Ukraine: Paying For Own Representative Office: A Three- Prospective View

Ukrainian lawmakers technically distinguish representative offices in Ukraine from their parent entities under a foreign jurisdiction. In this connection, relevant literature views Ukrainian representative offices as being almost independent players in the legal relations. However this is not the case: the interim status of structural units of economic entities entails a number of distinctions of the status of representative office as compared to the status of the principal management bodies of the parent economic entity ("head office"). These distinctions become sensible in the links between the representative office and the head office. One such "transacting" link is the head office’s financing of the representative office’s costs expenses. Several approaches may be applied to such transaction, and the very differences between them shall raise difficulties in applying the respective provisions in Ukrainian law.

As cross-border "interaction" aspects are our primary interest, this article focuses on the relations between a representative office registered in Ukraine and its head office located abroad. Ukrainian law determines two types of Ukrainian representative offices established by foreign economic entities:

1. " permanent" representative office (branches, departments, sections, etc.) – economic activities are the main function of such units, and
2. "non-commercial" representative office (missions, exhibitions, fairs, commerce chambers, etc.) – for such units economic activities, if any, are ancillary.

The term "representative office" shall hereinafter be used for a permanent representative office in Ukraine, that is an entity authorized to perform economic activities. Due to the volume of this review, issues of financing a "non-commercial" representative office are not addressed herein.

A representative office is registered in Ukraine by way of being recorded in the register and registered with the tax authorities. Unlike the structural unit of a Ukrainian legal entity, the foreign parent entity has to apply to the Ministry of Economy for registration and pay an excessive fee, as compared to the Ukrainian counterpart, which only submits information to the administrator of the relevant state register.

From the standpoint of Ukrainian economic law, the legal capacity of the head office entitles it to pay expenses and costs of representative office activities in Ukraine. Such payment may be effected at the head office’s own initiative or at the request of the representative office. Technically, expenses may be paid from the bank account of:

1. the head office, upon request of the respective bodies of the economic entity;
2. another representative office (including a Ukrainian one), upon instructions/request by the head office;
3. a third party, on the basis of an agreement with the head office or another representative office.

Considering the Ukrainian currency control laws, not every bank would immediately agree to perform such transaction. Nonetheless, the corporate status of representative offices simplifies the process of confirming the intention to perform such operations. In all mentioned cases, from the legal and economic (intra-economic, corporate) standpoint the head office functions as a body (bodies) of the economic organization in which both the representative office and head office are parts. The head office forms and delegates powers concerning the organization and activities of permanent representative offices on the basis of the legislation of the respective jurisdiction and/or foundation documents. The head office is entitled to vest a representative office with property and with the authority to manage such property or may rescind the abovementioned powers and manage the vested property itself. Thus, these relations of the head office can be viewed as intra-economic relations between an economic entity and its unit (representative office).

Alternatively, if the relations of a head office and representative office would be qualified as horizontal (between quasi-independent economic entities), this approach would face difficulties. Initially, upon enactment of the Economic Code of Ukraine in 2003 and until February 25, 2005,¹ structural units (branch, department, representative office, etc.) were generally considered economic entities, but even at that time their relations with the head office were regarded as intra-economic relations.

Foreign trade activities belong to the economic relations too; however they are not usually divided into intra- and inter-economic relations. It is possible to assert that relations between a representative office and head office shall not constitute foreign trade relations, as they deviate in a number of ways from the legally binding principles of foreign trade activity. From the foreign trade entity’s viewpoint, classification of the relations with the head office is more complicated: the representative office remains an independent player in the foreign trade activities under special law²; however, at the same time it is excluded from the list of such players under the Economic Code of Ukraine (Article 377)³.

As the second wave of argumentation in favor of relations’ intra-economic nature, one can alternatively argue that the authority of the head of an economic entity (legal entity) to represent the entity in relations with other economic entities shall include the authority to represent each and all structural units of such economic entity.

