Kyiv-Mohyla Academy

International Taxation.Taxation of cross-border transactions: Corporate Profit Tax

March 2014

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PwC

Content

• Taxation of business (trading) profits• Taxation of passive income• Corporate profit tax vs. withholding income tax• Double tax treaties• Transfer pricing issues• Limitations on tax deduction for certain expenses• Tax rulings• Questions and answers

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Types of Income from Cross-Border Transactions

• Business (trading) profits (supplies of goods, works or services)

• “Passive” income

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Taxation of Business (Trading) Profits (“Active” Income)

• Business profits (supplies of goods, works or services) are generally subject to corporate profit tax only in the country of tax residence of the supplier

• The supplier may be subject to corporate profit tax in the country of customer (the source country) if its activities in that country create a taxable presence (a permanent establishment)

• The permanent establishment concept is a threshold / sourcing rule

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Taxation of Permanent Establishments in Ukraine

• Corporate profit tax applies to business (trading) profits received by non-resident companies through their permanent establishments (PE) located in Ukraine:

- A PE is considered to be a separate taxpayer in Ukraine

- Generally, rules applicable for taxation of profits of Ukrainian entities are applicable for taxation of PE profits

- Double tax treaties may provide different rules

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Taxation of “Passive” Income

• “Passive” income (specific transactions listed in national legislation) is generally subject to withholding tax in the source country

• Examples include: dividends, interest, royalties, capital gains, etc.

• Withholding tax rates are established by national legislation

• Double tax treaty protection (elimination or reduction of tax) may be available

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“Passive” Income in the Ukrainian Legislation

• Dividends, interest and royalties paid by Ukrainian residents

• Freight fees• Engineering fees• Lease payments paid by Ukrainian residents or in respect

of property situated in Ukraine• Income from sales of real property (including that of a

permanent establishment) situated in Ukraine• Profit from trading in securities and corporate rights• Income from joint activity agreements (simple

(unincorporated) partnerships) or long-term contracts carried out in Ukraine

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“Passive” Income in the Ukrainian Legislation(continuation)

• Remuneration from cultural, educational, religious, sports and entertainment activities in Ukrainian territory

• Agency, brokerage and commission fees paid by Ukrainian residents

• Advertising fees for the production and/or distribution of advertisements regarding a Ukrainian resident

• Income from (re)insurance of risks• Income from entertainment activities• Charitable contributions• Other income from a non-resident's business activities in

Ukrainian territory (except for income from the sale of goods, services or works)

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Taxation of “Passive” Income in Ukraine

• Withholding income tax applies to certain types of Ukraine-source income (“passive” income) derived by a non-resident:

- Withheld by the Ukrainian resident from income

- Paid at recipient's cost (as a rule)

- Remitted to the budget at the moment of making payments to non-residents

- No mechanism to pay the tax where settlements are made between non-residents

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Withholding Income Tax Rates in Ukraine

• Standard rate - 15%

• Freight income - 6%

• Insurance and reinsurance payments – 12% (few exemptions available) to be paid at the expense of the resident

• Advertising fees – 20% (to be paid at the expense of the resident)

• Double tax treaty protection (elimination or reduction of tax) may be available (see next slide)

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Double Tax Treaty Protection

• Withholding tax may be eliminated in the source state and taxed in the country of the recipient only

• Withholding tax rate may be reduced in the source state and relief provided in the country of the recipient

• Conditions for elimination / reduction of tax:

- The recipient should be a resident in the respective contracting state

- The recipient should be the beneficial owner of the income

- Other conditions

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Withholding Income Tax vs. Corporate Profit Tax

• Withholding tax is a type of corporate profit tax

• If a non-resident supplier does not have a PE in Ukraine, only certain items of Ukraine-source income (“passive” income) may be subject to Ukrainian withholding tax; no corporate profit tax would apply

• If a non-resident supplier has a PE in Ukraine, its business profits/other income attributable to the PE would be subject to corporate profit tax in Ukraine; no withholding tax would apply

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Double Tax Treaties

• The main purpose of double tax treaties is to avoid international double taxation

• Double tax treaties have other purposes and benefits (e.g. protection against tax discrimination)

• Tax treaties cannot create a tax liability, nor they can deteriorate the position of taxpayers (as a general rule)

• Ukraine has concluded double tax treaties with approx. 70 countries

• Tax treaties prevail over Ukrainian domestic lawMarch 2014

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Double Tax TreatiesStructure of OECD Model Convention

1. Scope – persons, taxes covered

2. Definitions – resident, PE

3. Taxation of income

4. Taxation of capital

5. Methods for elimination of double taxation

6. Special provisions

- Non-discrimination

- Mutual agreement procedure

- Exchange of information

- Assistance in the collection of taxes

7. Final provisions

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Double Tax TreatiesStructure of OECD Model Convention (continuation)• Scope – persons, taxes covered

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Double Tax TreatiesStructure of OECD Model Convention (continuation)• Definitions

- Residents

- Permanent establishments

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Double Tax TreatiesStructure of OECD Model Convention (continuation)• Taxation of income

- Income from immovable property

- Business profits

- Dividends

- Interest

- Royalties

- Capital gains

- Other income

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Double Tax TreatiesStructure of OECD Model Convention (continuation)• Methods for elimination of double taxation

- Credit method

- Exemption method

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Double Tax TreatiesStructure of OECD Model Convention (continuation)• Special provisions

- Non-discrimination

- Mutual agreement procedure

- Exchange of information

- Assistance in the collection of taxes

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Double Tax TreatiesStructure of OECD Model Convention (c0ntinuation)• Final provisions

- Entry into force

- Language

- Protocols

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Transfer pricing (TP)

