## 1ukrea2019005 — IMF FAD mission report (May 20 – June 3, 2019) ## Source details **Canonical URL:** [1ukrea2019005 — IMF FAD mission report (May 20 – June 3, 2019)](https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019005.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1ukrea2019005.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1ukrea2019005.pdf.json) --- ### Executive assessment and headline recommendations - Main conclusion: - Substituting the Corporate Profit Tax (CPT) with a Distributed Profit Tax (DPT) / Exit Capital Tax (ECT) is assessed as "bad tax policy" and detrimental for Ukraine on multiple fronts. - Primary recommendation: - Upgrade and improve the existing CPT administration and incentives (e.g., more attractive accelerated depreciation, SFS reform) rather than adopt ECT/DPT. - Priority complementary action: - Strengthen international taxation (BEPS-aligned measures) to make worldwide income taxation effective in light of planned exchange control relaxation. ### DPT / ECT — design features and asserted benefits - Scope and mechanics: - Applies to legal persons and PEs of non-residents that distribute profits or deemed dividends; excludes legal persons and individual entrepreneurs using the Simplified Tax System. - Fundamental change: defers taxation until distribution; tax base is distribution amount rather than period accrual profits. - Accumulated deferred tax assets and previous CPT losses cannot offset ECT liabilities. - All withholding taxes on Ukrainian-sourced income of non-residents are eliminated under the ECT model. - Tax base examples and rates: - Tax base includes: direct dividends and capital gains to non-ECT payers, transfers by PEs to parent companies, deemed profit distributions (interest/royalties to related parties or LTJs), cross-border TP adjustments to non-ECT payers. - ECT rates depend on transaction type: - "15 percent on dividends and capital gains payments to non-ECT payers"; - "20 percent on 'deemed profit distributions' (i.e., interest above certain threshold, royalties beyond specified limits, etc.)"; - "5 percent on interest payments under certain conditions". - Purported advantages (proponent claims summarized): - Eliminates accounting-based net earnings measurement; levied on net cash flow; reduces need for debt financing; simplifies depreciation relevance; potential to materially shrink SFS staff. - Mission caveat: - Many alleged advantages are conditional and undermined by verification needs, transfer pricing complexity, and SFS institutional weaknesses. ### Fiscal impact, revenue risk, and distributional effects - Historical and projected CPT revenue benchmarks: - CPT historical revenue: "average 3.9 percent of GDP" (2001–2018). - Expected CPT revenue for "2017 – 2019": "average expected CPT revenue is 2.7 percent of GDP". - Mission and MoF fiscal projections: - Mission conservative estimated sustained loss from DPT: "1.7 percent of GDP (2020-21)". - MoF projects a UAH 65.6 billion drop in CPT collections in 2020 (assuming a 50 percent dividend payout ratio). - CPT for 2019, without ECT/DPT, is projected at 2.63 percent of GDP. - Introduction of the DPT in 2020 is estimated to translate into a revenue loss of 1.4 percent of GDP. - Estimated decline in revenues for 2021 is UAH 101 billion, or 2 percent of projected GDP. - International experience: - Only 4 countries replaced CIT with DPT: Estonia (2001), North Macedonia (2009), Georgia (2017), Latvia (2018). - Estonia example: CIT revenue collapsed from "an average of 2 percent of GDP in 1995–99" to "0.7 percent of GDP in 2001"; recovery took 14 years and never fully returned to late-1990s levels. - North Macedonia DPT revenue averaged 0.9 percent of GDP (2009–2014), 0.6 percentage points lower than prior four-year period; corporate tax revenue tripled to over 3 percent of GDP after CIT reinstatement. - Georgia: CIT plus DPT revenue fell by a third in first year versus previous five-year average. - Distributional and regressivity concerns: - DPT tax break is regressive because CPT incidence falls mostly on shareholders. - Ukraine tax structure context: for 2001-2018 an average of 55 percent of total taxes were indirect; PIT is a flat rate of 18 percent; direct taxes are one-third of tax revenues. - A reduction in corporate taxation revenue would render the system more regressive and could undermine equity legitimacy. - Investment effect: - No evidence that DPT increases private investment in adopter countries; corporate investment in Ukraine averaged about 16 percent of GDP since 1998 (dropped below 10 percent in 2014); for 2016-2017 Ukraine’s CGFCF exceeded Estonia’s. - IMF Staff Report (May 2019): main obstacles to private investment and FDI are weak institutions (notably judiciary) and weak regulation. - Transitional fairness: - Disallowing past losses under ECT disadvantages 'old' capital relative to new investors and reduces value of assets not fully amortized. ### Tax avoidance, anti-avoidance needs, and administrative complexity - Avoidance risks: - DPT creates a double tax cut: elimination of withholding tax on shareholders + indefinite deferral of corporate profit tax. - Risk of incorporation by wage earners taxed at 18 percent PIT into independent service companies to exploit 15 percent ECT/DPT rate; current anti-avoidance protections viewed as ineffective. - Potential for distributions among DPT-paying entities to be used to pay shareholders’ expenses. - Recommended anti-avoidance measures (examples): - Deem individuals rendering services through personal service companies to be employees of the principal, obliging withholding of wage tax and social security. - Deem substantial-interest shareholders to earn an arm’s length salary subject to withholding. - Apply income deeming to independent contractor companies (example: Netherlands directors’ fee rule; illustrative EUR 44,000 figure cited). - Administrative and compliance burdens: - Enforcement would require transaction-by-transaction control of company outflows, extensive transfer pricing enforcement, coded payments reporting via banks, and stress on SFS capacity. - Draft ECT reportedly disallows broad financial statement checks by tax authorities (except TP adjustments), further constraining enforcement. - Tax practitioners view draft ECT as containing easy-to-exploit loopholes and limits on tax authority powers that could render ECT a semi-voluntary contribution. ### Compensatory measures proposed and distributional implications - Proposed compensatory measures (with distributional effects): 1. Increasing the VAT rate (by two percentage points). 2. Cutting public expenditures (adverse for low-income households). 3. Advance payments by companies for two years based on prior CPT liability. 4. Imposing a gross asset-based minimum tax. 5. Using privatization proceeds (unsustainable and against good practice). - Distributional note: - Two proposals (advance payments and gross asset-based minimum tax) reduce free cash flow or reserves and may hurt start-ups with current tax losses while favoring established profitable firms. ### Alternative investment incentive: accelerated depreciation - Recommendation: - Apply accelerated depreciation (Group 4 asset class—plant and machinery and structures housing them) for another five years if urgent need to promote private investment. - Rationale: - SFS familiarity avoids introducing new instruments. - Accelerated depreciation improves liquidity by reducing net present value of tax payments and reduces effective tax rate without surrendering tax on economic profit. - Observation: - Ukraine’s current law already permits accelerated depreciation and indefinite carry-forward of losses; investors already benefit from generous depreciation rules, raising questions on marginal investment gains from DPT. ### Voluntary Disclosure (VD) program — purpose, design concerns, and recommendations - Objectives of planned VD: 1. Declaration of natural persons’ foreign asset ownership. 2. Payment of outstanding taxes related to these assets. 3. Broadening of the tax base. 4. Facilitate future application of indirect control methods over personal income. - Scope and timing: - VD scheduled from 1 July 2019 to 31 December 2019. - Taxpayers must disclose foreign-based assets, property and income for reporting periods preceding the three-year statute of limitations. - Proposed VD Fee structure and mechanics: - Fee rates applied to self-assessed asset base: - 9 percent for disclosed assets kept abroad (gross-asset fee). - 5 percent for disclosed cash held in qualifying Ukrainian domestic bank accounts. - 0 percent on disclosed cash if invested in state banks/state securities (mission recommends eliminating 0 percent option). - Fee payable within 30 days of VD submission. - VD report submitted electronically with digital signature; one VD report allowed per person (amendable by submitting a new VD report before deadline). - Immunity and guarantees: - Payment of the Fee in lieu of standard taxes grants legal certainty and immunity against further investigations and prosecution for prior related tax misdemeanors with respect to disclosed assets, subject to exceptions (property tax excluded; assets from proceeds of specified crimes excluded). - VD shields natural persons from criminal prosecution for specific crimes listed in draft law, and from administrative penalties for tax and exchange control infringements only if they voluntarily disclose their assets. - Public persons face additional requirements and may not obtain immunity for assets from corruption-related proceeds. - Valuation, audit, and supporting documentation: - VD applicants may self-assess valuations but should seek accuracy; recommended supporting documents include bank statements, foreign valuator certificates for unlisted instruments and fixed property, insurer statements for insurance policies, and declarations for cash and other assets. - Mission recommends valuation by bank statements and independent valuers in asset jurisdictions. - Estimated scale and context: - BIS LBS indicated Ukrainian client accounts with reporting banks of USD 3.5 billion by end-2017. - Benefits and drawbacks: - Benefits: repatriation of flight capital, short-term revenue gains, balance of payments improvement, improved medium-term compliance if coupled with stronger administration. - Drawbacks: amnesties are discriminatory, erode tax morale if repeated, and generate disappointing long-run revenue effects if not one-off. - Key operational and AML/CTF alignment recommendations: - Align VD with FATF and AML/CTF principles; ensure Customer Due Diligence and beneficial ownership identification by receiving financial institutions. - Centralize administration in an independent "Amnesty Unit" staffed by NBU and SFS personnel, chaired by an independent person (e.g., retired judge), and with strict confidentiality and access controls. - Apply strong AML/CTF verification, allow limited extensions for practical problems, and publish monthly statistical reports to Minister of Finance and Rada. - Do not grant a zero percent Fee for repatriated assets reinvested in government securities (violates horizontal fairness). - Cover facilitators (legal persons) under the amnesty to reveal avoidance structures; protect identities inadvertently revealed in applications. - Extend amnesty period to 10 or 12 months to accommodate due diligence and cross-border verification; ensure one-off commitment not to repeat VD. ### Operational features and recommended VD administration - Amnesty Unit design and procedures: - Centralized unit, no regional branches; personnel from NBU currency control and SFS; independent chairperson; terminate after processing all successful applications and exhausted appeals. - Elevated confidentiality and special tax secrecy provisions for Unit staff; applications stored under Unit access control. - Quorum options: full Unit review of all applications or team adjudication (two adjudicators: one NBU, one SFS) with appeals considered by full Unit. - Levy collection and repatriation mechanics: - Levies (5 and 9 percent) to be paid from foreign-held assets before bank fees/commissions; payments processed through banking system to an NBU-controlled account; Unit reports reconciled levy payments monthly. - Rules for common practical problems (deceased applicants, illiquid assets, frozen accounts, ownership disputes) and refunding overpayments recommended. - Public awareness: - Continuous media coverage and FAQs; monthly Unit statistics on adjudication progress, levies, receipts, and disclosed foreign-source accruals. ### BEPS implementation package — overview and key technical recommendations - Draft laws and BEPS actions under consideration: - Seven draft laws: BEPS Actions 3 (CFC), 4 (Interest limitation), 6 (Treaty abuse), 7 (PE), 8–10 (Transfer Pricing), 13 (CbC reporting), 14 (MAP). - CFC rules (Action 3) — scope and design highlights: - Mission recommends applying CFC rules at the level of the first “onshore” resident person rather than tracing to ultimate beneficial owner irrelevant for practical interactions. - Control tests proposed (Article 39.1.2): single resident ≥50% ownership; aggregate resident ownership ≥50% (substantial shareholder applies at 25% threshold); de facto control test. - Recommendations include: reduce substantial shareholder threshold to 10 percent; treat settlor of a foreign trust as controller in all cases; tracing rules should assume 100 percent control once control at a tier is established. - CFC income taxed at PIT rate of 18 percent; comparable tax exemption if effective tax rate on CFC income is not lower than 13 percent (i.e., 5 percentage points below Ukraine’s current nominal corporation tax rate). - Mission recommends deleting the 9 percent repatriation rate for CFC income (risk of encouraging offshore passive investment). - Include dividend ordering rules where CFC has both CFC-taxed and non-taxed profits. - Interest deduction limitation (Action 4) — EBITDA rule: - MoF proposes limiting interest deductions to 30 percent of EBITDA; excess interest up to ALP could be carried forward indefinitely with yearly reduction of excess by five percent. - Mission recommendations: - Apply EBITDA rule to net interest expense rather than gross interest. - Eliminate carry-forward of non-deducted interests. - Exempt the financial sector from the EBITDA rule. - Defer deduction of accrued interest subject to withholding until withholding tax is paid. - Consider asymmetric vs simpler approaches to interaction with ALP; prefer net-interest/ no carry-forward approach as simpler. - Anti-treaty abuse measures (Action 6) and indirect transfers: - MoF proposes PPT approach; mission suggests LOB is administratively simpler and affords greater certainty though both are acceptable. - Recommend aligning indirect transfer of immovable property rule with Article 13(4) of OECD/UN Models; include mining and petroleum rights; collect tax by treating owner of Ukrainian immovable property as payment agent of non-resident purchaser. - Permanent Establishment (Action 7) and profit attribution: - Propose aligning Article 14.1.54 with PE concept in treaties; revise PE definition to apply to residents and non-residents; clarify server PE and commissionaire/agency arrangements; consider narrowing or deleting preparatory and auxiliary activities exception. - Apply functionally separate entity approach for attributing profits to PEs but retain flexibility to mitigate double taxation when counterpart jurisdiction uses different approach; apply withholding tax to internal dealings recognized as interest or royalties. - Transfer Pricing (Actions 8–10) — key points: - Draft expands definitions of related parties and controlled transactions (increase equity threshold from 20 to 25 percent; additional presumptions based on commercial dependency and leverage). - Mission recommendations: - Limit new related-party definitions to apply for CbC reporting where IFRS consolidation triggers are relevant. - Do not adopt 75 percent participation threshold for international financial organizations. - Avoid commercial dependency and debt/equity ratio presumptions for defining related parties; use them as audit risk indicators instead. - Clarify controlled transaction scope; eliminate presumption that non-resident agents in LTJs are related. - Low value-added services: - Draft permits 5 percent cost-plus safe harbor for low value-added services; mission recommends eliminating the regime or severely constraining it and retaining rendition/benefit tests. - Commodities and CUP