Ukrainian Tax Litigation: Recent Trends

Co-author Andriy Kuleba

(junior associate of Lavrynovych and Partners Law Firm)

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One of the crucial problems faced by those bringing lawsuits against tax assessments is still the congestion of administrative courts in Ukraine. While at the level of the courts of first instance the mentioned problem is not heavily felt (in most cases tax disputes are resolved within one or two months), at the level of the courts of appeal and the Highest Administrative Court of Ukraine (hereinafter – the “HAC”) the situation is much more difficult. There are so many cases under the consideration of the senior courts that you will normally have to wait for the appointment of your court hearing for at least one year in the court of appeal and for at least two years in the HAC. It is obvious that bona-fide taxpayers are very unsatisfied with such state of affairs.

With respect to the categories of tax disputes, the situation is still practically without changes. The cases related to shams (“fake nature” deals) are leading in the number.

In this context it is worth mentioning new approaches of inspectors of taxes in their struggle against shams or perhaps it is more proper to say “pseudoshams”. At present, some “taxmen” not only “cancel” input VAT and deductible expenditure of a “guilty” taxpayer, but also compel such a taxpayer to enter into his accounts an additional income for the purposes of the calculation of taxes. They contend that since the taxpayer has actually received goods/services, but the underlying transaction was nothing, but a sham, such goods/services have been obtained by him free of charge and therefore should increase his base of assessment.

It also worth noting the landmark judgment of 14 November 2012 of the panel of justices of the HAC chaired by Justice Bukhtiiarova I. A. (“PVK “BUDIVELNYK”, LLC v State Tax Inspection in Obolon District of Kyiv, case No  2а-9864/11/2670). In this judgment the HAC came to the following revolutionary conclusions:

- the tax authorities do not have a right to qualify transactions as shams in their tax audit reports and 

 

- the presumption of the lawfulness of a transaction is applicable in the tax relations (a transaction based upon which the taxpayer obtains the tax benefit in the form of input VAT or deductible expenditure is not taken into account for the purposes of taxation if only there is a court judgment invalidating the transaction in question).

The aforesaid judgment with regard to the presumption of the lawfulness of a transaction directly contradicts the position of the HAC stated in its well-known letter dated 2 June 2011 No 742/11/13-11. In this letter HAC let us expressly know that the presumption at hand is not applicable in tax relations.

However, despite so different formal approaches even at the level of the HAC, the key role in deciding “sham cases” has been and is still attributed to the determination of the genuine (true) nature of underlying transactions based on primary accounting documents and other evidence submitted to the court. 

 

If the fake nature of a transaction has found its confirmation during the court hearings, it is very unlikely that such a “magic wand” as a reference to the absence of the judgment in respect of the invalidation of the transaction (the implementation of the presumption of the lawfulness of a transactions) can help you. 

 

The recently formed Ministry of Revenues and Levies of Ukraine also expressed its opinion on shams in tax relations (letter dated 27 May 2013 No. 3642/6/99-99-19-04-01-15). As usual, the “taxmen” were “unprecedentedly clear” in their statements, “The bodies of the State Tax Service in the discharge of their monitoring and controlling functions can reflect in tax audit reports the indicators of shams, but the additional tax assessment should be exclusively imposed for the breaches of tax rules”. What the Ministry was trying to say by these words remains the mystery. As one can see, we have not obtained a clear answer to the question whether the tax authorities are entitled to treat transactions between taxpayers as shams anymore.

Finally, we would like to mention an increase in the number of “transfer pricing” cases. Perhaps, not the least role here was played by the new transfer pricing rules (Article 39 of the Tax Code of Ukraine) which came into force on 1 January 2013.

Unified Tax in Table Format

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The simplified tax system which at its outset numbered the two groups of the unified tax payers only showed the considerable rise and currently numbers as many as six groups of the unified tax payers (Chapter 1 of Part XIV of the Tax Code of Ukraine). 

What follows is the brief characteristic of today’s six groups of unified tax payers.

