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Transfer Pricing in Ukraine: Overview of the new rules and next steps 2013

Transfer Pricing: Major Changes in the Legislation - 2013

Transfer Pricing Reform in Ukraine

Transfer Pricing (“TP”): the new TP Law

On 4 July 2013 the Ukrainian Parliament adopted the Law “On Amendments to the Tax Code of Ukraine (Regarding Transfer Pricing)” (hereinafter –”the Law”)

Key considerations:

Increased responsibilities of taxpayers to defend transfer prices Increased liability for violation of TP rules Numerous gaps in the regulations Short timeframe for preparation to the new rules

Major changes:

► The list of related parties and controlled transactions was narrowed down

► New Transfer Pricing (hereinafter – “TP”) rules will apply for Corporate Profit Tax (hereinafter – “CPT”) and Value Added Tax (hereinafter – “VAT”)

► The Law contains a detailed description of five TP methods based on the OECD Guidelines

► Obligatory TP reporting

► TP documentation requirement

► TP audits

► Significant penalties for not filing the TP reporting

Challenges of implementation:

► The Law comes into force on 1 September 2013

► Some important regulations required for application of the new rules, have not been approved yet

► Until 2018 - special rules for export and import transactions with certain products (see below)

► Inconsistency with other provisions of the Tax Code, numerous “grey areas” in the Law


Controlled Transactions

Transactions with the following counterparties fall under TP control (subject to the threshold below):

► All non-resident related parties

► Related parties – tax residents of Ukraine if these:

► Are loss-making companies, or

► Are not regular CPT or VAT-payers, or pay these taxes at a lower rate, or

► Use single tax or agricultural tax regimes

► Residents of “low-tax” jurisdictions (including non-related parties)

► A “low-tax" jurisdiction is a jurisdiction where a nominal or effective CPT rate is at least 5% below the Ukrainian CPT rate

► The list of “low-tax” jurisdictions is to be approved by the Cabinet of Ministers

► An exemption could apply to companies which can produce a certificate from a foreign tax authority confirming that the tax rate applied by the company is sufficiently high

Threshold for controlled transactions:

► A transaction is subject to control if the annual amount of all transactions with the same counterparty is at least UAH 50 million (USD 6.25 million)

Criteria for controlled transactions: type of counterparty and aggregate transaction amount

► Definition and criteria of related parties can be interpreted very broadly

► The list of “low-tax jurisdictions” will be approved by the Cabinet of Ministers and can change in 2014 once the Ukrainian CPT rate decreases

► To calculate the threshold, a taxpayer might need to consider all transactions with a counterparty (transactions affecting tax income, tax expenses as well as transactions that normally are not recorded in the tax accounts). The scope of transactions subject to TP control may be broader than it appears!

Key considerations:


Transfer Pricing Methods

► TP methods:

► Comparable uncontrolled price (CUP)

► Resale minus

► Cost plus

► Transaction net margin method (TNMM)

► Profit split

► The basis for application of the methods:

► Functional Analysis and Comparability Analysis (comparability criteria and basis for the functional analysis are defined in the Law)

► Open and public sources of information shall be used as a source of arm’s length prices

► The formula for calculating an arm’s length price (profitability) range will be approved by the Cabinet of Ministers

► A separate TP methodology for banking services will be approved by the Ministry of Incomes and Taxes (hereinafter – “Tax Ministry”) and the National Bank of Ukraine

► Special rules will apply to the export/import of certain commodities until 2018 (see page 13)

The description of the TP methods in the Law is much less detailed than the OECD Guidelines

Taxpayers are not allowed to decrease their tax liabilities resulting from the application of the TP methods

General TP principle: for tax purposes, prices in controlled transactions should be at arm’s length


TP methods: hierarchy

The Law establishes a hierarchy of the TP methods

► The CUP method is the preferred method. CUP is rarely used in practice because of the lack of information regarding identical (similar) goods, works, services

► The application of other traditional TP methods (cost plus and resale minus) may be complicated by the lack of reliable comparable accounting data

► TNMM is the most common method, if other methods cannot be applied. In contrast to other jurisdictions, in Ukraine the Law provides no restrictions on applying this method

CUP

Cost plus Resale minus

TNNM Profit split


TP Reporting and Documentation

Key considerations:

