Currently, many countries have certain issues related to the payment of taxes, as existing rules enable businesses to use abusive practices with regard to tax rates, regulations, and benefits in different countries. To prevent this, the Organization for Economic Cooperation and Development (OECD) has developed recommendations with respect to combating tax evasion – BEPS Plan (Base Erosion and Profit Shifting).
Within the framework of the BEPS Plan, a number of steps have been developed to cover various areas to counteract aggressive tax planning, including refinement of transfer pricing rules, prevention of tax evasion by applying international treaties, taxation of incomes of controlled foreign companies, information exchange. On 1 January 2017 Ukraine joined the implementation of BEPS Plan minimum standard in terms of implementing some of its activities. And one of the vectors for introducing provisions of the BEPS Plan into Ukrainian legislation is to refine procedures of control over transfer pricing and profit shifting.
Since 2019, a number of innovations in tax legislation with relation to transfer pricing have been introduced, which can be summed up as follows:
1. Statutory provisions related to the clarification of criteria to recognize transactions as controlled ones
If a non-resident, whose form of incorporation is included in the List approved by the Cabinet of Ministers (No. 480), paid income tax (corporate income tax) in the reporting year, and subject to the absence of other grounds, transactions with it could be recognized as non-controlled ones. The tax payment shall be confirmed by the certificate issued by the authorized body of the non-resident country.
From 2018, economic transactions conducted between a non-resident and its permanent representative office in Ukraine are recognized as controlled ones if the total volume of such transactions, as determined under accounting rules, is more than UAH 10 million. This statutory provision was amended in 2019, and currently the concept of economic transactions for transfer pricing purposes, conducted between a non-resident and its permanent representative office in Ukraine, also includes internal economic settlements.
2. Introduction of the principle of substance over form prevalence
The principle (doctrine) of substance prevailing over form is one of the underlying principles of international taxation and international financial reporting standards. The main idea of this doctrine is that transactions are recorded according to their substance and not only based on their legal form. The determination and analysis of the contribution of each party to the transaction, the functions performed by the parties to the transaction, the risks incurred are based on concluded agreements, accounting data, the actual actions of the parties to the transaction and the actual circumstances of its conduct pursuant to the transaction’s substance.
For transfer pricing purposes, this means that if the actual conditions/actual actions related to a controlled transaction do not meet the terms and conditions of the agreement concluded or the transaction is conducted but not documented, the characteristics of the controlled transaction for the transfer pricing purposes shall be determined pursuant to actual actions of the parties to the transaction and actual conditions of its conduct. If it is proved that the transaction’s substance does not comply with its legal form, it will be quite possible to re-qualify the transaction for taxation purposes.
3. Clarification of requirements in respect of comparability of transactions
The characteristics of the assets involved in a controlled transaction can be used to determine comparability including, but not limited to, the following: the type of asset (intangible assets, machinery and plant, etc.), the nature of the asset (age, market value, location, availability of protective rights, etc.).
Analysis of the impact on the terms of transactions related to intangible assets is carried out taking into account including, but not limited to, the following: their characteristics, categories, the field of application, useful life, contractual conditions, maintenance activities, etc.).
4. Clarification of the criteria to choose the investigated party
From now on, when choosing an investigated party to the transaction, there will be a requirement to take into account not only the grounds of the pricing method application, the degree of existing functions and risks, the possibility to find the most comparable transactions or persons, but also the opportunity to obtain the most comprehensive and documented information on the financial performance of the controlled transaction to be used to calculate profitability index.
This statutory provision is quite liberal for taxpayers and establishes the requirement to choose the investigated party only if there is well-documented financial information available. Foremost, this applies to cases when a non-resident contracting party may be subject to investigation. Such a clear statutory provision is intended to mark a decisive end to the choice of the party for analysis, avoiding any doubt related to different interpretations and enabling to choose in favor of a resident as the person more available in terms of documentation.
5. Establishing requirements in respect of additional justifications in transfer pricing documentation
From now on, if the information is used to determine the profitability range throughout several tax periods (years) and to calculate the weighted average of the profitability index, additional justification on the choice of this very time interval is required.
The mentioned statutory provisions are intended to increase the degree of understanding of the quality of such economic research being conducted so as to choose the most comparable tax period. It is believed that the greatest degree of comparability is applicable to the comparison of information for the related reporting period, and the use of several periods for calculations can sometimes be followed by certain manipulations to obtain a more favorable range.
6. The statutory provisions related to the procedure and terms to conduct inspections on compliance with the “arm’s length” principle are specified
Currently, the term to conduct an inspection of a taxpayer is interrupted in the event of ongoing court proceedings related to a taxpayer’s claims against the appointment, conduct or subject of such inspection until the completion of such legal proceedings.
In the event of a liquidation procedure, taxpayers that conducted controlled transactions are required to submit documents for the control of them for the period of at least 2,555 days preceding the date of the taxpayer’s liquidation to be archived in the established manner (in respect of other transactions – 1,095 days).
Also, from now on the right of the regulatory authority to send requests to provide documents (information) not only to the parties to the controlled transaction but also to those involved in the supply chain has been established. In the event of failure to receive the requested information, the regulatory authority shall have the right to conduct a counter-inspection.
As additional measures on the part of the regulatory authority, the right to hold meetings with the taxpayer to discuss the methodology used during the inspection, to send inquiries to the authorized bodies of foreign states in respect of financial statements of a non-resident (a party to the controlled transaction), its economic activities and the circumstances of the transaction conduct, has been established.
7. The procedure has been regulated for imposing a fine in the event of an independent adjustment by the taxpayer of tax liabilities
One more liberal novelty for taxpayers. From now on, if an independent adjustment of tax liabilities in relation to controlled transactions is conducted, the fine on the amount of the unpaid tax liability will be imposed after the deadline for submission of accounts expiration (October 1). Namely – from the 271st day (earlier – from the 91st day). The mentioned statutory provision is intended to encourage companies to make independent adjustments without waiting for attention on the part of regulatory authorities.
The mentioned changes in transfer pricing legislation became a continuation of introduction of world taxation practices and, in part, a clarification following the results of generalization of control practices in previous years. The next set of changes related to the establishment of three levels of documentation for multi national companies, simplified justification procedures for intra-group services and other aspects will be introduced in the near future.
All this speaks loudly of deliberate attention to transfer pricing rules on part of legislators and the recognition of the great importance of control in this area. In the near future, we expect the establishment of a large transfer pricing audit department within the regulatory authority, the main anticipation of which will be the conducting of activities aimed at increasing budget revenues. The number of inspections and documentation requests will increase and, therefore, companies should monitor transfer pricing risks on an ongoing basis.