Ukraine: Recent Amendments To Corporate Taxation Law

On 22 January 2002, amendments to the Law of Ukraine "On the Taxation of Profits of Enterprises" (the "Profits Tax Law") of 24 December 2002 (the "Amendments"), were officially published. The Amendments are the culmination of the efforts of the Ukrainian authorities to change the taxation regime within the existing legislative base, prior to the prospective adoption of the new Tax Code of Ukraine by the Ukrainian Parliament (Verkhovna Rada). The Amendments also mark a significant clarification of a number of points concerning the taxation of corporate taxpayers in Ukraine, which either have remained unresolved or were subject to ambiguous interpretations by the tax authorities.

For the first time in the Ukrainian taxation practice, the Amendments comprehensively explain the methods of determining the "usual prices" between related companies. As a consequence, transfer pricing, which is often used by multinational companies for the optimization of their taxation in different jurisdictions, will have an important effect on the taxation of the local businesses of multinationals in Ukraine.

Under Article 1.20.1 of the Profits Tax Law, the term "usual price" is now defined as "unless otherwise defined herein, the price of goods (works, services) established by the parties to an agreement. Unless proven otherwise, it shall be deemed that the usual price corresponds to the level of the fair market price." [Emphasis added.]

Further, the fair market price is defined as "the price used for the transfer of goods (works, services) to another owner, provided that the seller wishes to transfer such goods (works, services), and the buyer wishes to receive them, in the absence of any duress, both parties are mutually independent, either legally or actually, [and] possess adequate information about such goods (works, services), as well as the prices established on the markets for identical (or, in their absence, similar) goods (works, services)". Moreover, in order to determine the "usual price" of goods (works, services), information about agreements with identical (or similar) goods concluded on comparable conditions should be taken into account.

Apart from the above general rules, certain methods may now be used for the determination of the "usual price", such as the "resale price method" or the "cost plus method". Moreover, the Cabinet of Ministers may establish the methodology for the fixing of prices of natural monopolists (e.g., electricity distribution companies, etc.).

Importantly, the Amendments have shifted the burden of proving (in accordance with the procedure established by law) that a price is not the "usual" price (and thereby raising suspicions of an attempt to avoid taxes) to the tax authorities. The taxpayer now has the option either to substantiate the level of the contractual prices, or simply to refer the tax authorities to the definition of the "usual price" in the Amendments, i.e., to assert that the price is contractual.

Although not perfect, the new rules establish a presumption of the fairness of the contractual prices and provide a basis for taxpayers to dispute any arbitrary attempt by the tax authorities to determine indirectly the contractual prices and to levy taxes on deemed revenues. Hopefully, these clearer rules will contribute to the more adequate and consistent application of transfer pricing rules in Ukraine.

The Amendments introduce more detailed rules relating to the distribution of dividends by Ukrainian corporate taxpayers. Formerly, dividends distributed to resident shareholders were taxable at a 30 per cent tax rate, while distributions to non-residents were subject only to withholding tax at the rate of 15 per cent, unless a valid double taxation treaty provided otherwise.

The Amendments introduce a number of new provisions into the taxation regime of dividends under the Profits Tax Law, as follows:

1. dividends payable by a Ukrainian corporate taxpayer distributing the dividend are now subject to taxation at 30 per cent tax (to be reduced to 25 per cent starting 1 January 2004) before or upon making the dividend distribution; such corporate taxpayer must make an advance payment of such tax, in addition to the amount of the dividends (i.e., so that there will be no reduction in the amount of the dividend); the overall tax liability of such corporate taxpayer will be reduced by the amounts of such advance tax payments made during a particular reporting period;
2. a Ukrainian corporate taxpayer distributing a dividend must apply the above rules regardless of the residency status of the recipient shareholder, so that both Ukrainian residents and non-residents receive equal dividend distributions (without any deductions in the amount of the dividend, but not taking into account the withholding (repatriation) tax, which such corporate taxpayer must withhold on behalf of a non-resident shareholder) from such corporate taxpayer;
3. a Ukrainian corporate shareholder receiving a dividend is now specifically exempt from any taxation of dividend distributions received as a result of its shareholdings in a Ukrainian corporate taxpayer under Article 7.8.6 of the Profits Tax Law, whereas a non-resident shareholder receiving a dividend will still be liable to withholding tax in the amount of 15 per cent, which is payable at source by the Ukrainian corporate taxpayer distributing a dividend, which must act as the tax agent of such non-resident shareholder, unless a valid double taxation treaty provides relief from such withholding tax for the non-resident shareholder.