method: - CUP preferred for commodities; require internal comparable transactions used as benchmarks to be regular, significant, and on similar volumes; external prices must be publicly issued by reputable sources (e.g., Reuters, Bloomberg). - Limit allowed TP adjustments for grain exports to quality and freight differences; treat FOB Black Sea port as benchmark including port logistics. - Country-by-Country (CbC) reporting (Action 13): - BEPS threshold is annual group turnover of €750 million; draft imposes filing obligations on Ukraine residents in certain cases and an additional domestic obligation for Ukraine MNEs with turnover ≥ USD50 million; mission recommends reconsidering burden on subsidiaries when parent does not file and ensuring USD50 million rule not overly burdensome. - Mutual Agreement Procedures (MAPs) (Action 14): - Clarify competent authority delegation between MoF and SFS; avoid MAP interrupting audits before SFS summary of findings; ensure statute of limitations suspended during MAP; prefer competent-authority-only initiation where feasible; restrict taxpayers from unilaterally terminating MAP by disagreement. ### Specific numeric and legal thresholds preserved from the source - Revenue and projections: - "average 3.9 percent of GDP" (CPT, 2001–2018). - "average expected CPT revenue is 2.7 percent of GDP" (2017–2019). - Mission conservatively estimates "1.7 percent of GDP (2020-21)" revenue loss from DPT. - MoF projects UAH 65.6 billion drop in CPT collections in 2020 (50 percent payout assumption). - CPT for 2019 projected at 2.63 percent of GDP. - DPT introduction in 2020 estimated to translate into a revenue loss of 1.4 percent of GDP. - Estimated 2021 revenue decline UAH 101 billion, or 2 percent of projected GDP. - Tax rates and thresholds: - ECT/DPT proposed rates: "15 percent", "20 percent", "5 percent" depending on transaction type. - PIT flat rate: 18 percent. - Proposed CFC tax credit comparability: effective tax rate not lower than 13 percent (i.e., 5 percentage points below Ukraine nominal corporation tax). - Proposed CFC de minimis revenue threshold: EUR 1 million. - Proposed CFC substantial shareholder threshold: current draft 25 percent (mission recommends 10 percent). - Proposed interest limitation: 30 percent of EBITDA (mission suggests net interest, eliminate carry-forward, exempt financial sector). - TP related-party participation thresholds discussed: increase from 20 to 25 percent; special 75 percent rule for international financial organizations criticized. - CbC BEPS filing threshold: €750 million (global); additional domestic threshold discussed: USD50 million. - VD Fee rates and timing: - VD Fee: 9 percent (assets kept offshore); 5 percent (disclosed cash in qualifying domestic banks); 0 percent (proposed for repatriated assets reinvested in government securities — mission recommends eliminating 0 percent). - VD scheduled: from 1 July 2019 to 31 December 2019. - Fee payable within 30 days of VD submission. - Statute of limitations: - TP audits statute of limitations in Ukraine: seven years; other audits three years. - MLI and treaty data: - Ukraine is party to 73 tax treaties. - Ukraine signed the MLI on July 23, 2018. *Source: IMF FAD capacity development mission report (mission visit May 20 – June 3, 2019) — PREFACE, Executive Summary, and selected chapters as provided in the content unit.* ### PREFACE __________________________________________________________________________________________ 6 ### 1ukrea2019005 - PREFACE __________________________________________________________________________________________ 6 ### Executive summary: Overall assessment and main recommendations - Main conclusion: The mission did not find new elements to change the position in FAD’s May 2017 technical report — substituting the Corporate Profit Tax (CPT) with a Distributed Profit Tax (DPT, also referred to as Exit Capital Tax, ECT) is "bad tax policy" and detrimental for Ukraine on several fronts. - Key risks and findings: - Revenue risk: conservatively estimated sustained loss of "1.7 percent of GDP (2020-21)" if DPT adopted. - Underestimation concerns: the estimate assumes businesses would distribute half of their profits and does not consider spillover effects on the Personal Income Tax (PIT) via incorporation by high-income individuals seeking deferral and lower rates. - No credible compensatory measures included in the proposal; potential options such as raising VAT or cutting public expenditures would adversely affect low-income households; imposing an asset tax on businesses appears inefficient. - Distributional impact: the tax break implied by the DPT is regressive because CPT incidence falls mostly on shareholders. - Investment claim: no evidence that DPT increases private investment in countries that adopted it. - Complexity and enforcement: DPT is not simpler in practice—verification of deemed dividend distributions would require transaction-by-transaction checks referencing complex transfer pricing methods, stressing SFS institutional weaknesses. - Alternative approach recommended: - Upgrade current CPT instead of adopting ECT, including: - Adopt a more attractive accelerated depreciation regime. - Reform SFS administration to combat corruption. - Prioritize strengthening international taxation aspects (BEPS-aligned measures) given planned relaxation of currency exchange controls and the need to make worldwide income taxation effective. - Voluntary Disclosure (VD) program assessment: - Authorities consider a one-off VD to address undeclared assets kept abroad under exchange controls. - Reviewed draft VD key feature: a "9 percent fee payable for non-declared assets in lieu of outstanding taxes" which would provide, in certain terms, immunity against prosecution for violating currency controls and related tax laws. - Advantages: broaden the tax base through annual returns on disclosed assets. - Suggested improvements to the draft VD: - Eliminate proposed "0 percent fee for repatriated assets reinvested in government securities" because it violates horizontal fairness. - Require valuation of self-declared assets using bank statements and independent valuers in jurisdictions where assets are located. - Manage VD through a centralized independent "Amnesty Unit" staffed by NBU and SFS, rather than regional SFS adjudication. - Ensure tight application of anti-money laundering (AML) and counter-terrorist financing (CTF) preventative measures for program effectiveness. - BEPS implementation package assessment: - Reviewed seven draft laws prepared by MoF and NBU to implement BEPS actions; generally positive initiative that will help protect Ukraine’s tax base. - Technical improvements recommended for draft laws, especially on: - Controlled Foreign Corporations (CFC). - Permanent Establishment (PE). - Transfer Pricing (TP). - Interest Deduction Limitation rules. - Specific recommendation highlights: - Simplify CFC rules by applying to the "first onshore" person rather than tracing to ultimate beneficial owner in Ukraine. - Proposed interest deduction limitation (30 percent of EBITDA) should: eliminate the carry-forward currently permitted; limit deductions to net interest expense (rather than gross interest); exempt the financial sector. - Tighten definitions: related parties and controlled transactions are overly broad and may force independent persons into TP obligations. - Design PE concept to apply equally to on-shore and off-shore PEs; define "server PE" so it becomes operational. - Correct loopholes: indirect transfer of assets provision omits reference to mining and petroleum rights; CFC rule permits a lower tax rate on foreign sourced passive income, creating an incentive for Ukrainian residents to invest abroad. - Acknowledgement of inherent BEPS complexity: some complexity is unavoidable; report suggests measures to strengthen anti-abuse provisions despite unresolved BEPS issues (e.g., allocating risks among related parties, low value-added services regimes). ### I. The Distributed Profit Tax (DPT) / Exit Capital Tax (ECT) — proposal and design - Scope and fundamental change: - Debate ongoing whether to replace the current CPT with a DPT (ECT). - ECT applies only to legal persons and Permanent Establishments (PEs) established by non-residents that distribute profits or deemed dividends. - ECT does not apply to legal persons and individual entrepreneurs using the Simplified Tax System. - Essential difference: tax deferral until entity distributes profits; tax base is the distribution amount rather than period accrual profits. - Accumulated deferred tax assets (including tax losses) from previous CPT cannot serve as offsets against the ECT. - All withholding taxes on Ukrainian-sourced income of non-residents are eliminated under the ECT model. - Tax base, deemed distributions, and rates: - Tax base includes: - Directly distributed dividends and capital gains to residents and non-residents in cash or in kind who are non-ECT payers. - Transfers of funds by PEs to parent companies considered remitted profits or deemed profit distributions. - "Deemed" profit distributions examples: payments of interest and royalties to related parties or parties in low tax jurisdictions (LTJ); cross-border transfer pricing adjustments to non-payors of ECT. - ECT does not apply to transactions between ECT payers who are residents of Ukraine. - ECT is charged on selected transactions rather than on financial results for the period. - ECT rates depend on transaction types: - "15 percent on dividends and capital gains payments to non-ECT payers"; - "20 percent on 'deemed profit distributions' (i.e., interest above certain threshold, royalties beyond specified limits, etc.)"; - "5 percent on interest payments under certain conditions". - Additional design notes: - Deeming rules and verification obligations introduce complexity despite appearance of simplification. - The label "ECT" may be misleading relative to international usage of "exit tax" (see footnote noting different meaning and potential misinterpretation). ### Alleged benefits and Box 1 summary (arguments supporting the DPT) - Alleged benefits summarized by proponents: - Eliminates complex accounting-rules based measurement of taxable profit (subject to net earnings accounting). - Partially addresses neutrality between debt and equity (but weak enforcement may incentivize distributing deemed dividends through interest payments). - Levied on net cash flow. - Reduces need for debt financing. - Tax depreciation rules become largely superfluous for tax but retained for accounting. - Company no longer pays tax on retained earnings; losses reduce net earnings from which distributions are made, so SFS still needs monitoring. - Capital gains remain exempt until distribution (complications of determining capital gain remain). - Potential for materially shrinking SFS staff (naive assumption). - Mission caveat: many of these purported advantages are conditional, and practical enforcement and administrative realities undermine simplicity gains. ### Key concerns about the DPT: revenue and distributional consequences - Revenue concerns: - CPT historical revenue: "average 3.9 percent of GDP" (2001–2018). - Expected CPT revenue for "2017 – 2019": "average expected CPT revenue is 2.7 percent of GDP". - Conservatively estimated revenue loss from DPT: "1.7 percent of GDP (2020-21)". - Estonia example: CIT revenue collapsed from "an average of 2 percent of GDP in 1995–99" to "0.7 percent of GDP in 2001" after reform; it took 14 years to reverse the initial impact and revenue never recovered to second-half 1990s levels. - Recent tax amendments in Estonia attempt to reverse trend by applying a reduced CPT rate if companies declare more regular dividends. - Distributional impact and fairness: - DPT tax break is regressive; CPT incidence mostly on shareholders. - Investment effect: - No evidence that DPT increases private investment in adopter countries. - Administrative complexity and enforcement: - Deemed dividends verification requires transaction-level checks and complex transfer pricing methods. - Puts severe stress on SFS institutional weaknesses (e.g., transfer pricing enforcement). - Transitional issues: - Disallowing past losses under ECT creates disadvantage for 'old' capital vs new investors; manifests as loss in value of assets not fully amortized for those losses. *Source: PREFACE and Executive Summary, IMF FAD capacity development mission report (mission visit May 20 – June 3, 2019) as provided in the content unit.* ### 5. By introducing the DPT, the MoF, assuming an overly optimistic 50 percent ### 5. By introducing the DPT, the MoF, assuming an overly optimistic 50 percent ### Fiscal impact: projected revenue losses - MoF projects a UAH 65.6 billion drop in CPT collections in 2020 (assuming a 50 percent dividend payout ratio). - CPT for 2019, without the proposed ECT/DPT, is projected at 2.63 percent of GDP. - Introduction of the DPT in 2020 is estimated to translate into a revenue loss of 1.4 percent of GDP. - The estimated decline in revenues for 2021 is UAH 101 billion, or 2 percent of projected GDP. - Proponents argue dynamic effects from increased employment and economic growth will at least partially compensate the direct loss in revenue; international experience does not support that claim. ### International experience with DPT replacing CIT - Only 4 countries have adopted a DPT in substitution of a CIT: Estonia (2001), North Macedonia (2009), Georgia (2017), and Latvia (2018). - North Macedonia kept the regime for five years, dropping it in 2014 when it restored the CIT. - Estonia: for the first five years after adopting DPT it averaged 0.5 percentage points below the previous five (almost 30 per cent drop), slowly recovering since then. - Revenue collections in these countries are characterized as disappointing. - North Macedonia: while DPT was in effect (2009–2014) DPT revenue averaged 0.9 percent of GDP, 0.6 percentage points lower than in the prior four-year period; when the CIT was reinstated, corporate tax revenue tripled to over 3 percent of GDP. - Georgia: in the first year in operation, Georgian CIT plus DPT revenue fell by a third compared to the average in the previous five years; Georgia kept the classical CIT for the financial and oil/gas sectors, extending the restriction from 2019 till 2023. - Moldova’s 2008 zero CIT rate is not equivalent to substituting CIT for a DPT; the zero rate on CIT ended in 2012. ### Impact on corporate investment and FDI - Corporate investment in Ukraine since 1998 has averaged about 16 percent of GDP, dropping below 10 percent in 2014. - For the period 2016-2017 Ukraine’s CGFCF exceeded that of Estonia. - Table summary (1998–2017 averages, percent of GDP) includes Ukraine 15.9 for 1998-2017 and country-specific series (examples): Estonia 17.9, Georgia 19.9, North Macedonia 11.2. - Evidence from DPT countries does not indicate a significant sustained boost to corporate investment: Estonia’s apparent impulse to investment seems short-lived and Estonia’s CGFCF is now lower than in Ukraine. - Georgia’s strong CGFCF growth since 2013 is reversed since 2017 after DPT introduction. - North Macedonia’s CGFCF did not change much after DPT adoption and slightly increased when the regime was abandoned. - IMF Staff Report (May 2019) argues main obstacles for greater private investment and FDI in Ukraine are lack of strong and independent institutions (notably the judiciary) and weak regulations. - World Bank survey evidence: national taxes rank number 11 among top 20 factors determining firms’ locational decisions. ### Distributional effects and regressivity - Ukraine’s tax system increasingly favors indirect taxation: for 2001-2018 an average of 55 percent of total taxes were indirect. - PIT is a flat rate regime at 18 percent. - Direct taxes contribute only a third of tax revenues. - CIT contributes progressivity since incidence falls predominantly on owners of income from capital; emerging consensus: an increase in CIT in the short run tends to fall almost entirely on income from capital and only marginally on labor/consumers in the long run depending on capital mobility. - U.S. CBO and Joint Committee on Taxation assign 25 percent of the burden of the corporate tax to labor when preparing distributional results. - A reduction in revenue from corporate taxation as predicted with DPT adoption will render the Ukrainian tax system even more regressive and may undermine equity legitimacy. ### Tax avoidance risks and required anti-avoidance measures - DPT would amount to a double tax cut: elimination of current withholding tax on shareholders and permitting indefinite deferral of corporate profit tax. - Risk: wage earners taxed at flat 18 percent PIT may incorporate as independent service companies to benefit from 15 percent ECT/DPT rate; currently no effective anti-avoidance legislation exists to stop this. - When CPT rate is low relative to PIT, high-wealth individuals or service employees tend to incorporate and collect dividends rather than remuneration subject to PIT; distributions among DPT-paying legal entities are exempt under the proposed DPT, enabling companies to spend on shareholders’ behalf. - Recommended anti-avoidance measures: - Deeming individuals rendering services through a personal service provider-company or as sole proprietor/independent contractor to be employed by the principal, obliging the principal to withhold wage tax and/or social security contributions. - Deeming individuals or shareholders with a substantial interest to earn an arm’s length salary from which wage tax and/or social security contributions must be withheld by the company. - Apply income deeming provisions to independent contractor companies so a reasonable portion of income received is treated as labor income (example: Netherlands directors’ fees treated as ordinary employment income; employee owning at least 5 percent is deemed to earn an annual salary of at least EUR 44,000 unless proven otherwise). - Introduction of DPT without accompanying anti-avoidance legislation could constitute another revenue leakage. ### Proposed compensatory measures and their distributional effects - Proposed measures to preserve revenue neutrality may exacerbate regressivity: 1. Increasing the VAT rate (by two percentage points). 