► Although regular tax returns should be filed before the TP report, they should include TP self-adjustments

► Internal TP methodology should be developed prior to filing tax returns and TP report

► Penalties for not filing the TP report may exceed the amount of additional tax liabilities assessed for violation of the TP rules

The Law introduces special TP reporting and TP documentation:

► TP reporting (a report about controlled transactions)

► A template will be approved by the Tax Ministry

► Filing is mandatory for all taxpayers who conducted controlled transactions during the reporting year

► Deadline for filing: 1 May of the year following the reporting year

► Initial TP reporting will have to be submitted in 2014

► Penalty for not filing is 5% of all controlled transactions

► TP Documentation (detailed analysis of the controlled transaction)

► No official template. The Law provides general documentation requirements for large taxpayers (see page 8)

► Documentation should be filed at the tax authorities’ request, which cannot be sent to a taxpayer earlier than 1 May of the year following the reporting year

► Large taxpayers are not obliged to submit primary documents (agreements, invoices, acceptance acts, etc.)

► Deadline for submission: 2 months for large taxpayers, 1 month for other taxpayers

► Penalty for non-submission: 100 minimal wages (approx. UAH 115 thousand/ USD 14.3 thousand)


TP documentation requirements ► TP documentation should contain the following information:

► comprehensive information on related parties

► information about the group (structure, description of activities, group TP policies)

► description of the transaction (terms and conditions)

► description of goods (works, services), including physical characteristics, quality and reputation in the market, the country of origin and manufacturer, trademark, etc

► terms and conditions of the settlements (payments)

► factors that impacted the price

► Functional Analysis and Risk Analysis

► Economic Analysis (TP method applied, is substantiation, the amount of income / expenses, the profitability level, the calculation of the arm’s length price/profitability range, the approach to selection of comparables, sources of information);

► Comparability analysis of commercial and financial conditions of selected transactions

► Information on corresponding adjustments made by the taxpayer (if any)

► TP Documentation must be prepared in Ukrainian

Large taxpayers are obliged to submit documentation on tax authorities’ request

The tax authorities may not request documentation before 1st of May following the end of the reporting year

The deadline for submission: 2 months from the date, when the request was received


TP Adjustments

► Represent downward adjustments of tax liabilities of the contracting party if tax liabilities of the other party were increased resulting from the application of the TP rules

► Domestic adjustments (when both parties are Ukrainian taxpayers)

► Permission of the tax authorities is required

► Proof that additional taxes have been paid by one of the contracting parties is required

► Procedure for approving the corresponding adjustments to be determined by the Tax Ministry

► Cross-boarded adjustments (when one party is a non-resident)

► No procedure in the Law. Reference has been made to existing double tax treaties

Corresponding adjustments can be rejected by the tax authority

Cross-border corresponding adjustments could be difficult in practice

Corresponding adjustments

Self-adjustments

► Self-adjustments are upward adjustments of tax liabilities performed by taxpayers resulting from the application of the TP rules

► Self-adjustments should be recorded in CPT and VAT returns. Deadline for filing the TP report is not aligned with the deadlines for filing CPT and VAT returns

► Self-adjustment of previously filed tax return triggers a 3%-5% penalty

Self-adjustments of filed tax returns always result in penalties

Reverse adjustments

► Represents a rejection of a corresponding adjustment

► Performed based on a notification from the Tax Ministry


TP Audits and Penalties

► A special type of tax authority performs audits to verify compliance with the TP rules (hereinafter – “TP audit”)

► TP audits should be performed independently from other tax audits

► Compliance with TP rules cannot be audited during other tax audits

► TP audits will be performed by local tax authorities and led by a representative from the Tax Ministry

► The duration of the TP audit is 6 months, with a possibility to extend for another 6 months

► The timeframe for providing information to the tax authorities during a TP audit is 10 days (except for TP documentation)

Undergoing a TP audit may enable a taxpayer to self-adjust its CPT and VAT returns for the audited period

The penalty for not filing the TP report may be calculated based on all controlled transactions (not just a transaction that was not included in the report )

TP audits

► The penalty for not filing a TP report is 5% of all controlled transactions of a taxpayer

