Corporate Income Tax: Reloaded

Co-authored by Anton Babak 

Within the scope of the Tax Reform of 2015 the Corporate Income Chapter of the Tax Code of Ukraine has been completely recast. What follows is a brief description of new corporate income tax (“CIT”) rules mainly being in force as from 1 January 2015.

General Changes

-  CIT is no more levied on profits determined under special tax accounting rules. It is now levied on pre-tax profits calculated in accordance with book accounting standards, but subject to certain adjustments (tax differences);

- Tax differences are not mandatory for small enterprises (with annual income up to UAH 20 million). They may opt for not to apply the tax differences. In this case CIT is chargeable on the amount of “raw” book profits;

- Tax authorities has obtained the right to audit book accounts of taxpayers (either under the Ukrainian GAAP or the IFRS). This does not come as a surprise as at present book profits do make up the basis of the tax assessment;

- Approach to the expenditures that are not associated with the conduct of the taxpayer's business has dramatically changed. As for now, these expenditures are generally allowable;

- 4% limitation on the deductibility of consulting, marketing, advertising and engineering services bought from non-residents do not apply anymore;

- Borrowers under inter-companies interest free loans are no more chargeable to CIT on the deemed interest accrued on such loans and in certain cases on the principal of such loans;

Tax Differences

- Depreciation and amortization: special depreciation and amortization rules provided by the Tax Code of Ukraine apply. They do not differ in any material respect from those being in effect formerly;

- Transfer pricing rules: pre-tax book profits can be increased taking account of differences between arm’s length and contractual prices;

- Thin-capitalization rules: certain interest expenses incurred in respect of related non-residents are now disallowed. The restriction normally applies to taxpayers whose debt-to-equity ratio exceeds 3.5 (for banks and financial organizations - 10);

- Purchases from residents of blacklisted jurisdictions and non-profit organizations: a deductibility restriction is now set at 70% of the amount of the actual expense. The restriction can be overridden where the taxpayer is able to justify under transfer pricing rules the arm’s length character of the underlying transactions;

- Royalty: deductibility restrictions essentially remain the same as before (e.g. a full non-deductibility of royalties paid out to residents of blacklisted jurisdictions and a 4% restriction on the deductibility of royalties paid out to other non-residents). The novelty is that the above restrictions can now be circumvented where the taxpayer is able to justify under transfer pricing rules the arm’s length character of the underlying transactions;

- Transactions in securities: special tax accounting rules disabling the utilization of securities-related losses remain in force.

Administration Novelties

- New rules concerning advance CIT on dividends operates. Advance CIT is nowadays payable not on the full amount of the dividend distribution, but only on the excess of this amount over the taxed profits of the corresponding tax period;

- New rules with regard to filing tax returns and paying monthly advance payments have been laid down (will be effective from 2016). The new deadline for filing annual tax returns will be 1 June of the year following the tax year. The threshold for those required to pay monthly advance payments of CIT will increase to UAH 20 million of the annual income (as against current UAH 10 million). A twelve-month period for the calculation of monthly advance payments will be determined from June of the current tax year through May of the next tax year (as against the present March-February period).

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

Blocked VAT-Accounts Finally Get Started

Co-authored by Andrii Kuleba 

 (Junior Associate of 

Lavrynovych & Partners Law Firm)

Ukraine has finally implemented the system of blocked VAT-accounts to combat VAT-fraud. Ukrainian system of blocked VAT-accounts is innovative and does not have any equivalents in the world. It is based on a prepayment principle. A supplier in first place remits VAT to his blocked VAT account, and only after that the purchaser can enjoy his resultant input VAT deduction.

There is a special formula to calculate the limit on issuance of VAT invoices. Under this formula the maximum amount for which a supplier is permitted to issue a VAT invoice is determined taking account of his input VAT. Should the supplier intends to issue a VAT invoice for the amount exceeding one calculated according to the formula, he first needs to deposit additional funds to his blocked VAT-account.

The system of blocked VAT-accounts also entails the fully electronic administration of VAT:

- VAT invoices and VAT returns are issued/filed in electronic format only;

- All VAT invoices are subject to registration in the electronic register maintained by the state fiscal authorities. Only based on VAT invoices registered with the above register a purchaser can claim his input VAT deduction.

Blocked VAT-accounts have been in test-mode operation since 1 February 2015. The test-mode operation means that VAT is administered electronically and VAT liabilities are settled towards the state revenues through blocked VAT-accounts. However, over this transitory period of time the limit on issuance of VAT invoices (calculated under the special formula) does not apply. Thus, suppliers are not supposed to finance their blocked VAT-accounts before making taxable supplies in certain cases.

Since 1 July 2015 the system of blocked VAT-accounts will become fully-operational, which first and foremost mean the application of the limit on the issuance of VAT invoices.

It is also worthwhile to mention that the current system of blocked VAT-accounts has been seriously modified in response to the severe criticism of business society in respect of its adverse effect on VAT taxable persons.

