## 1ukrea2020003 ## Source details **Canonical URL:** [1ukrea2020003](https://www.imf.org/-/media/files/publications/cr/2020/english/1ukrea2020003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1ukrea2020003.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1ukrea2020003.pdf.json) --- ### Mission composition and stakeholders engaged - Remote IMF Fiscal Affairs Department (FAD) mission, initially programmed for June 30 – July 13, then extended to July 21, 2020. - Mission team: Messrs. Roberto Schatan (mission head), Martin Grote (FAD); Messrs. Lee Burns and Oscar Molina (external experts). - Presentation of aide memoire and recommendations to Minister of Finance Mr. Sergii Marchenko. - Ukrainian counterparts: Ministry of Finance (Deputy Minister Ms. Svitlana Vorobey; Messrs. Roman Goptsii, Yevhen Kozlov, Kostiantyn Penskoy; Ms. Liudmyla Palamar; Victor Orcharenko; Mr Andrii Khomutskii; Ms Olena Markevich), State Tax Service (Igor Danylov, Tetiana Radchenko, Mr Viacheslav Krugliak), Presidential Office (Ms Olena Diachenko), National Bank of Ukraine (Mr Oleg Strynzha). - Private-sector video conferences: European Business Association, American Chamber of Commerce, KPMG, Deloitte, EY, PwC and Cargill. - Support: Mr. Ihor Shpak (IMF Kiev office) and interpreter Ms. Iryna Krupska. ### Core executive-summary findings (high level) - Ukraine is simultaneously pursuing tax modernization (aligning international income tax aspects to OECD standards) and fundamental reform proposals to replace the Corporate Profit Tax (CPT) with a Distributed Profit Tax (DPT) / Exit Capital Tax (ECT). - Central ECT/DPT concept: defer taxation of corporate profits until distribution as dividends to shareholders. - Prior FAD position against ECT adoption because it would: - lead to a significant loss of revenue; - be fundamentally regressive; - be complex to control; - provide no evidence of fostering investment growth. - Partial/phased ECT adoption risks: - corporate splitting to exploit thresholds; - profit shifting via transfer pricing (no legal ALP obligation for domestic transactions); - diversion rather than net increase in investment; - pilot results may be misleading if extrapolated nationally. - Recommendation: evaluate recently adopted accelerated depreciation of fixed investments before adopting ECT. ### Voluntary Disclosure Program (VDP) — assessment and recommendations - Purpose: allow taxpayers to regularize assets (foreign and domestic) that evaded income tax for a fee; make future income visible to STS. - Political timing: entry into force of Controlled Foreign Company (CFC) regime creates an opportunity for taxpayers with foreign-held assets to regularize. - Mission review of VDP Policy Draft of 3 July 2020: noted improvements (market-related valuations by certified valuers in asset country; removal of zero fee for converting repatriated assets into government bonds; strengthened forfeiture where proceeds relate to crime). - Further recommended improvements: - Exclude politically exposed persons (public office bearers, their family members, and close associates) from VDP eligibility. - Clarify how financial institutions will apply AML/CFT controls on repatriating clients. - Increase the 2.5 percent Fee on funds invested in Ukrainian government stock to at least 5 percent (rate currently in Tax Code). - Features recommended for elimination: - Remove UAH 400,000 permanent amnesty provision allowing undeclared assets up to that amount to be regularized without questions. - Remove provisions regularizing some assets without value caps (apartments/houses under 120 m2, industrial buildings/land plots below specific surface areas, one vehicle regardless of value). - Operational recommendations: - Require payment of applicable VDP fee at time of filing (or deposit before application); forfeit paid fees if origin relates to crime. - Prohibit impersonal notary applications for PEPs; impose sanctions on notaries who assist laundering. ### VDP fee structure (as in draft) - One-time declaration fee proposals: - 9 percent on financial instruments in foreign bank accounts and property registered abroad. - 5 percent on financial instruments held in Ukrainian bank accounts with balances kept until end of VDP, and on property and other assets located in Ukraine. - the full PIT rate of 18 percent on cash to discourage cash holdings. - 2.5 percent of the nominal value of government bonds of Ukraine with a maturity of 12 months without the right of early redemption, purchased before submission of the one-time declaration. - Mission view: - 2.5 percent levy on government bonds is too generous and should be increased to at least 5 percent; treat bond levy similarly to repatriated bank balances. ### De minimis thresholds and asset regularization - Draft thresholds and contrasts: - Current draft: de minimis cap for financial instruments at UAH 400,000. - 2019 draft: UAH 1 million. - Draft Law 1232: UAH 30,000. - Draft provides automatic legalization for certain domestic immovable property categories: - apartment/flat total area not exceeding 120 m2; - dwelling house/industrial building area not exceeding 500 m2 (apparently to be lowered to 300 m2); - land plot not exceeding norm of gratuitous property transfers under art 121 Land Code of Ukraine; - one motor vehicle intended. - Mission concerns: - De minimis threshold creates an “amnesty within an amnesty”; mission prefers all foreign assets disclosed with ad valorem fee applied. - Thresholds reflect weakness in STS access to cadasters; recommend improving cadasters rather than blanket regularization. ### VDP administration and lessons from South African amnesty - South African experience (Box 1 and Box 2) lessons: - Amnesty Unit had no investigative powers and relied on applicant attestations; rejected cash balances and cash fee payments; processed 43,000 applications with major end-period surge. - Operational needs: electronic systems, provisional/final letters, flexible payment periods, refund controls, inclusion of companies/trusts, and longer amnesty duration (recommendation to extend to up to 12 months). - Financial outcome: levies of some R3 billion (2003: approximately USD 387.5 million in current value). - Ukraine-specific administrative challenges: - Unclear centralized vs regional STS administration; risk of diverting staff from normal collection duties. - Asset valuation, fee collection, repatriation delays, and reporting obligations need clear design. - Mission recommendations (paragraph 42): - Exclude all PEPs and close associates from VDP. - Oblige financial institutions to apply full AML/CFT controls and report suspicious transactions. - Prioritize AML/CFT controls; require VDP fees paid before or at filing (no reimbursement if subsequent investigations reveal crime). - Increase bond levy from 2.5 percent to at least 5 percent. - Do not grant permanent blind amnesty up to UAH 400,000; resolve unregistered properties via cadastral program and consider indirect method flexibility. ### Indirect method for estimating taxable income — support, design, and caveats - Mission supportive of adopting an indirect/presumptive method to increase STS enforcement power by shifting burden of proof to taxpayers when discrepancies exist between reported income and third-party evidence. - Core operational effect: - discrepancies between reported income and third-party evidence give rise to presumptive “deficiency of tax” unless taxpayer rebuts with documentation. - Benefits: - Heightens taxpayer perception of risk; encourages voluntary compliance and VDP participation. - Key legal/operational limitations in Ukraine: - Banking secrecy restricts STS access to financial data; STS can obtain banking information only with judge authorization on a case-by-case basis — severely diminishing large-scale indirect method effectiveness. - With limited third-party info, indirect method risks arbitrary application. - Legal design recommendations: - Legislate the indirect method with clear presumptive income parameters and rebuttal documentation; preserve taxpayer rights to contemporaneous information and challenge. - Consider using the financial sector regulator as intermediary for STS access to banking information instead of courts. - Consider phasing: either make indirect method independent of VDP or defer indirect method by one year to allow VDP operation. - Operational procedure (Box 5 and paragraphs 61+): - Basic formula (procedural steps preserved): From third party sources determine total cash expenditure during fiscal year; add known increase in cash on hand at end of period; less nontaxable receipts (e.g., transfers between own accounts, loans) = corrected gross receipts; less gross receipts as per declaration = understated income. - STS must access data on bank deposits (business/personal), loans, and financial institutions including credit unions and investment trusts. - Recommend automated/machine checking against third-party data with pre-established parameters and routine invitation letters to taxpayers to self-correct before audit. - Safeguards: clear regulations on indicators, rebuttable presumptions, evidentiary standards (inheritances, loans, documentation requirements). - Preconditions for effective VDP and indirect method: - good registries of real estate and movable property; easier STS access to financial information; strong confidentiality guardrails; ongoing exchange of information; indirect method in law. ### Cadasters, property registers, and alternatives to broad regularization - VDP substitutes for incomplete cadasters, but voluntary real-estate disclosure unlikely to solve overlapping title problems. - Recommendations (Appendix I, Box 3): - Elevate cadastral registration as high-priority central government initiative; allocate adequate multi-year resourcing. - Develop centralized legal cadaster and decentralized fiscal cadasters using satellite imagery and on-the-ground follow-up; link power utility electricity connections to owner tracing. - Anti-avoidance proposals: make avoidance of title registration punishable; prevent registration before payment of transfer/stamp duties and outstanding property taxes; exclude immovable property from amnestied thresholds. - Create a common property identifier (PIN) and IT/GIS-centric platform; consider Ministry of Finance coordination. ### International tax measures — progress and recommended amendments (Law 466, Bill 2524) - Law 466 (May 2020) enacts UTC provisions implementing BEPS Actions 3, 4, 6, 7, 8-10, 13, and 14. - Place of Effective Management (PEM) residence test: - New Article 133.1.5 treats a foreign-formed legal entity with its PEM in Ukraine as a resident for CPT purposes only (taxed on Ukraine-source income), potentially undermining CFC rules. - Recommendation: repeal PEM residence option; if retained, apply self-executing basis and review for BEPS Action 5 breach. - Controlled Foreign Company (CFC) rules (Article 39²): - Generally well designed but have weaknesses and exemptions to amend. - Substantial shareholder threshold: Law 466 reduced to more than 10 percent (report recommends consistent application); Bill 2524 proposes phasing: 25 percent for 2022 and 2023 reporting years, 10 percent after 2023. - Recommendations: - Apply CFC rules to resident individuals. - Narrow “active” passive income exemption; limit to specified cases (examples: banking/insurance interest where entity is regulated bank/insurer; royalties from IP actually developed by CFC; rental income with substantial property management). - Repeal exceptions for settlor/founder of foreign trusts; treat settlor/founder as controller in all cases. - Repeal lower tax rate on timely CFC distributions (distribution concession of 9 percent). - Link liquidation/distribution concession to VDP payment so exemption applies only where VDP fee is paid. - Treat change in residence from CFC to PEM resident as a deemed dividend to the extent of untaxed CFC profits. - Align control thresholds under Article 39 2 .1.2(a) and (b) (report prefers "50 percent or more"). - Allow foreign tax credit (FTC) for Ukrainian tax paid by a CFC on Ukraine-source income included in CFC taxable profit. - Exempt dividends paid between CFCs with a common Ukraine controller from CFC taxation; introduce dividend ordering rules. - Indirect transfer of immovable property: - Law 466 taxes gain on indirect transfers; revised withholding rule: for two non-resident parties purchaser must withhold 15 percent of sale price. - Concerns: purchaser may not know seller’s cost; enforcement challenging when both parties non-resident. - Recommendations: - Insert 365 day test period (done), eliminate 50 percent ownership threshold, and include direct/indirect ownership in relation to immovable property (report notes only 365 day test was adopted). - Define "immovable property" to expressly include mining and petroleum rights and production sharing contracts. - Prefer collection by requiring owner of Ukrainian immovable property to pay tax on behalf of non-resident seller. - Do not include a corporate reorganization exception. ### Transfer pricing (TP), business-purpose test, commodities, and thin capitalization - Transfer pricing improvements in Law 466: related-party threshold increased from 20 to 25 percent; commodity pricing aligned with BEPS Action 10 (CUP preferred). - Commodity pricing specifics and recommendations: - Use CUP preferably; permit "quoted prices" from recognized agencies. - Administrative regulations should list agencies (examples: Bloomberg, Thomson-Reuters, Platts, Argus Media). - Limit commodity list initially to wheat, corn, soybean, sunflower oil. - Limit allowable adjustments to freight, insurance, port costs and quality differences; define “average” and “range of quotation prices” and “range of ranges.” - Business restructuring: - Law 466 limits TP application to restructurings that reduce financial result — report recommends eliminating reference to “negative impact to financial results” so TP applies symmetrically. - Business purpose test: - Law 466 defines business purpose as economic gain or preservation/increase in asset value; treats transactions without reasonable economic cause as lacking business purpose when main purpose is tax reduction or when an independent person would not engage in transaction. - Mission concerns: - Law 466 links business purpose to actual results, which is problematic; independent parties can engage in loss-making transactions. - Law 466 applies business purpose test to all transactions with non-residents — overreach; recommended to limit test to controlled transactions. - Omission of “realistically available options” weakened the test; Bill 2524 proposes adding this concept and delinking test from actual results. - Report recommendations: - Redefine business purpose to focus on objective rationale, not actual results. - Limit application to controlled or deemed controlled transactions (including goods). - Treat test as an aid to ALP application; if no business purpose, non-recognition should apply rather than self-adjustment. - Do not allow self-adjustment as remedy for failing business purpose test; remedy should be non-recognition. - Thin capitalization: - Law 466 expands thin cap to include debt with all non-residents; deduction disallowed where debt exceeds 3.5 times equity and then limited to 30 percent of taxable profits (second threshold lowered from 50 percent of EBITDA). - Report suggests 3.5 ratio is high; consider lowering toward 2 to 1 or using a single profit-based cap. - Bill 2524 proposes excluding debt with foreign banks from thin cap; report warns back-to-back loans may circumvent rules. - Interaction with ALP: ALP applies but thin cap supersedes where thin cap yields stricter limit. - Recommendations: - Lower debt-to-equity ratio (consider 2:1). - Clarify scope (all debt vs debt with non-residents) and interaction with ALP. - Remove exceptions for international financial organizations and ensure Ukrainian taxpayers dealing with such entities comply with TP and thin cap. ### Permanent Establishment (PE) and Place of Effective Management (PEM) - Law 466 updates PE definition to align with OECD/UN Models and BEPS Action 7; includes anti-fragmentation rules and revised agency PE rule. - Construction PE: - Law 466 sets construction PE time limit to 12 months (Bill 1210 had 183 days). Report notes most Ukraine treaties use 12 months but many partner treaties have 6 or 9 months; suggests reverting to 183 days (6 months / 183 days) to preserve bargaining power. - Services PE: - Recommendation: extend services PE paragraph (b) to non-resident individuals providing services on their own account and to services provided by employees/contractors to align with UN Model. - Attribution to PE: - Adoption of functionally separate entity approach consistent with OECD; recommendation to retain flexibility to modify allocation when other country uses different methodology to limit double taxation/double non-taxation. - PE registration: - New Article 64.5 requires registration where non-resident carries on business through a PE, has interest in Ukraine immovable property, or opens a Ukraine bank account. - Recommendation: require registration for all PEs (including agency PEs) and require tax representative appointment for non-residents without physical presence. ### Appendix II — Mexico’s legislation on indirect method (summary) - Mexico’s Tax Code (Articles 55–62) provides detailed triggers, presumptions, reconstruction procedures, and evidentiary presumptions for presumptive determinations including use of third-party information, daily-average reconstruction methods (30-day or 7-day rules), and specific presumptions for unrecorded acquisitions and inventory shortfalls. - The mission references Mexico’s law as an operational example for Ukraine’s indirect method design. *Source: IMF staff report text from content unit 1ukrea2020003 (PREFACE and selected chapters, including mission composition, executive summary, VDP assessment, indirect methods, international tax measures, transfer pricing, CFC, PE, cadasters, and appendices).