Number of group	Requirements to taxpayers				Rate of tax
	Individual entrepreneur/ legal entity	Permitted number of employees	Yearly revenue (gross receipts)  up to, UAH	Allowed business activities
1	Individual entrepreneur	0	150,000	Personal services Selling goods at retail markets	Fixed monthly charge in the range from 1 to 10 per cent of the minimum statutory salary. The precise rate is to be determined by local authorities.
2	Individual entrepreneur	Up to 10	1,000,000	Provision of services, including personal services, either to (i) other payers of unified tax or to the general public (B2C rather than B2B) Manufacturing and/or selling goods Restaurant business	Fixed monthly charge in the range from 2 to 20 per cent of the minimum statutory salary. The precise rate is to be determined by local authorities.
3	Individual entrepreneur	Up to 20	3,000,000	No special limitation	3 % charge levied on gross receipts (if VAT is additionally payable) 5 % charge levied on gross receipts (if VAT is not additionally payable)
4	Legal entity	Up to 50	5,000,000	No special limitation
5	Individual entrepreneur	No limitation	20,000,000	No special limitation	5 % charge levied on gross receipts (if VAT is additionally payable) 7 % charge levied on gross receipts (if VAT is not additionally payable)

10 days for tax appeal

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The Tax Code of Ukraine sets forth two limitation periods in respect of challenging tax assessments in courts. The general rule is that a lawsuit against the tax assessment should be brought with 1095 days after the deadline established for the payment of the underlying tax liabilities (paras 56.18 and 102.1 of the Tax Code of Ukraine). However, where the taxpayer has already resorted to the administrative proceedings conducted by the tax authorities of the higher level, this period is reduced to one month after the cessation of such administrative proceedings (para 56.19 of the Tax Code of Ukraine).

Nonetheless, in practice, it is strongly recommended to challenge the tax assessments in court with 10 calendar days upon either (i) the receipt of the tax assessment or (ii) the receipt of the decision of the tax authorities of the higher level issued pertaining to the taxpayer’s appeal.

The point here is that after the expiration of the above 10 days term the tax liability becomes overdue (tax debt). Although the consequent filing of the action with the administrative court should result in the tax liability is no more considered to be overdue (para 56.18 of the Tax Code of Ukraine), this provision is very difficult to rely on in practice. If the action is not filed within the aforesaid 10 calendar days, the tax authorities may treat the tax liabilities overdue (tax debt) and take steps towards the collection of the tax debt.

What does it mean for the taxpayer?

First, the assets of the taxpayer (to the extent to which their book value is compatible with the amount of the tax debt) is subject to tax pledge. Accordingly, the taxpayer faces significant obstacles related to the disposal of his property.

Second, the taxpayer is deprived of the entitlement to an automatic VAT refund. The availability of the tax debt is sufficient ground for moving the taxpayer outside the scope of this simplified procedure (para 200.19.7 of the Tax Code of Ukraine).

Finally, the taxpayer may experience certain problems while applying for labour permits required for the employment of foreign people in Ukraine. In order to obtain such a permit the employer should summit the tax compliance certificate issued by the tax authorities*. It can be assumed that the indication of the tax debt in the certificate may be viewed as a hindrance for receiving the labour permit.

How to act if you see that you cannot manage to prepare and file the high quality lawsuit with the administrative court within 10 days after the receipt of the tax assessment?

The usual practical solution is as follows. The taxpayer lodges the “formal” administrative claim with the tax authorities of the higher level. At the time when the tax authorities are considering your claim (at least 20 days), you are preparing and filing the high quality lawsuit with the administrative court.

*- Para 5 of the Procedure for Issuance, Prolongation and Cancellation of Labor Permits for Foreigners and Stateless Persons approved by the Resolution of the Cabinet of Ministers of Ukraine of 8 April 2009 No 322. 

Excise Duty on Securities

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As usually the case, the Verkhovna Rada (Ukrainian Parliament) decided to make a gift to taxpayers and improve the tax legislation for the New Year. One of the most striking products of this "improvement" is special tax on transactions in securities and derivatives (hereinafter - the "Special Tax").  The tax has been introduced by the Act of Ukraine "On Amendments to Tax Code of Ukraine with regard to Further Improvement of Administration of Taxes and Duties" of 6 December 2012 and has been effective since 1 January 2013.

It should be noted that, despite its name, the Special Tax is not a distinct tax, but merely a sort of excise duty. The proponents of the Bill have decided not to bother themselves with creating a new Chapter of the Tax Code of Ukraine for the introduction of the Special Tax qua separate tax. They have slighted the arguments put forward by the respective parliamentary committee in support of the fact that the proposed tax is a new and separate tax on financial transactions and cannot be considered an excise duty in terms of its economic substance.

Below is the brief description of the Special Tax.

Taxpayers. The Special Tax is chargeable on individuals and legal entities (irrespective of their residency). There are two types of the taxpayers: (i) those carrying out transactions in derivatives and (ii) those alienating securities. The taxpayers of the Special Tax are not subject to separate registration in the tax authorities.