First, there is now the real possibility for taxable persons to return the overpayments of tax accumulated in their blocked VAT-accounts.

Second, taxable persons are now given the opportunity to increase the limit on issuance of VAT invoices (calculated under the special formula) by the surplus of their input tax of previous tax periods.

Third, in order to minimize distractions of working capital, the limit on issuance of VAT invoices (calculated under the special formula) will automatically increase by the average monthly amount of VAT liabilities remitted to the state revenues by the taxable persons over the last 12 months.

 

VAT-Revolution: Modification

It is more than a month has passed since the publication of the article on the new system of VAT administration. Over this period of time, some important points have shown up. 

 

Firstly, there is a high likelihood of the new administration system being revoked. The revocation of the new system is provided for by the Coalition Agreement. Moreover, the bill No 1141 on the revocation of this system has been registered by the Verkhovna Rada (Ukrainian parliament).

Secondly, the blocked VAT-accounts will not be opened at the Clearing Сenter for Servicing Contracts in the Financial Markets. Pursuant to the effective resolution of the Cabinet of Ministers of Ukraine No 569 such accounts will be rather opened at the State Treasury of Ukraine.

Thirdly, on 4 December 2014, the State Fiscal Service of Ukraine published a methodological document "Basic Rules of the Electronic VAT Administration." The document provides clarification on many aspects of the operation of the new system of administration.

*- Photo from http://www.slovoidilo.ua

Blocked VAT-Accounts: Not That Effective

Over the time that has passed since the publication of my article on the new system of VAT administration, I have lost my illusions as to 100% efficiency of the new system. 

Blocked VAT-accounts are well able to resist VAT-fraud when it comes to transactions between taxable persons. However, they are virtually powerless against VAT-abuses when it comes to transaction between taxable and non-taxable persons. A sham company can supply goods/services to a non-taxable person and fail to declare its output VAT. A limit on the registration of VAT invoices in the unified electronic register will not help here. The sham company just will not issue a VAT invoice at all thereby avoiding depositing funds into its blocked VAT-account. The VAT "saved" in such a way the sham company will be able to transfer to an unconscientious trader by providing him with “all-loved” consulting services plus, of course, black cash in suitcases.

Let me illustrate this loophole of the new administration system by way of example.

Company A is willing to convert UAH 1 mln. into black cash and still enjoy fake input VAT.  Company A reaches out to Company B (a sham company). The parties enter into a contract for consulting services (Company A is the client, and Company B is the contractor) at the amount of UAH 1 mln., inclusive of UAH 166.66 thousand of VAT. Company A transfer UAH 1 mln. to Company B as an advance payment for the consulting services.

Company B does not hurry with the issuance of the VAT invoice to Company A for the amount of UAH 166.66 thousand. The point here is that for registering such a VAT invoice in the unified register, Company B would have to fund its blocked VAT-account for UAH 166.66 thousand. Instead, Company B seeks a possibility of issuing the VAT invoice to Company A without depositing any funds into its blocked VAT-account.

To this end, Company B buys for the same UAH 1 mln. computer equipment from Company C (a taxable person) and gets for itself a VAT invoice for the amount of UAH 166.66 thousand. The purchase is of true nature. Company B really gets the computer equipment.

Now, having the VAT invoice confirming its entitlement to UAH 166.66 thousand of input VAT, Company B issues a VAT invoice to Company A for the same amount with no funding of its blocked VAT-account.

At the final stage Company B sells the purchased computer equipment to Company D (non-taxable person) for UAH 1.1 mln., including UAH 183.33 thousand of VAT. Again, it is a true nature transaction. The computer equipment actually goes to Company D.

It seems as if there were no options for Company B, but to fund its blocked VAT-account for UAH 183.33 thousand necessary for the issuance of the VAT invoice to Company D. However, Company D resorts to “unexpected maneuver”. It does not issue the VAT invoice and does not record its resultant output VAT in the VAT return.

Company D is not a taxable person and by and large does not need the VAT invoice. Therefore, it will not complain to the State Fiscal Service of Ukraine about Company B failing to issue it with the VAT invoice. Furthermore, the law itself does not provide any enforcement mechanism that can be used to compel Company B to provide Company D with the VAT invoice. A provision setting out 15 days time limit for registering a VAT invoice in the unified register is not enshrined by any effective legal sanctions.

After receiving the funds from Company D Company B illegally converts them into black cash and transfer the obtained black cash to Company A, of course, less of the conversion fees charged.

By the way, the question arises as to the amount of black cash conversion fees. It appears that a 27-30% fee mentioned in my preceding article is rather an overstated amount. Arguing that the amount of the fee would soar that high, I was premised on the assumption that the new administration system would completely close the gap allowing sham companies to evade VAT.

As the aforesaid example shows I was wrong. The new system of administration still permits sham companies to evade VAT, but this will be much more difficult than it is today. Sham companies will incur additional operating expenses. To secure a "deal" they will have to at least carry out a real purchase of goods and find a non-taxable customer ready to buy such goods from them at prices close to market ones.