2. Cutting public expenditures (mostly adversely affecting low-income households). 3. Letting companies pay for two years an advance payment based on their previous fiscal year’s CPT liability. 4. Imposing a gross asset-based minimum tax. 5. Using privatization proceeds (characterized as unsustainable and against good practice). - Two of these proposals (advance payments and gross asset-based minimum tax) would cut into free cash flow or reserves, possibly impacting start-ups with current tax losses and benefiting established profitable firms. ### Administrative complexity and compliance concerns - Shareholders have incentive to defer profit distributions or disguise them via other transactions to avoid the DPT; to counter this the regime would need to tax ‘deemed’ dividend distributions and at a higher rate than formal distributions. - DPT enforcement would require controlling all company outflows transaction by transaction, extensive enforcement of transfer pricing rules, and checking potential deemed dividend distributions for every transaction. - The ECT draft law reportedly disallows tax authorities to check financial statements of ECT payers (except for transfer pricing adjustments). - ECT payers transacting with non-ECT payers must insert specific transaction codes into payment documents; commercial banks must accumulate coded payments data and share with tax authorities regularly, adding to banking costs. - SFS permitted to request explanations only when discrepancies exist between coded payment data and ECT reporting system; disguised taxable events can be challenged in court. - Tax practitioners view the ECT Draft Law as containing numerous easy-to-exploit loopholes difficult to police; limits on tax authority powers and specifics of taxable events could render ECT effectively a semi-voluntary contribution. ### Accelerated tax depreciation and investment incentives - Countries often use tax incentives (accelerated depreciation, investment tax credits, capital allowances) to attract investment; benefits should be measured as incremental economic activity induced by the incentive. - Costs of tax concessions arise through forgone revenues or opportunity cost of public expenditures. - Where statutory CIT is relatively high, decreasing the rate may reduce tax-planning pressure; Ukraine’s CPT rate of 18 percent is already well below the worldwide average statutory CIT rate of 23 percent. - Reductions in statutory CIT to attract investment should be tempered; other instruments (e.g., subsidizing cost of investment) may be more efficient. - Generally, tax on economic profit should not influence investment decisions; surrendering tax on economic profit should be avoided on efficiency grounds, especially where profits are location-dependent. - Current Ukrainian law permits accelerated depreciation and indefinite carry-forward of losses, potentially translating into a de facto multi-year tax holiday for investors if depreciation deductions generate tax losses for more than one year. - Investors in Ukraine already benefit from generous tax depreciation rules on fixed assets; unclear how much additional investment DPT would generate as firms may park funds in cash reserves. _Italic: IMF staff summary based on provided PDF excerpt._ ### 26. The mission suggests that if there is an urgent need to promote private ### 1ukrea2019005 - 26. The mission suggests that if there is an urgent need to promote private ### Accelerated depreciation and corporate tax change - The mission suggests applying the accelerated depreciation tool for plant and machinery (Group 4 asset class) and structures housing them for another five years if there is an urgent need to promote private investments. - Rationale: - The SFS is familiar with accelerated depreciation, avoiding the need to introduce alternative instruments such as an investment allowance or investment tax credits. - Accelerated depreciation allows for a faster depreciation schedule than available for the rest of the economy. - Tax payments in nominal terms are unaffected, but their net present value is reduced, thereby improving the liquidity of firms. - Accelerating a depreciation allowance reduces the effective tax rate. ### Recommendations (from the mission) - Given the transitional and permanent projected revenue losses as a direct result from introducing a DPT, Ukraine should not attempt this radical corporate tax change. - Correct discretionary and non-proportional enforcement actions by the SFS with the view to improving the administration of the CPT—it does not justify the introduction of a new tax. - In lieu of the proposed ECT, consider adopting more attractive accelerated depreciation schedules that directly reward investment into plant and machinery. ### Voluntary Disclosure (VD) programs — background and purpose - Key estimates and context: - Zucman estimates that approximately 8 percent of the global financial wealth of households is invested in tax havens, of which ¾ is unrecorded. - Offshore assets are mainly owned by European residents and often held in European tax haven jurisdictions with strict bank secrecy and data privacy laws. - Three counter-measures against offshore tax evasion discussed: 1. Exchange of information between countries (first line of defense) — limited by treaties that only permit exchange about specifically named persons (no “fishing expedition”). 2. Obtaining confidential bank data from tax havens via whistleblowers (second line) — exceptional and possibly not sustainable long-term. 3. Voluntary disclosure programs (VD) with tax amnesties and asset repatriation (third line) — increasingly used to broaden the income tax base by taxing reported earnings from offshore portfolio and fixed investments. - Characteristics and cautions: - Tax amnesties provide short-term revenue recovery and aim to bring evaders into the tax net; frequent amnesties erode tax morale and long-term revenue. - VD programs combined with asset repatriation are more successful when embedded in a governance framework with bilateral tax treaties with automatic exchange of information (AEOI Standard) and AML cooperation. - VDs typically offer relief from penalties/interest or immunity from imprisonment for assets voluntarily declared and adjudicated; confidentiality for disclosed assets is often granted. - Effective VD success requires increased detection capability and strong follow-up enforcement (higher penalties, reputational risks, prosecution for non-disclosure). ### Key elements of tax amnesties and VDs - Purposes: raising revenues quickly and/or encouraging repatriation of illegally held foreign assets. - Typical features and cautions: - Amnesties vary in duration, qualifying taxes, and relief on penalties and interest. - Evidence suggests tax amnesties without VD generate much less incremental revenue than expected and have high opportunity costs (diverting tax administration resources). - Amnesty programs should be one-time events to clean the slate before introducing new tax instruments or organizational reforms. - VD design features: - Limited period linked to specific opportunities (e.g., AEOI cooperation). - Allow voluntary disclosure and regularization of taxes on non-disclosed foreign assets; sometimes paired with tax relief for repatriation. - Fixed assets like real estate are less amenable to repatriation but disclosure for income tax purposes (rental and capital gains) remains important. ### Cross-country VD experiences and outcomes (selected figures) - A 2015 OECD survey found 47 countries implemented tax amnesties; 13 jurisdictions administered disclosure programs with incentivized asset repatriation. - Reported results from selected countries: - Argentina: USD 100 billion of disclosed assets under the Amnesty Program between July 2016 and March 2017. - Indonesia: USD 321 billion increase in tax base from the June 2016–March 2017 amnesty; asset repatriation remained unfulfilled. - Italy: €4 billion revenues from taxes and repatriated assets from the 2014 Tax Amnesty with capital repatriation. - South Africa: About €7.8 billion of foreign assets disclosed during the 9 months-long amnesty; VD levies collected amounted to 0.7 percent of tax collections in the 2005/06 tax year and 2.3 percent of personal income tax (PIT) for the same period; foreign asset disclosure translated into an annual increase of PIT collections by an estimated €52 million. ### Ukrainian Voluntary Disclosure (VD) proposal — objectives and design - Objectives of the planned VD program: 1. Declaration of natural persons’ foreign asset ownership. 2. Payment of outstanding taxes related to these assets. 3. Broadening of the tax base. 4. Future implementation of the “indirect control methods” over personal income. - Scope and timing: - Taxpayers must disclose foreign-based assets, property and income for reporting periods also preceding the Ukrainian tax statute of limitations of three years. - The VD program is scheduled from 1 July 2019 to 31 December 2019. - Fee and legal certainty: - The VD program requires the payment of a one-off voluntary disclosure fee (the "Fee") at different rates for assets declared by the resident natural person. - Payment of the Fee in lieu of all standard taxes grants legal certainty and immunity against further investigations and prosecution for prior related tax misdemeanors with respect to those disclosed assets and property. Parties or resources that assisted with acquisition do not need to be revealed. ### Eligibility and eligible assets - Eligible participants: - Any Ukrainian individuals (including entrepreneurs) who own (co-own) and/or are beneficiaries/beneficial owners (controllers) of assets eligible for VD may participate. - Eligible assets: - Portfolio investments (funds), fixed property, and other assets acquired before 1 January 2019. - Includes rights or beneficial ownership of securities, rights to shares in property of legal persons, rights to funds, including a controlling interest in controlled foreign companies (CFCs). ### Guarantees, scope of immunity, and limitations - Guarantees for natural persons (if the Fee is paid for disclosed assets and income): - Relief from any other tax obligation or compulsory payments under the Tax Code (including a military levy)—but only with regard to disclosed assets/income, with the exception of the property tax. - If the SFS audits an individual for periods before 1 January 2019 after the VD ends, the audited tax base and tax liabilities are reduced by the amounts of assets voluntarily declared. - During and until the end of the VD period, natural persons may not be audited for periods before 1 January 2019. The legislation should stipulate that individuals already under investigation by the SFS cannot apply for the VD. - The VD shields natural persons from criminal prosecution for crimes set forth in the draft law (i.e., sham business activity, negligence, document forgery, tax default) and penalties for tax transgressions with respect to the disclosed assets and sources of their acquisition. In assessing the tax penalty, chargeable income shall be decreased by the disclosed VD base. - Applicants receive immunity against administrative penalties for tax and exchange control infringements, but only if they voluntarily disclose their assets. - Information provided as part of the VD program shall remain confidential—to protect against repeated audits for adjudicated and regularized assets. This immunity does not apply in the case of criminal investigations—for which a VD amnesty should not be granted. - Any information revealed during a VD may be audited in the case of “public” persons. - Being the beneficial owner of assets held by a trustee/nominee owner, the individual may disclose such assets, determine the VD Fee base and pay the Fee. - Limitations on immunity: - Co-owners of assets must severally apply to individually secure immunity from prosecution. - “Public persons” (i.e., politicians and officials) qualify for immunity but must meet additional requirements such as audits and disclosure about the sources of funds used for acquiring offshore assets. - Immunity does not apply to assets acquired from proceeds of committed corruption and crimes regardless of their timing (except for Articles 205, 212, 212-1, 366, and 367 of the Criminal Code of Ukraine). *Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019005.pdf* ### 42. Individuals, qualifying for the VD program, may (1) include into their report any ### 1ukrea2019005 - 42. Individuals, qualifying for the VD program, may (1) include into their report any ### Voluntary Disclosure (VD) report: submission, valuation, and immunity - Individuals qualifying for the VD program may (1) include into their report any assets for which they seek immunity. - (2) They may—but are not obligated—to value the disclosed assets. - (3) VD applicants self-assess the base for the Fee calculation of the disclosed asset(s). - (4) VD applicants should however seek to accurately value their assets and pay the Fee to secure immunity against further taxes and penalties. - The VD report is submitted to the SFS in electronic form, which is authenticated by appending a digital signature. - A natural person may only submit one VD report; to amend a previous report a new VD report must be submitted before the VD deadline. - Exchange control amnesty only applies to disclosed foreign assets; non-disclosed foreign assets remain fully subject to potential civil and criminal prosecution. - “Public persons” disclose assets under the general VD procedure but immunity will not be granted for assets acquired out of proceeds from corruption and related crimes. - Public persons’ assets are considered disclosed only after the VD report has been audited by the assigned authority as per required procedures of the anti-bribery law. ### Proposed VD Fee and completion period - The Fee is levied by applying the relevant rate (varied by an election of either keeping assets abroad or repatriating them) to the asset base as delineated by the individual. - Applicable rates: - 9 percent for assets voluntarily disclosed by an individual who determines the VD Fee base and includes cash not held in bank accounts or held on bank accounts abroad; - 5 percent rate for disclosed cash (in both UAH and foreign currency) held in accounts of qualifying Ukrainian domestic banks; - 0 percent on disclosed cash amounts if invested in state banks/state securities to incentivize such portfolio holdings. - The Fee is payable within 30 days upon submission of the VD report. - The 9 and 5 percent fees are imposed on gross assets. - Note: these gross-asset fees may be high effectively, compared to the 18 percent PIT withholding on interest income and capital gains. ### Audit of VD report data and immunity scope - Information provided in the VD report