ALERT: Anticipating the Big Tax Reform
In September 2019 the Parliament of Ukraine commenced a large scale legislative overhaul of the country’s tax system through draft laws No.1208, No. 1080, No.1051, No.1057, No.1073, No.1053-1 and No.1210. Overall, these drafts attempt to unify tax innovations and to eliminate any contradictions in the tax system.
The first two draft laws amend current Criminal legislation. Draft law No.1208 proposes the establishment of the National Bureau of Financial Investigations as a unified law enforcement body in the sphere of economic crimes. The draft law No.1080 (adopted as a law by parliament on 18th September) changes the minimal threshold from around 960 thousand UAH to 2 881 thousand UAH for criminal liability for tax evasion.
Draft laws No.1073 and No. 1053-1 (both adopted as laws by parliament on 20th September) aim to eliminate the grey economy in Ukraine and conduct a process of unshadowing by adopting a full fiscalisation of all transactions. The main requirement is to use sales registers in every settlement operation to combat tax evasion. Moreover, the law provides customers with significant new rights. For instance, a buyer may claim a full refund if a transaction was conducted with infringements of tax legislation. This legislative innovation will motivate customers and sellers to comply with the law. The most comprehensive draft law is No.1210 (around 500 pages of amendments mostly in the Tax Code of Ukraine). This Bill is a requirement of the base erosion and profit shifting (BEPS) Action Plan. The BEPS was initiated by the G20 and issued by the Organisation for Economic Cooperation and Development (OECD) in 2015. Currently around 130 countries joined the Project (Ukraine joined in 2017). Moreover, the application of BEPS in Ukrainian legislation is a requirement of the Ukraine–European Union Association Agreement.
1.1. The BEPS addresses tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. It is no doubt true that international corporations attempt to “shift” profits from higher–tax jurisdictions to lower–tax jurisdictions and such attempts cost developing countries USD 100-240 billion in lost revenue annually. The Action Plan implements 15 measures to tackle tax avoidance and those 15 measures are reflected in draft law No.1210.
1.2. For instance, it introduces a new term into current legislation: Controlled Foreign Company (CFC). Such a company is incorporated outside Ukraine, but is legally controlled by a resident of Ukraine. The recognition of this concept reduces the risk that taxpayers strip the tax base of their country of residence and shift income into a foreign company that is controlled by domestic taxpayers.
1.3. The draft law establishes exemptions and thresholds, approaches for determining the type of income, computation of CFC income, and the attribution of CFC income to shareholders. Such rules may, therefore, prevent CFCs from deliberately shifting income into foreign affiliates.
1.4. Furthermore, the draft law thoroughly regulates issues of transfer pricing. It establishes new legal terms and legal regimes such as Multinational Enterprises (MNEs) and MNE groups. In addition, the draft law describes mechanisms of tax accounting for such companies (e.g. international corporations are obliged to submit reports annually including information about each tax jurisdiction in which they do business in Country-by-Country (CbC) Reports).
1.5. Moreover, the draft law No.1210 covers legal issues of permanent establishment status. Generally companies pay tax in a certain jurisdiction if they have a permanent establishment there. Some companies adopt strategies that nominally replace affiliates that traditionally acted as distributors, resulting in a shift of profits out of the jurisdiction where the sales took place. Thus the definition of a permanent establishment is crucial for determing whether a company as a non-resident should pay income tax in another jurisdiction.
Overall, the proposed amendments of draft law No. 1210 cover all of the BEPS measures (including multinational collaboration to eliminate double taxation and tax evasion). Such rules of law are absolutely brand new for Ukrainian legislation. However, the new legislation does not give much time for tax authorities to implement all changes in their acts (most rules will be in force from 01/01/2020).
2.1. The draft law No. 1210 does not only seek to implement the BEPS Action Plan: it also proposes to reform the treatment of financial liability. Financial liability will be based on the principle of guilt (like in Criminal law), meaning the tax authority should define all circumstances of a breach and provide sufficient evidence of guilt to establish liability (whereas now this process is formal without proof of guilt). Furthermore, the draft law also establishes the possibility of liability of the tax authorities and a mechanism of indemnification of losses for companies. Such innovations, eventually, will help defend businesses from undue pressure by the state and tax authorities. In addition, the proposed amendments introduce a new level of appeal for taxpayers. Currently, a company that does not agree with a decision of the tax authorities may appeal it only to a higher tax authority, whereas the draft law determines a second level of appeal in the Appeal Council of Ministry of Finance of Ukraine.
Overall, the draft law No.1210 is very progressive and is directed to fulfill Ukraine’s international obligations. Once implemented the BEPS Action Plan will allow Ukraine to use modern mechanisms of tax control and improve the process of taxation significantly.
To sum up, the proposed tax reform across one newly adopted law and six draft laws is very comprehensive and covers many aspects of tax and connected legislation and it can be considered the Ukrainian parliament’s most ambitious reform of the Tax Code of Ukraine ever. It could even be compared to “shock therapy” because the reform envisages a very reduced time framework (most changes should be in force in three months).
In addition, the reform will become a positive signal for international organisations, the G20 and investors. Ukraine is going to use generally accepted rules of taxation that international companies and investors know and understand. The issues of taxation and tax evasion are very crucial for the stable development of the economy and Ukraine shows that tax compliance plays an important role in state policy.
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