* ### PREFACE __________________________________________________________________________________________ 5 ### PREFACE ### Mission composition and stakeholders engaged - The mission was a remote technical assistance mission from the IMF’s Fiscal Affairs Department (FAD), initially programmed for June 30 – July 13, and then extended to July 21, 2020. - Mission team: Messrs. Roberto Schatan (mission head), Martin Grote (both from FAD), and Mr. Lee Burns and Mr. Oscar Molina (external experts). - The mission presented the aide memoire and recommendations to the Minister of Finance, Mr. Sergii Marchenko. - Ukrainian Ministry of Finance participants included: Deputy Minister Ms. Svitlana Vorobey; Messrs. Roman Goptsii, Yevhen Kozlov, Kostiantyn Penskoy; Ms. Liudmyla Palamar; Victor Orcharenko; Mr Andrii Khomutskii; Ms Olena Markevich. - State Tax Service (STS) participants included: Igor Danylov, Tetiana Radchenko, Mr Viacheslav Krugliak. - Additional participants: Ms Olena Diachenko (Presidential Office), Mr Oleg Strynzha (National Bank of Ukraine). - Private sector video conferences held with: European Business Association, American Chamber of Commerce, KPMG, Deloitte, EY, PwC and Cargill. - The mission acknowledged support from Mr. Ihor Shpak (IMF Kiev office) and interpreter Ms. Iryna Krupska. ### Core executive-summary findings (high level) - Ukraine’s tax policy debate is simultaneously pursuing modernization (including aligning international income tax aspects to OECD standards) and fundamental reform proposals, notably to replace the Corporate Profit Tax (CPT) with a Distributed Profit Tax (DPT), generally referred to in Ukraine as the Exit Capital Tax (ECT). - The central concept of the ECT/DPT: not taxing profits as they accrue to the corporation, deferring tax to when the corporation distributes dividends to the shareholder. - Prior FAD position: argued against adoption of the ECT because it would: - lead to a significant loss of revenue; - be fundamentally regressive; - be complex to control; - provide no evidence of fostering investment growth. - A partial or phased adoption of the ECT (e.g., for small taxpayers or select regions) raises significant risks: - Incentives for companies to split up to exploit the system. - Profit shifting through transfer pricing (no legal ALP obligation for domestic transactions). - Diversion of investments rather than net investment increases. - Monitoring a pilot ECT program could be highly misleading if extrapolated nationally. - Ukraine has recently adopted accelerated depreciation of fixed investments; this targeted incentive should be allowed to generate expected results instead of adopting ECT. ### Voluntary Disclosure Program (VDP) — assessment and recommendations - Purpose of the VDP: allow taxpayers to regularize, for a fee, financial or physical assets that have evaded income tax; grow future tax base as income from declared assets becomes visible to the STS. - Political case for timing: entry into force of Controlled Foreign Corporation (CFC) regime creates an opportunity for taxpayers with foreign-held assets to regularize obligations. - VDP covers foreign-held assets and domestic assets. - The mission reviewed VDP Policy Draft of 3 July 2020 and noted improvements versus prior drafts: - Market-related valuations must be undertaken by certified valuers in countries where assets are located. - No longer a zero fee for converting repatriated foreign assets into Ukrainian government bonds. - Strengthened guarantees that proceeds of crime and bribery cannot be concealed: fees paid for declared assets may be forfeited if the VDP supervisory authority subsequently establishes that origin relates to crimes. - Further recommended improvements: - Politically exposed persons (public office bearers, their family members, and close associates) should not qualify for the VDP. - Clarify how financial institutions will apply strict anti-money laundering and counter-finance of terrorism controls on clients repatriating assets. - Increase the novel 2.5 percent Fee on funds invested in Ukrainian government stock to at least 5 percent, a rate currently in the Tax Code. - Features recommended for elimination: - The draft allows for UAH 400,000 in undeclared assets to remain untaxed and regularized without questions, even if the person does not submit the one-time asset declaration — described as a “permanent amnesty” up to that amount. - Thresholds not always binding: some assets in Ukraine can be regularized without a value cap (apartments, houses under 120 sq. m, industrial buildings and land plots below a certain surface area, and one vehicle regardless of value). - The mission does not consider a permanent amnesty a good practice, and views improvements to cadasters and use of indirect methods as preferable instruments to address unregistered property. ### Indirect method for estimating taxable income — support and caveats - The mission is supportive of adopting an indirect method for estimating taxable income in Ukraine to significantly increase STS enforcement power. - Core operational effect: shifts burden of proof to the taxpayer; discrepancies between reported income and third-party evidence would require the taxpayer to document that additional items are non-taxable, otherwise STS may assess a “deficiency of tax.” - Indirect method’s benefits: - Heightens taxpayer perception of risk. - Encourages voluntary compliance and VDP participation. - Key limitation for Ukraine: access to taxpayers’ financial information is restricted by financial secrecy law; STS can obtain such information only with a judge’s authorization on a case-by-case basis. - This severely diminishes effectiveness of the indirect method, which is most powerful with large-scale third-party data access. - With limited information, the indirect method can still operate but risks arbitrary application. - Legal design recommendations: - Indirect method must be clearly defined in law and regulations, including presumptive income parameters and documentation that can rebut STS presumptions. - Appendix 2 provides Mexico’s law on indirect method as an example (the report references this example). - Sequencing recommendation between indirect method and VDP: - The indirect method should increase risk perception and thereby encourage VDP participation; thus the indirect method should have independent access to information separate from the VDP. - Alternatively, the indirect method could be legislated to enter into force deferred by one year to open a window for the VDP to operate first. ### International tax measures — progress and recommended amendments - Law 466 (May 2020) enacts UTC provisions implementing BEPS Actions 3, 4, 6, 7, 8-10, 13, and 14, aligning UTC with international norms and protecting Ukraine’s tax base from international tax avoidance. - New test in UTC: Ukrainian residence of legal entities based on Place of Effective Management (PEM) in addition to place of incorporation. - A foreign-formed legal entity with its PEM in Ukraine can opt to be treated as a resident. - Problem identified: a PEM resident is taxed only on Ukraine-source income, which may unintentionally open opportunities to avoid CFC rules. - Recommendation: repeal the PEM residence test because of risks to the tax base and undermining CFC rules. - Controlled Foreign Company (CFC) rules: - Newly enacted CFC rules are comprehensive and generally well designed but contain weaknesses. - Recommended amendments: - Narrow the “active” passive income exemption. - Repeal exceptions applicable to a settlor or founder of a foreign trust. - Repeal the lower tax rate on CFC distributions made on a timely basis (creates incentive to invest outside Ukraine). - Law 466 provides an exemption: gains on disposal of an interest in a foreign entity are exempt from tax as an incentive to wind-up CFCs prior to commencement of CFC rules. - Recommendation: incorporate this incentive into the VDP so the exemption applies only if the relevant VDP fee has been paid. - Indirect transfer of immovable property: - UTC now includes taxing rights over gains arising from indirect transfers of immovable property, closing a loophole where non-residents could avoid tax by selling shares in entities holding Ukrainian immovable property. - The tax is to be collected by the non-resident purchaser withholding tax from proceeds of sale. - Report notes doubt about effectiveness of this collection mechanism and makes recommendations on alternative collection options. ### Transfer pricing (TP) and business-purpose test — appraisal and recommendations - Transfer pricing rules were considerably improved but need further technical refinements on commodity pricing, business restructuring, thin capitalization, and the business purpose test. - Law 466 adopts a business purpose test for all transactions with non-residents; as written: - Transactions that fail the test are effectively non-deductible, possibly including costs of sales. - Law 466 defines failure of the test when transaction was not profit-motivated or its actual result did not produce an economic gain. - Mission assessment: this is an overreach because independent parties can engage in transactions that produce losses; STS should not second-guess legitimate business decisions absent fraud. - Recommended approach: - Apply the business purpose test only in the context of controlled transactions required to comply with the Arm’s Length Principle (ALP). - Use the business purpose test as an aid in applying the ALP, particularly where independent comparables are unavailable, to determine whether transaction pricing should be disregarded or priced at arm’s length using the most appropriate method. - Bill 2524 (preliminary version reviewed by mission) largely restored balance by delinking the business purpose test from actual results; if the final Rada-enacted Bill did not include this correction, it should be reconsidered. - Reintroduce the business link requirement for deducting business expenses: - Historically (until 2014), Ukraine required deductible expenses to be connected to the business of the taxpayer. - The requirement was removed due to frequent conflicts and biased STS interpretations (requiring expense to generate actual profits rather than be necessary for business development). - Recommendation: consider reintroducing the business link requirement with clear operational rules, and limit the business purpose test exclusively to transfer pricing application. ### Boxes and appendices referenced in the content unit - Boxes in the report include case studies and operational examples (listed in the source), notably: - Box 1: Lessons from the South African Exchange Control Amnesty with Supporting Tax Measures - Box 2: Aspects of the South African Amnesty Legislation that were Difficult to Implement - Box 3: Updating Ownership Registers of Immovable Property in lieu of a VDP Process - Box 4: Legislation on Indirect Methods – the Case of Mexico - Box 5: A Basic Formula for an Indirect Method including Cash - Box 6: Disallowing the Deduction of Non-Business Expenses - Box 7: Understanding the Business Purpose Test in Transfer Pricing - Appendices: - Appendix I: Approaches to Develop and Maintain Up-to-Date Property Cadasters - Appendix II: Mexico’s Legislation on Indirect Method *Source: 1ukrea2020003 - PREFACE (IMF FAD mission preface and executive summary, including mission composition, main findings, and policy recommendations).* ### 1. The Ministry of Finance (MoF) requested to include in this report a critical review ### 1ukrea2020003 - 1. The Ministry of Finance (MoF) requested to include in this report a critical review ### A. New Momentum for the Distributed Profit Tax (DPT) / Exit Capital Tax (ECT) - Context and political drivers - The government of Ukraine is under renewed pressure to enact legislation substituting the Corporate Profit Tax (CPT) for a DPT, labeled in Ukraine as the Exit Capital Tax (ECT). - The National Reform Council, chaired by Mr. Saakashvili, is spearheading the effort; recent proposals in Poland for a similar scheme for small and medium sized taxpayers added impetus. - The ECT discussion is a continuation of long-standing tax policy debate and should be read together with previous ECT discussions by IMF missions (2017 and 2019 TA Reports). - Core technical assessments (as reflected in FAD (2019) Report and applicable to current initiatives) - The ECT: - Significantly erodes tax revenue; - Is regressive; - Adds complexity to the system; and - There is no evidence internationally that it would increase private investment. ### B. Compromise Proposals and Revenue Estimates - MoF central concern - MoF estimates any of the three registered bills on ECT would cost around UAH50 billion, which is almost half of CPT revenue or close to 4 percent of all tax revenue projected for 2020; therefore MoF would not support these reforms without compensating measures. - Rada Finance Committee proposal (small taxpayers threshold) - Proposed ECT for small taxpayers with sales up to UAH150 million. - Would benefit 97 percent taxpayers (legal persons) and cost the budget about UAH 8.5 billion (assumes static behavioral response). - MoF estimates potential revenue loss of about UAH13.5 billion per year if firms split to exploit threshold. - This proposal has not been formally registered as an initiative in Rada; a document was released for public comment. - MoF alternative (pilot by region) - Roll out ECT in only five regions with little business activity, restricting revenue loss to approximately UAH 1 billion, or 0.4 percent of total CPT revenue. - Intended as a pilot program to test whether the system increases investment before broader expansion. - Private-sector / IT industry proposal - Grant ECT in special economic zones for IT companies; MoF estimates revenue cost of UAH1.2 billion. - Industry claims distributing dividends equivalent to just 10 percent of industry profits would compensate CPT losses; mission notes uncertainty because ECT discourages dividend distribution. - Arguments invoked in favor of ECT under current conditions - COVID-19 economic stress cited as reason to provide low-cost loan capital and support small businesses through simplified tax obligations and lower administrative costs. - MoF view: accounting regulations and deemed dividends calculations make ECT intrinsically complicated. ### Discussion — Technical and Administrative Risks - Distributional and incidence concerns - FAD position: ECT is radical, changes incidence and administration of corporate tax; regressive because CPT currently falls principally on shareholders while ECT defers tax on profits, reducing likelihood shareholders pay. - Enforcement and administrative complexity - Enforcement under ECT is complicated; State Tax Service (STS) would face significant problems controlling that profits are not spent on behalf of shareholders without taxation. - Administrative motivations drive some proponents who seek reduced engagement with STS to avoid perceived discretionary enforcement. - Behavioral and transfer pricing (TP) risks - Partial ECT (e.g., small taxpayers only) creates incentives to split companies to gain tax benefits; magnitude of avoidance is hard to estimate. - Ukraine lacks transfer pricing regulations for domestic transactions; CPT firms could shift profits to ECT-related parties without arm’s length constraints, creating significant revenue risk. - ECT transfer pricing rules for deemed dividends apply only against profit shifting out of an ECT company, not for profit shifting from a CPT company into an ECT-related party. - Simplified Regime interaction - The Simplified Regime for small taxpayers has shortcomings and is itself complex; ECT would overlap with the Simplified Regime (including Group 3 legal persons), creating additional arbitrage opportunities. - Simplified Regime design should encourage formalization through deductible expenses and invoice use; ECT taxes distributed or deemed dividends where invoices are not relevant. - Risks of regional pilots and sectoral targeting - Pilot in a few regions may produce ‘false positive’ investment shifts from other regions (zero-sum), and results may not scale nationally. - Pilot programs create vested interests and competitive pressure for expansion, potentially producing inefficient capital allocation. - Benefiting specific sectors (e.g., IT) via ECT is selective industrial policy that is hard to justify; IT is mobile and hard to define. - Ukraine introduced accelerated depreciation in May 2020 (Law 466), a more robust and targeted tax incentive to increase investment across sectors — prudent to wait and evaluate its effect. - ECT vs. short-term liquidity needs - ECT is structural with long-term negative budget impact and not appropriate as a response to temporary shocks like COVID-19. - CPT provides automatic stabilizers: no tax when businesses have no profits and losses can be carried forward; revenues collected when profits return. ### II. Voluntary Disclosure Program (VDP) — Previous Advice and Key Policy Elements - Summary of 2019 TA Mission analysis and concurrence points - Objectives reflected in prior proposals: - Promote transparent ownership of foreign and domestic assets regardless of period owned. - Waiver by STS of outstanding taxes, penalties and interest during VD period to encourage declaration of foreign assets. - Institute an attractive VDP fee system as quid pro quo to part-compensate avoided/evaded taxes. - Introduce some horizontal fairness and prospectively grow Ukraine’s tax base; precursor to indirect control method for assessing personal income. - Key policy advice and positions: - Individuals already under investigation by STS should not be eligible to apply for VD; previous FAD advice against allowing applicants under audit remains unaccepted by authorities. - Mission concurred with a proposed 9 percent VDP Fee for disclosing foreign-held assets kept offshore to tax worldwide income on existing rates. - Mission concurred with proposed 5 percent VDP Fee for disclosed foreign liquid assets repatriated and deposited in Ukrainian bank accounts (fee differential maintained in subsequent drafts). - Mission advised against a zero percent Fee for repatriated assets reinvested in government securities; subsequent drafts increased this fee to 2.5 percent. - Full alignment of VDP and asset repatriation with AML and CTF preventive measures is an agreed minimum condition between the Fund and Ukrainian authorities. - Displaying enhanced tax administration collection and enforcement capacity prior to any amnesty is important; repeated amnesties harm long-term tax compliance. - Tax avoidance and evasion facilitators (legal persons) should be covered by the VDP to reveal avoidance structures; this has been incorporated into the revised 2020 draft. - Advice to establish a special central amnesty administrative unit (STS and NBU staff jointly adjudicating applications) has not yet gained traction. - Recommend extending amnesty period to 10 or 12 months given time-consuming due diligence and verification with foreign authorities. - Proposed amnesty unit should prepare monthly statistical reports to the Minister of Finance on VDP uptake, amnesty and asset repatriation to demonstrate activity, fairness, and regularization certainty. - References to specific drafts and timing - 2019 TA Mission: Schatan, R., M. Grote, and L. Burns, 2019. Ukraine—Distributed Profit Tax; Voluntary Disclosure of Assets, and BEPS Implementation, IMF, Fiscal Affairs Department. - Draft Law 1232 by Mr. D. O. Hetmantsev, People’s Deputy of Ukraine, 2019 and an English Draft of a further amended Draft Law 1232 commented on by FAD TP on 25 May 2020. *IMF mission report content as provided in the source PDF.