may not be audited or used against a taxpayer as part of a tax enforcement action by the SFS. - Assets only contained in the VD report receive “ring-fenced” immunity against such SFS enforcement action, including an in-office audit of computational errors in calculating the Fee base. - If technical errors or additional asset information need to be corrected and reflected in the VD report, the individual can amend the respective data but must submit it in a new VD report within the prescribed VD deadline. ### Estimated amount of hidden portfolio assets abroad - BIS Locational Banking Statistics (LBS) revealed the existence of large accounts of Ukrainian clients held with reporting banks to the amount of USD 3.5 billion by the end of 2017. - After liberalization, holders of these accounts should regularly report on balance changes in them. ### Costs and benefits of voluntary disclosure programs - Drawbacks and risks: - Amnesties are discriminatory: compliant taxpayers absorb the full statutory tax burden while non-compliant taxpayers receive waivers (interest, penalties, and even tax). - International experience suggests long-run revenue effects of amnesties are discouraging; frequent amnesties have a deleterious effect on long-term revenue collections. - The mission strongly advises authorities, if they choose to announce a VD, to commit to a one-off opportunity which will not be repeated. - Benefits: - Key benefit is repatriation of flight capital and increased tax revenues from an expanding tax base. - VD program can be positive for the balance of payments as foreign assets are repatriated, together with strengthening of the financial system. - Over the short term, VD-amnesty program will yield additional revenues cost-effectively as fewer regular audits may be required and costly litigation can be minimized. - VD programs could improve medium-term tax compliance if coupled with a more capacitated revenue administration. - An amnesty eases the transition of non-compliant taxpayers towards a new enforcement environment by replacing penalties and interest with single levies. ### Strengthening the draft Ukrainian VD program: scope and administration - Recommended key provisions and principles: - Any Ukrainian resident natural person, or trust may apply for tax amnesty relief; legislation should explicitly provide for individuals, deceased estates, trusts and close corporations to apply for amnesty if they were facilitators in taking capital offshore. - Good practice: specifically exclude public and private companies from applying as applicants. - The application period should be a year or less. - The VD and tax amnesty should only apply to individuals and entities that come voluntarily forward—those already under investigation by the authorities involving their foreign assets are precluded from the amnesty. - The application or VD must be filed in the form of an affidavit; the applicant must affirm that the foreign assets disclosed do not stem from any unlawful activity, except exchange control and tax law violations or any associated misrepresentation or nondisclosure in respect of those violations. - Operational considerations: - The proposed VD program targets foreign income-earning assets that may have been structured and controlled through Controlled Foreign Corporation (CFC) owned by Ukrainian residents. - The imminent introduction of BEPS legislation, with related CFC legislation, constitutes an additional trigger for the initiative. - Risks (money laundering and continued tax avoidance) can be mitigated through proper planning and organizing administration in a specially established amnesty unit. - Extending the allowed period for the VD program would be helpful given the proposed relatively short window and potential for large volumes of transactions to overwhelm financial institutions and the NBU. - Financial institutions and the NBU need to apply proper verification processes in terms of AML and CTF measures; distinguishing ordinary transactions from those related to the VD program may be especially burdensome. ### Adhering to core principles and AML alignment (Do’s and Don’ts) - Do’s (selected): - The VD program must be clear about its goals and scope. - The program must evidence a cost-effective increase in short-term revenues. - The adopted VD program must be aligned with the generally applicable compliance and enforcement culture of the tax administration. - The VD program needs to specifically improve compliance levels of the target group and maintain a credible deterrent against future compliance slippage. - Clear legislation and regulations for an asset repatriation program need to create taxpayer certainty and guarantees against subsequent recurring tax audits of previously disclosed and hence regularized foreign assets. - The short-term gross revenue gains should be balanced against reduction in taxpayer compliance, administrative cost of the amnesty, and forgone revenues from waived interest, penalties and tax. - Tax authorities should be adequately resourced and have an advanced data management system to cope with the influx and complexity of applications. - Tax amnesties need to be an integral part of wider voluntary compliance and enforcement strategies. - To protect against abuse, authorities should put in place arrangements for mutual legal assistance and exchange of information, prosecutions, and asset recovery investigations and proceedings where applications were unsuccessful. - Don’ts (selected): - Do not repeat the VD but begin to enforce the tax and currency legislation to the full letter of the law. - Individuals who are already under investigation by the SFS cannot apply for the VD program. *Source: 1ukrea2019005 - 42. Individuals, qualifying for the VD program, may (1) include into their report any (PDF).* ### 52. It is reassuring that the NBU seeks to align the Ukrainian VD and asset repatriation ### 1ukrea2019005 - 52. It is reassuring that the NBU seeks to align the Ukrainian VD and asset repatriation ### Alignment with FATF and AML/CTF principles - Four FATF principles to guide repatriation programs (FATF, 2012): - Repatriated assets are deposited with a financial institution that is subject to AML and CTF measures. - Assets coming from countries that do not adequately apply the FATF recommendations are given particular attention. - The authorities raise awareness among financial institutions on the potential for abuse and the money laundering risks in the asset repatriation program. - Any documents or statements issued regarding the assets repatriated endorse the legitimacy of their origin. - Consequence for participating financial institutions: - Financial institutions must conduct a Customer Due Diligence for clients who repatriate assets and identify the beneficial owner of the account into which the assets are repatriated. ### Domestic and international coordination for tax amnesty and repatriation - Key coordination needs: - Ukrainian tax authorities should receive sufficient investigative powers to trace the origin of assets or refer such investigations to competent authorities in the jurisdiction where assets are located. - Mechanisms should exist to allow effective information sharing on taxpayers and their repatriated assets. - Countries from which assets are being repatriated should provide full cooperation to the Ukrainian authorities. ### Consideration of an amnesty charge for domestic tax infringements - Current gap: - The concept note on Ukrainian VD does not provide for a penalty payment for non-disclosed and non-taxed domestic income that gave rise to foreign asset acquisition. - Proposed approach: - Introduce an additional charge on undisclosed domestic income that may have given rise to the creation of foreign assets. - Example from other practice: - South African foreign asset amnesty imposed an additional 2 percent charge on all domestic tax infringements related to foreign assets. - Characteristics of such a domestic amnesty: - Applicants must disclose the amount and date of foreign assets shifted offshore. - Domestic amnesty levy of 2 per cent on previously undisclosed amounts (applied only to domestic transgressions related to foreign assets). - Domestic amnesty excludes other violations such as VAT, wage withholding tax, and social security contributions due to the serious fiduciary nature of such violations. ### Procedural and administrative matters — Institution of an Independent “VD and Amnesty Unit” - Proposed structure and staffing: - Establish a centralized amnesty unit for processing applications. - Appoint an independent chairperson (e.g., a retired judge). - Include personnel from both the currency control division in the NBU and the SFS. - The unit will terminate after processing all successful VD applications and after all unsuccessful applicants have exhausted their appeals. - Confidentiality and file management: - Elevated confidentiality standards required to guarantee disclosed offshore affairs will not trigger repeated audit harassment. - Officials should operate under special tax secrecy provisions for officials assigned to the amnesty unit. - Centralized unit without regional branches to guard against repeated tax audits by only making successful applications available to the SFS and the NBU. - All amnesty applications should be stored physically and/or electronically in the amnesty Unit’s central filing facility under access control of the Unit. - The Amnesty Unit should provide information about the amnesty’s progress to the Minister of Finance and the Rada to ensure transparency and accountability. - Decision-making quorum and adjudication: - Legislation should provide for quorum arrangements. - Option 1: all applications considered by all Unit members at a full Unit meeting (guards against single discretionary decision-making but slows adjudication). - Option 2: quorum arrangements whereby applications are considered by teams of two adjudicators, one from the NBU and one from the SFS. - All declines and appeals of applications will be considered at full Unit meetings. ### Valuation of assets and required supporting documents - Self-assessment risk: - Applicants voluntarily self-assess the base for the Fee calculation; accurate valuation recommended to secure immunity against future taxes and penalties. - Not requiring expert valuation may hurt both parties; other programs require market value statements at a set amnesty date with full description and supporting documents. - Particulars of asset types and required documents to confirm value at a specified amnesty declaration date: - Cash: Declaration by applicant providing description and value - Bank accounts, call deposits, term deposits, and any other short-term asset: Declaration describing and valuing asset accompanied by an original or certified copy of statement of account - Listed financial instruments: Statement of account stating price and value - Unlisted financial instruments: Valuation certificate from a foreign valuator stating price and value - Fixed property: Valuation certificate from a valuator in, or government of, the relevant country, stating price and value - Foreign insurance policies: Valuation certificate from insurer stating value - Collective investment schemes: Valuation statement from management company - Intangible assets, e.g., copyrights: Valuation certificate from a valuator in country where asset is located stating value - Other foreign assets: Declaration by applicant providing description and value ### Levy collection, repatriation of funds, and related problems - Levy levels and payment mechanics: - VD and amnesty levy: 5 and 9 percent (levies should be paid from foreign-held assets before fees or commissions charged by financial institutions on conversion). - Principle: levies in lieu of outstanding taxes should not be further eroded by banking sector charges. - If the amnesty levy for domestic tax violations is accepted, it can be paid within 30 days of the approval of the application from local funds. - Amnesty applicants and facilitators should pay the levies through the banking system to an NBU controlled account. - The proposed amnesty unit would report monthly on reconciliated levy payments without physically handling the levy funds. - Common practical problems requiring discretionary extension powers by the Unit: - (1) Applicants passing away between submission and adjudication, resulting in asset blocking for probate purposes. - (2) Fixed investments that could not be withdrawn within the permitted period for payment of the levy. - (3) Executors of deceased estates that could not access foreign assets owing to insufficient provisions in domestic wills to deal with foreign assets. - (4) Assets frozen abroad owing to infrequent previous use by account holders. - (5) Ownership disputes arising in divorce proceedings instituted after amnesty application but before adjudication. - (6) Illiquid assets (e.g., real estate) held abroad. - (7) Incompetence of representatives of amnesty applicants, certain foreign banks in transferring funds to Ukrainian banks, domestic authorized banks, or exchange dealers. - (8) Withdrawal conditions imposed by foreign banks, inter alia, in terms of disclosure legislation in foreign jurisdictions. - Rules should exist for refunding levy overpayments. ### Public awareness and reporting obligations - Public awareness measures: - Continuous media coverage of the Unit’s activities; explain amnesty procedures during submission period (e.g., frequently asked questions in a weekend newspaper, participation in radio and TV programs). - Reporting obligations of the Unit: - Prepare monthly reports on updated statistics on: - progress with adjudication of applications; - unauthorized assets disclosure; - levy imposition; - amount of receipts and accruals disclosed from foreign sources. - Manage reporting requirements in terms of financial intelligence legislation where assistance was rendered with clarification, completion or submission of amnesty applications. - Exemptions granted to amnesty applicants may need to be explained to foreign jurisdictions as developed economies have increased compliance requirements for financial institutions. ### Treatment of facilitators and advisors - Current position: - Ukrainian concept amnesty does not generally apply to advisors and facilitators that merely assisted applicants in violating exchange control regulations and related tax acts. - Concerns: - Advisors and facilitators may attempt to dissuade applicants from coming forward out of fear of prosecution. - Protections and limited extension: - Authorities should not force applicants to disclose identities of assisting parties; the amnesty unit should erase names inadvertently revealed on application forms. - With these protections, there is no general need to extend amnesty to advisors and facilitators as no names will be requested or revealed. - Limited extension option: - A limited class of facilitators who physically assisted in the violation (e.g., trustees, employees, wholly owned companies and trusts that illegally held or accumulated foreign assets on the applicant’s behalf) could be eligible for relief by being added to an applicant’s application. - A facilitator may only come forward if the related applicant files an amnesty application. ### Consolidated recommendations (as provided) - Impose only the 9 percent VD Fee for disclosing foreign-held assets but keeping them offshore and incentivize the foreign asset disclosure and repatriation of assets with a 5 percent VD Fee. - Do not grant a zero percent Fee for repatriated assets and reinvested in government securities. - Fully align the VD and asset repatriation program with AML and CTF rules. - Ex ante make sure that there is no need for a follow-up VD, tax amnesty and asset repatriation program as repeated amnesties have a deleterious effect on long-term tax compliance behavior. - Cover facilitators (in the guise of legal persons) under the same amnesty so that tax avoidance structures and mechanisms can be revealed. - Establish a special central amnesty administrative unit comprised of SFS and NBU staff who can adjudicate applications and protect taxpayers by erasing their application record if not successful in getting immunity for exchange control and tax violations. - Extend the amnesty period to 10 or 12 months as due diligence and verification of asset registers is time consuming, especially since it involves data sharing and coordination with competent authorities in other tax jurisdictions. - Extend the VD, tax amnesty, or asset