Transfer Pricing: Administration, Inspections and Penalties

Co-author Dmytro Savchuk

(senior associate of Lavrynovych
and Partners Law Firm)

On September 1, 2013 the Law on Amendments to the Tax Code of Ukraine governing the matters of transfer pricing (hereinafter – «TP») entered into force becoming virtually epochal for the economy of Ukraine. Since the main purpose of the law is to raise the state revenues by eliminating the artificial lowering of income in controlled transactions (hereinafter – «CTs»), the law prescribes special characteristics of administration, additional inspections and penalties for these transactions. Let us consider the aforementioned innovations in a more detail.

ADMINISTRATION

The important point is that the administration of CTs is carried out directly by the Ministry of Revenue and Duties of Ukraine (hereinafter – the «Ministry of Revenue»), and not by local tax authorities. TP returns and TP documentation are to be filed specifically with the Ministry of Revenue which monitors the prices in CTs and schedules inspections of CTs.

The mechanism of CTs administration works in the following manner.

Filing of TP returns. If any CTs have taken place, the TP return must be filed in electronic form (in the absence of CTs the filing of the said return is not required). The reporting period is a calendar year. The TP return must be filed by May 1 of the year following the reporting year (by May 1, 2014 for the calendar year 2013). The form of the return has been already approved by the order of the Ministry of Revenue No 669 dated November 11, 2013.

In case a CT has taken place, but no relevant return has been filed, a local tax administration (in case of independent identification of such a CT) sends a notification on the CT concerned to the Ministry of Revenue and informs the taxpayer of sending this notification. The dispatch of the said notification is viewed as an independent basis for the carrying out of the inspection of the taxpayer in accordance with the procedure given below.

Submission of TP documentation. The TP documentation includes source documents, other documentation, and information relating to CTs, namely information on related parties, goods/services, delivery terms, the results of economic analysis for the substantiation of the price used in the CTs.

TP documentation is submitted only upon a written request of the Ministry of Revenue and solely upon the availability of the grounds for issuing such a request. The grounds for issuing the said request are as follows: (i) establishing the deviations from the arm’s length price in the course of the monitoring conducted by the Ministry of Revenue, and (ii) failure to file the TP return by the taxpayer or its filing with violations. The request at issue can be sent only after the expiry of the time limit for filing the TP return, i.e. not earlier than May 1 of the year following the reporting year.

The time limit for the submission of TP documentation is one month from the date of the receipt of the request (two months for large taxpayers). It is important to note that in addition to the TP documentation requested by the Ministry of Revenue, the taxpayer may submit any other documentation that he deems appropriate for the purpose of the substantiation of the CT’s price.

INSPECTIONS

For exercising control over CTs, there has been a new type of tax inspections introduced, namely inspections of CTs. These are conducted separately from scheduled and unscheduled inspections. The new type of inspections has following characteristics:

- An inspection of CTs is conducted based on the decision of the Ministry of Revenue;

- A taxpayer is informed about the inspection of CTs ten calendar days prior to the date of its commencement;

- An inspection of CTs is not conducted on-site (the documents provided by the taxpayer upon the request sent at the beginning of the inspection are checked);

- An inspection of CTs can be conducted in parallel with other types of tax inspections;

- The duration of the inspection is up to six months with the right to extend the inspection for other six months where provided for by the Tax Code of Ukraine (carrying out an expert examination, requesting information from foreign government bodies, etc.);

- One CT can be inspected only once a year; in addition, if according to the results of the CT inspection, no TP violations have been identified, the inspection of the counterparty cannot be conducted in respect of this very CT.

Apart from the introduction of the new type of inspections, the grounds for the exercise of documentary unscheduled inspections (on-site and off-site) have been expanded so that they can catch the TP matters. It should be noted that the grounds for the performance of CT inspections and documentary unscheduled inspections regarding TP are almost the same. Thus, the taxmen, in fact, are granted the right to choose the type of the inspection in each particular case. Notices of assessment based on the results of CTS inspections and documentary unscheduled inspections regarding CTs are issued and challenged according to the standard procedure.

PENALTIES

According to the Tax Code of Ukraine special penalties for the breach of the TP legislation are established. Thus, for the failure to file the TP return the tax payer will be imposed a penalty in the amount of 5% of that of the CT, and for the non-submission of the TP documentation the taxpayer may be fined 100 minimum wages (approximately USD 15,000).