* ### 17. The current mission wishes to reiterate that tax evasion is a pervasive problem to ### 17. The current mission wishes to reiterate that tax evasion is a pervasive problem to ### Overview and purpose of amnesties and VDPs - Tax amnesties give taxpayers a chance to come clean about past offenses and to escape or reduce taxation and/or penalties or interest for late payments. - Short-term effect: governments retrieve part of tax revenues previously evaded. - Longer-term aim: bring back tax evaders into the tax net, expanding the tax base. - Amnesties have also been used to reverse capital flight (Voluntary Disclosure Programs, VDPs). ### Risks of general tax amnesties - Frequent tax amnesties trigger long-term declines in revenue collections due to erosion of tax morale of compliant taxpayers. - If repeated, taxpayers may reasonably conclude it pays to transgress tax laws as revenue authorities show leniency by forgiving penalties and interest. - Amnesties without strong AML/AEOI frameworks are less successful than those combined with asset repatriation programs under bilateral tax treaties with automatic exchange of information (AEOI Standard) and AML cooperation. - VDPs differ from many amnesties: often waive penalties and interest or grant immunity from imprisonment for disclosed/adjudicated assets, and grant confidentiality only for voluntarily declared and adjudicated assets. ### International experience and trends - A recent OECD survey of 2015 found that 13 out of 47 countries which implemented tax amnesties introduced special disclosure programs for foreign-held assets. - Out of the 47 countries, five required or offered asset repatriation. - Emerging market economies with recent VDPs pursuing asset repatriation include: Brazil, Indonesia, Mexico, Argentina, Chile, Kenya and Turkey. ### VDPs for foreign-held assets — objectives and design features - VDPs are a recent compliance trend and use relatively narrow windows as part of a broader compliance strategy. - Success depends on increased detection capability (central bank, financial intelligence authority, exchange of information, revenue administration) and firm commitment to follow-on enforcement actions against non-disclosed assets. - VDPs aim to increase voluntary compliance by targeting high-risk non-compliance (foreign assets) and to broaden the tax base prospectively rather than focusing solely on short-term capital repatriation. - Effective VDPs: - Are limited-period programs tied to a specific opportunity (e.g., AEOI provisions). - Tightly manage benefits to disclosing taxpayers so they still "pay a price" for past non-compliance (e.g., fees on gross assets). - Ensure follow-on tougher audits and enforcement against those who do not disclose. ### Key elements and costs of tax amnesties and VDPs - Countries introduce amnesties mainly for quick revenue or repatriation of illegally held foreign assets. - General amnesties vary in duration, qualifying taxes, and types of absolved penalties and interest. - Evidence suggests amnesties (without a VDP) generate much less incremental revenue than expected and carry high opportunity costs by diverting tax administrators from normal collections. - Amnesty programs should be one-time events concurrent with introduction of a new tax instrument or an efficiency-enhancing organizational model for revenue administration. - VDPs often regulate repatriation modalities; obligatory repatriation is less frequent. Fixed assets like real estate have limited applicability for repatriation but are important for income tax disclosure (rental and capital gain income). ### Best practice preconditions for amnesties and VDPs - Unambiguous enabling legislation and authority for a revenue agency to administer the VDP. - Specification of non-discretionary program parameters: duration, timing, penalties and interest waivers, applicable fees, payment provisions, qualifying taxpayers. - Rapid secondary regulations to resolve unforeseen problems and build taxpayer confidence. - Legal guarantees to entice declaration and to protect against penalization and intrusive investigations for those covered. ### Ukraine’s ongoing revisions of the VDP and one-time asset declaration - The TA mission has reviewed four (4) different versions of the VDP with asset repatriation released since 2019. - The July 3 draft received from the Ministry of Finance is a fourth draft and contains broad principles without detailed legal provisions on reporting, valuation, confidentiality, applicant identity, or administration; it is a work-in-progress. - The mission cannot be taken as supporting the July 3 Draft VDP; comments are on feasibility/acceptability of key provisions only. - Acceptability of the final VDP depends on review of the full draft with required safeguards on AML/CFT regulations. ### Major provisions in the revised draft One-Time Declaration - Legalization of assets held as on December 31, 2021, by an adult natural person of Ukraine. - Voluntary one-time declaration lists undisclosed assets on which taxes and fees were not paid under the Ukrainian Tax Code (UTC), other tax legislation, or currency regulation. - Voluntary declaration filing period: from April 1 till end of December 2021. - The STS is the nominated administrator of the VDP and will waive applicants from all outstanding taxes, penalties and interest liabilities for the non-disclosed assets. - Applicants must pay a flat fee on the nominal value of the undisclosed assets as a compensatory measure to regularize asset ownership going forward. - The latest VDP draft envisages the one-time declaration can be submitted in the period from April 1 to December 31, 2021 to the State Tax Service of Ukraine in electronic or paper form (these dates need confirmation by the legislator’s final approval). ### Qualifying persons and eligible assets - Any Ukrainian natural person who owns (co-owns) and is a beneficiary or beneficial owner (controller) of eligible assets can participate. - Eligible assets include: financial instruments such as foreign currencies, bank metals, fixed and movable property, unfinished constructions, and other assets acquired as of December 31, 2021. - Includes rights or beneficial ownership of securities, intangible assets, rights to shares in property of legal persons or rights to funds, including a controlling interest in controlled foreign companies (CFCs), on which no taxes and fees were paid under the UTC. ### Treatment of public office bearers and PEPs - Public office bearers are permitted to apply but may need additional requirements. - From an AML/CFT perspective, all “politically exposed persons” (PEPs)—individuals entrusted with prominent public functions, their family members and close associates—should be prohibited from participating in the VDP. - The Fund’s Legal Department recommends sufficient sanctions against these persons to dissuade them from taking advantage of the program. ### Aligning the VDP with AML/CFT provisions - The current draft does not explicitly state adjudication procedures will fully comply with Financial Action Task Force (FATF) principles; the final draft is expected to explicitly abide by Ukraine’s commitments under AML/CFT rules (customer due diligence, recordkeeping, suspicious transaction reporting). - The 2019 TA Mission received assurances from the NBU that the Ukrainian VDP will follow FATF principles that among others disallow full or partial exemption from AML requirements. - FATF principles include: 1. Repatriated assets are deposited with a financial institution subject to AML/CFT measures. 2. Assets from countries not adequately applying FATF recommendations receive particular attention. 3. Authorities raise awareness among financial institutions on money laundering risks in repatriation programs. 4. Documents/statements issued regarding repatriated assets are not official endorsements that the assets are of legitimate origin. - Financial institutions should be obliged to apply AML/CFT controls for clients who repatriate assets (including identifying beneficial owner, reasonable measures to establish origin, and reporting suspicious transactions). ### Mission view on AML prioritization and equity implications - The mission believes AML/CFT controls will support a successful rollout of the VDP and suggests prioritization. - Amnesties are discriminatory: compliant taxpayers bear the full statutory tax burden while non-compliant taxpayers receive discounted burdens (waiver of interest, penalties, tax). - International experience suggests long-run revenue effects of frequent amnesties are discouraging; however, prioritizing a foreign asset VDP would immediately expand the personal income tax base and be equity-enhancing since high-net worth Ukrainian residents have not complied with worldwide income tax provisions. ### Impersonal (notary) application and identity protection - The July 2020 draft allows applicants to authorize a notary to apply on their behalf (impersonal one-time declaration) to protect identity and confidentiality. - The draft law stipulates proceeds from crime and bribes cannot be regularized. - Even with notary protection, the concealed applicant cannot receive state guarantees for amnesty nor confidentiality of identity against other law enforcement agencies. - To prevent collusion and misuse by notaries, consideration should be given to making notaries jointly and severally exposed to criminal prosecution with steep penalties—possibly loss of professional license—if they assist laundering proceeds from organized crime and bribery. ### Improved deterrents, investigative powers, and evidence retention - The revised draft permits the STS to request notaries for additional information where questions arise concerning the source of proceeds behind declared assets; notaries must provide information supported by documents confirming origin. - There is no prescribed limit for keeping submitted one-time declarations or records with the STS, enabling future reference for investigations. - Authorities informed the Mission that the STS already has full investigative powers to verify origin of assets; whether STS can rely on close interagency coordination with other law enforcement agencies needs further assessment. - Requiring payment of the applicable VDP fee at time of filing (or depositing it at a recognized financial institution before application is lodged) and forfeiture of paid fees if satisfactory answers on asset source are not provided increases the risk for applicants attempting to launder criminal proceeds. - The mission was informed the 4th draft VDP will require full payment of the fee at the time of the application or even the depositing of the fee at a recognized financial institution before the application is being lodged. *Source: 1ukrea2020003* ### 35. The draft law provides that proceeds from crime and bribes cannot be regularized. ### 1ukrea2020003 - 35. The draft law provides that proceeds from crime and bribes cannot be regularized. ### Proceeds from crime and bribes: legal effect in the draft law - Proceeds from crime and bribes cannot be regularized under the draft law. - If crime proceeds are identified: - State guarantees provided by the VDP are null and void. - Filing a one-time declaration and payment of the respective fees cannot legalize proceeds or assets acquired by criminal means. - Any provided amnesty immunity is waived if the applicant’s declared income or assets are directly linked to criminal activities. - The declarant is not released from criminal liability for committed crimes. - Other law enforcement agencies can launch a full investigation on the applicant. - The draft law does not provide for the reimbursement of the paid fees. ### Lessons from the South African Exchange Control Amnesty (Box 1 and Box 2) - Investigative powers and information sharing: - The Amnesty Unit had no investigative powers; it could ask applicants for more information but not initiate investigations. - The Unit could not make information available to the SA Police Service or any other investigative body. - Information (including applications) could only be shared with the SA Revenue Service (SARS) and the SA Reserve Bank (SARB, exchange control). - SARS and SARB could not subsequently use information disclosed in amnesty applications as a basis for investigation against amnesty applicants for amnesty-declared and regularized assets. - The Unit could not request details on the source of funds held abroad to avoid implicating other parties. - In practice the Unit relied on applicants’ declarations that funds were not proceeds of crime or corruption. - The Unit used attestation letters warning applicants that amnesty could be withdrawn and lodged fees forfeited if satisfactory explanations were not provided. - The Unit rejected acceptance of cash balances and cash fee payments; operation relied on banks’ electronic reporting and payment systems. - Operational scale and timing: - The Unit processed 43,000 applications; a simplified, non-investigative approach was driven by volume. - More than 50 percent of applications were received in the last week of the amnesty period, including the final day until 23:59 midnight. - Initial submission time frames were too tight; extensions increased uptake and public trust. - Digital capacity was underdeveloped in 2003; paper-based processing of 43,000 applications was burdensome. Future amnesties should be electronic. - Administrative design lessons and problems encountered: - Initially each application required full Unit meeting consideration; later changed to two-person teams (a SARB representative and a SARS representative). - The stipulated payment period of 3 to 6 months was problematic; discretion to extend was needed. - Refund provisions caused problems; refund requests pointed to clerical errors and posed laundering risks. - Initial restriction to individuals (not companies or trusts) was too limiting. - Provisional and final letters were necessary; provisional letters tied finalization to levy payment and were based on applicant declarations of source of funds. - People already under investigation by exchange control could not qualify, creating administrative complications when records were poor; administrators later felt amnesty should cover those under or potentially under investigation. - The Unit existed longer than envisaged; advice to extend amnesty duration up to a full year. - Financial outcome from South Africa: - Levies amounting to some R3 billion (2003: approximately USD 387.5 million in current value) were collected. ### VDP fee structure and proposed rates (paragraph 36) - One-time declaration fee differentiated by asset type: - 9 percent on financial instruments in foreign bank accounts and property registered abroad. - 5 percent on financial instruments held in Ukrainian bank accounts with balances kept until the end of the VDP, and on property and other assets located in Ukraine, including real estate and similar objects. - the full PIT rate of 18 percent on cash in order to discourage cash holdings. - 2.5 percent of the nominal value of government bonds of Ukraine with a maturity of 12 months without the right of early redemption, and purchased before the submission of the one-time declaration. - Mission view: - The mission considers the 2.5 percent levy on government bonds as a too generous tax expenditure that cannot be justified and compromises horizontal equity. - The 2.5 percent rate is noted as not being applied on any other tax base of the present