repatriation to trust beneficiaries and heirs of an estate. - The proposed amnesty unit must prepare monthly statistical reports to the Minister of Finance and Rada on the uptake of the VD program with associated tax amnesty, and asset repatriation. ### BEPS implementation package — introduction and BEPS Action 3 (CFC) highlights - Context: - Since the BEPS project released its final reports in 2015, Ukraine has been interested in updating its international taxation system according to new global standards. - The FAD (2017) report recommended adopting the minimum standards: Action 5; Action 6; Action 13; and Action 14. - Exchange control liberalization implications: - Planned liberalization of exchange controls has triggered interest in adopting BEPS actions beyond minimum standards. - Residents will be able to transfer increasing amounts of capital abroad; MoF and NBU believe this should be accompanied by CFC rules (Action 3) to tax passive income earned abroad by residents. - Strengthening restrictions to interest deductions (Action 4) may be justified given potential capital outflows and increased indebtedness by resident entities. - Draft laws under consideration: - The MoF and NBU developed draft laws for adopting seven BEPS actions: 3 (CFCs); 4 (Interest deductions); 6 (countering treaty abuse); 7 (defining permanent establishment); 8–10 (transfer pricing); 13 (CbC reporting); 14 (mutual agreement procedures). - BEPS Action 3 — purpose and draft Article 39: - Purpose: introduce CFC rules to counter deferral of tax through taxpayers shifting passive income to non-resident companies they control. - Effect of CFC rules: treat passive income of a CFC as income of the Ukraine resident who controls the CFC, advancing the taxing point from distribution to the time passive income is derived. - Draft CFC rules located in proposed Article 39 of the Tax Code (TC) and are comprehensive, providing key design features recommended in the BEPS Action 3 Report. - Relevant taxpayer and potential issues: - Relevant taxpayer: resident individual who is the ultimate beneficial owner and controller of a foreign company (Article 39.1.2). - Ultimate beneficial owner is determined according to money laundering legislation. - Rationale: in approximately 95 percent of cases, the person holding the shares in a foreign company is a resident individual. - Anticipated behavioral response: - Residents may create more complex domestic holding structures to disguise ultimate beneficial ownership, adding complexity and avoidance risk. - Technical issue: - Applying CFC rules to the ultimate beneficial owner may create a mismatch when dividends are paid to a resident entity while a resident individual was previously taxed on the CFC income. *Source: IMF country report excerpt provided in the content unit.* ### 72. It is preferable that the CFC rules apply at the level of the first “onshore” resident ### 1ukrea2019005 - 72. It is preferable that the CFC rules apply at the level of the first “onshore” resident ### Scope and application - CFC rules should apply at the level of the first “onshore” resident person (resident individual or resident entity) in the chain of ownership of a foreign company to protect rule integrity and avoid mismatches in relation to dividends paid out CFC-taxed income. - Primary targets are foreign companies as legal persons separate from shareholders, but CFC rules should also apply to any foreign entity treated as a separate taxpayer under the TC (including “foreign arrangement without legal personality” such as partnerships, trusts, foundations). ### Foreign entities subject to CFC rules - CFC rules need only apply to foreign entities taxed as separate entities under the TC; entities taxed on a “look through” basis need not be subject to CFC rules. - Partnerships are understood to be taxed as separate entities under the TC and thus appropriately covered by the CFC rules. ### Control and substantial shareholder rules - CFC rules apply only to foreign companies controlled by resident individuals; the definition of “control” is central to rule integrity. - Three alternative tests of control for foreign companies (Article 39.1.2): - (1) A single resident individual has a 50 percent or greater ownership interest in a foreign company. - (2) Resident individuals have, in aggregate, 50 percent or greater ownership interest in a foreign company; in this case a substantial shareholder rule applies so that only those resident individuals that have a 25 percent or greater ownership interest are subject to tax under the CFC rules. - (3) A resident individual individually, or with related resident persons, exercises de facto control over the foreign company. - Ownership interest is based on both voting and value rights; if different, the higher percentage interest applies (Article 39.1.3). - Ownership interest includes interests of related persons (Article 39.1.4) to prevent fragmentation (example where five related persons each hold 20 percent—anti-fragmentation treats as single 100 percent interest). - Tracing rules apply where the first foreign company is a holding company, but tracing is currently based on simple multiplication of interests (Article 39.1.4), which can limit effectiveness (example: 50 percent × 50 percent = 25 percent indirect interest). - Recommended adjustment: tracing should assume that if there is control at a particular tier, the tracing percentage is 100 percent for establishing CFC status; once control is established, the resident’s share of CFC income should be measured by straight multiplication of interests. - Substantial shareholder threshold discussion: - Current threshold: 25 percent. - Suggested alternative: reduce to 10 percent to align with usual commercial direct vs portfolio investment thresholds and because a 10 percent holder should have access to sufficient financial information to calculate CFC income. - De facto control: - Based on economic control exercised individually or collectively with related persons; should take account of all related persons, resident or non-resident. - De facto control principle: resident individual can exercise significant influence over decision making regardless of legal rights (Article 30.1.6); five circumstances listed where a person is treated as having de facto control, but list should not be exhaustive. - Concern: individuals (including non-residents) may be permitted to declare de facto control (Article 39.1.6), which could allow non-residents to declare control and prevent a foreign company being a CFC; better to retain SFS flexibility to determine de facto controller. ### Foreign arrangements without legal personality (trusts, etc.) - Foreign trusts can be deferral vehicles; CFC rules usually tax the settlor of the trust. - Settlor is effectively treated as the controller of the trust (Article 39.1.5), with exceptions (Article 39.1.5.1) where: - (1) the settlor is not able to direct distribution of profit of the trust; - (2) the settlor does not have a reversionary interest in the assets of the trust; - (3) the settlor does not exercise de facto control over the trust. - Best practice recommendation: treat a resident individual who is the settlor of the trust as the controller in all cases. ### Calculation of CFC income and taxation - Adjusted taxable profit of a CFC is included in the personal income of a resident individual controller based on their percentage interest in the CFC. - Percentage interest of a de facto controller is deemed to be 100 percent; same rule should apply to a resident settlor of a foreign trust. - CFC income is taxed at the standard PIT rate of 18 percent. - Adjusted taxable profit is the pre-tax financial accounting profit of the CFC based on audited accounts, subject to modifications, including: - add-back of impairment write downs; - limiting the deduction of interest expense to 30 percent of EBITDA. - Resident controller entitled to credit for foreign tax paid by the CFC in relation to CFC income (Article 170.13.2.4); tax credit proportionate to the controller’s share of CFC income. - Exemptions and adjustments apply to calculation of adjusted taxable profit (see comparable tax, active income, de minimis, public company exemptions). ### Comparable tax exemption - Adjusted taxable profit does not include comparably taxed income (Article 39.4.1). - Two bases for determining comparable taxation: - (1) There is a tax treaty or an information exchange agreement between Ukraine and the country of residence of the CFC; exception should apply only when the country does effectively exchange information with Ukraine. - (2) The country of residence of the CFC is not a listed jurisdiction (black list) and the CFC has paid an effective tax rate on its income that is not lower than five percentage points below the nominal rate of corporation tax in Ukraine. Based on the current rate of corporation tax, the effective rate of tax paid by the CFC must not be lower than 13 percent. Effective rate calculated as tax paid to the CFC’s country of residence as a percentage of pre-tax financial accounting profit. - Note: risk in using a “black” list is that every country not on the list may be treated as comparable; positive that the black list is supplemented by the differential effective tax rate approach. - Territorial tax countries: prudent to include territorial taxation on the black list because PEs in tax havens can result in foreign income not taxed in the CFC’s residence country and may escape the comparable tax test except via effective tax rate calculation. ### Active income exemption - Exemption for active income applies on an entity basis (Article 39.4.1). - Entity passes active income test if share of passive income as a percentage of total income for a year is less than 50 percent; then no CFC taxation of any income for the year. - If share of passive income is 50 percent or more, the entity fails the test and there is CFC taxation of all its income for the year. - Definition of “passive income” should include dividends, interest, royalties, rents, annuities, and capital gains on sale of passive assets; “interest” should be broadly stated to include any form of return under a financial instrument. - Exception for “active” passive income: e.g., royalties where CFC genuinely developed the industrial or intellectual property right, and interest derived by a bank, should be treated as active income. ### De minimis and public company exemptions - De minimis exception: where total revenue of a CFC for a year does not exceed EUR 1 million (Article 39.4.2.1). If a resident individual controls more than one CFC, the EUR 1 million threshold is tested by reference to total revenue of all CFCs. - Public company exemption: CFC that is a public company listed on a recognized stock exchange is exempt (Article 39.4.2.2); given the 25 percent substantial shareholder threshold this exemption would rarely apply, but reducing the threshold to 10 percent would increase its relevance. ### Dividends paid by CFCs - Dividend paid by a CFC to another CFC of the same controller is treated as exempt income of the recipient CFC (Article 39.3.2.5) to avoid double CFC taxation as profits pass through a chain of CFCs of the same controller. - Taxation of dividend paid by a CFC to the resident individual controller depends on timing: - Interim dividend received by the controller in a Ukraine bank account: supporting CFC income taxed at 9 percent (rather than 18 percent). - Dividend paid by a CFC to a Ukraine bank account of a resident controller by the end of the calendar year following the reporting period: taxed at 9 percent (controller can file an adjusted tax return to effect reduction from 18 percent to 9 percent). - Dividend paid out of CFC income outside this time period: no further tax (i.e., the 18 percent tax on CFC income applies). - Policy rationale: 9 percent rate is to encourage repatriation of CFC income. - Observed risk: 9 percent rate may encourage passive investments offshore rather than domestic investment (illustrative scenario where a resident invests via a CFC in a jurisdiction that does not tax interest, then repatriates dividend within two years to obtain 9 percent rate). - Application of exemptions means all income of a CFC for a tax year will be either fully taxed CFC income or non-taxed CFC income; a CFC may fail the active income test in one year and pass in another, resulting in both taxed and non-taxed profits across years. When dividends are paid outside the two-year 9 percent window, it is necessary to determine whether dividends are supported by CFC-taxed profits (exempt) or non-taxed profits (taxable at 18 percent). *Source: 1ukrea2019005 - 72.* ### 103. There does not appear to be any dividend ordering rules to apply where a CFC has ### 1ukrea2019005 - 103 ### CFC dividend ordering and related issues - There does not appear to be any dividend ordering rules to apply where a CFC has both CFC taxed and non-taxed profits, although the mission was advised that the CFC could nominate the profits that support the dividend. - Possible methodologies for ordering profits supporting a dividend include: (1) first out of CFC taxed income; (2) first out of non-taxed income; or (3) pro-rata out of CFC taxed and non-taxed income. - It is important that there is a clear rule applied for the ordering of profits supporting a dividend. - Similar issues arise in relation to the taxation of gains on disposal of shares in a CFC. Recommendations (CFC rules) - Apply CFC rules at the level of the first “onshore” person in Ukraine. - Only treat a foreign entity as a CFC if it is not taxed as a look through entity in Ukraine. - Tracing should be based on the assumption that, if there is control at a particular tier in the chain of companies, the tracing percentage is 100 percent. - Consider reducing the substantial shareholder threshold to 10 percent. - Apply the de facto control test by reference to all related persons and not just resident persons. - Limit or delete the rule that permits an individual to declare themselves to be a person exercising de facto control over a company. - Treat a settlor of a foreign trust as the controller of the trust in all cases. - Out of abundant caution, include territorial taxation in the list of situations that would have the effect of a LTJ (as in Australia). - Ensure that there is a comprehensive definition of “passive income”, including a definition of “interest”. Exclude obvious examples of “active” passive income. - Delete the 9 percent rate for repatriated CFC income. - Include dividend ordering rules to apply where a CFC has both CFC-taxed and non-taxed income. ### Limitation on Interest Deductions (Action 4) — The EBITDA Rule - Ukraine proposes replacing the existing thin cap rule (TC, arts 140.1 – 140.3) by limiting interest deductions to 30 percent of EBITDA (the ‘EBITDA rule’). - The excess interest payments up to the limit set by the Arm’s Length Principle (ALP) could be carried forward indefinitely, but with a yearly reduction of that excess of five percent. Reform benefits of the MoF proposal - Apply the limitation to all interest payments, to non-resident and resident lenders, or to independent or related parties (current thin cap applies only to non-resident related parties). - Eliminate the debt to equity ratio of 3.5 to 1 as a precondition to limiting the deduction of interest payments. - Reduce the limit to qualifying interest deductions from 50 to 30 percent of EBITDA. - Eliminate the ad hoc definition of related parties for the sole purpose of applying the thin cap rule (50 percent participation in equity – TC Article 141.2, instead of 20 percent in the general rule – TC, Article 14.1.159). Interaction with the Arm’s Length Principle (ALP) - The draft proposal states that, if the ALP allows for an interest payment (to a related party) higher than 30 percent of EBITDA, the interest limitation would apply anyway. - The proposal is not explicit about the opposite situation (when the ALP sets an interest payment lower than the EBITDA rule); it can be inferred the intent is that the ALP would apply in that case. - Two conceptual approaches: - Asymmetric approach: EBITDA rule stops abusive deductions; ALP binds taxpayers when payments are below the threshold. - Simpler approach: Once an EBITDA rule is in place, arm’s length considerations may be redundant (simpler but may sacrifice some tax base). - Carry-forward complexity: Article 14.1.49 of the proposed reform would recharacterize all non-AL payments to non-residents as dividends (non-deductible and subject to