Models for income tax calculation for permanent establishments of non-residents

Overall, Tax Code of Ukraine envisages 3 (three) methods for determination of taxable income) for a non-resident operating in Ukraine via permanent establishment, subject to taxation in Ukraine.

However, as the current tax laws do not establish priority of application and not quite clearly regulate criteria of choosing a specific method for calculating taxable income of permanent establishments, we will review their practical application in detail.

  1. Taxation in compliance with the general procedure, envisaged for all payers of income tax with submission of Tax Declaration.

Taxable income includes income in the form of the financial result prior to taxation determined in the financial statement of the taxpayer in accordance with the national accounting regulations (standards) or international financial reporting standards.

This method of taxation stipulates that a permanent establishment is viewed as a taxpayer conducting its activity independently from such non-resident. Therefore, when applying this method, revenues that originated in Ukraine and received directly by the permanent establishment (contracts for services are concluded with the permanent establishment) and costs for operations and maintenance of the permanent establishment  also borne directly by the permanent establishment are taken into consideration. In case a part of revenues is received directly by a non-resident or a part of costs is covered by a non-resident, it does not seem possible to take them into account using the aforementioned method of calculating taxable income. In addition, under such conditions, the amount of taxable income of permanent establishment can substantially differ from the real income received by the non-resident as a result of its operations in Ukraine, which could force a controlling body to use another method of calculation and comparison.

  1. Taxation based on determination of taxable income through calculation of the amount of separate revenues of the permanent establishment (by percentage on the basis of information from the separate balance sheet of the non-resident) with application of the Calculation 1

The statement that a non-resident conducts its operations in Ukraine and beyond its borders and does not determine income from its operations conducted through its permanent establishment in Ukraine is used as a criterion for choosing this method.

Taxable income includes the difference between separate revenues of the permanent establishment (based on calculations) and the costs borne by the permanent establishment (Clause 2 of Chapter II of the Procedure No. 544).

The legislator uses the wording ‘borne by the permanent establishment’ to define the costs borne directly by the permanent establishment of the non-resident.

For the purposes of calculation of the amount of separate revenues of the permanent establishment and also percentage of the permanent establishment’s revenues in total revenues of the non-resident, the permanent establishment must submit to the controlling body of Ukraine data on total volumes of revenues and costs of the non-resident in general and also information on the total number of its employees and value of its fixed assets. The documents must be certified by a tax body of the non-resident’s country, properly legalized and translated into the Ukrainian language.

The algorithm of calculating separate revenues of the permanent establishment includes calculation of its share (percentage) in the total volume of the aforementioned indicators (costs, employees, fixed assets) of the non-resident in general and accordingly determination of the share in the total revenues of the non-resident.

Taking into account the above, it is clear that Calculation 1 should be applied, in particular, in case when the permanent establishment directly bears all costs related to the non-resident’s operation in Ukraine (or their majority), while the non-resident receives revenues.

This method is quite difficult to apply in practice, as permanent establishments have no success in approving a separate balance at an agency of the State Fiscal Service of Ukraine, taking into account absence of the procedure of approval and quite important for such calculation information, approved by the tax body of the non-resident’s country.

  1. Taxation based on determination of taxable income through calculation of the amount of costs of the permanent establishment (applying 0.7 coefficient to the amount of revenues earned). In this case, Calculation 2 is applied

Tax Code of Ukraine envisages that the controlling body determines taxable income using this method (during an inspection). This is fully logical, as this method only requires information from the accounting reports drawn by the permanent establishment and does not require certified information from the non-resident. In addition, it is stipulated that in any case income before taxation will amount to 30% of the amount of received revenues and that the tax burden will be fairly decent.

Taxable income includes the difference between the amount of revenues of the permanent establishment, determined in correspondence with the accounting rules and the amount of costs, determined by multiplying the amount of revenues by 0.7 coefficient.

To generalize the information above, Method 1 (Declaration), ideally, should be used in case all revenues and costs from the operations of a non-resident in Ukraine are received and borne by the permanent establishment.

Method 2 (Calculation 1) is applied in case all costs from the non-resident’s operation in Ukraine are borne directly by the permanent establishment, while the revenues are received by the non-resident.

Method 3 (Calculation 2) is applied when the revenues received by the non-resident in Ukraine are received directly by its permanent establishment, while the costs are fully or partially covered by the non-resident.

Furthermore, starting from January 1, 2018, when determining taxable amount, permanent establishments need to take into consideration the new standards, envisaging that commercial transactions between a non-resident and its permanent establishment in Ukraine are viewed as controlled for the purposes of transfer pricing. A separate value criterion may be set for such transactions – volume of transactions that can impact the taxable amount must exceed UAH 10 million for the reported year. This factually means that the general rules of transfer pricing, envisaging the necessity to prove that the conditions of the transactions meet the arm’s length principle, now apply to permanent establishments.

Since 2015 EUCON International Legal Center has organized the International Forum on Transfer Pricing. The next 4rd International Forum “TRANSFER PRICING – 2018” will be held on May 23, 2018. The main purpose of our forum is to discuss current issues and problems of transfer pricing in Ukraine.

Source: KyivPost

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