personal income tax system. ### De minimis tax-free threshold and asset regularization (paragraphs 37–40) - Draft thresholds and caps: - Draft Bill confirmations: de minimis amount for foreign and domestic assets capped for financial instruments at UAH 400,000. - The 2019 VDP draft provided for a higher de minimis threshold of UAH 1 million. - Draft Law 1232 caps the de minimis threshold at UAH 30,000. - The minimum amount of assets deemed to have been acquired without having violated the tax code and thus automatically legalized/regularized includes: - Cash, securities, financial instruments, jewelry, precious (bank) metals, antiques and art objects, the total value of which is equal to 400,000 hryvnias; - Immovable property located in the territory of Ukraine which as of March 31, 2021 belongs to a natural person, including: - (a) an apartment or flat in an apartment building of unfinished construction, the total area of each of which does not exceed 120 m2; - (b) a dwelling house or a dwelling house of unfinished construction and / or an industrial building used for its intended purpose in the declarant's economic activity and not leased by the owner, leasing, loan or building of an unfinished construction industry with a total area not exceeding 500 m2 (this apparently will now be lowered to 300 m2); - (c) a land plot that does not exceed the norm of gratuitous property transfers during the privatization period (art 121 of the Land Code of Ukraine); - Movable property the ownership of which was registered in accordance with the legislation of Ukraine (at this stage only one motor vehicle is intended). - Corporate rights, the issuer of which are business entities that are subject to entry in the Unified State Register of Legal Entities, Individual Entrepreneurs. - Note: there is no minimum of amnestied amount for income stemming from committed crimes and bribes. - Mission concerns: - The TA mission is not convinced a tax-free threshold for foreign assets is warranted; it creates an “amnesty within an amnesty.” - The mission argues all foreign assets should be disclosed and the ad valorem VDP fee paid on total value of undisclosed assets. - The de minimis threshold signals potential weakness in STS capacity to verify domestic asset registers on immovable property and motor vehicles. - If STS cannot access up-to-date Ukrainian cadasters, the de minimis deemed regularization confirms difficulty in enforcing tax compliance and applying the indirect method or lifestyle audits. - Enforcement and detection capability: - Today’s banking system together with its financial intelligence and AEOI protocols should pick up repatriations or changes in deposits of even relatively small amounts. - If the STS could access banking information, it could enforce foreign asset disclosures, trace foreign financial transactions, and enforce worldwide taxation provisions after the VDP. ### VDP administration challenges (paragraph 41 and Box 2) - Draft laws disclose little about how potentially large numbers of VDP applications will be managed across STS regional offices or whether centralized administration is contemplated. - Amnesty and VDP administration challenges: - Staff resources may be withdrawn from normal taxpayer registration, collection and enforcement functions, risking overall tax revenue decline if not managed proactively. - Asset valuations, fee collection, delays in repatriation of funds, and reporting obligations are practical administration challenges. - The STS may adopt its normal business model despite lacking practical amnesty experience. - Specific practical administrative difficulties observed in South Africa (high-level summary from Box 2): - Tight initial submission time frames required extension; extensions increased applicant confidence and uptake. - Processing rules initially required full-Unit consideration of each application; later changed to two-person teams. - Payment periods and refund provisions caused issues; discretionary extension and robust refund controls are necessary. - Paper-based processing was onerous; electronic systems with automated responses are preferred. - Poor exchange control records created conflicts between investigation status and amnesty eligibility; broader coverage may be preferable. - Large application volumes extended the Unit’s lifespan; longer amnesty periods are advisable. ### Recommendations (paragraph 42) - All politically exposed persons, their family members, and close associates should be prohibited from participating in the proposed VDP. - Financial institutions should be obliged to apply fully AML/CFT controls for clients who repatriate assets, taking reasonable measures to establish the origin of the asset(s), and reporting any suspicious transactions to the financial intelligence unit. - Prioritize AML/CFT controls to support VDP implementation for foreign assets; taxing for the first-time overseas wealth held by affluent Ukrainians will improve distributional fairness. - To deter attempts to launder proceeds from crime, require payment of applicable VDP fees before or at the time of lodging the one-time asset declaration without reimbursing it if subsequent investigations reveal incidence of crime. - Increase the 2.5 percent VDP fee on government bonds to at least 5 percent on par with the fee withheld on repatriated balances held in domestic banks. - Do not grant a blind and permanent amnesty to assets under the threshold of UAH400,000. Resolve the problem of unregistered properties with a specific program to regularize these. Also, consider the corresponding flexibility under the indirect method, not in the VDP. *Source: 1ukrea2020003 - 35. The draft law provides that proceeds from crime and bribes cannot be regularized.* ### 43. The new proposals of a de minimis deemed asset declaration threshold has been ### 1ukrea2020003 - 43. The new proposals of a de minimis deemed asset declaration threshold has been ### Voluntary Asset Declaration Substituting for Incomplete Cadasters - Key motivation for a VDP: encourage stricter compliance by voluntary disclosure of foreign-held and domestic assets when authorities lack credible and comprehensive legal cadasters and vehicle registration data. - The envisaged special asset declaration rule not subject to documentary verification reflects weaknesses in administration and verification processes (see par 22 above). - Apparent doubt that the STS can cross-check taxpayers’ assets in property title registries or motor vehicle registrations of the interior ministry undermines reliance on self-declaration. - Voluntary disclosure of real estate by owners is unlikely to solve problems where incomplete and contested overlapping property titles exist, especially when state subsidies are means-tested and create disincentives for honest declaration. - Recommendation in lieu of relying on voluntary declarations: update and maintain a comprehensive legal cadaster (centrally maintained) and decentralized fiscal cadasters using satellite imagery and on-the-ground follow-up, and utilize electricity connections of the power utility company to assist with owner-tracing (see Appendix 1 for approaches). ### Updating Ownership Registers of Immovable Property (Box 3) - Property tax reforms can catalyze merging fragmented institutional approaches: recording ownership titles, cadaster-based property location description, market value assessment, data bank cooperation, and upgrading legal and geodetic registers. - Anti-avoidance legislative measures suggested by global experience with non-registration of ownership changes: - Attempting to avoid registration of change of ownership in the central property title registry should be a punishable offence. - Litigation enforcing a sales contract should only be allowed in court if parties can prove change of ownership has occurred. - Transfer of ownership evidenced by change to the title deed should occur only after full payment of relevant transfer or stamp duties and all outstanding property taxes. - Transfer of property should not be registered before the property tax is paid. - Immovable property should not be included in the amnestied threshold; its taxes should be paid as they are important revenue sources for subnational government. - These reforms contribute to traceable ownership and stronger property tax bases. ### Multiple Objectives for Investment in Cadasters - Establishing and maintaining accurate cadasters supports: - Creating certainty for owners of property rights essential for real estate investment. - Accessing finance with immovable property as collateral. - Maintaining a buoyant property market with seamless ownership transfers. - Establishing a productive property tax system (preferably value-based) as an important local government own-source revenue. - Given porous asset ownership registries in Ukraine which may take years to correct, prioritize VDP for foreign assets while central government elevates cadastral registration as a high-priority initiative requiring adequate resourcing and multi-year management. - Conclusion: these measures need to be in place before an efficacious operation of the indirect method can be established. ### Recommendations (from cadastral/VDP discussion) - Submit any property declaration under a voluntary one-time asset disclosure to official verification, especially if there are overlapping property titles. - Elevate the cadastral registration as a high-priority central government initiative that will require adequate resourcing and be prepared to manage this for a couple of years to advance the centrality of this key data bank. ### Indirect Methods and the Perception of Risk - Enforcing income tax in Ukraine is particularly challenging: historically, a large portion of assets of the rich have been held abroad and out of reach to the STS (MoF). - When STS can attest that a taxpayer’s lifestyle is far above declared income, STS has few instruments; the burden of proof is on the tax authority to show omission of earned income. - Statute of limitations of 3 years and periods with scarce records limit STS’s reach. - Presumptive taxation (an indirect method) estimates income when direct records are unavailable; it documents differences between consumption spending or bank deposits (including cash holdings) and declared income. - Under presumptive taxation, the tax authority estimates omitted income, but the taxpayer bears the burden of proof to show the difference is not taxable income. - Indirect methods increase perception of risk, creating an incentive for voluntary compliance. - Possible reasons for holding funds abroad include lower taxation jurisdictions (e.g., Cyprus), past foreign exchange regulations or capital controls, economic and political uncertainty, or illicit transactions. - Low perception of audit risk may result from shortages in trained personnel, resources, technical limitations, and lack of data, especially on cash transactions. ### Implementing the Indirect Methods — Practical Constraints - Major obstacle: intermediated access to taxpayers’ financial information. Indirect methods rely on third-party information (banks record transaction values, parties, dates). - Current banking secrecy laws in Ukraine constrain STS access; information is obtainable only with judge authorization on a case-by-case basis, reducing effectiveness of large-scale data analysis. - Indirect methods can still operate with limited information, for example using data from other government agencies and public notaries, though access to other government agency data requires collaboration agreements and is not automatic for STS. - Remedies to information-sharing concerns: - Legal provisions protecting confidentiality of information, including severe penalties for breaches. - Clear rules on how the indirect method can be applied. - Consider having the financial sector regulator act as intermediary to banking information requested by STS (rather than courts) to enable better taxpayer risk profiling and more effective audit targeting. - Taxpayers’ rights under the indirect method: - STS should share contemporaneous information and calculations leading to an assessment so taxpayers can challenge presumptions. - Taxpayers should have enough time to obtain documentation. - STS should exhaust available means to determine inconsistencies are indeed omitted taxable income; the indirect method should not be the first and final stop in inspection work. ### Elements of an Indirect Method - Core: assess taxpayer income based on indicators other than reported records to detect potential unreported income using objective indicators (increases in assets, purchases, business or personal expenses, reductions in liabilities). - Indicators support presumptions of omitted income; taxpayer bears burden to challenge that presumptive income is taxable. - Powers to estimate taxable income indirectly must be established in law; legislation may grant discretionary authority or limit indicators to a specific list. - Application can be graduated: - Greater authority for uncooperative taxpayers or when books/records are unavailable. - More restrictive use for cooperative taxpayers, based on discrepancies from certain third-party information. - Taxpayer challenge: differences may reflect taxed income, loans, inheritances, or income beyond statute of limitations; taxpayer must be able to document claims (relying on mere assertions is insufficient). ### In Sum — Key Features the Indirect Method Should Have - Legal framework: legislation must state that unreported income may be identified according to objective indicators and enable the tax authority to recalculate income and issue a new assessment. Presumptive income should be legally defined as taxable unless and up to the amount the taxpayer cannot refute with valid documentation. - Rebuttable presumption: initial burden of proof on the tax authority to demonstrate discrepancies, with subsequent shift to taxpayer to challenge the presumption. - Balancing rules vs discretion: the law-authorized use of the indirect method should increase taxpayers’ perception of risk without allowing arbitrary use by inspectors; establish objective selection criteria and acceptable indicators for presuming taxable income (see Box 4 for Mexico’s example). *Italicized source attribution: 1ukrea2020003 - 43. The new proposals of a de minimis deemed asset declaration threshold has been* ### 61. The general procedure for applying the presumptive tax is quite simple. To the ### 1ukrea2020003 - 61. The general procedure for applying the presumptive tax is quite simple. To the ### Indirect method / Presumptive taxation: procedure and operational requirements - General procedure: - If all expenses made by the taxpayer are equal or below the sum of his/her filed income in the return and his/her non-taxable income, no additional tax is due. - Where expenses exceed reported income, and the taxpayer cannot prove the excess was financed from non-taxable sources, the tax authority will notify the taxpayer that a tax deficiency has been found. - A presumption can be made about expenses or taxpayer’s funds available in financial institutions or in cash or in valuable goods (e.g. gold). - Income reported in the taxpayer return should be subtracted from the funds available after this adjustment and the excess should then be presumed to be non-reported income. - Data access and verification needs: - The STS must be able to verify the amount of funds saved by taxpayers and therefore needs to access data on bank deposits, including business and personal accounts, and loan accounts. - The STS would need to access financial data from all financial institutions, including credit unions and investment trusts. - Box 5 — Basic Formula for an Indirect Method including Cash (procedural steps preserved verbatim): - From third party sources, determine taxpayer’s total cash expenditure during fiscal year; - Add known increase in cash on hand at the end of the period; - Less nontaxable receipts (e.g., transfers between own accounts, loans) - Equals corrected gross receipts - Less gross receipts as per declaration - Equals understated income ### Administrative issues and safeguards - Current limitations: - The STS has very limited access to third party information. This limits application of the indirect method to tax unreported income. - Bank secrecy will have to be relaxed for the indirect method to work to its full extent, though having the method in the law will help Ukraine in individual audits where information about excess consumption is obtained (e.g., purchase of large real estate). - Automated/machine approach: - A mechanical application using software to search a large database for mismatches between tax returns and third-party information (financial institutions, car agencies, notaries, property registries) according to pre-established parameters is recommended. - Routine ‘machine’ checking reduces discretionary criteria used by tax officials to select taxpayers for review. - STS could first send an automatically generated letter inviting taxpayers to explain discrepancies or self-correct; failure to come forward would trigger an audit starting from the estimated income discrepancy. - Minimizing arbitrary use: - Risk: indirect methods may be used arbitrarily. - Mitigation: regulations should be clear about when and how the method should be used, the parameters to determine presumptive income, and the documentation taxpayers need to prove differences are not taxable. - Examples of evidentiary standards: - Inheritances: records must demonstrate goods, funds or assets were in possession of the deceased person. - Loans: for tax purposes, a loan should be documented with bank transfer records, not just a contract or a signed “I owe you” (IOU) among individuals; absent