withholding). Excess interest above the EBITDA threshold can be carried-forward only up to the AL amount; payments above this would be recharacterized as dividends and not carried-forward. Calculating AL interest each year is therefore necessary to determine carry-forward. Net vs Gross Interest and the Financial Sector - The proposed rule applies to gross interest expenditure — stricter than a rule on net interest expenditure (interest expenditure reduced by interest income). - The gross-interest limitation should not apply to the financial sector, where holding financial liabilities is an essential element of the business model and EBITDA is not a suitable measure of economic activity. - If the MoF insists on the stricter version, it should exempt the financial sector. - Applying the deduction limit to net interest expense would be mostly irrelevant for the financial sector given banking and insurance institutions normally have a net interest income; this version may not require a financial-sector exemption. - There is no internationally agreed standard for limiting interest deductions in the financial sector; a cautious approach is to exempt the financial sector and assess base erosion problems specifically for that sector in Ukraine. Policy options - Simpler options recommended: - Apply only the EBITDA rule based on net interest expense, eliminate the carry-forward, and possibly lower the threshold for the EBITDA rule (the BEPS Action 4 report suggestion ranges from 10 to 30 percent). - Alternatively, disallow the deduction of all net interest payments above the AL level when this is below the threshold and eliminate carry-forward for interests recharacterized as dividends. Unsolved problem with interest deductions - Interest is deductible when accrued but withholding applies only when it is paid — allowing tax planning where income sourced in Ukraine is deducted but remains untaxed. - The foreign recipient could be exempt in its residence country under a territorial regime and benefit from double non-taxation (and possibly not be affected by the Ukrainian regulation on LTJ). - Suggested supplement: require that no deduction be allowed for an expenditure subject to withholding until withholding tax is paid (as in Australia). Recommendations (Interest deductions) - Replace current thin cap rule with the EBITDA rule proposed by the MoF, considering the following adjustments: - Eliminate carry-forward of non-deducted interests. - Apply EBITDA rule to net interest expense. - Exempt the financial sector from the rule. - Defer deduction of accrued interest subject to withholding until withholding tax is paid. ### Anti-Treaty Abuse Measures (Action 6) - BEPS Action 6 addresses abuse of tax treaties; the MLI implements anti-treaty abuse measures in existing treaties. - It is proposed to amend the TC to include an anti-treaty shopping rule and to provide for the taxation of indirect transfers of Ukrainian immovable property as provided for in Article 13(4) of the OECD and UN Models. - The anti-treaty shopping rule functions as a domestic law provision that overrides tax treaties; taxation of indirect transfers under Article 13(4) is a jurisdictional issue that needs to be replicated in the TC. Treaty shopping - The MLI specifies two methodologies: (1) the principal purpose test (PPT); and (2) a limitation of benefits (LOB) rule. A signatory can use either PPT or LOB, or both. - PPT: a treaty benefit is denied if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of an arrangement that resulted in that benefit. The onus is on the SFS to establish that a principal purpose was to obtain treaty benefits. - LOB: treaty benefits limited to qualified persons (generally genuine residents). An entity is a qualified person only if resident individuals hold, directly or indirectly, 50 percent or more of the voting or value rights in the entity, unless an active business exception applies. Making or managing investments (holding passive investments) is not an active business. - The MoF proposes to implement the PPT approach due to complexity concerns with LOB. The mission considers LOB better for Ukraine because it affords greater certainty and simpler administration, although both approaches are acceptable within the MLI framework. - Interim measure: incorporate the PPT into Article 103.2 of the TC as a treaty override rule, subject to constitutional considerations and amendment of Article 3 of the TC to make PPT an exception to legislative priority in favor of tax treaties. The PPT in Article 103.2 should be interim and cease to apply to an existing treaty once the MLI applies to that treaty; it should not apply to future treaties. Indirect transfers of immovable property - Current TC treats income from sale of immovable property located in Ukraine by a non-resident as taxable (Article 141.1.1(f)); indirect transfers (sale of shares/interests in entity holding the immovable property) can avoid this taxing right. - Proposal: treat a gain made by a non-resident on an indirect transfer of Ukrainian immovable property as Ukraine-source income (Article 141.1.1(g)). The rule applies only to the sale of an interest in a foreign legal person (not to interests in resident legal persons, which are covered by Article 141.1.1(f)). - Technical design issues and recommendations: - Broad definition of “immovable property” is needed; in particular, include mining and petroleum rights relating to land in Ukraine and consider including mining and petroleum information to prevent value attribution planning. The definition should be clarified in the TC because it is also the treaty definition of immovable property (Article 6(2) of tax treaties). - The rule should apply to both resident and non-resident legal entities that hold Ukraine immovable property; otherwise avoidance is easy through a non-resident holding the immovable property. - The proposed rule applies where a foreign legal entity sells an interest in another foreign legal entity that, directly or indirectly, holds shares in a Ukraine legal entity that owns Ukraine immovable property. Two thresholds must be satisfied before the rule applies: - 50 percent or more of the value of the interest in the foreign entity that is sold is derived, directly or indirectly, from an interest in a Ukraine legal entity. - 50 percent or more of the value of the interest in the Ukraine legal entity is derived from Ukrainian immovable property. - The inclusion of the first threshold departs from Article 13(4) and may unnecessarily narrow the scope of the rule; it is recommended that drafting of Article 14.1.54(j) be closely aligned to Article 13(4) of the OECD and UN Models. *Source: 1ukrea2019005 - 103* ### 126. Finally, the rule may be avoided by, immediately before the indirect transfer, ### Indirect transfers, Permanent Establishment, and Transfer Pricing (paragraphs 126–150) ### Indirect transfers of Ukrainian immovable property (paras. 126–129) - The rule may be avoided by, immediately before the indirect transfer, shifting other assets into the entity that owns the Ukraine immovable property so as to fall below the 50 percent immovable property threshold. - The revised Article 13(4) of the OECD and UN Models provides that the rule applies where the 50 percent threshold is established at any time in the period of 365 days prior to the indirect transfer. This should also be provided for in Article 14.1.54(j) of the TC. - Collection challenge for Ukraine tax on an indirect transfer: - Proposal: collect tax by withholding with the non-resident purchaser required to withhold tax at 15 percent from the profit on disposal. - Difficulty 1: purchaser knows the sales price but not the seller’s profit, which requires knowledge of the seller’s cost. - Difficulty 2: given the transaction is between two non-residents, enforcement of a withholding tax liability is unclear. - Two options for collection: - Treat the entity that owns the Ukrainian immovable property as a payment agent of the non-resident who has made the gain (MoF proposal). - Deem the entity that owns the Ukrainian immovable property to have made a pro-rata disposal and re-acquisition of the property if there is a 10 percent or greater change in the underlying ownership of the entity. - Legal liability difference: - Agency approach: primary liability remains with the non-resident; non-resident can claim a foreign tax credit (FTC) in their home country for the Ukraine tax paid. - Deemed disposal approach: primary liability is shifted to the entity that owns the property; likely loss of FTCs as liability is shifted to the owner of the immovable property. - The agency approach is often preferred as it operates consistently with international norms. Recommendations (indirect transfers) - Use the LOB method to counter treaty shopping abuses. - Make clear that the domestic anti-treaty shopping rule is an interim measure applicable only until the MLI is implemented. - Align the drafting of the rule for taxation of indirect transfers of Ukrainian immovable property with terms of Article 13(4) of the OECD and UN Models. - Include a definition of immovable property that covers mining and petroleum rights, and mining and petroleum information. - Collect the tax on a gain on an indirect transfer by treating the owner of the Ukrainian immovable property as the payment agent of the non-resident who has made the gain. ### Definition of Permanent Establishment (Action 7) — overview (paras. 130–136) - Draft BEPS law revises the TC definition of permanent establishment (PE) to align with the OECD and UN Model Treaties as amended based on the BEPS Action 7 Report (Article 14.1.193). - The amended definition in the OECD and UN Models closes longstanding loopholes, strengthening source taxation of business profits. - In the TC: - A non-resident carrying on business in Ukraine through a PE is treated as a taxpayer (Article 133.2.2). - Jurisdictional rules relating to source of income (Article 14.1.54) do not rely on the concept of PE. - Allocation of business profits to PEs is based on the functionally separate entity approach (Article 141.4.7). - Administrative role: - Non-resident must apply for registration before commencing to carry on business in Ukraine through a PE (Article 64). - PE registration applies regardless of whether the non-resident is subject to tax in Ukraine. - SFS empowered to audit a non-resident conducting business through an unregistered PE (Article 78.1.14). ### PE as a jurisdictional concept and current gaps (paras. 133–139) - Typical uses of PE in tax law: 1. Business profits attributable to a PE are domestic source income (aligns with Article 7(1) of tax treaties). 2. Withholding tax rules: PE concept determines geographic origin of withholding income via two sourcing rules: - Income paid by a resident is sourced in that jurisdiction unless payment is an expenditure of a foreign PE of the resident. - Income paid by a non-resident is sourced in that jurisdiction if it is an expenditure of a PE of the non-resident in the jurisdiction. 3. Branch profits tax equalizes tax treatment of branches and subsidiaries; PE = branch for tax purposes. - Ukraine TC deviations: - Article 14.1.54 states Ukraine-source income is any income derived by residents or non-residents from any activities in Ukraine; no qualification limiting Ukraine-source income to income from activities that amount to a PE. - Interest and royalties paid by a resident are Ukraine source income under Article 14.1.54(a) with no exception for payments that are expenditures of a foreign PE of the resident and no inclusion of payments made by a Ukraine PE of a non-resident. - No branch profits tax in the TC. - No unilateral relief from double taxation under the TC; distinction between domestic and foreign income of residents is not operative. - Treaty interaction: - PE as a jurisdictional concept is largely relevant through tax treaties. - Where conflict exists between a tax treaty and the TC, the tax treaty prevails (Article 3 of the TC). - Recommendation: update Article 14.1.54 to align jurisdictional rules with PE concept in treaties. ### Treaty and Tax Code definitions of PE, and scope (paras. 141–145) - Tax law definition of PE can be broader than treaty definition; treaty negotiations often narrow PE scope. - Ukraine has 73 tax treaties; broader tax law PE definition is relevant where no treaty applies or where treaty does not cover a situation. - Examples where tax law PE definition may be broader: 1. No preparatory and auxiliary activities exception or exception limited to a representative office. 2. Shorter temporal limits for construction and services PE rules. 3. No independent agent exception to the agency PE rule. - Legal principle: tax treaties are permissive; taxation permitted under a treaty must be provided for in tax law to be effective. - Suggested alignment: Article 14.1.193 should be based on the broadest definition in Ukraine’s tax treaties; alternatively, Article 14.1.54 could state that any income Ukraine has the right to tax under a tax treaty is treated as Ukraine-source income. ### Technical issues with the revised PE definition (paras. 146) - The revised definition in Article 14.1.193 largely follows OECD and UN Models, but technical points raised: 1. Definition operates one way—only defines a PE of a non-resident in Ukraine; should be drafted generically to apply to residents and non-residents as in Article 5 of OECD and UN Models. 2. Reference to “server” needs clarification: - A server (physical asset) located in Ukraine owned or leased by a non-resident can constitute a PE if location is fixed. - A non-resident with a website hosted on a third party ISP server is not usually regarded as having a PE since the non-resident has no rights over the server; ISP not a dependent agent. 3. Suggest change references to “six months” in paragraphs (a) and (b) to “183 days” to avoid complex part-month rules. 4. Paragraph (c) may not fully capture amendments to Article 5(5) of the OECD Model and may not capture commissionaire arrangements (possible translation issue). 5. Consider deleting or limiting the preparatory and auxiliary activities exception to a representative office; representative offices usually conduct market research, advertising, and non-transactional operations which often fall within the exception. 6. If the preparatory and auxiliary activities exception is retained, delete the reference to “delivery” in paragraph (a) and clarify that paragraph (e) applies only where the activity is preparatory or auxiliary. ### Attribution of profits to a PE (paras. 147–149) - Article 141.4.7: taxable profit of a non-resident conducting business in Ukraine through a PE is calculated on the basis that the PE is a separate entity with internal dealings valued by reference to the arm’s length principle — i.e., functionally separate entity approach applies. - Under the functionally separate entity approach: - “Remuneration” for internal dealings can include a mark-up when supported by functions, assets, and risk, determined by analogy to Article 9 of the OECD Model and the OECD Transfer Pricing Guidelines. - Example: head office Treasury charges a notional interest rate with a mark-up to a Ukraine PE; Ukraine PE can deduct the notional interest paid; mark-up allocates profit to treasury. To fully apply, withholding tax should be charged on deemed interest paid to head office; deemed interest also subject to EBITDA limitation on interest deductibility. - If internal interest charge is not supported by functions, assets and risks, Ukraine PE can deduct only portion of actual external interest cost properly allocated to the PE. - Alternative approach used by some countries: “relevant business activity” approach — internal transfers not recognized as separate transactions; overall profit of the relevant business activity is determined and a part allocated to the PE based on sourcing rules. - Risk: if Ukraine applies functionally separate entity approach but the other country applies relevant business activity approach, there is risk of double taxation or double non-taxation. - UN Model (Article 7(2) and (3)) continues to support both methods; prudent to retain flexibility. Recommendations (PE and profit attribution) - Amend Article 14.1.54 to provide that the business profits of a non-resident are Ukraine-source income if attributable to a PE in Ukraine. - Amend Article 14.1.54(a) to provide that interest and royalties are Ukraine-source income when paid by: - (1) a resident other than as an expenditure of a foreign PE of the resident; or - (2) a Ukraine PE of a non-resident. - Revise the definition of PE so that it applies to both residents and non-residents. - Clarify the scope of treatment of a server as a PE. - Review the agency PE rule to ensure that it properly covers commissionaire arrangements. - Consider deleting or narrowing the preparatory and auxiliary activities PE exception. - Apply the functionally separate entity approach to allocating profits to PEs but retain flexibility to modify the outcome when the other country uses a different method of profit allocation so as to limit the possibility of double taxation or double non-taxation. - Where the functionally separate entity approach applies, apply withholding tax to internal dealings recognized as interest or royalties. *Source: IMF content unit 1ukrea2019005, paragraphs 126–150.