Corporate profits tax (CPT)

Value added tax (VAT)

Controlled transactions

Obligations of the taxpayer

To report on controlled transactions

To substantiate the market level of the prices in the controlled transactions

Reporting on TP Report on controlled transactions

TP documentation(only upon tax authorities’ request)

Deadlines for reporting

till 1 May of the year following the reporting

year

The request for the provision of TP documentation can be sent to the taxpayer only after 1 May of the year following the reporting year. Deadlines for the provision of TP documentation:˗ for large taxpayers – 2 month

from the day of obtainment of the request;

˗ for other taxpayers – 1 month from the day of obtainment of the request

Penalties for non-compliance

5% of the value of the controlled

transaction

100 minimum monthly salaries for failure to submit TP documentation

Non-filing of TP report and / or TP documentation, or provision of TP documentation with violations that were not amended at the request of the tax authorities results in a TP audit

Up to 50% of underpaid tax liability (UAH 1 until 1 September 2014 for each violation)

Transactions with related parties: •non-residents;•residents that:-are non-CPT and / or non-VAT payers; -apply special tax regimes; -apply CPT and / or VAT rates other than standard;-declared tax losses for the previous tax year> UAH 50 mln

Transactions with residents of low tax jurisdictions (where the CPT rate is less than the Ukrainian rate by 5% or more)> UAH 50 mln

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TP documentation and reporting requirements

BusinessBusiness

Report Transfer pricing documents

Monitoring

Tax authoritiesTax authorities

• Before 1 May following the reporting year, all affected taxpayers should file a report on controlled transactions

• TP documentation, substantiating the market level of prices, should only be submitted upon the request of the tax authorities based on the conditions for an unscheduled tax audit

• Large taxpayers* should provide documentation on TP upon tax authorities request within 2 months from the day the request is obtained

• Other taxpayers should provide primary and other documentation on TP upon tax authorities request within 1 month from the day the request is obtained

• The request for the provision of TP documentation can be sent to taxpayers only after 1 May of the year following the calendar year in which the controlled transaction took place

• The tax authorities conduct monitoring without the taxpayer’s involvement and can request additional informationSpecial penalties for non-compliance:

− 5% of the controlled transaction value - for failure to file a TP report−100 minimum monthly salaries - for failure to file TP documentation

* Large taxpayer - a company with (a) income received in the last 4 quarters that exceeds UAH 500 mln, or (b) taxes paid during the last 4 quarters in an amount that exceeds UAH 12 mln

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TP methods

1

2

3

4

5

Comparable uncontrolled price

method

Resale price method

“Cost plus” method

Net profit method

Profit split method

price in transaction with RP =

price in transaction with NP

gross margin in transaction with RP =

gross margin in transaction with NP

net profit margin in transactions with RP=

net profit margin of the comparable RP

economically justified split of profits between RP

Methods Substantiationmanufacturer that sells

identical goods to RP and NP

trader that resells comparable goods to RP

and NP

service company that provides comparable services to RP and NP

trader that resells goods only to RP

transactions with intangible assets

Example

The main TP principle (“arm’s length” principle) –prices in transactions with related parties (RP) should be determined at the same level as in

transactions with non-related parties (NP)

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In which cases should one method or another be applied?

Comparable uncontrolled price

method

Resale price method

“Cost plus” method

Net profit method

Profit split method

exchange quotations available in transactions with intellectual property (e.g. royalties) in comparable transactions with non-related parties, if reliable information

on the comparable transactions is available

resale of goods provision of work, services production of goods (in case of capital-intensive activity) if there is insufficient information for using other methods if there is significant interdependence between the controlled transactions

and other transactions between parties involved in the controlled transaction

if the parties in the controlled transaction own/employ intangible assets that significantly impact the level of profitability

Methods Apply in the following cases

resale of goods without processing preparation of goods for resale and their transportation mixing of products, if the characteristics of the final products (semi-

finished goods) do not differ significantly from the characteristics of the mixed products

provision of services sale of goods, raw materials or semi-finished goods to related parties sale of goods (works, services) under long-term contracts

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Restriction for Deduction of Certain Expenses

1. Payments made by Ukrainian residents to offshore entities are deductible in amount of 85% of such payments.

2. If 50% or more of the charter capital of a taxpayer is owned or controlled by non-residents, the interest accrued/paid by such taxpayer to such non-residents or its related parties, can be deducted in the amount not exceeding (quasi thin capitalization rules):

Interest 50% of taxable profit

income excluding any interest

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Restriction for Deduction of Expenses (continuation)

3. A 4% limitation of the previous year’s net revenue is imposed on the deductibility of royalties paid to non-residents.

4. The deduction for consultancy, marketing and advertising fees purchased from a non-resident is restricted to 4% of the previous year’s net revenue.

5. The deduction for engineering fees purchased from a non-resident is restricted to 5% of the customs value of imported goods.

6. Payments listed in 3, 4 and 5 are not deductible if paid to offshore entities.

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Tax Rulings

• A tax ruling (consultation) is assistance given by the tax authorities to a specific taxpayer regarding the practical use of tax law provisions

• There are two types of tax rulings:

- general tax rulings (i.e. rulings which may be used by all taxpayers) and

- individual tax rulings (i.e. rulings addressing specific issues raised by a taxpayer in its request)

• General tax rulings have precedence over individual tax rulings

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Tax Rulings (continuation)

• Tax rulings are not binding upon taxpayers

• However, a taxpayer may not be penalized if it acted based on a general tax ruling or an individual tax ruling addressed to it

• A taxpayer may dispute a tax ruling in the court

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Thank you for your attention!Questions?

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