bank transfer records, the rule should treat such receipts as taxable presumptive income. ### Voluntary Disclosure Program (VDP) and its interaction with the indirect method - Role and intent of the VDP: - The MoF has argued the VDP is an important component of the package to institute the CFC regime and to facilitate worldwide income taxation in Ukraine, capturing wealth believed to be held abroad. - The VDP would be open to all assets, including those at home, under important restrictions explained elsewhere in the report. - Connections between presumptive taxation and VDP: - Assets declared under the VDP which have paid the corresponding fee should be considered as non-taxable income under the indirect method — consumption paid from these funds should be treated as withdrawn from legitimate savings. - Income generated by disclosed assets should henceforth be considered taxable income as any other. - The VDP can serve as an opportunity to establish a sanctioned income buffer for the presumptive tax regime and may facilitate tax auditors’ work by tracing and documenting disclosed assets. - Limits of VDP as a substitute: - A credible indirect method is essential for the VDP to work; they reinforce each other but the indirect method should be available to the tax authority regardless of a VDP. - The corner stone of an indirect method is access to reliable, high quality third-party information (financial institutions, vendors, public notaries). - The VDP is a goodwill offer to regularize asset ownership prior to higher tax enforcement but does not substitute for regular third-party information access. - Preconditions ideally in place prior to launching a VDP: - good registries of real estate and movable property; - easier access to financial information for the STS; - strong confidentiality guardrails for taxpayer information at the STS; - ongoing exchange of information with foreign competent authorities; - an indirect method in place in the law. ### Policy recommendations (presumptive taxation and VDP related) - Adopt a presumptive income taxation regime in the law. - Include in the legislation the general rule on how to construct indirectly taxpayers’ income, including the sources of funds that would not be taxable under this regime. - Defer to regulations the specific operation of the indirect method, describing the type of documentation that will [be] acceptable to rebut the presumptive determination by the STS. - Consider removing the banking secrecy for the STS, or at least replace the courts by the financial sector regulator as intermediation body for the STS to obtain taxpayers’ information from the banking system. ### International tax measures — Place of Effective Management (PEM): findings and recommendations - Context: - Ukraine is a member of the BEPS Inclusive Framework and obliged to implement the four BEPS minimum standards. Law 466 (May 22, 2020) enacts provisions implementing BEPS Actions 6, 13, and 14 minimum standards and also enacts provisions implementing BEPS Action 3 (CFCs), Action 4 (limitation on the deductibility of interest), Action 7 (PE definition), and Actions 8-10 (transfer pricing). - Law 466 introduces a new residence test for legal entities based on the place of effective management (PEM). - Structure and scope of the PEM test in the UTC: - PEM is not included in the general definition of “resident” in Article 14.1.213 of the UTC but is included in the list of resident taxpayers for the purposes of the CPT in Article 133.1. - New Article 133.1.5 provides that a foreign-formed legal entity is a resident taxpayer under the CPT if its PEM is located in Ukraine; however, this applies only for purposes of the CPT. - Consequence: a foreign-formed legal entity with its PEM in Ukraine may be a resident taxpayer for CPT purposes but a non-resident for other purposes of the UTC, so CFC rules do not apply to it. - Meaning and interpretation of PEM: - PEM refers to where high-level management, commercial, and financial decisions necessary for conduct of an entity’s business as a whole are made — the location of the superior directing authority (e.g., board of directors). - Article 133.1.5: paragraph (a) refers to holding executive body meetings in Ukraine; if such meetings are held in different countries, place of effective management is in Ukraine if such meetings are more regularly held in Ukraine. - Paragraphs (b) and (c) refer to a broader notion of management carried out primarily in Ukraine. - The UTC recognizes PEM may be divided between different locations and includes rules allocating divided PEM to Ukraine. - Risks and inconsistencies: - Opt-in risk and potential abuse: - Applying PEM residence on an opt-in basis increases the possibility of abuse as Ukraine residents controlling foreign-formed legal entities can, in effect, elect the entity’s residency status for favorable tax outcomes. - Article 133.1.5 appears framed as self-executing but also provides that a foreign-formed legal entity can elect to be a resident taxpayer and can renounce its status; the Ministry confirmed that (from a literal reading) the PEM residence test applies only on an opt-in basis. - Scope of taxation inconsistency: - A PEM resident taxpayer is subject to tax under the CPT on a territorial basis only (Article 134.1.1 of the UTC) — taxed only on Ukraine source income. - This creates an unusual situation where a resident legal entity’s scope of taxation depends on the basis for being a resident (incorporated in Ukraine → worldwide taxation; foreign-formed with PEM in Ukraine and elects resident → territorial taxation). - Interaction with CFC rules: - The PEM test operates only one way — to determine Ukrainian residence — and does not determine residence of other countries for CFC rules. - Under the CFC rules, a legal entity is a foreign legal entity if incorporated or formed outside Ukraine; thus a foreign-formed entity with PEM in Ukraine can be both a resident (by election) and a foreign legal entity under CFC rules; Article 133.1.5 resolves this by providing a foreign legal entity that is a PEM resident is not a CFC. - BEPS Action 5 risk: - The combination of electing PEM residence plus territorial taxation may create a breach of BEPS Action 5 because a PEM resident may lack sufficient economic presence in Ukraine if core income-generating activity is offshore with limited physical presence in Ukraine. - Recommendations regarding PEM: - Repeal the PEM residence option. - If PEM residence is retained, then (i) apply PEM residence on self-executing basis and (ii) review PEM residence for possible breach of BEPS Action 5. *Source: Excerpt from the provided IMF content unit 1ukrea2020003.* ### 82. Law 466 updates the PE definition in Article 14.1.193 of the UTC so that it better ### 1ukrea2020003 - 82. Law 466 updates the PE definition in Article 14.1.193 of the UTC so that it better ### Changes to the PE definition (Law 466) - Law 466 updates the PE definition in Article 14.1.193 of the UTC to better align with the definition in the OECD and UN Models, as amended based on the BEPS Action 7 recommendations. - Specific amendments: - (i) provide anti-fragmentation rules for the construction and services PE inclusions, and the preparatory and auxiliary activities exception; - (ii) revise the agency PE rule. - Amendments to the PE definition in Bill 1210 were discussed in the 2019 Mission Report and some recommendations from that Report are captured in Law 466. ### Permanent Establishment and jurisdiction to tax - International norm: a country’s jurisdiction to tax the business income of a non-resident is limited to income attributable to a PE of the non-resident located in the country. - If there is no PE, there is no taxing right over the business income of a non-resident. - If there is a PE, the country can tax only those profits attributable to the PE. - Article 14.1.54 of the UTC: any income derived by a non-resident from a business activity in Ukraine is Ukraine-source income. - Article 14.1.54 is not expressly confined to income conducted through a PE. - Article 133.2.2: a non-resident with a PE in Ukraine deriving Ukraine-source income is a taxpayer for CPT purposes. - Article 141.4.7 (as amended by Law 466): taxable profit of a PE is determined on the basis that the PE is a separate entity dealing wholly independently with other parts of the non-resident entity. - Result: a non-resident legal entity is liable for CPT on profit attributed to the Ukraine PE. - Tax treaties: - Ukraine has over 70 tax treaties; treaties divide taxing rights and typically prioritize residence country taxation by limiting or excluding source country taxation. - Treaties can limit source taxation via lower withholding rates or a narrower PE definition. - Article 3.2 of the UTC: in case of conflict between the UTC and a tax treaty, the treaty prevails. - Examples: a lower withholding tax rate (10 percent) applies to royalties; some treaties apply an 18 month time limit for construction PEs. - Treaties are limiting only and cannot create a tax liability that does not arise under domestic law. ### Permanent Establishment and PEM - PE definition in Article 14.1.193 includes a place of management consistent with tax treaties. - Place of management is PE only if it satisfies general PE requirements (fixed place of business); temporary performance of management functions in Ukraine does not constitute a PE. - PEM (place of effective management) primarily functions as a residence concept; for Ukraine the PEM of a foreign-formed legal entity located in Ukraine could give rise to a PE of the entity in Ukraine under prior law. - Observed inconsistency: Ukraine introduced PEM as a residence concept but taxes a PEM resident only on Ukraine-source income (i.e., as if it is a PE). ### Construction PE - Law 466 narrows scope of construction PE relative to Bill 1210 by extending the time limit from 183 days in Bill 1210 to 12 months in Law 466. - Context: - Majority of Ukraine’s treaties: construction PE time limit is 12 months. - Over 20 treaties: time limit less than 12 months (most commonly 6 months; several at 9 months; one at 3 months). - A few treaties have 18 or 24 months. - Interaction with treaties: - Where a treaty time limit is longer than domestic law (e.g., 18 months), the treaty’s longer time limit applies. - Where a treaty time limit is shorter (e.g., 6 months), the longer UTC time limit applies, causing Ukraine to lose benefit of broader treaty-based source taxing rights. - Cross-border mismatch example: - If a treaty between Ukraine and another State sets 6 months and both domestic laws follow 6 months, a Ukraine resident construction company will be taxed in the other State for projects exceeding 6 months, whereas a construction company resident in the other State will be taxed in Ukraine only for projects exceeding 12 months. - Policy view: - No obligation to align UTC PE definition with majority of treaties. - Given Ukraine is a capital importing country, there is a case for reverting to the 6 month time limit specified in Bill 1210 to preserve bargaining power in treaty negotiations. ### Services PE - Current services PE inclusion appears to apply only where services are provided through employees; provision of services personally by a non-resident individual on their own account appears excluded from paragraph (b). - Such an individual only has a PE if they have a fixed place of business in Ukraine, which may not occur (e.g., hotel stays). - Purpose of services PE: establish PE status based on period of physical presence rather than fixed place of business. - Recommended amendments: - Paragraph (b) should apply to non-resident individuals providing services on their own account. - Paragraph (b) should apply to services provided by a non-resident through employees or other personnel (including independent contractors) to align with the UN Model. ### Attribution of profits to a Permanent Establishment - Article 141.4.7 of the UTC: taxable profit of a non-resident conducting business in Ukraine through a PE is calculated according to the functionally separate entity approach (the authorized OECD approach, now in Article 7(2) of the OECD Model). - Under this approach, PE profits are calculated on the basis the PE is a separate entity dealing wholly independently with other parts of the entity. - The arm’s length principle applies; internal “price” can include a mark-up if supported by functions, assets, and risks. - Policy rationale: - Attribution of profits to a Ukraine PE is a source issue and OECD’s functionally separate entity approach aims to achieve consistency in allocation and limit double taxation or double non-taxation. - Implementation: - Law 466 replaces former formulary allocation with the functionally separate entity approach. - Recommendation: retain some flexibility to modify profit allocation where the other country does not use the functionally separate entity approach to limit double taxation and double non-taxation. ### Registration of PEs - Law 466 adds Article 64.5 requiring registration of non-residents: - (i) carrying on business in Ukraine through a PE; - (ii) that have an interest in Ukraine immovable property; or - (iii) that open a Ukraine bank account. - Typical practice: register any non-resident deriving domestic source income not subject to final withholding at source. - Best practices and observations: - If a non-resident has no physical presence, appoint a local representative to meet tax obligations. - One-stop shop for business and tax registration is common: business registration authority notifies tax authority automatically. - Scope of PE registration: - Should apply to all PEs as defined in Article 14.1.193, not only PEs involving a fixed place of business. - Should include PEs without physical presence (e.g., agency PEs); agent should be required to register in the name of the non-resident. - Should apply even if the non-resident does not have a PE under an applicable tax treaty, since the PE may be a withholding agent or VAT-liable. - Tax representative mechanics: - Usual practice: tax law specifies an individual or class of individuals located in-country to act as tax representative (registration, filing, paying tax). - UTC could provide that local manager or other local senior employee of a non-resident is the tax representative; service of notification on that person effects registration of the Ukraine PE. ### Recommendations (PE and attribution) - If the PEM residence test is repealed, review the scope of the place of management inclusion in the PE definition. - Revert to the 183-day time limit for the construction PE rule. - Ensure that the services PE rule applies to an individual providing independent services. Also, consistent with the UN Model, ensure that the services PE rule applies when the services are provided by employees or contractors. - 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 methodology of profit allocation so as to limit the possibility of double taxation or double non-taxation. ### Controlled Foreign Company (CFC) Rules (Law 466) - Law 466 inserts new Article 39² into the Tax Code providing for CFC rules. - Purpose of CFC rules: counter deferral of tax by resident taxpayers shifting passive income to foreign entities they control. - Deferral defined as postponement of current taxation in Ukraine of foreign income that has economically accrued to a Ukraine resident taxpayer through their controlling interest in a foreign entity. - Without CFC rules, foreign income of a foreign entity is not taxed in Ukraine until distribution as a dividend or sale of the interest. - Start date and transition: - CFC rules intended to commence from January 1, 2021; Bill 2524 proposes first reporting year for CFC rules is 2022. - Delay provides resident taxpayers with more time to prepare (e.g., liquidate existing CFCs or use VDP). - Delay partly due to the delay in passing Law 466 limiting time to arrange liquidation and repatriation of profits. - Substantial shareholder threshold: - Bill 1210 threshold: 25 percent. - Law 466 reduced threshold to 10 percent consistent with the 2019 Mission Report recommendation. - Bill 2524 proposes phasing-in the 10 percent threshold: - 25 percent threshold applies for the 2022 and 2023 reporting years. - 10 percent threshold applies for reporting years after 2023. *IMF country report content unit.