The relations between a body and an economic entity constitute representation by virtue of law or foundation documents (Article 65 of the Economic Code of Ukraine, Article 92 of the Civil Code of Ukraine) and are governed by corresponding regulations of economic and civil laws on representative offices⁴. From this point of view, a decision of the head office to pay expenses of a representative office shall not require additional grounds, such as contracts, requests and other inter-economic documentation. Obviously, exceptions are those cases when the head office has delegated powers to and obligated the representative office to apply for payment of expenses each time – for example for intra-economic reporting.

Accordingly, under economic laws of Ukraine the actions of a head office would require the same documentation for payment of expenses when they relate to a representative office’s activities (whether as general administrative costs or special projects) as if paying for expenses of the head office itself. From the standpoint of economic obligations, transactions entered into by the head office shall create, change or terminate economic rights and undertakings directly for the representative office.

The laws of Ukraine impose a specific obligation on an economic entity to maintain primary records, to account the results of its activities, and to submit financial reports in due course⁵. As demonstrated above, as a representative office is not an economic entity, it appears that the cost and revenue accounting may be carried out by the head office only. However, the requirements for the entities can be extended to representative offices by virtue of analogy (Article 8 of the Civil Code of Ukraine); and the Law of Ukraine "On Accounting and Financial Reporting" also indirectly affects representative offices⁶. Finally, although not an act of economic law, the Law of Ukraine "On Taxation of Enterprises’ Profit" directly obligates head offices to maintain accounting and conduct reporting⁷. Such extrapolation of the tax legislation has been practiced in Ukraine for a considerable time now. At the same time, there is no clear prospect for comprehensive economic law enactment on activities of representative offices; therefore, the representative office in Ukraine has to use a web of laws and regulations of conflicting nature.

The basis of the accounting of economic transactions consists of the primary records establishing the mere fact that such transactions were conducted. Law establishes requirements as to the form of primary documents (hard copy or electronic copy) as well as the obligatory details of such documents, namely:

1. title of the document (form);
2. date and place of execution of the document;
3. title of the economic entity on whose behalf the document is executed;
4. content and volume of the economic transaction, the unit of measurement thereunder;
5. positions of the persons responsible for conducting the economic transaction and for its correct execution;
6. personal signature or other data based on which it is possible to identify the person who participated in the economic transaction⁸.

Based on the above minimum requirements for primary accounting documents, a representative office’s accounting may reflect the expenditures paid by the head office, provided that it has the necessary documents confirming, in particular:

1. the material terms of the agreement with the (independent) third party for the supplied products (works, services, etc.); such terms usually refer to the price, quantity, calculations, liability, etc. Documents in confirmation of the conditions include invoices or bills, agreements, correspondence, price lists, etc.;
2. the connection between the economic activity of the representative office and the expenses (costs) paid – for example, request or correspondence of the representative office, order (instruction) of the head office;
3. the fact of payment – payment order, statement of account, SWIFT copy, signed receipt, act on works completed, etc.; and
4. the fact of intra-economic distribution ("transfer") of costs for allocation as an alternative – evidence of non-inclusion of paid expenses into the gross expenditures of the head office⁹ – for example, copy of the relevant accounting register, act, order, regulation, etc. Standard documents of the head office may be used provided that they comply with Ukrainian legislative requirements for primary documents.

Primary accounting documents of a representative office must be provided as originals or, if such originals cannot be provided, as duly certified copies, for example copies signed (and sealed) by officials of the head office. Thus, the internal accounting rules provide additional bureaucratic burden on the maintenance of the structural units in Ukraine, which may expand depending on the approach taken by the monitoring agencies. The general pattern of the record-keeping procedures, however, follows the distributions of functions among the structural units of the legal entity, provided each unit is properly staffed to allow the paperwork.