Given the additional operating expenses, sham companies will charge more for their services. How much will it be - it is difficult to say. However, it is clear that it will be something above the current 7-10%, but below 27-30% suggested in my previous article. Perhaps, it will be something around 12-15%.

What could the government do to block/restrict the VAT-evasion possibilities open to supplies involving non-taxable customers?

In my opinion, the government may consider assigning certain controlling responsibilities to banks or to non-taxable customers, in particular those of them being sole traders or legal entities.

Banks can be prohibited from processing payments made by non-taxable persons to taxable persons, until the taxable person (supplier) provides the bank with the confirmation of the registration of the corresponding VAT invoice in the unified register.

As for non-taxable persons, they could be obliged to complain to the tax authorities about their taxable suppliers failing to provide them with the confirmation of the registration of the VAT invoices in the unified register. This obligation would be appropriate to safeguard by means of a fine being equal to the amount of the VAT for which the VAT invoice should have been issued. The presence of such a significant fine would encourage the non-taxable persons to complain to the tax authorities about the taxable persons failing to issue the VAT invoices. The tax authorities would therefore be able to receive promptly the information about the abuse and would be able to respond to it accordingly.

*- Photo from http://villains.wikia.com

Free Economic Zone “Crimea”: How to Pay Taxes?

Co-authored by Andrii Kuleba 

 (Junior Associate of 

Lavrynovych & Partners Law Firm)

Crimea is not ours anymore…

The armed aggression of Russia has led to the annexation of the Autonomous Republic of Crimea in March 2014. Finally, in August 2014 the Verkhovna Rada (Parliament) managed to adopt the Act setting out rules for conducting business in the temporarily occupied territory of Crimea.

This is the Act of Ukraine “On the Creation of the Free Economic Zone “Crimea” and Specifics of Conducting Business in the Temporarily Occupied Territory of Ukraine” (hereinafter – the “Act”).

According to the Act the whole territory of the Autonomous Republic of Crimea, including the City of Sevastopol, becomes the free economic zone “Crimea” (hereinafter – the “FEZ “Crimea”).

The specific feature of the Act is that it establishes two different regimes of conducting business in Crimea. First one is actually the FEZ “Crimea” (Chapter I of the Act). Second one is the FEZ “Crimea” under temporary occupation (Chapter II of the Act).

What follows is a brief review of the tax treatment in respect of the FEZ “Crimea” under temporary occupation:

- Individuals and legal entities residing/located in the territory of the FEZ “Crimea” are equated to non-residents for the purposes of taxation (hereinafter – “persons equated to non-residents”).

- Ukrainian tax registration of persons equated to non-residents is cancelled. The FEZ “Crimea” source income of such persons is not liable to Ukrainian taxes and duties.

- Persons equated to non-residents may pay Ukrainian unified social contribution on a voluntary basis.

- FEZ “Crimea” source income of Ukrainian residents is treated as foreign source taxable income.

- Non-FEZ “Crimea” source income obtained by persons equated to non-residents in the territory of Ukraine is subject to Ukrainian withholding tax. Inasmuch as Ukraine does not recognize the annexation of Crimea, it is quite reasonable that the double tax treaty between Ukraine and Russia will not apply to this income.

- Transactions involving persons equated to non-residents (irrespective of whether the parties to them are related enterprises) are considered to be controlled transactions for the purposes of transfer pricing rules. Unfortunately, it is not clear from the Act whether such transactions are recognized as controlled automatically or only after reaching a value limit of UAH 50 million. At the moment, the State Fiscal Service of Ukraine sticks to an approach being favorable for the taxpayers. According to its position such transactions become controlled only after reaching the aforementioned value criterion (the letter of 6 November 2014).

- Goods supplied from the territory of FEZ “Crimea” to the other territory of Ukraine fall under the import regime with the payment of import duty, excise tax and VAT. However, such goods can be exempt from import duty where they are of Ukrainian origin confirmed by a certificate issued by Ukrainian chamber of commerce. The exemption at hand is confined to import duty only and does not apply to VAT and excise tax.

- Ukrainian goods from the other territory of Ukraine to be supplied to the FEZ “Crimea” fall under the export regime. According to the logic of the Tax Code of Ukraine, these goods must attract a zero rate of VAT. However, pursuant to an oral statement made by the leaders of the State Fiscal Service of Ukraine at a meeting with the members of the European Business Association held on 14 November 2014, there are no grounds for the application of the zero rate to such goods.

- Some tax incentives are made available to enterprises changing their location from the territory of the FEZ “Crimea” to the other territory of Ukraine. Such incentives, inter alia, include: (1) the cancelation of tax debts and the relief from sanctions for the failure to file tax returns since the beginning of the temporary occupation; (2) the exemption from import duty, VAT and excise tax for fixed assets and stock evacuated from the temporarily occupied territory; (3) possibility to deduct for the tax purposes an amount of documented expenses with respect to the evacuation of fixed assets and stock as well as to apply 100% depreciation charge with regard to the evacuated fixed assets.

Photo from http://alp.org.ua/