► The penalty for not filing TP Documentation is 100 minimum wages (approx. UAH 115 thousand/ USD 14.3 thousand)

► The penalty for understatement of tax liabilities as a result of non-compliance with the TP rules is up to 50% of the understated tax (will not apply until 30 September 2014)

► There is no exemption from penalties for not filing the TP report or TP documentation during the transition period

Penalties

Penalties may exceed the amount of additional TP tax liabilities


TP: Sources of Information

► The list will be defined by the Cabinet of Ministers Unofficial sources of information may be used only in the absence of relevant information from official sources

If a taxpayer has comparable transactions with unrelated parties, the tax authorities can only use information from these transactions as a source of arm’s length prices during a TP audit

Official sources of information

Other sources of information The tax authorities are obliged to use the same sources of information as a taxpayer (unless the taxpayer did not use the official data when it was available)

► Prices determined at public auctions, tenders, trade exchange quotes

► Statistical data of government authorities

► Reference prices from specialized business publications, (including electronic/Internet publications)

► Information databases used for TP purposes

► Data about prices, ranges and adjustments published in the media

► Data from financial statements of taxpayers published in the media or the Internet

► Valuation reports

► Information about controlled transactions of another taxpayer


TP: Advance Pricing Agreement (“APA”)

► Can be concluded between large taxpayers and the Tax Ministry

► The following TP issues can be resolved and addresses in the APA:

► Prices of controlled transactions

► Applicable TP method

► Sources of information used for TP purposes

► Term of the contract, etc.

► The procedure for concluding an APA is not set by the Law

► The Law does not state clearly that an APA is binding on the tax authorities’ (i.e., cannot be challenged by the Tax Ministry)

Concluding an APA is available only for large taxpayers

Unilateral APA

A cross-border APA may not be possible until the procedure is approved

Bilateral and multilateral APA

► The procedure will involve foreign companies and foreign tax authorities

► The procedure has yet to be established by the Cabinet of Ministers


TP: Special rules for cross-border transactions

► Scope:

► Covered products - oil and gas, metals, chemicals, grain (the full list of covered customs codes is in the Law)

► The Cabinet of Ministers is entitled to extend the list of covered products

► Covered transactions: export/import to/from "low-tax jurisdictions“ (see page 4)

► Transactions with companies from other jurisdictions (including related parties) are not covered by special rules (general TP rules apply)

► Applicable methods:

► Prices from the list of sources of information approved by the Cabinet of Ministers, or trade exchange quotes (for listed items). A 5% deviation is allowed

► The Cabinet of Ministers is entitled to change the allowable deviation

► A taxpayer can use general TP methods subject to disclosure of the supply chain up to the first unrelated company

Further comparability adjustments of approved reference or trade exchange quotes are not allowed

The list of low-tax jurisdictions (with a CPT rate at least 5% below Ukrainian CPT rate) is not yet approved

The Law states that special rules apply “at the choice of a taxpayer”. It is not clear whether the tax authorities can demand a disclosure of the supply chain in each case where a taxpayer chooses to follow general TP methods

Special TP rules for import / export of certain products

(until 1 January 2018)


New TP Law: Important Dates

1 September 2013 ► New TP rules come into force. The CPT and VAT liabilities in the fourth quarter of

2013 should be calculated based on the new TP rules

10 February 2014 ► CPT return for 2013 should include TP self-adjustments, if any (TP adjustments

only for the last quarter of 2013?)

1 May 2014 ► Deadline for filing the TP report (only for the last quarter of 2013?). Penalty for

not filing is 5% of all controlled transactions

1 July 2014

► Large taxpayers must submit TP documentation within two months after they receive the tax authorities’ request. The tax authorities can request TP documentation starting 1 May 2014 (1 July = 1 May + 2 months). For other taxpayers the deadline is one month

30 September 2014 ► The penalty-free period expires for understatement of tax liabilities based on the

TP rules

Preparing for the New TP Rules


Preparing for the New TP Rules (1/4)

Transfer pricing

TP risks

Effective tax rate

TP documentation

TP methodology

Supply chain

Indirect taxes/ customs duties

Advance pricing agreement with tax authorities TP controversy

Internal controls

Business processes

People/ TP function

Informational systems

Risk of double taxation

Intra-group agreement

► With the new law in hand and government budgets under pressure, the Ukrainian tax authorities will scrutinize

prices in intercompany transactions

► New realities mean that taxpayers need to constantly monitor, document and often defend prices in intercompany

transactions

Transfer pricing has a broad business impact:



Some key questions that should be considered in the new environment are:

Transfer pricing policies

► Is my company's TP policy compliant with the new Law?