This being said, it should be remembered that if based on the results of a CT inspection the tax liability in respect of a particular tax is assessed by the tax authority, the taxpayer will be charged a penalty amounting to 25% (50% for a repeated breach) of the amount of such a liability. However, for now the Tax Code of Ukraine has fixed the tax concession period for charging the above penalty: up to September 1, 2014 the penalty will be charged in the amount of 1 UAH.

Additionally, given that the deadlines for TP returns on one part and VAT and corporate income tax returns on the other part are not the same, there can apparently be a situation where taxpayers would have to make self-adjustments after filing the VAT and corporate income tax returns and pay 3% (5%) penalty in respect of the voluntary elimination of tax errors. For example, at the time of the filing of a VAT return the taxpayer did not have the substantiation of the CT price and used the contract price. At the time of the filing of the TP return he understood that this price did not correspond to the arm’s length price. Therefore, for the purpose of avoiding additional charges from the tax authorities and the associated 25% (50%) penalty, the taxpayer decided to make a correction to the VAT return with the resulting 3% penalty.

* - Photo from http://www.dreamstime.com

Transfer Pricing Methods

Co-author Anton Babak

(junior associate of Lavrynovych
 and Partners Law Firm)

On September 1, 2013 the amendments to the Tax Code of Ukraine related to transfer pricing entered into force. The said amendments have particularly affected the methods of the computation of an arm’s length price, which thereafter started being referred to as the methods of the computation of a price in controlled transactions (hereinafter – «CTs»).

The list of methods remains unchanged. They are as follows:

- Method of comparable uncontrolled price;

- Resale price method;

- Cost plus method;

- Transaction net margin method;

- Transaction profit split method.

However, with the amendments to the Tax Code of Ukraine the rules for the application of each of the above-mentioned methods have been worded in a much greater detail. Furthermore, there have been introduced some new terms related to the application of the methods. These are such terms as gross margin of costs, net margin, net margin of expenses, etc.

Since September 1, 2013 the hierarchy of the said methods has been in operation. A taxpayer may apply any method, however if there is a possibility to employ the method of comparable uncontrolled price, this particular method must be applied. It is also possible to use several methods simultaneously (i.e. a combination of methods).

Transfer Pricing: from Sources to Sources

Co-author Andriy Kuleba
(junior associate of Lavrynovych and Partners Law Firm)

The Law of Ukraine No. 408-VII «On Amendments to the Tax Code of Ukraine regarding Transfer Pricing» dated July 4, 2013 (hereinafter – the «Law on TP») defines two categories of information sources to be used for determining the price of controlled transactions (hereinafter – «CTs»):

• Officially recognized sources;
• Other sources.

Officially recognized sources. This category includes informational sources on market prices, the list of which has been approved by the Resolution No.866-p of the Cabinet of Ministers of Ukraine dated October 23, 2013.

According to the abovementioned Resolution the officially recognized sources, in their turn, are divided into two following groups: (i) the basic sources and (ii) the auxiliary sources. The latter are used where there is no information on market prices in the basic sources or where the information available in the basic sources is insufficient.

The basic sources include: the monthly newsletter «Review of Prices of Ukrainian and World Commodity Markets», the periodical analytical products «Commodity Monitor. Ukraine» and the «Digest of Commodity Prices on World Markets», the weekly bulletin «Steel Market: Analytics, Forecasts, Scenarios», the official web-site of the Ukrainian Agrarian Exchange and the Bulletin of the Ministry of Revenue and Duties.

The auxiliary sources embrace: the official web-sites of the Ministry of Regional Development and the Ministry of Agrarian Policy.

Other sources. Under the Law on TP these, in particular, include: statistical data of the government authorities and institutions, commodity market quotes; reference prices of specialized business periodicals and publications (including online periodicals and electronic publications), informational programs (software); information on prices and quotes made public in mass media, and other publicly available informational sources.

Such sources as informational programs (software), among which the databases can be reckoned, deserve special attention. For example, the databases the «Ruslana» and the SPARK are widely used in Russia and the CIS, whereas Amadeus is so used in Europe.

One may note the SPARK which is the largest in the CIS corporate database of registered legal entities of Russia, Ukraine, Kazakhstan and other countries. It was created in 2002-2003 by the experts of group of companies «Interfax Group» based on the information of the State Statistics Service of the Russian Federation. The said database uses only publicly available information acquired upon contractual terms from official sources. In Ukraine the SPARK started being actively promoted towards the end of 2012.