Scope of the charge. By analogy with the taxpayers there are two groups of taxable transactions: (i) transactions in derivatives and (ii) transaction related to alienating securities (any form of disposal involving the transfer of the title). The taxable base is the contractual value of the securities or derivatives specified in the primary accounting documents.

Tax rates

Taxable transaction	Tax rate
Selling securities on a stock exchange with regard to which a stock exchange rate is calculated. Transactions in derivatives conducted via a stock exchange.	0%
Selling listed securities outside a stock exchange	0,1%
Selling unlisted securities outside a stock exchange (securities not admitted to the trading on a stock exchange, or though admitted but traded as unlisted securities).	1,5%
The execution of derivatives outside of a stock exchange.	5 tax-exempt incomes of citizens (UAH 85) for each executed derivative.

The mode of payment. The Special Tax should be withheld and remitted to the tax authorities by the tax agent by the deadline prescribed for a quarterly taxable period. The duties of tax agents are imposed on securities traders and the issuers of the securities of open-end investments funds (for the placement, redemption and repurchasing of such securities only). With regard to derivatives, the above fixed tax in the amount of 5 tax- exempt incomes of citizens is directly paid by the parties to derivatives (at least, such a conclusion can be drawn from reading the pure law, not yet covered by the clarifications of the tax authorities).  It is noteworthy that each party to the derivative is subject to the aforesaid fixed tax.

Risks and problems. The Act to the extent to which it concerns the determination of tax rate cannot brag about its unambiguousness which can naturally result in some problems and risks for the taxpayers.

First, the law is not completely clear on the point whether the taxpayer is eligible for the zero rate where the stock exchange rate has been calculated, but the securities of the taxpayer have not taken part in this calculation (the stock exchange rate has been calculated based on the bids/asks of other persons selling the same securities on the stock exchange). This may, for example, arise where the securities have been sold by the taxpayer based on the addressed bids/asks that are not taken into account when calculating the stock exchange rate.

It may be assumed that the tax authorities will pursue the position on the applicability of the zero rate only to those securities that have actually participated in the calculation of the stock exchange rate.

Secondly, in order to apply the zero rate to the transactions in securities traded on a  stock exchange the legislator requires  the stock exchange rate of such securities to be calculated in accordance with the requirements established by the National Securities and Stock Market Commission (hereinafter - "Commission") and approved by the central executive body in charge of financial policy. To date, the following requirements though set by the Commission (decision of 22 November 2012 № 1688), but without any approval on the part of the above-mentioned central executive body (probably, the Ministry of Finance of Ukraine).

So, on formal grounds (the lack of the approval referred above) the tax authorities may not recognize the entitlement to the zero rate in respect of any transaction in securities carried out on the stock exchange.

Thirdly, the legislators have, for unknown reasons, forgotten to set forth a tax rate for transactions in securities conducted on a stock exchange with regard to which the stock exchange rate has not been computed. This may, for example, occur when during the trading session of a stock exchange in the course of which the taxpayer sold his securities there were less than three unaddressed bids and less than three unaddressed asks pertaining to the respective securities. Under the Procedure for Determining Stock Exchange Rate of Securities approved by the above decision of the Commission, in order for a stock exchange rate to be calculated there must be not less that the above specified number of the unaddressed bids and asks in relation to such securities.

If the stock exchange rate of securities has not been computed, but they have been sold on a stock exchange, then, on the one hand, there are no grounds to apply the zero rate, and, on the other hand, there are no grounds for the application of other rates (0.1% and 1.5%) either. The latter are relevant for transaction in securities carried out outside a stock exchange only.

How to act in this situation seems to be a sophisticated question. It is logical to argue that because the rate is not specified, the tax should not be levied at all. Not surprisingly, the tax authorities may have their separate opinion on this matter.

Policy considerations. Finally, here are some speculations on the policy consideration underlying the launch of the Specific Tax. Given that the exemption (zero rate) is granted to transactions in securities and derivatives traded on a stock exchange, it is not difficult to guess that one of the key objectives was to support the business of stock exchanges. But is this really the main purpose?

Perhaps, by enacting the Act the legislator intended to strike a blow to tax avoidance (tax mitigation). It is not a secret for anybody that securities are widely used in tax avoidance schemes. If the blow to tax avoidance has been stricken indeed, this will hold true only for securities that cannot be traded on a stock exchange at all (e.g. promissory notes).

“Tricks” with promissory notes with 1.5% tax charged at each stage of the sale may be too expensive to afford. In the meanwhile, as for shares and bonds, there should be no serious problems. In order for the zero rate to become applicable, it suffices to include the securities in the list of a stock exchange as unlisted securities which can be done almost anytime and even with reference to securities of rather dubious quality.