* ### 151. TP regulation in Ukraine has been contentious and difficult to implement. Since ### TP regulation in Ukraine has been contentious and difficult to implement ### Definition of Related Parties and Controlled Transactions - Findings: - A new definition of related parties (Article 14.1.39) would classify two entities as associated or part of a group if they have consolidated accounting obligations under International Financial Reporting Standards (IFRS) or if the obligation arose because an entity in the group traded in a stock exchange. - The draft law text makes this definition applicable for Article 39 of the Tax Code (TC), which encompasses all transfer pricing, not only CbC reporting (BEPS Action 13). - The participation threshold for related parties via equity would increase from 20 to 25 percent. - A special rule would treat international financial organizations with ‘privileges and immunity’ as associated enterprises only if they have (directly or indirectly) at least 75 percent participation. - Proposed commercial integration control: any taxpayer that obtains or spends more than 75 percent of its income or expenditures from a single legal entity is presumed related. - Over-indebtedness presumption: a debt 3.5 times equity capital (not applying to banks) would be a trigger to assume relatedness. - Partners in a joint venture with 25 percent or more of a common property would be considered related. - The current general definition of “controlled transaction” (Article 39.2.1.1) refers to all transactions that “may affect the taxpayer’s taxable income” and is considered too broad. - The TC lists example transaction types for TP purposes (Article 39.2.1.4) with loose enumeration; defining controlled transaction as any transaction among related parties would simplify and tighten scope. - The law presumes a foreign resident is related in some cases (e.g., when it resides in a LTJ) and extends the presumption to cases where the foreign resident is an ‘agent’ (Article 39.2.1.1 - b), which can be overly broad and reduce availability of market price observations for the CUP method in commodities. - Risks and criticisms: - Increasing equity threshold from 20 to 25 percent could be justified for obtaining more independent comparables, but the special 75 percent rule for international financial organizations is “highly unusual and unclear.” - The 75 percent commercial dependency rule can be an overreach, capture legitimate commercial arrangements, and be evaded by splitting entities. - The debt 3.5 times equity rule is unusual for presuming relatedness, can be easily avoided, and is redundant; better used as an audit risk criterion. - Classifying joint venture partners as related by a 25 percent common property threshold is misguided; partners remain independent shareholders and should not be presumed related. - Treating transactions with legitimate brokers in non-listed jurisdictions as controlled can be counterproductive for CUP comparables. - Recommendations: - Clarify that the new definition of related parties as a function of IFRS obligations only applies to CbC reporting. - Do not introduce the special 75 percent participation threshold defining related parties for international financial organizations. - Do not introduce commercial dependency ratios as a deemed control threshold for defining related parties. - Eliminate the definition of related parties as a function of debt to equity ratios (make it a risk analysis parameter for selecting audits). - Eliminate “classifying partners” in joint venture as related parties. - Define “controlled transactions” as all those that take place among related parties. - Eliminate the presumption that trading with a non-resident agent (in a non-listed jurisdiction) is a controlled transaction. ### Anti-Abuse Measures - Findings: - Deemed dividends: the proposal would recharacterize as (deemed) dividends profits transferred abroad through TP manipulation to collect withholding taxes (Article. 14.1.49). Overpayment of royalties or interests may also be subject to withholding taxes possibly at rates higher than dividends depending on tax treaties. - Business restructuring: intra-group business restructurings would be subject to TP rules (Article. 39.2.1.4 - e). The draft law describes restructuring as another business transaction “for the purposes of transfer pricing” rather than stating a clear TP principle. - Business rationale provisions (Articles 39.2.1.10-11) use terms “business reasons” and “rational business reason” inconsistently; the draft places the burden of proof on the tax authority (Article 39.2.1.11). - TP and Profit Level Indicators (PLI): when a PLI denominator is an accounting variable affected by related party transactions, the draft requires the taxpayer to notify the authority about the proportion affected and justify its use (Article 39.4.6). - Analysis and risks: - Recharacterizing payments as deemed dividends could yield unintended results under tax treaties; consistency in treatment may imply loss of revenue relative to applying domestic withholding rates. - The ALP principle for restructurings should state that ALP applies when value (function, asset, or business risk) is transferred among related parties and that independent parties would not enter such arrangements without compensation that preserves indifference in net present value terms. - The lack of a clear “business reasons” test risks disallowing legitimate loss-making commercial transactions; the appropriate ultimate test is whether an independent person would be willing to engage in the transaction. - Requiring the tax authority to bear the burden of proof for rational business reasons is impractical without taxpayer documentation; burden of proof should be first on the taxpayer. - Recommendations: - Clarify that recharacterized amounts are deemed dividends and are subject to the rate of withholding as per domestic law. - Instead of listing business restructuring as another controlled transaction, define the TP principle applicable to business restructuring. - Define rational business reason consistently as having a clear profit motive for the individual entity (where no party a priori would be left worse-off). - Place the burden of proof for a rational business reason of a transaction onto the taxpayer. - Priority options for a PLI containing TP should be to change either the denominator or the TP method. ### Low Value-Added Services - Findings: - The proposal adopts the OECD (2017) guidance on low value-added services and attempts to simplify TP application on non-core, support, and relatively minor intra-group services. - Segregating low value-added services from pass-through costs, high value-added services, and services exclusively for benefit of the provider is complex; draft law provisions include eight paragraphs listing examples of low value-added services, ten types of services that may not be recognized as such (Article 14.1.183), and five paragraphs on parent company maintenance costs (Article 39.3.2.12). - The draft permits a simplified safe harbor: low-value added services considered compliant with the ALP when charged with a mark-up of 5 percent over costs (Article 39.3.2.10). - OECD is revising chapter VII (intragroup services); May 2018 public inputs indicate current guidance is unsatisfactory. - Analysis and risks: - The regime advantages MNEs with centralized overheads by allowing a capped mark-up without market benchmarking, but recipient countries often view such charges skeptically because segregation is difficult and charges may represent significant reductions in domestic returns or be used to shift profits. - Administrative verification is burdensome due to unclear definitions and benefit/rendition tests. - Premature adoption is risky while OECD guidance is under revision. - Recommendations: - Eliminate the regime for low value-added services (second best: place a strict limit to total deduction for this item as a low percentage of EBITDA). - Keep rendition and benefits tests for allowing deduction of service payments to related parties. ### Commodities - Findings: - The proposal prioritizes application of the Comparable Uncontrolled Price (CUP) TP method for commodities, consistent with prior FAD recommendations. This is appropriate for commodities (mainly grain exports). - Selection of comparable market commodity transactions and use of quoted prices from organized commodity markets is identified as key to safeguard the tax base. - The proposal allows other types of market comparables with CUP, mentioning ‘internal comparables’ and ‘prices between unrelated entities’ (Article 39.3.3.4) but without qualifying conditions. - Analysis: - CUP with quoted market prices is generally most reliable for commodities; allowance of unqualified internal comparables and unrelated-entity prices needs further qualification to ensure robustness of comparables. *IMF mission assessment of proposed amendments to Ukraine’s TP regime (extract).* ### 172. MNEs can generate their own internal comparable transactions by trading ### MNEs can generate their own internal comparable transactions by trading ### Internal comparable transactions and CUP for commodities - MNEs can generate internal comparable transactions by trading occasionally small amounts at discounted prices with unrelated parties to create a convenient market benchmark difficult for the tax authority to challenge. - Regulations should specify that such internal uncontrolled transactions, to be acceptable as a market benchmark, would have to be contracted: - on a regular basis, - with several clients, - in volumes similar to those negotiated with related parties. - Regulations should specify that any other market price references would have to be publicly available and issued by a reputable independent source (e.g., Reuters or Bloomberg). - Footnote guidance: TP for commodities was amply discussed in the 2017 FAD technical report. R. Schatan et al (2017) contains a more detailed discussion on TP methods and their application to Ukraine’s commodity export. ### TP adjustments and use of CUP for grain exports - TP methods allow for adjustments to market observations so that they are more comparable to the controlled transaction being valued. - The draft law allows such adjustments in applying CUP to commodities without restrictions (Article 39.3.3.4), leaving too much discretion to the taxpayer (or the tax authority). - Given the homogeneity of certain commodities (grains) and the availability of quoted FOB prices for Ukraine exports from different Black Sea ports, the types of adjustments allowed of these prices should be limited and explicitly specified in the law. - Example limited adjustments: quality specifications and freight costs when exports are from a port different than those referenced for quoted prices. - Footnote: Costs of port logistics should be part of the selected grain export price for TP purposes (i.e., as if paid by the Ukrainian exporter), so the benchmark should be FOB Black Sea port. Each commodity may require its own type of adjustments. Recommendations (from source) - Qualify internal comparable observations used in CUP method for commodity exports so that they are regular and significant operations. - Qualify external unrelated comparable observations used in CUP method for commodity exports so that they are publicly issued by independent and reputable sources. - Limit type of TP adjustments for grain exports to, for example, quality of commodity and freight costs. - Clarify that complying with information release when applying a TP method other than CUP on grain exports, tax authority can nevertheless modify profit margin or revert to CUP. ### New guidance on risk - Risks assumed in entering a controlled transaction are a comparability factor to find a market benchmark; identifying these risks is complex and partly depends on contract drafting among related parties. - The OECD BEPS report on TP (Actions 8-10) attempted to limit discretion in risk allocation based on each affiliate’s capacity to assume the risks and their ability to control them. Control of risk is a vague concept; OECD TP Guidelines remit it to the party in charge of decision-making. - The MoF draft proposal updates legislation with the new OECD standards and reproduces weaknesses (Article 39.2.2.5). - Suggested safeguards: - Condition risk profile of an individual affiliate to also comply with the ‘rational business reason’ principle. - Focus comparability analysis on business traits and functions normally observable in independent firms. - Eliminate from current law references to “implementation of strategic management”, “price policy” or “strategy of production and sale” as examples of functions that may indicate risk assumption. Recommendations (from source) - Condition risk profile of an affiliate to ‘rational business reason’. - Eliminate from current law references to “implementation of strategic management”, “price policy” or “strategy of production and sale’ as examples of functions that may indicate risk assumption. ### Country-by-Country Reporting (Action 13) - BEPS Action 13 developed new TP documentation requirements for MNEs: country-by-country (CbC) reporting. - CbC reporting under BEPS Action 13 applies only to globally significant MNEs based on an annual group turnover of €750 million. - Intended filing mechanism: CbC Report filed only with the jurisdiction where the global parent company is resident, with automatic exchange to other jurisdictions where the MNE operates. - Potential limitations on Ukraine’s ability to receive CbC Reports: 1. There may be no obligation under the tax law of the parent company’s country of residence to file a CbC Report. 2. Ukraine may not have an information exchange arrangement with the parent company’s country of residence. 3. Even if there is an information exchange arrangement in place, there may be delays in the CbC report being exchanged with Ukraine. - BEPS Action 13 allows a MNE to appoint a “surrogate parent entity” to prepare and submit the CbC Report where the parent company’s jurisdiction imposes no obligation. - The draft transfer pricing legislation obliges a resident taxpayer belonging to an international group with an annual turnover of €750 million or more to file the group’s CbC report with the SFS in the following cases (Article 39.4.10 of the Tax Code): 1. The resident taxpayer is the parent company of a globally significant group. 2. The resident taxpayer is the surrogate parent company of a globally significant group. 3. The resident taxpayer is a member of a globally significant group and there is no obligation on the parent company to file a CbC Report to its country of residence and no surrogate parent company has been appointed. 