Rules for using information sources. Ultimately, a few words have to be said about the general rules for using information sources. Based on the Law on TP, two main rules can be pointed out:

Rule No. 1 – other sources can be used only in case of absence of information in officially recognized sources or where the information available in such sources is insufficient.

Rule No. 2 – in the case that a taxpayer uses officially recognized sources, the Ministry of Revenue and Duties of Ukraine must also use the same officially recognized sources, except where the Ministry has proved that the taxpayer had to use another officially recognized source.

* Photo from http://tvi.ua

New Transfer Pricing Rules: Coverage

On September 1, 2013 the Law of Ukraine No. 408 -VII «On Amendments to the Tax Code of Ukraine Concerning Transfer Pricing» (hereinafter – the «Law on TP») dated July 4, 2013 entered into force. The present article will review the application field of the new rules of transfer pricing (hereinafter – «TP») introduced by the aforementioned Law, including the types of taxes and controlled transactions (hereinafter – «CT») caught.

Taxes Covered by TP Rules

The TP rules to the full extent, including filing TP returns and TP documentation, apply only to VAT and corporate income tax. The so-called «abridged» application of the TP rules is possible for specific purposes related to the collection of personal income tax (hereinafter – «PIT»). For instance, para 164.5 of the Tax Code of Ukraine provides that if an individual draws income in a nonmonetary form, the value of such income calculated in accordance with the arm’s length prices is the basis of assessment. The computation of arm’s length prices is, in its turn, the realm of the TP rules. Nonetheless, it seems to be clearly understood that the maximum that can be done in this situation is the application of the TP methods for the computation of the arm’s length price (no obligations in respect of filing TP returns and TP documentation for PIT payers in any case).

On the other hand, the Ministry of Revenue and Duties of Ukraine (hereinafter – the «Ministry of Revenue») has recently prepared the draft law, according to which, in particular for the purposes of PIT determination, it is suggested to use the term «fair market price», which has nothing to do with the TP rules, instead of «arm’s length price». This is the Law of Ukraine “On Amendments to the Tax Code of Ukraine (regarding the Use of the Term “Arm’s Length Price”). If such amendments are made, the question of the possibility to apply the TP rules for the PIT purposes will be taken off the table automatically.

Controlled Transactions (CTs)

The following transactions are recognized as controlled in accordance with the Law on TP:

• All transactions with related parties-non-residents;
• Transactions with certain categories of related parties-residents (taxpayers operating at loss, unified tax payers, non-VAT taxable persons and/or non-payers of corporate income tax);
• Transactions with unrelated parties-non-residents subject to corporate income tax at the rate, which is 5 or more percent less than that in Ukraine (the list of relevant jurisdictions is yet to be approved by the Cabinet of Ministers of Ukraine).

The abovementioned transactions are treated as controlled not automatically, but only where the amount of taxpayer’s transactions with a specific counterparty (regardless of whether this is a single transaction or a set of transactions) reaches or exceeds the value limit of UAH 50 million, excluding VAT.

If one asks himself what has drastically changed when compared to the situation which existed prior to the entry into force of the Law on TP (before September 1, 2013), he can note the following:

• Barter transactions between unrelated parties have being excluded from the list of CTs*;
• The field of the TP application to the related parties-residents has been narrowed. Prior to September 1, 2013 all transactions with related parties had been defined as controlled ones, whereas since September 1, 2013 only transactions with certain categories of related parties residents have been defined as such;
• The value limit for classifying transactions as controlled has been introduced. The said limit had not existed prior to September 1, 2013, therefore all transactions regardless of their amount had been subject to control;
• One may also assert that control over transactions with unrelated parties-non-residents subject to corporate income tax at the rate of 5 or more percent less than that in Ukraine has been introduced, however such an assertion will be rather debatable. The question at issue is that prior to September 1, 2013 transactions with any entities (regardless of whether they are residents/non-residents or related/unrelated parties) that were not subject to corporate income tax or were subject to this tax at the rates, other than the standard rate, had been recognized as controlled ones. Transactions with any unrelated party-non-resident paying corporate income tax at the rate of 5 or more percent less than that in Ukraine fell under the aforesaid definition.