Overall, the taxation of dividends has changed significantly under the Amendments, especially for resident corporate shareholders, which are now exempt from any taxation of dividends received from a Ukrainian company (specific rules apply, however, for shareholders receiving dividends in lieu of salary). Although, at the corporate level, the Ukrainian corporate taxpayer distributing a dividend will now have to make an advance payment in addition to the amount of its dividend distributions, no deductions will apply to the actual amount of the dividend (expect for the withholding tax payable by such corporate taxpayer on behalf of non-resident shareholders, who do not enjoy any relief under a valid double taxation treaty). In practice, this means that a resident shareholder is put into a more advantageous position than a non-resident one, with the latter being still liable for a withholding tax (payable by the Ukrainian corporate taxpayer on its behalf) or for paying the relevant tax at home.

The Amendments set forth new definitions of "financial" and "operative" leasing, as well as changing the rules for the taxation of such operations. While the object of "operative" leasing is taxed without creating substantial tax consequences for the lessor or the leasee, the object of "financial" leasing is taxable under the Amendments in a way similar to the taxation of a simple sale transaction.

The Amendments introduce a significant change to the tax accounting rules in the Profits Tax Law. Formerly, either the cash method or the accrual method was used, based on the earlier event of making payment or receiving the goods (works, services), in order to account for the expenses incurred by a taxpayer. The Amendments introduce new rules to determine the moment when the expenses incurred by a taxpayer become deductible for profits tax purposes.

In particular, now only the accrual method may be used for transactions of Ukrainian corporate taxpayers with (A) non-residents or (B) residents, which either (i) are not payers of the corporate profits tax, (ii) are exempt from the corporate profits tax, (iii) pay the corporate profits tax at a rate lower than 30 per cent, or (iv) pay the corporate profits tax under a special procedure, i.e., a single tax or a fixed tax.

Despite some unfortunate ambiguous drafting, it appears that the Amendments impose the requirement on a Ukrainian corporate taxpayer to specify in any commercial agreement its tax status as a regular corporate taxpayer paying the corporate profits tax at the regular 30 per cent rate (in contrast to the tax status of Ukrainian-resident taxpayers specified in (B) above), in order to apply the cash method for the tax accounting of their expenses. If such regular Ukrainian corporate taxpayers fail to specify their tax status, or in the absence of a written agreement between them, only the accrual method may be used for the tax accounting of the expenses incurred by such taxpayers.

The Amendments increase the rates of depreciation for capital assets, and supplement the classification of assets for depreciation purposes with a new, fourth group of assets. Under the Amendments, the new depreciation rates for the specified four groups of capital assets per calendar quarter are as follows:

• Group I: buildings and installations - 2 per cent (previously, 1.25 per cent);
• Group II: automobiles and spare parts, furniture, electronic, optical, and electro-mechanical appliances and instruments, and other office appliances - 10 per cent (previously, 6.25 per cent);
• Group III: capital assets not included in other groups - 6 per cent (previously – 3.75 per cent); and
• Group IV: computers, other machines for the automatic processing of information, software, related readout and printout devices, other information systems, telephones (including satellite phones), microphones, and portable radio transmitters - 15 per cent.

The new rules on depreciation in Groups I, II, and III will become effective from 1 January 2004. The new Group IV depreciation rules apply from 1 January 2003.

The Amendments introduce a number of minor, but significant, changes to the taxation of corporate taxpayers. Firstly, the rate of taxation of companies’ profits will be reduced to 25 per cent from 30 per cent starting from 1 January 2004. Secondly, a new definition of a "non-resident with an offshore status" has been introduced for the purposes of applying Article 18.3 of the Profits Tax Law, which provides for a limitation on the deductibility (i.e., only 85%) of any amounts paid to or through a non-resident having a special offshore status (as opposed to other foreign non-residents), i.e., as per the list of certain offshore zones published by the Cabinet of Ministers of Ukraine. These "offshore zones" are considered to be tax havens and include, inter alia, Cyprus, Netherlands Antilles, and Channel Islands. Thirdly, the Amendments introduce new rules for the tax reporting of land transactions, as well as for contributions under voluntary insurance arrangements.

Although many issues still remain unresolved, the Amendments introduce a number of new rules, which help to clarify the taxation regime of Ukrainian corporate taxpayers. Moreover, some rules introduced by the Amendments are definitely aimed at lightening the tax burden of corporate taxpayers in Ukraine.