* ### 106. Arguments have been made to the Ministry against applying the CFC rules to ### 1ukrea2020003 - 106. Arguments have been made to the Ministry against applying the CFC rules to ### Fairness Argument - Objections to applying CFC rules to resident individuals focus on: - (i) it is unfair to tax resident individuals on income that they have not received; and - (ii) concerns about potential disclosure of the offshore investments of individuals, particularly in CFCs. - Four investment scenarios analyzed for a resident individual making passive investments: - (i) resident individual invests in Ukraine passive investments directly (individual owner); - (ii) resident individual invests in Ukraine passive investments indirectly via a controlled Ukraine company (CUC); - (iii) resident individual invests in foreign passive investments directly (individual owner); - (iv) resident individual invests in foreign passive investments indirectly via a CFC (resident individual is the controller). - Tax outcomes and effective rates: - Direct ownership by a resident individual (domestic or foreign passive income): effective tax rate is 19.5 percent, comprising 18 percent PIT and 1.5 percent military tax. Foreign-source withholding tax may be creditable against Ukraine PIT. - Investment via a CUC (Ukraine-formed legal entity): CUC pays 18 percent CPT on passive income on a current basis. If CUC distributes to resident individual controller, additional 6.5 percent tax on the passive income (after CPT) comprising 5 percent dividend tax and 1.5 percent military tax, resulting in an effective rate of 23.55 percent where the individual holds the investment through a CUC. Reinvestment by the CUC is after CPT, so a minimum of 18 percent CPT is paid currently. - Investment via a CFC (in absence of CFC rules): Ukraine tax on passive income deferred until distribution to the resident individual; if CFC in a tax haven, there may be little or no tax until distribution. - Purpose of CFC rules: - Remove the deferral benefit of investing through a CFC by taxing the resident individual controller currently on the passive income of the CFC. - Make tax outcomes largely the same regardless of whether investments are domestic or foreign and whether held directly or through CUC or CFC, ensuring fairness between investors and efficiency between investments. - CFC income is calculated on the assumption that the CFC is a resident of the controller’s country (Ukraine), applying Ukraine tax rules for resident companies to calculate CFC income regardless of whether the controller is a resident individual or resident entity. ### Disclosure of Interests in CFCs - VDP and liquidation concession: - Planned introduction of CFC rules was an initial impetus for the VDP; an early aim was to encourage Ukraine residents to disclose and regularize investments in CFCs. - Law 466 includes a liquidation concession to encourage liquidation of CFCs prior to commencement of the CFC rules. - Article 170.13.1 of UTC: a liquidation distribution paid by a foreign legal entity or a foreign entity without legal status to a Ukraine resident is exempt income. Absent this concession, liquidation distributions would be subject to Ukraine tax at 18 percent and, for individuals, an additional 1.5 percent military tax. - Conditions for the liquidation concession: - (1) The foreign legal entity or foreign entity without legal status must be formally liquidated or terminated under the foreign law of incorporation/formation. - (2) The resident taxpayer must apply for the exemption via the taxpayer’s tax return for the tax period in which the liquidation distribution is received and include: - (i) information concerning the liquidated entity and the property comprising the liquidation distribution; and - (ii) a copy of the liquidated entity’s financial accounts prepared in accordance with IFRS as at the date of liquidation or termination. - Time limits for the concession: - Liquidation must commence on or after January 1, 2020 and be completed before December 31, 2020. Bill 2524 proposes extending the completion date to December 31, 2021, coinciding with the later CFC start date of January 1, 2022. - Interaction with VDP: - The liquidation concession is not explicitly linked with the VDP; the relationship should be specified because the VDP fee depends on whether assets continue to be held offshore or are repatriated (lower fee for repatriation). - The liquidation concession effectively involves repatriation and therefore should apply only where the VDP fee has been paid in respect of the liquidated interest in a foreign entity. - Confidentiality and security of disclosed information: - Normal rules for confidentiality of tax information held by STS apply, per Article 17.1.9 of the UTC (tax officials can disclose taxpayer’s tax information only with taxpayer approval or in accordance with the Laws of Ukraine). - If it better encourages voluntary disclosure, information could be subject to the same security requirements as information received under Exchange of Information arrangements so that STS-held information concerning CFCs has the same level of security. - Recommendation: - Link the liquidation concession with the VDP so that the concession applies only where the relevant VDP fee is paid. ### Weaknesses in the CFC Rules - General: - Introduction of CFC rules has faced criticism, but several weaknesses in the CFC and related legislation reduce the real effect of those concerns; amendments are needed to remove or limit these weaknesses. - PEM resident and CFC Rules: - Prior to Law 466, place of incorporation or formation was sole residence test for legal entities under the UTC, allowing easy creation of foreign-formed non-resident entities to defer Ukraine tax. - PEM residence test may limit this where foreign entity is effectively managed from Ukraine, but: - A PEM resident is taxable on a territorial basis rather than worldwide income as with Ukraine incorporated legal entities. - Article 133.1.5 of the UTC expressly provides that a PEM resident is not a CFC despite foreign formation. Thus the CFC rules do not apply to PEM resident’s CFCs. - Electing PEM resident status can be used to avoid CFC rules; a PEM resident with only foreign income faces no current Ukrainian taxation of that income. - Dividends paid by a PEM resident: - Exempt income if paid to a resident legal entity; or - Subject to a 6.5 percent tax rate (dividend tax plus military tax) if paid to a resident individual. - Use of PEM resident to hold foreign passive investments can reduce effective tax rate from 19.5 percent to 6.5 percent. - Recommendation: repeal the PEM residence rule to prevent subversion of the CFC rules. - Change in Residence: - PEM residence is opt-in; residence change can avoid Ukrainian CPT on unattributed profits of a CFC (e.g., pre-CFC income or active income). - If a CFC pays a dividend and deferral > 2 years, the 18 percent rate applies (plus 1.5 percent military tax if controller is a resident individual). If deferral < 2 years, 9 percent applies under distribution concession. - Alternative planning: change CFC to PEM resident to repatriate profits without CPT; subsequent tax is only 6.5 percent on dividends to resident individuals. - Countermeasure: treat the change in residence as giving rise to a deemed dividend derived by the former CFC (now PEM resident). The deemed dividend is foreign dividend and subject to tax at 18 percent. The deemed dividend should apply only to untaxed profits derived while entity was a CFC. - Active Passive Income: - Law 466 includes an exception from CFC taxation for “active” passive income (Article 392.4.1 of UTC applies to passive income as defined in Article 14.1.268 and requires two conditions): - (1) The CFC actually performs functions, bears risks, and uses assets in operations that result in derivation of the passive income. - (2) The CFC has necessary resources to perform these functions, manage these risks, and use these assets, particularly adequate personnel, and adequate equity and fixed assets. - The inclusion of an exemption for “active” passive income aligns with prior recommendation, but using FAR (functions, assets, risks) transfer pricing methodology to determine whether passive income is “active” is incorrect: - FAR determines whether there is sufficient economic activity/presence for allocating profits, not whether income is active or passive. - Better policy: identify a limited number of specific cases where passive income is classified as active and excluded from CFC taxation. Proposed three standard cases: - (1) Interest derived by a CFC that is a bank or insurance company, provided the CFC is registered as a bank or insurance company under the banking or insurance law of its country of incorporation. Exception should not apply to in-house financier or captive insurance within an MNE. - (2) Royalties derived by a CFC in respect of licensing of industrial or intellectual property actually developed by the CFC (not to apply to a “patent box” within an MNE). - (3) Rental income derived by a CFC from lease of commercial premises where the CFC provides substantial property management services to tenants. - Foreign Discretionary Trusts: - CFC rules apply to foreign arrangements without legal personality, such as discretionary trusts; settlor/founder is treated as controller. - Exceptions in Article 392.1.5.1 may allow some discretionary trusts, particularly “blind trusts”, to be excluded and used as a deferral vehicle. - Recommendation from 2019 Mission Report: treat settlor or founder of trust as controller in all cases (i.e., no exceptions). - Distribution Concession: - Concessionary tax rate of 9 percent applies to CFC income repatriated to a Ukraine bank account of the Ukraine controller either as an interim dividend or as a dividend paid by the end of the calendar year following the end of the relevant reporting period supporting the dividend. Resident controller can file an adjusted return to effect reduction from 18 percent to 9 percent. - Purpose: encourage repatriation of CFC income. - Effect: foreign income derived through a CFC taxed at a lower rate than Ukraine-source income, likely encouraging offshore investment over domestic investment. - Recommendation: repeal the repatriation concession so foreign income is taxed at the same rate as domestic income. - Technical Issues: - Overall the CFC rules are well designed; several technical amendments were made in Law 466 based on 2019 Mission Report recommendations. - Control Rule: - Article 392.1.2 of the UTC sets out the control rule, providing for legal control and economic control. - Two alternative legal control tests: - (1) A single Ukraine resident holds an interest of more than 50 percent in the foreign entity — that resident is the controller (paragraph (a)). - (2) Ukraine residents collectively hold 50 percent or more of the interests in the foreign entity — any Ukraine resident holding an interest of more than 10 percent in the foreign entity is treated as a controller (paragraph (b)). *Source: 1ukrea2020003 - 106.* ### 133. It is noted that, under Bill 1210, both thresholds were aligned with 50 percent or ### 1ukrea2020003 - 133. ### Control thresholds and substantial shareholder threshold - Under Bill 1210 both control thresholds were aligned with "50 percent or more" applying as the threshold in both cases. - Law 466 has the thresholds out of alignment; the Report states: "There would seem to be no reason why a different control threshold should apply under the two control rules." - International practice: both thresholds are used in CFC rules, although the "more than 50 percent" threshold is more common. - Advantage of the "50 percent or more" threshold: prevents a 50:50 joint venture entity from avoiding the control rule. - The Report’s position: "The fundamental point is that the same control threshold should apply under Article 39 2 .1.2(a) and (b) of the UTC." - Substantial shareholder rule: - Under Bill 1210 the substantial shareholder threshold was "25 percent or more." - Under Law 466 this was reduced to "more than 10 percent" consistent with the recommendation made in the 2019 Mission Report. - The "25 percent or more" threshold appears to still apply under Article 39 2 .2.1 of the UTC; the Report: "This should be clarified to ensure that the substantial shareholder threshold is consistently applied in the CFC rules." - Note on Bill 2524: "It is proposed in Bill 2524 that the 25 percent or more threshold would apply for the 2022 and 2023 reporting years." ### Credit for CFC tax - Controllers of a CFC are entitled to a credit for foreign tax paid by the CFC on profits of the CFC included in the taxable income of the controller. - The credit is limited to the Ukrainian tax payable by the controller on the CFC’s taxable profits. - The Report: "It is correct policy to allow a controller a credit for the foreign tax paid by the CFC on the CFC’s profits attributed to the controller." - Issue identified: - The credit is limited to foreign tax paid by the CFC, but a CFC may pay Ukrainian tax on its attributed income. - Ukraine-source income derived by a CFC through a PE in Ukraine and a dividend paid by a Ukraine resident company to the CFC are excluded from the CFC’s taxable profits. - Other Ukraine source income (such as interest or royalties) are included as CFC income and will be subject to Ukraine withholding tax. - Recommendation: "It is usual policy under CFC rules to allow the controller a credit for Ukrainian tax paid by a CFC on any income of the CFC included in its taxable profit for CFC purposes." ### Dividends paid between CFCs and exemption scope - CFC rules apply down unlimited tiers of foreign entities provided the control rule is satisfied at each tier. - A CFC has two broad classes of profits: - (i) CFC taxed profits (i.e. profits taxed to the resident controller of the CFC); and - (ii) CFC exempt profits (i.e. profits that benefit from an exemption from CFC taxation). - Main exemption: where the CFC passes the active income test under 39 2 .4.1 of the UTC; active income benefits from deferral until distributed as a dividend to the resident controller. - A dividend is "passive income" under Article 14.1.268 of the UTC. - Consequently, absent an exemption, a dividend paid by a CFC to another CFC may be subject to CFC taxation in the hands of the receiving CFC. - Double taxation avoidance: Article 39 2 . 3.2.5 provides that "a dividend paid out of CFC-taxed profits is not included in the adjusted profit of the receiving CFC." - The dividend remains treated as passive income and may affect whether the receiving CFC passes the active income test. - Concern about scope of Article 39 2 . 3.2.5: - The English translation of Law 466 limits the exemption to "accrued income", interpreted to mean CFC-taxed income. - If a dividend is paid out of exempt active income to another CFC, it may be subject to CFC taxation in the receiving CFC, effectively converting exempt active income into taxable passive income. - The Report’s recommendation: "Article 39 2 . 3.2.5 of the UTC should apply to any dividend paid by a CFC to another CFC where the CFCs have a common Ukraine controller." - Rationale: common use of holding company structures to reinvest active business profits across subsidiaries; CFC rules should not convert active income into passive income through payment of a dividend. ### Dividend ordering rules - Because a CFC may have both taxed CFC profits and CFC-exempt profits, it is necessary to know which profits support the payment of a dividend to determine tax treatment. - This is relevant for: - (i) a dividend paid by a CFC to a resident controller; and - (ii) a dividend paid by a CFC to another CFC with the same resident controller. - Current practice: ordering of profits for the purposes of paying a dividend is a matter for the company; the company can nominate the profits supporting a dividend. - Recommendation reiterated from the 2019 Mission: "explicit dividend ordering rules should be included to ensure effective tracking of profits, particularly through a chain of CFCs." ### Recommendations (CFC and dividends) - Apply CFC rules to resident individuals. - If the PEM residence rule is retained in its present form, treat a change in residence from CFC to PEM resident as a deemed dividend to the extent that the legal entity has untaxed CFC profits. - Limit the exemption for "active" passive income to a small number of specified classes of such income. - Treat a settlor or founder of a foreign trust as the controller of the trust in all cases. - Repeal the distribution concession. - Align the control thresholds under Article 39 2 .1.2(a) and (b) of the UTC; the "50 percent or more" threshold is preferred. - Ensure that the 10 percent substantial shareholder rule is applied consistently in the CFC rules. - "Allow a FTC for any Ukraine tax paid on Ukraine source income included in the taxable profit of a CFC." - "All dividends paid between CFCs with a common controller should be exempt from CFC taxation." - "Include dividend ordering rules to apply where a CFC has both CFC-taxed income and CFC-exempt income." ### Indirect transfer of immovable property — key changes and recommendations - Law 466 provides for taxation of a gain derived by a non-resident arising on an indirect transfer of immovable property in Ukraine. - New Article 14.1.54(i) provides a source rule for indirect transfers of immovable property. - Revised Article 141.4.1(e) provides for the taxing rule. - For a transaction between two non-residents, revised Article 141.4.2 provides a withholding rule under which the purchaser of the shares or other interest is required to withhold tax at the rate of 15 percent of the sale price. - Recommendation from 2019 Mission to align with Article 13(4) of the OECD and UN Models required three broad changes to Articles 14.1.54(i) and Article 141.4.1(e): - (i) the inclusion of the 365 day test period; - (ii) the elimination of the 50 percent or more ownership threshold; and - (iii) the inclusion of the directly or indirectly rule in relation to immovable property as well as the ownership of shares or other interest. - Only amendment made was the inclusion of the 365 day test period. - Recommendation reiterated: insert a definition of "immovable property" in the UTC that expressly includes mining and petroleum rights, including an interest in a production sharing contract; this was not adopted with Law 466. - On withholding as collection mechanism: two difficulties identified: - (i) the purchaser will not know the seller’s cost to work out the gain; and - (ii) as the transaction is between two non-residents with no physical presence in Ukraine, STS enforcement of the withholding tax liability is difficult. - Preferred collection approach (from 2019 Report): require the entity that owns the Ukrainian immovable property to pay the tax as representative or agent of the non-resident seller, based on the assumption the owner can recover the tax under shareholder agreement or sale agreement tax clause. - Recommendations (indirect transfer): - "Include a definition of immovable property that covers mining and petroleum rights, including an interest in a production sharing contract, and mining and petroleum information." - "Collect the tax on an indirect transfer by requiring the owner of the Ukrainian real estate to pay the tax on behalf of the non-resident seller." - "Do not include a corporate reorganization exception." ### Transfer pricing changes — commodities and related measures - BEPS package adopted with Law 466 (May 23, 2020) included important reforms to transfer pricing. - Examples of changes: - Definition of related parties modified, increasing participation threshold from 20 to 25 percent. - Joint ventures can be related parties where one partner has a participation equal or above that threshold (L466, art 3. 