In terms of international practice for identifying the list of CTs, the first thing that everybody has to remember is the OECD’s «Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations». According to this document it is offered to view transactions as controlled only if they are made between related parties (residents and non-residents). As you can see, the Ukrainian approach is more «fundamental» and the control falls far beyond the scope of transactions with related parties.

However, it may be said that a wish to control certain transactions with unrelated parties is probably typical for the most CIS countries. Thus, for example, in Russia the transactions with unrelated parties-non-residents are treated as CTs if these transactions relate to goods of world exchange trade or are made with unrelated parties-non-residents registered in the jurisdictions included in the «black list» of the tax havens. In Kazakhstan and Belarus nearly all transactions in the area of international trade are recognized as CTs, regardless of whether the counterparty is a related or unrelated party.

The matter which seems to be drawing the most attention is the application of the TP rules to transactions with unrelated parties-non-residents subject corporate income tax at the rate of 5 or more percent less than that in Ukraine.

Firstly, the taxpayers would like to know which calculation formula must be used, specifically whether to deduct 5 percentage points (19% – 5% = 14%) or 5 % (19% – (5% from 19%) = 18,05%) from the corporate income tax rate applicable in Ukraine. Fortunately, on November 13, 2013 the amendments to the Tax Code of Ukraine (section 5 of the Law of Ukraine No. 657-VII «On Amendments to the Tax Code of Ukraine Concerning Inventory and Registration of the Taxpayers and the Improvements of Certain Provisions» dated October 24, 2013) entered into force and finally clarified this question. According to the amendments 5 percentage points, rather than 5%, must be deducted, i.e. a non-residents subject to corporate income tax at the rate of 14% and below instead of 18,05 % and below will be controlled.

Secondly, it is important to keep in mind that the control may affect not only those non-residents whose statutory corporate income tax rate is lower than in Ukraine, but also those of them whose effective rate is lower than in Ukraine. The premises of this approach can be found in the Law on TP itself which emphasizes two categories of non-residents falling under the control: (i) non-residents registered in a country (territory), where the corporate income tax rate is 5 or more percent less than in Ukraine and (ii) non-residents paying corporate income tax at the rate of 5 or more percent less than in Ukraine. 
 

It seems that the Ministry of Revenue does support this approach. For instance, Malta is included in the draft list of the jurisdictions the transactions with the registered residents of which are controlled, that has been developed by this ministry. This is against the background of the fact that the statutory rate of corporate income tax in Malta is much higher than in Ukraine and amounts to 35%. However, due to the dividend-related refund system existing in Malta, its effective rate of corporate tax is much lower than in Ukraine.

The So-Called «Safety Corridor»

Lastly, with the entry into force of the Law on TP the allowed 20% deviation of a transfer price from the arm’s length price stopped being applied. It should be recalled that the said deviation was in operation in respect of corporate income tax from April 1, 2011 to September 1, 2013 and in respect of VAT from December 16, 2006 to January 1, 2011. The existence of such 20% «safety corridor» allowed the taxpayers not to worry about the accordance of transfer prices with the arm’s length prices in most cases.

*- Prior to September 1, 2013 transactions covered by the legislation on arm’s length prices that was applicable at that time were not directly referred to as CTs. However, the fact that the control over prices in such transactions was in fact exercised allows to refer conditionally to these transactions as to CTs.

New Year Tax Gifts 2014

Photo from

http://hdwallpaperszon.com

Co-author Andriy Kuleba

(junior associate of Lavrynovych and Partners Law Firm)

Dear readers, take our warmest wishes for upcoming New Year and Christmas!

Below is a brief account of what will be expected since 1 January 2014 in the area of Ukrainian taxation (so-called New Year Tax Gifts 2014). 

 

