A new transfer pricing law that went into force on Sept. 1 is designed to cast a wider net and capture an additional $2.5 billion of potentially lost tax revenue over three years, the Ministry of Revenue and Duties recently told the Kyiv Post.
Generally defined as when two related companies – a parent company and a subsidiary, or two subsidiaries controlled by a common parent – trade with each other, the law requires companies to report all transactions with counterparties that exceed $6.1 million annually. The rule also applies to Ukrainian taxpayers that deal with non-residents whose own tax rate is at least five percentage points lower than the Ukrainian rate.
The new rules will compel Ukrainian companies to reveal the counterparties with whom they do business and make them more transparent for potential investors, believes Mykola Mishyn, the revenues and duties ministry’s point man on transfer pricing.
For a government that constantly struggles with rampant capital flight, the law could be a revenue boon, said Dmytro Donets, a lawyer at DLA Piper. A 2012 report by the Tax Justice Network ranked Ukraine 15th worldwide on a list of countries from which capital flees. The report found Ukraine contributing $166.8 billion to the global offshore industry. As the top foreign investor into Ukraine, offshore tax haven Cyprus has invested $17.6 billion, or almost one third of all foreign direct investment inflows into the country.
As a standard practice, Ukrainian companies, especially big exporters, work with partners from lower tax jurisdictions. In doing so, they manage to save huge amounts of money. For example, grain exporters save $10-$20 per ton, experts say. To compare, the government forecast 30 million tons of grain exports for the marketing year. This means that state coffers won’t receive $300-$600 million. Other industries produce much higher numbers.
The revenues and duties ministry is identifying the hundreds of companies that will have to submit transfer pricing reports. Those include companies that work in metallurgy, chemicals, coal mining, agriculture and retail. These companies must submit their first reports before May 1, proving that their transfer prices were set at market levels for the September-December period.
Legislation specifies how to determine the accepted market price for a good or service. Yet lawyers say not all prices are listed, especially in Ukraine’s lucrative information technology industry.
“There are not enough reliable independent sources of information. The sources suggested by the state are easily manipulated by the state,” said Zoya Mylovanova, senior associate at Beiten Burkhardt law firm. “Foreign sources, which could give some objective information for certain markets, are not admissible.”
Moreover, any price can’t be taken out of market context, Mariya Kolesnyk, an expert from AAA agro agency says. “How should forward contracts be treated? The price can also differ in different places. For example, prices in the Azov harbor are lower than in Odessa.”
The revenues and duties ministry, however, says the law does not limit the number of information sources. Businesses are free to use statistics or accounting information published on, for example, company websites, state agencies or banks, Mishyn says, noting that this can be done when the information isn’t listed in government-approved source.
In addition to confusion on accepted market prices, lawyers say the government failed to pass secondary legislation needed to properly implement the new transfer pricing rules.
“Eventually, companies would be required to allocate virtually all their human resources on controlling their transfer pricing instead of conducting business and promoting sales,” says Oleksiy Khomyakov, counsel at Asters law firm.
Companies who fail to report on time or who don’t reveal all of their required transactions face a penalty of 5 percent of the value of each transaction in violation.
“This is a huge amount and a big risk for business,” said Volodymyr Didenko, head of tax planning at Group DF, which has huge chemical assets in Ukraine.
Furthermore, there is no grace or transition period.
Asters lawyer Khomyakov estimated that it could cost a firm 2 percent of its annual sales turnover to implement a transfer pricing module.
Additional labor costs to hire someone to be responsible for transfer pricing could be as much as $50,000 annually, said DLA Piper’s Donets.