4. The resident taxpayer is a member of a globally significant group and there is no information exchange between parent company’s country of residence and Ukraine or, if there is, parent company’s country of residence has repeatedly failed to comply with information exchange requirements with Ukraine. - Concern: (3) may be overly burdensome because a Ukraine resident subsidiary may be unable to compel the global parent company to provide necessary information. - The transfer pricing rules specify an additional CbC reporting obligation on Ukraine MNEs with an annual global turnover of USD50 million or more; this is a purely domestic matter for Ukraine. - If imposed, the obligation must have a clear reason and should not be overly burdensome. - It has been suggested that this obligation be separated from CbC reporting; mission was advised this may reduce enactment prospects. Recommendations (from source) - Reconsider the feasibility of asking a Ukraine subsidiary of a globally significant MNE to file a CbC Report when no report is required to be prepared by the parent company and no surrogate parent company is appointed. - Ensure that the obligation on Ukraine MNEs with turnover between USD50 million is not an overly burdensome obligation. ### Mutual Agreement Procedures (Action 14) - Ukraine is a member of the Inclusive Framework (IF) and must adopt BEPS minimum standards; Action 14 on MAPs is a minimum standard requiring inclusion of Article 25(1)-(3) of the OECD Model Tax Convention in DTAs. - The MoF proposed draft text to include MAP regulation in the Tax Code to enable compliance with BEPS Action 14 minimum standard. - BEPS Action 14 objectives: - Treaty obligations with regards to MAP are fully implemented; - Administrative processes to do so are in place; - Eligible taxpayers have access to MAP. - BEPS Action 14 Report also proposes compulsory arbitration as an option; Ukraine has incorporated arbitration in several treaties but did not opt for the arbitration clause in the MLI. Delaying compulsory arbitration may be prudent while Ukraine builds MAP experience. - Ukraine has limited MAP experience: only one MAP concluded (2018) and no additional requests in the pipeline. - A well-defined relationship between the competent authority (the MoF) and the SFS is important; MoF lacks technical capabilities to assess many issues (e.g., bilateral APAs) and delegation rules are absent. - Competent authority powers are substantial; SFS should have a voice in the MAP process and resolutions must justify and record deviations from the SFS position. The Powers of the Competent Authority (observations) - Administrative regulations are needed to prevent random or arbitrary delegation that skips SFS expertise. - Resolutions by the competent authority should not operate outside institutional checks and balances. Corresponding Adjustment - Draft law allows taxpayer to request the “controlling authority” (presumably the SFS) to authorize a ‘corresponding adjustment’ mirroring a foreign related party’s TP change—this adjustment should be authorized by the SFS rather than done spontaneously by the taxpayer. - Draft law language should be more consistent; Articles 39.5.5.1 - 3 should: - Do not define the corresponding adjustment as a “right”, rather refer to the taxpayer’s right to ‘request’ a corresponding adjustment. - Grant the right to request the corresponding adjustment to the ‘taxpayer’ and not to a “party of the controlled transaction”. - Define who is the ‘controlling authority’, and this should be the SFS. - Base the right to request a corresponding adjustment on domestic law. - Establish that the request can be made to the SFS when the foreign resident entity has made its own adjustment, not when the foreign resident notifies the ‘intention’ to make the adjustment. - Footnote: The adjustment can be documented with a filed modified tax return by the foreign resident. MAP and Other Remedies - If a corresponding adjustment is rejected by the controlling authority, the taxpayer can request a MAP to the competent authority, “irrespective of remedies provided by the Code” (Article. 108.1.1). - The draft law is unclear whether the taxpayer can proceed simultaneously with other remedies and MAP, including litigation. - Recommendation: taxpayers should not be allowed to pursue MAP simultaneously with other remedies, including litigation. If MAP concludes with no agreement, the taxpayer should not be able to resort to other administrative remedies, except for litigation; this should be clarified in the Tax Code. Who Can Request MAP - Proposal allows both resident and nonresident parties to a controlled transaction to request a MAP (Article 108.1.2). - Alternative approach: require parties to go through their competent authority to request MAP; this may reduce frivolous cases and is permissible under BEPS minimum standard. - Given resource constraints, the second option (competent-authority-only initiation) should be preferred in Ukraine, but the MoF has ratified MLI having chosen the other option. When to Request a MAP - Draft law allows MAP requests “before or after a tax audit”, which would disallow them at any stage during an audit (Article 108.2.1). - Article 108.2.2 reads: “... the decision of tax assessment ... shall not be approved until completion of MAP ...”, which could be interpreted to allow MAP to interrupt an audit in progress. - Clarification needed: - If MAP can interrupt an audit, it should not suspend an audit before the summary of findings is issued to the taxpayer so the competent authority has the SFS’ formal position. - MAP should not become an instrument to stop audits before SFS can assess and provide findings; MAP is for resolving double taxation disputes, not replacing the audit process. *Source: IMF staff report excerpt (1ukrea2019005 - pages 64–71).* ### 193. Another cause for concern is how MAPs affect (or not) the statute of limitations. ### Another cause for concern is how MAPs affect (or not) the statute of limitations. ### MAPs and the statute of limitations - The draft law establishes that the tax audit would be suspended while the case is taken up for MAP (to be renewed if negotiations fail), but the version reviewed by the mission says nothing explicit about suspending the statute of limitations. - Without a rule that suspends all statute of limitations during MAPs, there would be no guarantee that the audit could be finalized if a MAP lasts long enough and does not find a solution to the dispute. - This could create an incentive for taxpayers requesting MAPs for the sole objective of playing the clock against the tax auditors. - The statute of limitations for TP audits in Ukraine is seven years. It could be expected that MAP cases would be resolved before that long (targeted average period to solve a MAP by Action 14 is two years). However, not all cases taken up by MAP are about TP and all other cases have a statute of limitations of three years. ### Taxpayer rejection of MAP outcomes and implications - The draft law explicitly allows taxpayers to reject in the end any agreement reached by the tax authorities under MAP. - If a taxpayer rejects a MAP agreement, the agreement per se arguably should be left to stand and the taxpayer should be notified accordingly, but the affected entity could still choose to litigate the MAP outcome against a position that has officially resolved double taxation. - The mission recommends eliminating the text in Articles 108.5.4 -5 that allow the taxpayer to terminate the MAP because it disagrees with the outcome. This would preserve the ability of a competent authority (in agreement with its taxpayer) to terminate a MAP at any time while preventing unilateral taxpayer termination based solely on disagreement. ### Recommendations on MAPs (as presented) - Clarify that MAP cannot stop an audit before the SFS has issued summary of findings. - Develop administrative regulations on how the MoF will delegate the competent authority for resolving MAPs. - Clarify the language in the proposed text so that taxpayers have the right to request a corresponding adjustment, not the right to the adjustment. - Trigger corresponding adjustment requests with an actual adjustment made by a non-resident, not just with notifying the intention of doing it. - Allow the taxpayer to access MAP without having exhausted other means of dispute resolution but he/she should not be allowed to pursue them simultaneously. - Opt whenever possible for MAPs to be initiated only through bilateral competent authority negotiations. - MAP should not suspend an audit before the SFS has issued its summary of findings. - Make sure that the statute of limitations is suspended for audits while MAP is being negotiated. - Do not expand in further agreements the acceptance of the arbitration option. ### Appendix I — Tax Treaties and the Multilateral Instrument (Action 15): key points - A tax treaty is an international agreement between two or more countries (“Contracting States”) that allocates taxing rights in respect of income or gains arising from economic activity occurring between the Contracting States. - Ukraine is a party to 73 tax treaties currently in force. - 70 tax treaties were negotiated by Ukraine as a sovereign nation and 3 treaties of the former USSR continue to apply to Ukraine as the successor to the USSR. - Implementation of BEPS recommendations, particularly Action 6 (abuse of treaty), Action 7 (avoidance of PE), and Action 14 (MAP), will require amendments to existing tax treaties. - BEPS Action 15 developed the MLI as the mechanism for timely implementation of BEPS treaty amendments to existing tax treaties, avoiding resource-intensive bilateral protocols. ### Strategy for MLI implementation and treaty policy - Ukraine signed the MLI on July 23, 2018 and has recently lodged the instrument of ratification with the OECD. - The MLI is complex and requires careful consideration of implications for existing tax treaties and negotiation of future treaties; implementation should be part of a broader tax treaty policy and updating of the Ukraine Model Treaty. - It is desirable to impose a moratorium on negotiation and signing of new tax treaties to allow MoF to focus on developing tax treaty policy, updating the Ukraine Model Treaty, and applying the MLI to existing tax treaties. ### Tax treaty policy components and partner selection - The tax treaty policy should include: - (1) clear guidelines for choosing treaty partners; - (2) a baseline for negotiations; - (3) the use of the Ukraine Model Tax Treaty in negotiations; - (4) the preparation of a Tax Treaty Impact Statement once a treaty has been negotiated but before it is signed. - Guidelines for choosing treaty partners: - Consider current level of trade and investment into Ukraine from the potential treaty partner; significant trade/investment justifies negotiation, little or no trade/investment requires greater care and investigation. - Prohibit negotiations with any country whose tax rules or practices pose a revenue risk to Ukraine (e.g., countries with no income tax, preferential regimes for foreign income, or territorial taxation). - Ensure treaty benefits are limited to genuine residents of the other Contracting State to avoid treaty shopping. - Inclusion of an anti-treaty shopping rule (such as a “LOB” Article) limits treaty shopping but will not necessarily counter all abuses, particularly in relation to services. ### Baseline for negotiations (minimum treaty content) - At a minimum a treaty should include the following: - A positive rate of tax on dividends, interest, royalties, and management and technical fees. - The taxation of indirect transfers of immovable property in Ukraine as provided for in Article 13(4) of the Model Treaties. - An anti-abuse rule. - Deviation from the agreed baseline in one treaty risks creating pressure to extend the same benefits in future treaties. ### Model Tax Treaty and updating the Ukraine Model - Ukraine’s Model Tax Treaty was prepared in 2005 and largely follows the UN Model; it needs updating for BEPS changes and should be integrated with tax treaty policy. - The latest versions of the OECD Model and UN Model were published in 2017 and include amendments relating to BEPS Actions 6, 7, and 14. - Key differences in the UN Model (relative to OECD Model) include: - Broader definition of PE with inclusions such as services PE, delivery agent, insurance, a shorter period (183 days) for construction PE, and supervisory services as a construction PE. - Application of a limited force of attraction principle for PE profit taxation (Article 7(1)). - PE profit attribution rules based on pre-2010 OECD Model allowing functional separate entity or relevant business activity approaches (Article 7(2) and (3)). - Source taxation of royalties permitted subject to a rate limit (Article 12); definition of “royalties” includes equipment lease payments (Article 12(3)). - Source taxation of fees for technical, management, or consultancy services permitted subject to a rate limit (Article 12A). - Retention of a separate Article for independent personal services (Article 14) rather than treating them as business profits under Article 7. - Retention of the right of the source country to tax “other income” sourced in the country under domestic law. - Given Ukraine’s emerging economy status, it is preferable that the Ukraine Model continues to be based largely on the UN Model, though it may be a mix of OECD and UN Models with greater reliance on UN to protect source taxation. ### Tax Treaty Impact Statement - Before signing a treaty, prepare a Tax Treaty Impact Statement to facilitate cost/benefit analysis, including: - (1) Reasons for choosing the treaty partner, including current volume of trade and investment. - (2) Assessment of how the treaty will increase trade and investment or otherwise lead to closer economic relations. - (3) Statement of any other benefits to Ukraine. - (4) Quantification of potential revenue loss for Ukraine under the treaty. ### Implementing the MLI — mechanics and recommended scope - A signatory to the MLI is a “contracting jurisdiction”; an existing treaty to which the MLI applies is a “covered tax agreement” (CTA). - A contracting jurisdiction must implement BEPS minimum standards (limitation of benefits and improving dispute resolution); it can opt out of other MLI provisions generally or for particular CTAs. - The MLI applies to an existing treaty only if both contracting jurisdictions have signed the MLI and agree on its scope of application to that CTA. - The MLI modifies the application of a limited number of Articles in a CTA and may add provisions; in case of conflict between treaties, the later-in-time instrument prevails. - The mission was advised Ukraine intends to implement only the minimum standards, and Article 9 of the MLI dealing with taxation of indirect transfers of immovable property. - In relation to entitlement to benefits, Ukraine intends to adopt only the principal purposes test (PPT). ### Additional optional MLI provisions recommended for Ukraine - It is recommended Ukraine adopts two other optional provisions in the MLI to protect against tax avoidance: - (1) The application of a 365-day holding period before a non-resident qualifies for the lower 5 percent tax rate on participation dividends under Article 10 of tax treaties (Article 8 of the MLI). - The holding period will ensure that the lower treaty rate does not apply to corporate shareholders in non-resident companies that engage in certain short-term share acquisitions (such as under securities lending arrangements). - (2) Amending Article 4 of tax treaties to permit the treaty residence of a dual residence company to be determined through mutual agreement based on place of effective management, place of incorporation or formation, or any other relevant factors (Article 4 of the MLI). - This is relevant for Ukraine because it uses place of incorporation as the sole test of corporate residence and the current tiebreaker rule in Article 4(2) of tax treaties will rarely apply to allocate residence to Ukraine. ### Limitations of the MLI and further treaty work - The MLI does not address all weaknesses in Ukraine’s current tax treaties; several current treaties include a zero rate on dividends, interest, or royalties. - PPT and/or LOB will limit treaty shopping abuses under zero rates, but zero rates can only be fully addressed through renegotiation or a protocol to the treaty. - The MoF is understood to be prioritizing renegotiation of such treaties; development of a treaty policy and updating of the Ukraine Model will help identify non-MLI issues with existing treaties. ### Recommendations on tax treaties and the MLI (as presented) - Develop a Tax Treaty Policy including guidelines on treaty partners, a baseline for negotiations, and the preparation of a Tax Treaty Impact Statement. - Update the Ukraine Model Treaty for BEPS changes to tax treaties and align the Ukraine Model Treaty with the UN Model 2017. - Reconsider the scope of application of the MLI to existing treaties once the tax treaty policy is developed and the Ukraine Model updated to ensure that, as far as possible, there is consistency between existing treaties and future treaties. - Put a moratorium on negotiating new tax treaties until after the tax treaty policy is developed and the Ukraine Model updated. - (Note: This may require a modification to the instrument of ratification.) *Source: IMF mission review text as provided in the content unit.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019005.pdf_