Tax Novelties since 1 January 2014

No	After Novelties Take Effect	Before Novelties Take Effect	Possible Consequences
VAT
1	The rate of VAT lowers to 17%*. *- It is expected by some commentators that the Ukrainian Parliament will change the law so as to avoid the reduction of the current 20% VAT rate in 2014.	The rate of VAT constituted 20%.	Favorable implications. Theoretically, it can cause the prices for VAT taxable goods and services to fall down by 2.5% with the resulting increase of total demand.
2	No requirement on the indication of the details of a customs declaration in the VAT invoice issued with regard to imported goods.	A VAT invoice issued in respect of imported goods must include the details of the relevant customs declaration.	The simplification of the procedure.
3	The supplies of grain crops (wheat, rye, barley, oats, corn, rice, sorgo, buckwheat, panic grass) and industrial crops (seeds of rape and sunflower) become VAT taxable.	Temporary exemption from VAT.	The exporters of the grain will run into a “headache” called “VAT refund”.
4	The supplies and imports of waste and scrap of ferrous and non-ferrous metals and the wood (certain items) become VAT taxable.	Temporary exemption from VAT.	Slightly forgotten problems for the exporters of metallurgical products related to the refund of VAT paid to the suppliers of the scrap and waste metals. It is not a rare occasion that the latter resort to non-transparent chains of supply in which the tax authorities are keen to discover “fake nature” deals.
5	Possibility to file for VAT registration by means of electronic communication (provided that there is an agreement executed between the taxable person and the tax authority on the recognition of the electronic documents).	No such possibility.	The simplification of the VAT registration.
6	The introduction of 5 calendar days term for the carrying out of in-office (cameral) audits of tax returns of VAT taxable persons with positive tax history for the purposes of automatic VAT refund. To have the positive tax history means to meet a number of criteria over 36 successive months.	In-office (cameral) audits for the purposes of the automatic VAT refund were to be carried out within 20 calendar days.	The acceleration of the VAT refund procedure for the taxable persons having positive tax history.
7	The cessation of the possibility of receiving VAT refund through the issue of financial treasury bills.	VAT refund was possible through the issue of financial treasury bills.	The VAT taxable persons lose the alternative way of VAT refund.
Corporate Income Tax
8	The rate of corporate income tax lowers to 16%*. *- It is expected by some commentators that the Ukrainian Parliament will change the law so as to avoid the reduction of the current 19% corporate income tax rate in 2014.	The rate of corporate income tax constituted 19%.	Positive implications. Reduced tax burden for enterprises.
Excise Tax
9	The rate of excise tax increases to UAH 32 for 1 liter of 100% spirits.	The rate of excise tax constituted UAH 29 for 1 liter of 100% spirits.	The increase in prices of alcoholic drinks.
10	The specific rate of excise tax for non-filtered cigarettes rises to UAH 77.50 per 1 thousand pieces, and for filtered cigarettes – to UAH 173.20.	The specific rate of excise tax for non-filtered cigarettes constituted UAH 72.70 per 1 thousand pieces, and for filtered cigarettes – UAH 162.60.	The increase in prices of cigarettes.
Administration
11	The introduction of documental unscheduled electronic audits for taxpayers using simplified tax system. Such audits are carried out exclusively at the instance of the taxpayer with the minor level of tax risk. The audits are called “electronic” considering that the documents for the audits are provided in the electronic form.	No such possibility.	This brings the unique possibility of having your tax calculations audited on a free-of-charge basis. The taxpayer applies to the tax authority and provides it with all required documents for the purposes of such an audit. The tax authority carries out the audit. Should tax irregularities be detected, the notice of assessment is not immediately issued. The taxpayer is given a time during which he is able to made the required adjustments himself (self-correction) without the imposition of 25 (50)% fine. At the same time, this does not exempt him from paying a 3 (5)% fine (for the self-correction of tax mistakes) as well as daily default penalty. If the taxpayer fails to correct the mistakes, the separate tax audit can be carried out with the resulting notice of assessment.
12	The Methodology of the Accounting of Temporary and Permanent Tax Differences comes into force (Accounting Standard “Tax Differences” approved by the order of the Ministry of Finance of Ukraine No. 27 dated 25 January 2011).	No such Methodology.	Additional requirements to the financial statements. Financial statements for accounting periods of 2014 should be prepared with the consideration of tax differences.
13	The applications on the voluntary VAT registration and on the selection of the simplified tax system regime may be filed directly with the Registrar of Companies at the moment of the state registration of a legal entity or a sole proprietor.	No such possibility.	More facile procedure for VAT registration and accession to simplified tax system regime.
Other Issues
14	The actual rates of ecological tax equal to 100% of the rates stipulated by the Tax Code of Ukraine.	The actual rates of ecological tax constituted 75% of the rates stipulated by the Tax Code of Ukraine.	Additional tax burden for ecological tax payers.
15	Renewal of real estate tax for individuals.	The real estate tax has already come into effect for individuals and legal entities. Nevertheless, since August 2013 the application of the tax to individuals has been suspended.	Additional tax burden for individuals holding residential real estate.