Ukraine loses approximately $10.2 billion a year due to shifting capital to the offshore accounts, according to unofficial information of local tax authorities. To avoid this, in July of 2013 Verkhovna Rada passed a law on transfer pricing which narrows the opportunities to take profits to the offshores.
Law became effective on Sep. 1 last year, but the date for the first filing of respective transfer pricing reports is due to May 1. So far, Cyprus and British Virgin Islands remain the most popular directions of Ukrainian businessmen’s taxing optimization policy. Meanwhile, the Internet is filled with advertisements offering all sorts of offshore services for Ukrainian clients.
“Given that the law-makers have not set any transitional period for application of transfer pricing legislation, many large businesses took the necessary steps to meet the new requirements just after the law came into effect. At the same time, we have doubts that the tax authorities from their side will be ready to properly apply the new legislation in 2014,” says Denys Lysenko, partner at Vasil Kisil & Partners law firm.
Oleksiy Homyakov, counselor for Asters law firm, adds, “The concept put into the foundations (of transfer pricing legislation) is quite progressive, even from the point of view of analogous relevant legal norms of prominent European countries. However, newly introduced rules of transfer pricing lack clear and well-defined… mechanism for administrating and controlling their implementation by subjects of economic activity.”
The standard scheme of taking profits to the offshore jurisdiction with lower taxes includes registering a resident company there as a first step. Then Ukraine-based producer of certain goods sells them to own offshore unit at an extremely low price to avoid paying a substantial amount of taxes under Ukrainian tax legislation.
When any interested party wants to purchase those products, it buys it from the offshore entity which pays significantly lower taxes according to the local rates. Goods that are being sold may never leave Ukraine in such a scheme.
Transfer pricing legislation is applied when there is a suspiciously low price for sale of goods to the foreign companies. Average market prices are used for assessment in this case.
Ukrainian legislation covers the deals whose aggregate annual value exceeds $5.1 million with home or foreign affiliated and non-affiliated residents. In case of foreign residents. transfer pricing laws are implied if corporate income tax rate in that country is lower than the Ukrainian by 5 or more percentage points, reaching 14 percent and less.
“Respective regulations are not perfect, and the taxpayers in some cases have already discovered their uncertainties and possibility of ambiguous interpretation,” explains Lysenko. “Part of them may be resolved by way of official interpretation (i.e. by way of a generalized tax ruling), another part — through legislative amendments. In both cases there should be a straightforward dialogue between the state and business representatives — which is hopefully forthcoming with the new Ukrainian government with an “investor-friendly face” now in place.”
British newspaper Guardian yet in 2010 estimated that a third of all the wealth on the entire globe is being held in offshore banks. Global Research, Canada-based center for research on globalization, estimated in 2013 that the global elite are hiding $18 trillion in offshore banks. However, the same year Guardian reported about $32 trillion kept on the offshore accounts in British Virgin Islands.
“Each jurisdiction has certain peculiarities of its transfer pricing legislation, which mostly depend on the particular legal and tax system. Today many EU and non-EU states follow the Organization for Economic Cooperation and Development Transfer Pricing Guidelines, which are generally considered to be a common standard, which may be followed and adapted with or without changes into domestic legislation”, comments Lysenko of Vasil Kisil and Partners.
Canada, China and the US have already introduced effective mechanisms of exchanging the taxation information between different countries, which stimulate global trade and prevent tax evasion, says Asters’ Homyakov.
Today a lot of different measures are being elaborated by the international organizations like OECD and Financial Action Task Force on Money Laundering and implemented by some states, aimed at limitation of tax advantages which may be achieved using offshore companies. Besides transfer pricing legislation, they include increasing transparency and improving exchange of tax-related information.
Offshore schemes are risky and expensive, adds Homyakov. “The only way of returning the capital and attracting new investments to Ukraine is a significant reduction of the amount of taxes.”
Lysenko foresees, positive changes regarding domestic legislative framework and judicial system may become the key argument for the Ukrainian business to re-invest in Ukraine. Another option, which is widely discussed, is a mere tax amnesty for offshore wealth. “(It) is not likely to yield any significant results, unless coupled with and supported by systemic legal and economic reforms,” Lysenko resumes.