► Are we exposed to significant TP risks? ► Can my company's financial statements be

impacted? ► Will my company's effective tax rate increase as a

result? ► Will our international TP policies be accepted in

Ukraine? ► Will my Ukrainian transfer pricing policy be accepted

by foreign tax authorities?

► What are the new transfer pricing documentation requirements ?

► Does my TP policy adequately respond to operational and business changes?

► Will our transfer prices be accepted by both tax and customs authorities?

► Do our TP practices match our TP policies? ► Do we need to secure our TP policies by considering

an advanced pricing agreement with the tax authority?

People and organization

► Do we have sufficient people to comply with the new TP documentation requirements?

► Do my people have the necessary skills to perform TP analysis and prepare documentation?

► How should the TP function be organized?

Processes and internal controls

► How do we need to change our business processes to support our TP policies?

► How should we design our internal controls system to ensure consistent application of our TP policy?



IT-systems

► Do I need to enhance my IT system to support the TP process?

► How can the preparation of TP documentation and internal control system be automated?

► How should the settings of existing IT-systems be modified in order to facilitate collecting information for TP controls?

Contracts and corporate governance

► Are my corporate policies compliant with new law? ► Are my contracts compliant with the TP rules?



How we can help

► EY will help you plan, document and defend your transfer pricing policies to let you minimize your tax risks and legitimately control your tax costs while meeting the new regulatory demands

► The extent of our involvement in the project and the scope of our services may differ depending on your requirements and needs

► Our full list of services in the TP area are on the following pages


Our TP services (1/2)

Brief description of services

Diagnostics

Analysis of a company’s activities and business to determine the list of related parties and controlled transactions which are subject to TP rules. Analysis of existing approaches to TP

Conducting a functional analysis and selection of applicable TP methods to determine the arm’s length price in controlled transactions

Identification of risks in the existing supply chain and pricing methodology, assessment of these risks (by calculating an arm’s length price range based on relevant market research and comparing the result with the actual transfer prices)

Design

Development of consistent pricing policies for controlled transactions in accordance with the law. Subsequent control and management of TP risks in the case of deviation of prices / profitability margins from the arm’s length level

Development of standard TP documentation for each controlled transaction to be filed to the tax authorities

Development of internal policies and methodologies necessary for an efficient TP function

Development of business processes that ensure the effective implementation of the TP policy, as well as the timely preparation of relevant documents. Development of internal control procedures


Our TP services (2/2)

Brief description of services

Implementation

Development and negotiation of the advance pricing agreement with the tax authorities

Introduction of the TP policy into the company’s internal processes

Configuration of IT-systems to automate TP business processes

Professional training of TP personnel

Monitoring

Monitoring the process of applying the TP policies and TP methods

Review of transfer prices and contracts (if and when required)

Regular assessment of TP risks

Controversy

Assessment whether the company is ready for potential disputes with the tax authorities; defense of the company’s TP structure during a tax audit or appeal


The results of timely and proper preparation for the new rules

Effective TP function

Timely preparation and approval of the TP documentation that

substantiates the level of transfer prices

Effective supply chain within the group

TP policy developed in accordance with the law and business realities

Efficient IT-systems that allow automation of

control and reporting procedures

Transparent and convenient business processes for timely

monitoring, reporting and risk assessment


Key employees of the transfer pricing group (1/2)

► Igor Chufarov is Partner of Tax and Legal department of EY in Ukraine and Russia.

► Since 2012 he devotes most of the time to transfer pricing projects and supervised projects for the largest Ukrainian group.

► Igor joined EY in 2003 from a leading Ukrainian bank where he worked as a senior tax advisor.

► Igor has over 13 years of professional experience in rendering tax and legal services, specializing primarily in providing advice to financial institutions and corporate restructuring.

► His costumers include major Ukrainian and international banks, telecommunication companies, oil and gas sector, the retail sector and IT.