17; UTC, art 14.1.159). - Commodity pricing aligned with BEPS Action 10; law makes CUP the preferred method for commodities. - Commodity pricing specifics: - Taxpayers must preferably use the Comparable Uncontrolled Method (CUP). - Law 466 permits use of "quoted prices" (Law 466, art 3. 8; UTC, art 14.1.94’) including those reported by recognized information agencies. - Administrative regulations should exemplify adequate agencies; suggested examples: Bloomberg, Thompson-Reuters, Platts, Argus Media (to be drawn up by MoF and STS with industry specialists). - The law defers to Cabinet of Ministers to list which products will be considered commodities for transfer pricing purposes (UTC, art 39.3.3.4). - Recommendation: keep the initial list short, primary candidates: wheat, corn, soybean, and sunflower oil. - Adjustments to quoted prices: - Quoted prices can be adjusted under the CUP for material differences. - Recommendation: limit allowable adjustments to freight, insurance, port costs and quality differences; Law 466 currently does not place limits (UTC, art 39.3.3.4). - Other transfer pricing reforms: - Ukraine fully adopted country by country (CbC) reporting rules, including Master and Local files. - Taxpayers must provide a "Notice of participation" in international group of companies and report yearly data on controlled transactions (UTC, art 39.4.2). - Legislative developments: - Bill 2524 was under discussion during the mission and the preliminary Bill addressed shortcomings in Law 466. - The Bill was voted in plenary on July 14, 2020; the mission did not have access to the final approved version, which differs from the preliminary Bill. - The Report’s recommendations are based on Law 466 and the preliminary Bill 2524; transfer pricing legislation may need further review. *Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1ukrea2020003.pdf* ### 154. The law states that commodity prices are defined as an average or as a range of ### 1ukrea2020003 - 154. The law states that commodity prices are defined as an average or as a range of ### Commodity prices (paragraph 154) - The law states that commodity prices are defined as an average or as a range of prices. This needs to be further explained in administrative regulations. - Possible intended meaning: the daily price is quoted by the reporting agencies as a daily average or a daily range of prices (Law 466, art 13. 2, UTC, art 39.3.3.7). - Clarifications needed in regulation: - Whether the price average or range is the estimate of the daily price calculated by the reporting agency, rather than an average or range calculated by the taxpayer on the basis of reported data. - What is meant by “range of ranges” and whether a taxpayer can add different daily price ranges from different sources to construct a range wider than that reported by any individual source; if so, specify consistency rules. ### Recommendations on commodity price rules - List in administrative regulation specialized agencies as sources of information for commodity price quotes, including Bloomberg, Reuters-Thomson, Platts, Argus Media, among others. - Limit the list of commodities which will be subject to the mandatory CUP method to a few main Ukrainian exports, such as wheat, corn, soybean and sunflower oil. - Limit the types of adjustments and discounts that taxpayers may apply to the application of the CUP method for commodities. At most, allow quality differences and freight, port and insurance costs paid by the customer; apply the arm’s length principle (ALP) when customer is a related party of these service providers. - Define in regulation “average” and “range of quotation prices”. Explain whether they refer to daily prices. Define also the concept of “range of ranges”. ### Business Restructuring (paragraphs 155–156) - Business restructurings reshape MNE functions, assets, risks and profit profiles across borders; tax bases are redistributed even when no explicit controlled transaction has taken place. - The OECD TP Guidelines (2017) recognize that such situations need to be valued at arm’s length. - Law 466 establishes that a business restructuring is one of the activities covered by transfer pricing. However, Law 466 (L466, art 13; UTC art 39.2.1.4) limits application of TP only to restructuring activities that reduce the financial result of the taxpayer. - Quotation: “Art 39.2.1.4: Economic activity for the purposes of transfer pricing are ... e) transactions in which the taxpayer's income and / or financial result is reduced as a result of ...transfer of functions ... tangible and / or intangible assets, benefits, risks and opportunities to another taxpayer in cases where in the relationship between unrelated persons such a transfer would not have taken place without compensation ...”. - Concern: limiting TP to restructurings that reduce financial results is biased; the obligation to apply TP should be symmetrical to the outcome of the reorganization, even if transferred activities are not yet yielding income (e.g. an unexploited license). - Recommendation: - Eliminate reference to “negative impact to financial results” as a condition to subject a business restructuring to transfer pricing regulations. ### Business Purpose Test — Definition (paragraphs 157–159) - The general concept of “business purpose” existed in the UTC prior to Law 466 but was vague. - Previously translated loosely as the intent of having an economic gain from a business activity (a profit motive); UTC (2019), art 14.1.231. - The expressions in art 14.1.231 as shown in the English translation, economic reason or business purpose, do not appear again in a word search of the entire UTC. - Law 466 (art 25, modifying UTC, art 14.1.231) added meaning: “business purpose” is for economic gain or the preservation or increase in the value of the taxpayer’s assets. - The concept is further defined by what it is not: - Transactions with non-residents have no reasonable economic cause (business purpose) if the main purpose (or the outcome) of the transaction is a reduction of taxable income or the tax paid by the resident taxpayer. - Also, there is no business purpose if under comparable conditions an independent person would not be willing to engage in the transaction. This does not apply when the controlled transaction involves the sale of goods. - Uncertainties and conceptual flaws: - The wording of the first condition is imprecise: a taxpayer might have intent of reducing taxable income even if results are positive, or vice versa. The law links business purpose with actual results, which is problematic because results are uncertain. - The second condition may exclude legitimate MNE behavior where independents could not replicate certain integrated operations (e.g., to avoid ‘hold up’ issues). The mere fact that independents would not enter into a similar transaction is not sufficient to proclaim lack of ‘business purpose’. ### Scope of application of the business purpose test (paragraphs 160–166) - Law 466 applies the concept generally to transactions with non-residents (all independent parties abroad); the burden of proof is on the tax authority except for transfer pricing cases. - Concern: subjecting all cross-border independent market operations to a business purpose test is an overreach of the tax authority. - This overreach may be linked to Ukraine placing no limit to accounting expenses deductible for CPT purposes (see Box 6). - The business purpose test is most appropriate for controlled transactions. The law already defines suspect transactions (e.g., trading with low tax jurisdictions (LTJ) and beneficial legal forms). - LTJ and beneficial legal forms are already defined in the law. These are subjected to deduction limitations unless the taxpayer complies with the ALP, treating them as if they were controlled transactions; UTC arts 39.2.1.2, 140.5.4. - Applying the business purpose test to all transactions with non-residents (but not to transactions with residents) may conflict with non-discrimination rules in art 24 of the OECD or UN Model Treaty Conventions. The problem is avoided if the rule applies only to (all) controlled transactions. - The concept of “realistically available options” for independents — important to determine whether an independent, profit-motivated party would have entered the transaction — was not adopted with Law 466. This omission weakens the business purpose test in transfer pricing methodology and should be corrected. ### Box 6 — Disallowing the Deduction of Non-Business Expenses (summary) - Until 2014 UTC did not allow deductions for expenses with no link to business activity. The 2014 reform removed that rule so any expense in financial accounts became deductible. - Result: system is hard to control and potentially a large tax loophole. Reform intended to reduce discretionary STS behavior and litigation. - Concerns and suggestions: - The current requirements do not protect the tax base, especially for expenses favoring non-residents. Introducing a business purpose test on transactions with non-residents does not correct the issue. - Recommendation: consider reinstating a well-designed deduction rule for expenses related to a business, explicitly stating that there need not be a direct link with profits. - Consider reexamining how jurisprudence is established so that a ruling of the Supreme Court may protect all taxpayers in the same situation and the tax authority may act according to SC rulings. ### Business Purpose Test and Transfer Pricing (paragraphs 164–166, Box 7) - The business purpose test is useful when no comparable market transactions exist (due to unique MNE opportunities or tax-driven schemes). - The test allows the tax authority to decide whether to: - Price the transaction at arm’s length with methods not relying on comparables, or - Not recognize the transaction for lacking business substance. - Key element: ask whether an independent, profit-motivated party would have entered into such transaction by examining realistically available options. - Example: centralized procurement by an affiliate that immediately sells back to the local affiliate at double price without goods leaving the warehouse may lack business purpose because the realistically available option would be to keep inventory and sell directly. - Weakness: Law 466 omitted the “realistically available options” concept, creating ongoing uncertainty. ### Box 7 — Understanding the Business Purpose Test in Transfer Pricing (summary) - Transfer pricing methodology requires functional analysis to delineate the transaction accurately and find uncontrolled comparables. - Recharacterization may be appropriate when the real transaction differs from contracts; profit assigned should respond to real business purpose. - The business purpose test applies when comparables are not found and determines whether a controlled transaction is legitimate (to be priced at AL) or should be disregarded for lacking business purpose aside from tax avoidance. - To pass the business purpose test it must be shown the transaction had a profit motive and benefited the MNE for reasons different from reducing the global tax bill, and the affiliate should not be worse off compared to realistically available business options. ### Consequences of failing the business purpose test (paragraphs 167–168) - Expenses incurred in transactions with non-residents that lack business purpose are not deductible. This anti-abuse rule was introduced by Law 466, art 3, adding to UTC art. 140.5.15. - Practical effects: - For purchases: the deduction for the expense is disallowed and the taxpayer must increase its financial result by the disallowed amount. - For sales to non-residents: costs of the sale are assumed disallowed; nothing in the law specifies whether the income from that sale remains taxable. - Given the provision applies to all non-residents, the ALP becomes separated from the business purpose test: - A genuine independent transaction may fail the business purpose test while remaining outside ALP considerations. - Possible incongruities: a taxpayer may comply with the ALP but not the business purpose test, or vice versa. - It may create situations where a taxpayer exempt from ALP (e.g., turnover below threshold) must still comply with the business purpose test. - Note: Law 466 introduced UTC art 140.5.5-1 to clarify consequences of not applying ALP to sales to residents in LTJ or in countries with beneficial legal forms: consequence is an increase in results by 30 percent of the value of the sale. It is not clear that this also applies when the transaction fails the business purpose test. *Source: 1ukrea2020003 - 154. The law states that commodity prices are defined as an average or as a range of (PDF chapter/section).* ### 169. Law 466 extends the possibility for taxpayers to self-adjust when they fail the ### 1ukrea2020003 - 169. Law 466 extends the possibility for taxpayers to self-adjust when they fail the ### Business purpose test: current law, problems, and amendments in Bill 2524 - Law 466 extends the possibility for taxpayers to self-adjust when they fail the business purpose test, allowing correction in the same way deviations from the ALP are corrected (UTC art 39.5.4.1 as modified by Law 466). - The report argues this defies the logic of the business purpose test: - Failing the test means independents would not engage in such trade at any price (except a price equal to zero). - By definition, a transaction with no business purpose cannot have an AL price; UTC art 140.5.15 mandates disallowing the expense rather than adjusting the price (or profit margin). - Strictly speaking, if there is no business purpose, it cannot be AL; failing the business purpose test should lead to non-recognition rather than self-adjustment. - Bill 2524 (drafted soon after Law 466) would amend several aspects: - Remove linking business purpose to actual results of the transaction; instead link to the demonstrated objective of the operation (B2524, art 6, modifies UTC art 14.1.231, as in L466). Rationale: actual losses are insufficient grounds to determine whether a business is legitimate. - Limit application of the business purpose test to controlled transactions (not to all transactions with non-residents). The report endorses this approach, noting the general problem that deductible expenses need not relate to the business itself should be treated separately. - Extend the test to controlled transactions that include sale (purchase) of goods (B2524, art 6, modifies UTC art 14.1.231, as in L466) to avoid a loophole exempting goods. - Apply the test uniformly: transactions not complying with the ALP should be adjusted to yield a market profit rate (or market price) and, if impossible due to no business purpose, be disregarded (non-recognized). - Include deemed controlled transactions (e.g., transactions with LTJ or with foreign residents benefiting from legal forms allowing no CIT; UTC arts 140.5.4 and 140.5.5-1; payment of royalties UTC art 140.5.6) within the universe of controlled transactions subject to the test. - Bill 2524 introduces a mismatch risk: if taxpayer does not review ALP compliance, taxable income is affected by “blind” penalties (deductions reduced by 30 percent in one case, income increased by 30 percent of sales in another, and no deduction of royalties above 4 percent of sales). If the same transactions fail the business purpose test, they risk being disallowed in their entirety, effectively making the test a separate condition from the ALP. - Bill 2524 proposes adding the concept of “realistically available options” to help determine what independents would do, a necessary parameter for ALP analysis. - Recommendations related to the business purpose test: - Redefine the concept of business purpose based on the intended rationale of the transaction and eliminate reference to its actual result. - Do not apply business purpose test generally to transactions with non-residents. - Limit the application of the test to controlled transactions or deemed controlled transactions which must comply with the ALP to avoid ‘blind’ penalties in their financial results. - Apply the business purpose test to all controlled transactions, including trade in goods. - Change the definition of the business purpose test such that finding no independent comparable observations is not a sufficient condition to fail the test. - Add the concept of “realistically available business options” to determine whether the absence of market comparables can be qualified as a failure of the business purpose test. - Define the business purpose test as a condition to comply with the ALP, not as a separate test. - Clarify that by failing the test the taxpayer also fails the ALP for the transaction in question. - The exemption for complying with the ALP should equally apply to the business purpose test. - Do not allow self-adjustment as a remedy for failing the business purpose test; the remedy is non-recognition. - Consider the possibility of reintroducing a general requirement that expenses have to be connected with the business of the taxpayer (regardless of the purpose of the business) in order to be deductible. ### Thin cap rule: scope, thresholds, interaction with ALP, and Bill 2524 changes - Law 466 expands the thin cap rule to include debt with all non-residents (L466, art 90. 