The Law of Ukraine "On Taxation of Enterprises’ Profit" provides that for tax purposes a representative office shall be recognized as a resident of Ukraine¹⁰ and for taxation purposes shall be equal to a taxpayer conducting its business independently of the head office (it may even receive a dividend (?!))¹¹. Accordingly, a representative office shall be leveled with an independent economic entity. Thus, irrespective of the economic status, profit amounts gained by the representative office are determined and taxed in accordance with the general rules, unless an international treaty of Ukraine provides otherwise¹².

The general rule for determining the taxable profit of a representative office is established by acts of the State Tax Administration¹⁴ ("Procedure"). The Procedure provides three alternative methodologies for assessment of tax liability¹³:

1. Independent assessment – by the head office in accordance with intra-economic practice, or, if such is not the usual practice then
2. Abstract assessment on the basis of a separate balance sheet of the financial and economic activities of the representative office subject to approval by tax authorities, or, when it is impossible to determine the profit in any of the above manners then
3. as the difference between gross income (adjusted by multiplying to a factor of 0.7) and gross expenditures.

According to the Procedure, only expenditures "incurred directly" by the representative office shall be included in the representative office’s gross expenditures for taxation purposes. Although inexpedient for economic activities, it is completely logical given that a representative office is presumed "independent." Following such logic, it is likely to expect application of the arm’s-length rules for transactions between the head office and representative office. Moreover, the representative office would not be able to pay from its own account the expenses of another representative office without incurring major tax liabilities for both – payer and beneficiary.

Bilateral double taxation treaties ("Treaties") allow, in spite of the Procedure, for certain deductions while determining the profit of the representative office, in particular for expenses incurred by the head office for purposes of the representative office. Such deductibles include management and general administrative expenses, regardless of whether such expenses were incurred in the country where the representative office is located or in any other place. In terms of legal effect, a Treaty has priority to law of Ukraine and the Procedure. In case a Treaty directly allows allocating expenses incurred by the head office to gross expenditures of the representative office, the Procedure may not be taken into account as an instrument supplementing the Treaty. On the contrary, the Treaty contradicts the Procedure and therefore the Procedure shall not apply to the extent that can be pointed out by the contents difference of operations definitions contemplated by the Treaty and the Procedure.

The Procedure refers to "gross" expenditures, which can have a fiscal connotation, whereas "expenditures" (Treaty) emphasizes economic content. The Treaties also specify that expenditures include management and general administrative expenses. Some Treaties clarify that deductible expenditures do not include royalties, remunerations, other payments for patent use, commissions, other amounts paid, except for amounts paid for covering expenses that were actually incurred¹⁵. It is interesting that Treaties specifically emphasize the settlements between a head office and representative office and therefore the Treaties are more consistent in maintaining the status of the representative office in its entirety with the head office and preserving the integrity of the fiscal policy with taxpayer’s status under economic law.

The laws of Ukraine contain numerous conflicts as concerns the status of a representative office of a foreign economic organization. The approaches vary even at the conceptual level and restrict the head office operations aimed at maintaining the economic activities of the respective representative office and in Ukraine generally. The desired trend in this situation would be to bring the tax legislation closer to the provisions on economic entities in the economic law, whereas the existing gap impedes the dynamic development of economic activities through representative offices.

The positive factor in this respect is the international obligation of Ukraine to unify the methodological approach to the avoidance of double taxation of income and property and to use the text of the model agreement in relations with the third parties¹⁷ under which "reasonable reallocation of documented expenses between an entity permanently represented in one Contracting State and its permanent representative office in the other Contracting State is permitted." Such expenses include management and general administrative expenses, research and development costs, interest and management fees, consultations and technical assistance, incurred both in the country in which the representative office is located and in any other place¹⁶. It would be natural to expect such principle to be established in national legislation. The bad news is that the obligation was assumed by the government of Ukraine as early as 1992; at the same time, the Law of Ukraine "On Taxation of Enterprises’ Profit" was adopted as early as 1994, not taking into account such obligation. Subsequent amendments and versions of the Law (over 60 only since 2000), have failed to take into account particularities of intra-economic relations between the head office of an economic entity and its foreign representative office.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.