► Igor received a degree in law from Dnepropetrovsk National University and a degree in economics from the National Mining University of Ukraine. He is a certificated attorney-in-law in Ukraine.

Igor Chufarov Partner Tax and Legal department, Kyiv

Tel: +380 44 492 8231 Mob: +380 67 507 7369 E-mail [email protected]

► Evgenia is a Head of Transfer Pricing Services n CIS

► Evgenia joined the firm as a partner in March 2011; before that she worked for more than 15 years with another Big Four company where obtained an extensive experience in providing advisory services to Russian and international companies on various areas of taxation and conducting business in Russia

► Since 2007 she has been focusing solely on transfer pricing

► Graduated from the Finance Academy of Russia in 1996 as an economist; member of the Association of Chartered Certified Accountants (ACCA); co-leader of the Transfer Pricing working group of the Association of European Business and a frequent speaker on transfer pricing topics

► Eugenia oversees transfer pricing planning and documentation projects for multinational and Russian clients in various industry sectors, including structuring of entry/exit strategies of clients from the transfer pricing perspective, adaptation of global transfer pricing policies to Russian requirements, business restructuring, development of sustainable transfer pricing methodologies, etc.

Evgenia Veter Partner Head of TP in the CIS, Moscow

Tel: + 7 495 660 4880 Mob: + 7 910 445 6779 E-mail: [email protected]

mailto:[email protected]




Key employees of the transfer pricing group (2/2)

Anna Johnson Manager Tax and Legal department, Kyiv

Теl: +380 44 490 3341 Моb: +380 67 239 6101 Email: [email protected]

Kestutis Rudzika Senior Manager, Transfer Pricing, Moscow

Тel: +7 495 664 7847 Mob: +7 965 331 65 71 Email: [email protected]

► Tax Professional, qualified corporate lawyer with more than 7 years of Global Corporate Tax experience and Transfer Pricing expertise

► Previously Kestutis was leading Transfer Pricing teams in another Big Four company in the Baltics, preparing local, pan Baltic and European Transfer Pricing documentation, leading TESCM projects, leading International Taxation, M&A teams. Prior to that, for 5 years Kestutis has worked as a Managing partner lawyer and was involved in a number of cross border financial, tax and legal assignments

► Kestutis has a wide ranging set of tax-technical skills, including extensive knowledge of Transfer Pricing and OECD Transfer Pricing regulations, International Taxation and especially PE regulations, US taxation, Business Reorganizations, TESCM, Complex Litigation

► Kestutis was awarded with an ADIT – Advanced Diploma in International Taxation, The Chartered Institute of Taxation, UK.

► Kestutis holds Transfer Pricing Certificate, The Chartered Institute of Taxation, UK, and Principles of International Taxation Certificate, The Chartered Institute of Taxation, UK

► Kestutis was awarded Master of Laws, LL.M., at Vilnius University

► Anna is an experienced Manager in the tax and legal department of EY in Ukraine, specializing in transfer pricing.

► Since 2011, Anna focuses solely on transfer pricing and international taxation. She obtained significant work experience with numerous TP projects when she was a key member of the TP group in Moscow.

► Anna has been involved in projects covering all aspects of transfer pricing, ranging from identification of controlled transactions to preparation of TP documentation, internal policies, procedures. She also represented clients in disputes with the tax authorities regarding TP issues.

► Anna has worked in EY since 2007. She also has experience working in Ukrainian law firms.

► Anna graduated with honors from the Kyiv-Mohyla Academy and has a Masters degree in Law. She fluently speaks Ukrainian, Russian and English.







Restriction on the use of these materials

► This presentation is prepared for the purpose of discussion specific transfer pricing issues related to the new transfer pricing law. The user of this presentation should take into account the following:

► These materials are based on our understanding and interpretation of the TP law provisions and should not be taken in isolation from the comments made by the presenters orally during a personal meeting.

► These materials describe separate transfer pricing issues out of specific context and cannot be applied to specific circumstances without additional analysis of such circumstances.

► The information contained in this presentation is for general guidance only. You should neither act, nor refrain from acting, on the basis of such information. You cannot provide, quote, copy fully or partly and circulate information made available to you by EY in this presentation to any third party without EY prior written consent. EY can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of use of any material in this presentation.

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