

It is most likely that courts, depending on their preferences and the level of concern about raising public revenues, will make decisions both in favor of taxpayers and in favor of the tax authorities. It can even be assumed that the matter will be put to rest on a lawmaker – amendments that will be made to the Tax Code will establish whether the 25% restriction should be applied to tax accounting of securities and derivatives transactions. Hopefully, such amendments will provide that the above restriction will not be applied. However, somewhere deep inside there is a feeling that things will turn out the opposite of what we expect.

Top-5 Transactions in Focus of Tax Authorities

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Buying High-Priced Consultancy Services

If a company buys consulting services at a high price (several hundred thousands or even millions of hryvnias), the act/certificate on works performed will not usually suffice for the successful passage of the tax audit. It is necessary to have a detailed report or another similar document reflecting the content of the consultancy services received. Otherwise, the tax authorities can cancel your input VAT/expenses and charge the penalties amounting to 25% of the additionally assessed tax liabilities.

Transactions Involving Non-residents

Transactions involving non-residents is a vast field for finding tax violations. First, the tax authorities check the compliance with withholding tax rules. Has the taxpayer reasonably taken advantage of the provisions of the tax treaty exempting the non-resident from taxation in Ukraine or setting out a lower tax rate than under national law?

Secondly, the legislation provides for a myriad of restrictions in respect of the deductibility of expenses incurred while dealing with non-residents. A striking examples are (i) the limitation on the deductibility of consulting, marketing and advertising services purchased from non-resident and exceeding 4% of the revenue of the previous year and (ii) the total non-deductibility of such services purchased from non-residents having offshore status. It is clear that sometimes the taxpayer may stumble and fail to comply with these limitations.

Transactions with Related Parties

Transactions with related (affiliated) parties are subject to transfer pricing rules. That is, if it is established that the movement of goods/services between related parties has taken place at prices other than arm’s length ones, the tax authorities may adjust the tax consequences of the respective transactions by applying arm’s length prices. This, in its turn, may result in additional tax liabilities and penalties for the taxpayer.

There has been recently an outbreak in tax authorities’ attempts to apply transfer pricing rules. On 1 January 2013 the new (more "perfect", at least according to the tax authorities) transfer pricing rules will come into effect. So, we can only expect an increase of such attempts in the new year.

Unusual Transactions

Suppose that an enterprise specialising in construction works suddenly and for unknown reasons engages in the exportation of steel. It seems that there is nothing illegal in such kind of activity. But it is rather doubtful that these transactions will not be subject to special scrutiny of the tax authorities. The tax authorities can find sham companies in the chain of supply (at least ones in their understanding), ignore the respective supplies for tax purposes and finally deprive the taxpayer of the input VAT/expenses.

Transactions in Securities

Transactions in securities were and remain a popular tool for tax avoidance/mitigation and therefore always attract the special attention of the tax authorities.

What is worth a wide-spread scheme of selling securitised real estate through investment funds? The latter ensures considerable tax savings as investments funds are almost completely exempt from corporate income tax in Ukraine.