The Ukrainian Parliament has adopted the new Tax Code of Ukraine (Tax Code) which became effective on 01 January 2011 (however the corporate profit tax (CPT) section will come into force on 01 April 2011).
In this alert we focus on certain CPT provisions of the Tax Code that may affect cross border transactions between Ukrainian and foreign businesses.
As a general comment, although the Tax Code sets a lower CPT rate of 23% (as opposed to the current rate of 25%) which is subject to a further annual gradual decrease to 16% by 2014, the tax burden for Ukrainian companies doing business with non-residents may in fact increase. Below we outline CPT related provisions that may have an adverse tax effect on tax structuring tools commonly used for cross border transactions.
Services
The deductibility of the costs of consultancy, marketing and advertising services received from a non-resident provider by a Ukrainian company is now limited to 4% of such company's income for the preceding reporting year. The deductibility of expenses incurred with respect to the purchase of engineering services from non-residents is also subject to limitation, at the level of 5% of the customs value of the equipment imported into Ukraine to which such engineering services relate.
If the non-resident service provider is an offshore company, the Tax Code disallows the deduction of all expenses incurred with respect to the purchase of consultancy, marketing, advertising and engineering services. The expenses related to engineering services can also be disallowed from deduction where a non-resident service provider is not the beneficial owner of such payment.
Royalty
The deductibility of royalties paid by a Ukrainian company to a non-resident is now limited to 4% of the Ukrainian company's income for the preceding reporting year, save for royalties paid by Ukrainian broadcasting companies and licences for foreign films and music and literary works. At the same time, the Tax Code completely disallows Ukrainian companies to deduct the expenses incurred with respect to royalties paid to a non-resident if such non-resident recipient: (i) is an offshore company; or (ii) is not the beneficial owner of royalties; or (iii) is not taxable on such royalties in a country where such recipient is a resident; or, finally, if (iv) intellectual property rights with respect to which royalties are paid have initially originated in Ukraine.
Interest
The interest paid by a Ukrainian borrower to its non-resident shareholder having, directly or indirectly, at least 50% of the shares in such borrower or to such shareholder's related parties is subject to a limited deduction. Such deduction must not exceed an amount equal to 50% of the taxable income of such Ukrainian company for the reporting period, increased by the amount of interest income derived from the placement of its own assets, if any. The disallowed remainder can be carried forward by the borrower to the next reporting period subject to the same limitation. The amount of allowed deductible expenses in relation to transactions with related parties shall not exceed an interest rate calculated on an arm's length basis.
Dividends
The Tax Code requires advance payment of CPT which is levied on top of the gross amount of dividends and the advance CPT payment must be paid by the distributing company to the state treasury prior to/together with the dividends distribution. Such advance payment is not a separate tax on dividends but constitutes a part of CPT that is paid in advance and then can be offset by the distributing company against its CPT liability for the tax period during which the dividend distribution is made. In practice, this advance CPT payment requirement could cause a cash flow shortage for the company thus preventing it from making a full distribution of dividends to its shareholders.
The advance CPT payment is not applicable in the following cases: (i) dividends are paid out to individual(s); (ii) dividends are reinvested in the issuing company and this does not result in alteration of the existing proportions of shareholdings; (iii) dividends are distributed by a collective investment institution; (iv) dividends are distributed to the shareholders of the parent company in an amount not exceeding the amount of dividends received by such parent company from its subsidiaries; (v) dividends are distributed by a real estate fund manager.
Capital gain
The capital gain realized upon alienation of Ukrainian shares, being a positive difference between the costs incurred and proceeds received for such shares, is subject to withholding tax at a rate of 15%, unless provided otherwise by an applicable double tax treaty (DTT).
The majority of Ukrainian DTTs envisage that the shares of a Ukrainian company deriving their value mostly from real estate situated in Ukraine are normally subject to a withholding tax in Ukraine. According to the Tax Code, the value of shares received by the founding shareholder upon establishing a Ukrainian company is not considered to be a cost for the purpose of determining capital gain when such shareholder alienates the shares. That means that a founding shareholder alienating its shares in a Ukrainian company will be subject to tax on the entire amount of received proceeds. Thus, the abovementioned provisions of the Tax Code of Ukraine may have an adverse tax effect on foreign investors into Ukrainian real estate holding companies.
Gross up clauses
The Tax Code of Ukraine explicitly prohibits gross-up clauses in contracts.
Back-to-back financing
The Tax Code introduces the concept of beneficial owner which was not entrenched in Ukrainian tax legislation before. This may affect back-to-back financing structures and syndicated lending and, consequently, the cost of financing.
Law: Tax Code of Ukraine, No. 2755-VI, dated 02 December 2010.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 17/01/2011.
