New changes in the transfer pricing rules (TP rules), which came into force on January 1, 2018, have demonstrated the new stage of evolution of the State’s position regarding the application of TP rules to transactions involving the permanent establishments of foreign companies in Ukraine (PEs).
Previously the provisions of Article 39 of the Tax Code of Ukraine (TCU) did not contain any information about how to apply TP rules to PEs. However, since the issue of such operations arose among taxpayers, the State Fiscal Service of Ukraine (SFSU) has provided written clarifications regarding its position on the matter.
In particular, in the period from 2015 to 2017, the SFSU’s position was based on the fact that PEs are not residents, despite the fact that PEs are equal to Ukrainian tax payers for corporate profit tax purposes. Thus, transactions between Ukrainian companies and PEs of their associated foreign companies or PEs of companies which are registered in a low tax jurisdiction, were considered as controlled transactions of the Ukrainian companies. At the same time no transactions or transfers of funds between foreign entities and their PEs in Ukraine were considered as controlled transactions in the mentioned period as well as the afore said transactions between Ukrainian companies and PEs were considered as controlled transactions of Ukrainian companies only, not of PEs.
From January 1, 2018 business transactions between foreign companies and their PEs in Ukraine are to be considered as controlled transactions in case the amount of such transactions exceeds UAH 10 million for the appropriate tax period (calendar year).
As a result of this regulation, any transactions between foreign companies and their PEs in Ukraine can be controlled for TP rules purposes. This generally correlates with the provisions of actual Double Tax Treaties signed by Ukraine and the corresponding OECD recommended approach to determining the profit amount, which should be taxed at the level of a PE.
However, foreign companies operating in Ukraine through their PEs should be aware of their risks which they may have in connection with these amendments.
First, the Article 39 of the TCU does not explain what exactly should be considered as “business transaction” between a foreign company and its PE in Ukraine as well as how to apply the arm’s length principle, taking into account the fact that PEs do not own any assets and do not have any own risks.
According to the OECD’s position on this issue, PEs should be considered as independent enterprises, with the only difference that instead of assets and risks, it is necessary to analyze the essential functions of the staff, but the OECD Guidelines are not a legislative act in Ukraine and are of a purely advisory nature for the Ukrainian taxpayers and the SFSU.
However, also the risk of the so called dependent agent permanent establishment (DAPE) shall be taken into account, and this risk may be even more significant for some foreign companies. The DAPE is a PE which formally does not exist but in fact there is a person which deals in interest of a foreign company and this person may be recognized as dependent agent of such foreign company which is equal to a PE for tax purposes.
Furthermore, while the Ukrainian legislation is changing regarding application of TP rules to PEs, the concept of DAPE is evolving internationally, as well as the TP rules application way to PEs.
For example, the Final Report on the BEPS Action Plan (Action 7) of 2015 contains amendments to Article 5 of the OECD Model Tax Convention. In accordance with these amendments a DAPE may be not only a person who “is acting on behalf of an enterprise and has, and habitually exercises an authority to conclude contracts in the name of the enterprise”, as it was before, but also a person who “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded by the enterprise” as well as person which acts “exclusively or almost exclusively on behalf of one or more enterprises which are closely related”.
Thus, the foreign companies which have any persons in Ukraine which may be recognized as DAPEs shall take their risks into account already now.
In addition, the fact that transactions between a foreign company and its PE may be considered as controlled transactions for TP rules purposes when their amount exceeds UAH 10 million for the appropriate year can make an option with a creation of a Ukrainian legal entity instead of a PE more attractive for many foreign companies operating in Ukraine, as for recognition of transactions between a foreign entity and its Ukrainian associated company as controlled transactions it is not enough to reach the amount of such transactions in excess of UAH 10 million per year, but it is necessary that the total income of the Ukrainian associated company exceeds UAH 150 million.
Thus, foreign companies should consider the existing risks, as well as the fact that the evolution of the Ukrainian Transfer Pricing rules applicable to PEs will continue.
Alina Bakulina, Partner, Head of Transfer Pricing Department
Tel.: +38044-249-7905