2), 1st par, modifying UTC art. 140.2). This addresses back-to-back loans arranged with unrelated parties. - Transitional provision (art 155) states: “The rules of interest accounting provided for in the first paragraph of para 140.2 of Article 140 of this Code shall apply ... to all loans, borrowings and other debt obligations accounted for on the taxpayer's balance sheet as of January 1, 2021". This has been interpreted by some analysts as covering all debt, including domestic lenders. - Bill 2524 would reduce the scope of the thin cap rule by excluding debt with foreign banks from the calculation (Bill 2524, initiative 104. 6). Bill 2524 also changes Law 466 in that thin cap is only applicable to debt with non-residents. - Concern: back-to-back loans can occur through banks, especially when withholding taxes on interest payments are lower for banking loans than other lenders. - Current interest deduction disallowance uses a double threshold applied sequentially: - i) debt in excess of 3.5 times of equity, and - ii) subject to a deduction limit of 30 percent of taxable profits. - Note: the second threshold was lowered from 50 percent of EBITDA with L466. - The report notes the first ratio (3.5) is high and most countries with debt-to-equity ratios have lower ratios, often 2 or 1.5 to 1. - Prior to Law 466, thin cap did not adequately interact with the ALP; non-compliance with both limits could trigger separate adjustments. Law 466 eliminated potential double adjustment (L466, art 90. 2), 5th par, modifying UTC, art. 140.2). - Interpretation (as clarified by Bill 2524 and MoF position): - The ALP applies only when it is stricter than the thin cap rule. - No amount of interest would be deductible above the thin cap threshold, regardless of the ALP. - The ALP would apply if the maximum deductible interest allowed under ALP is lower than the thin cap allowance. - Bill 2524 text (initiative 104, 6); UTC, art 140.2): “The “adjustments” resulting from thin cap will not apply when the amount of interest: a) is inconsistent with the arm’s length principle ...”. From a formal standpoint the ALP is applied first and then the thin cap rule supersedes it when resulting in an interest deduction cap below the AL level. - Recommendations related to thin cap: - Lower the debt to equity ratio in the thin cap rule; consider a 2 to 1 ratio. - Eventually consider keeping only one cap to interest deductions, a percentage of taxable profits. - Clarify similarly if the intent of the law was for the thin cap rule to include all debt. - Consider clarifying the interaction between the ALP and the thin cap rule, in the understanding that the ALP only limits interest payments below the thin cap level. ### Special rules defining related parties and thin cap exceptions - Law 466 introduces a higher participation threshold for International financial organizations (which by treaty with Ukraine have privileges and immunities), allowing them a 75 percent participation in a Ukrainian business before they are considered related and subject to TP rules (UTC art 14.1.159). The report questions the justification for this exception. - A related exception in Bill 2524 (preliminary version, art 104) would exempt Ukrainian companies indebted to these International financial organizations from the thin cap rule. The report notes the benefit accrues to the Ukrainian taxpayer doing business with the international organization. - Recommendation: - Eliminate the exception from complying with transfer pricing and thin cap rules for Ukrainian taxpayers that do business with International financial organizations. ### Appendix I: approaches to develop and maintain up-to-date property cadasters (summary of guidance) - UN and FIG “Bogor Declaration on Cadastral Reform” proposed development of modern cadastral infrastructures supporting land markets, land rights, sustainable development, land administration, and fiscal/legal/multi-purpose cadasters. - Recommendations for Ukraine: - Develop a clearly defined national fiscal cadaster vision, strategy and national framework; avoid un-coordinated, piecemeal approaches. - Establish the IT platform for the cadaster, likely GIS-centric spatial technology, meeting end-user requirements and building upon currently available national and local government data. - Assign responsibility for creation and management of the fiscal cadaster to the Ministry of Finance for coordination and synergies. - Build a data inventory containing detailed qualitative and quantitative information on each parcel and building; once mass collection is completed, only annual maintenance is typically required. - Ensure subnational fiscal cadasters can draw data from various existing sources (e.g., property physical attributes, addresses, ownership details). - Create a common property identifier (property or parcel identification number, PIN) for every property/building and parcel; one organization should be responsible for developing the standardized PIN methodology and linking the PIN to all associated data. - Example: Albania OSHEE experience - Pilot and nationwide data collection conducted; around 1,200 data collectors including around 400 GIS and mapping experts; data collected on hand-held tablets with GPS coordinates. - Total cost of project was around 1 billion ALL (US$ 9million), translating to around a US$ 9 per property registration cost. - OSHEE project limited to buildings with electricity connections; agricultural land inventory should be separately coordinated. _Italic: IMF staff report text from content unit 1ukrea2020003 (excerpts provided)._ ### Appendix II. Mexico’s Legislation on Indirect Method ### Appendix II. Mexico’s Legislation on Indirect Method ### Scope and triggers for presumptive determination (Article 55) - Tax authorities may presumptively determine: - taxable profits; - constructed taxable distributions from non-profit organizations subject to Title III of the Income Tax Law; - gross income; and - the value of the transactions, activities or assets on which contributions must be paid when any of the following conditions apply: - I. Taxpayers resist or hamper the tax authorities in the exercise of their audit competence; or fail to submit the tax return for the fiscal year for any contribution up to the time in which they notice to the taxpayer the beginning of an audit, and provided more than one month has elapsed as of the day on which the term to submit the relevant return expired. (The provisions of this section are not applicable to social security contributions.) - II. Failure to submit the accounting books and records, the supporting documentation of more than 3% of any of the items set forth in the returns, or failure to furnish the reports demonstrating compliance with the corresponding tax provisions. - III. Occurrence of any of the following irregularities: - a) Failure to record transactions, earnings or purchases, as well as alteration of the cost of sales, deviating more than 3% from the figures reported for the fiscal year. - b) Recording of purchases, expenses or services that did not take place or were not received. - c) Omission or alteration of existing stock that must be included in the inventory, or recording stock at prices different from their cost, provided the amount is in excess of 3% of the cost of the inventory. - IV. Non-compliance with obligations regarding valuation of inventory or absence of a procedure to record inventory control as provided for in tax provisions. - V. Officially approved cash registers not in operation or destruction/alteration of electronic equipment and systems authorized by tax authorities to record transactions for tax purposes, or prevention of their intended use. - VI. Other irregularities in accounting records that prevent tax authorities from understanding the taxpayers' transactions. - The presumptive determination is applicable in addition to warranted sanctions. ### Procedures for presumptive determination (Article 56) - Tax authorities shall compute gross income, transaction values, activity values or asset values for the fiscal year indistinctly by any of the following procedures: - I. Using data contained in the taxpayer's accounting records. - II. Taking as a basis the data contained in the returns for the fiscal year for any contribution, for the same fiscal year or any other, with necessary adjustments that are, if it is the case, consequence of a tax audit. - III. Using information provided by third parties upon request of the tax authorities, when they have business relations with the taxpayer. - IV. Using other information obtained by the tax authorities when exercising their audit authority. - V. Using economic or any other type of indirect research methods. ### Omissions in withholdings and presumptions (Article 57) - Tax authorities may presumptively determine contributions that should have been withheld when omissions in withholdings — specifically in the payment of such withholdings — exceed 3% of the withholdings actually paid. - For presumptive determination under this article, authorities may use any procedure in sections I through V of Article 56. - Special presumptions if unpaid withholdings relate to wages and salaries and the withholder has more than twenty employees: - I. Contributions are presumed to result from applying the relevant rate as if the employees were in the upper limit of the group in which each employee is classified for purposes of payment of social contributions … for the full period under review. - II. If the withholder has not paid social contributions for employees, unpaid withholdings are presumed to result from applying the relevant rate on an amount equal to four times the general minimum wage of the economic zone where the withholder is located for the full period under review, for each employee working for him. - Provisions also apply to presumptively determine the basis of other contributions when consisting of payments of wages and salaries of the Income Tax Law. ### Presumptions when verifying income, transactions, and compliance with rates (Article 59) - Tax authorities shall presume, unless there is evidence to the contrary: - I. Information in accounting records, supporting documentation and correspondence in taxpayer's possession relates to transactions undertaken by the taxpayer, even when not recorded under the taxpayer's name or recorded under another person, provided it is possible to prove that at least one of the transactions or activities recorded in said items was undertaken by the taxpayer. - II. Information contained in accounting systems under the taxpayer's name that is in the possession of persons under the taxpayer's employ or of the stockholders or owners of the enterprise relates to transactions undertaken by the taxpayer. - III. Deposits to the taxpayer's bank account that do not relate to entries in accounting records which the taxpayer is obligated to record represent earnings and the value of goods or activities on which contributions must be paid. - For this section, it shall be deemed that the taxpayer did not enter into accounting records the deposits made to banking accounts to the extent the taxpayer is obligated to record such deposits, if the taxpayer fails to exhibit such records upon request in a tax audit. - It shall also be presumed that deposits made in the course of a fiscal year in an amount exceeding MXP$1'000,000.00, into banking accounts of a person not registered with the Federal Taxpayer's Registry or who is not under the obligation of keeping accounting records constitutes income and represents the value of goods or activities for which they must pay contributions. - The preceding paragraph does not apply when before the authority initiates an audit the taxpayer regularizes this situation informing to the Tax Administration Service of such deposits, complying with all requirements establish on Temporary Tax Regulations. - IV. Deposits made to the personal bank checking accounts of managers, administrators or third parties are earnings and the value of goods and activities of the enterprise on which contributions must be paid, when they pay the debts of the enterprise with checks drawn on said bank accounts or when they deposit in said accounts amounts that relate to the enterprise and the enterprise does not record them in its accounting records. - V. Differences between assets as recorded in accounting records and the actual balance of such assets correspond to earnings and the value of goods or activities of the last fiscal year under review on which contributions must be paid. - VI. Checks drawn on the taxpayer's accounts issued to the taxpayer's suppliers or service providers that do not relate to transactions entered into accounting records are payments for merchandise acquired or for services for which the taxpayer obtained earnings. - VIII. Inventories of raw materials, semi-finished and finished products, fixed assets, deferred expenses and charges which the taxpayer has or holds, as well as the land where the taxpayer's activities take place are owned by the taxpayer. The property shall be valued at its market value and in the absence of such market value at its appraisal value. - IX. Goods the taxpayer declares as exported were sold in Mexico and were not actually exported, should the taxpayer fail to exhibit upon request supporting documents and information evidencing any of the following: - a) That the purchase of the goods actually took place or, if applicable, actual existence of the raw materials and of the installed capacity to manufacture or process the goods declared as exported. - b) The means used by the taxpayer in storing the goods declared as exported or the reasons for which such storage was not required. - c) The means used by the taxpayer to transport the goods abroad. If the taxpayer was not responsible for carriage, taxpayer must provide evidence of actual delivery of the goods and of the identity of the person that took delivery. - The presumption in this section operates even when the taxpayer has the export declaration documenting shipment of the goods. ### Unrecorded acquisitions and inventory shortfalls (Article 60) - When taxpayer fails to record acquisitions and tax authorities determine their existence, it shall be presumed the acquired property was sold and the sale amount equals: - I. Acquisition amount (including agreed price, contributions, ordinary or default interest, liquidated damages and any other item paid as a result of the acquisition) multiplied by the gross profit percentage with which the taxpayer operates. - II. The resulting amount is added to the acquisition amount and the sum shall be transfer value. - Gross profit percentage is obtained from taxpayer's accounting records for the fiscal year: gross profit divided by cost as determined for the taxpayer. Cost shall be determined following generally accepted accounting principles. If it is not possible to determine cost, it shall be assumed that gross profit is 50%. - The presumption does not apply when the taxpayer proves failure to record acquisitions was due to acts of God or force majeure events. - Same procedure to determine transfer value of goods by which inventories fall short. If acquisition amount cannot be determined, use amount of goods of same kind acquired by taxpayer in the fiscal year involved or their market or appraisal value. ### Reconstruction of income and determination when records are insufficient (Article 61) - If taxpayer qualifies for presumptive determination causes in Article 55 and cannot prove income or value of activities for period under review, presume income/value equal to one of: - I. If it's possible to reconstruct relevant transactions for at least thirty days as close to end of fiscal year as possible using accounting records/documents or third party information, determine income/value based on daily average of reconstructed period multiplied by number of days in period under review. - II. If records do not serve to reconstruct transactions for the thirty day period, use total amount of income or value of acts/activities observed for at least seven days including non-working days; resulting daily average multiplied by number of days in period under review. - Apply the relevant rate to the presumptively determined income or value. For income tax, taxable profit is determined first by applying to estimated gross income the ratio established in the Income Tax Law to determine such profit. ### Presumptions based on third-party information and documents (Article 62) - Tax authorities shall presume, unless there is evidence to the contrary, that third party information and documents relating to the taxpayer are transactions undertaken by the taxpayer when: - I. They refer to the taxpayer as identified by name, business or corporate name. - II. Any of the taxpayer's premises are identified as the place for delivery or reception of goods or supply of services relating to the taxpayer's activities, even when the name, business or corporate name of a real or fictitious third party is contained therein. - III. They show the name or address of a real or fictitious third party, if it is proved the taxpayer delivers or receives goods or services in that name or at that address. - IV. They refer to collections or payments made by the taxpayer or on the taxpayer's behalf, by means of an undisclosed agent or fictitious person. *Appendix II. Mexico’s Legislation on Indirect Method — Tax Code arts 55 – 62 (except 58) (Unofficial translation).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1ukrea2020003.pdf_