CFC IN UKRAINE - BACKGROUND
Ukraine in 2017 pledged to introduce a minimum standard for the BEPS (Base Erosion and Profit Shifting) plan. It aims to counteract tax erosion and the removal of profits from taxation.
Such a step was quite expected by the government of the country. Without a minimum standard, Ukraine had a good chance of being blacklisted by the OECD (Organization for Economic Cooperation and Development).
Therefore, already in 2018, an act was passed implementing the BEPS plan in Ukraine. They provided for the implementation of 8 steps of the BEPS plan, among which the third step directly related to the disclosure by residents of Ukraine of participation in various foreign structures.
Later, in 2020, the Law 466-IX came in force. It provided for the establishment of a controlled foreign company (CFC) regime in Ukraine.
In our opinion, the Ukrainian government acted shortsightedly when included individuals in the list of persons who act as controllers in relation to foreign companies. This step was not envisaged by the BEPS plan and the experience of European countries shows that the CFC regime applies only to legal entities-controllers. Ukraine has banally followed the path of the Russian Federation, where the same CFC rules for individuals have been relevant since 2015.
WHAT IS A CONTROLLED FOREIGN COMPANY
In simple terms, a CFC (controlled foreign company) is a structure that is registered abroad and owned or controlled by a resident of Ukraine.
Such a resident of Ukraine (controller) has a number of obligations to declare his company and submit reports. In addition, he is also obliged to pay taxes in Ukraine on the retained earnings of the CFC.
The controller can be a individual or legal entity.
A controlled foreign company will be considered both an enterprise in the classical sense of the word (for example, a limited liability company or its foreign equivalent), and some entity that is not considered a legal entity under the laws of foreign jurisdiction. For example, a trust under English law is considered an agreement of the parties and not a legal entity.
WHEN CFC BEGINS TO OPERATE IN UKRAINE
From January 1, 2021, the regime of controlled foreign companies begins to operate in Ukraine. This means that individuals and legal entities directly or indirectly owning a part in a foreign company, or controlling a foreign company, have obligations in Ukraine to file reports on CFCs and to pay taxes on retained earnings of the CFC.
In 2022, it will be necessary to submit the first CFC report based on the results of 2021.
POSSIBLE RESPONSE OF CFC TERMS IN UKRAINE TO 2022
The Parliament of Ukraine has registered draft of the law 3750 from 06/26/2020, which provides for the postponement of the introduction of the CFC regime in Ukraine from 2021 to 2022. If this bill is voted in Parliament and signed by the President, then in 2023 it will be necessary to submit the CFC report based on the results of 2022 (that is, as of December 31, 2022). It is difficult to assess the prospects of this bill at the current stage. On the one hand, there is tremendous pressure from business, which is interested in postponing the introduction of CFC in Ukraine. On the other hand, the Parliament earlier, within the framework of bill 2524, did not vote on amendments to the Tax Code of Ukraine regarding the postponement of the introduction of the CFC.
Separately, we note that on September 7, 2020, the Act 4065 expected by experts was registered in the Parliament, which also provides for the postponement of the CFC to 2022.
The controller has the following obligations:
- Preparation and filing of annual reports on CFCs (more details below);
- Payment of taxes on retained earnings of the CFC (which we will also discuss in more detail below);
- Informing the Ukrainian tax authorities:
- about any receipt of a share in a foreign company or the beginning of control over a foreign legal entity;
- about the establishment, creation or acquisition of property rights to a share in the assets, income or profits of education without the status of a legal entity;
- about the loss of a share or on the refusal of a share in a foreign company;
- aboutthe alienation of a share in a foreign legal entity or on the termination of actual control;
- about the loss or refusal of property rights to a share in the assets, income or profits of a company that does not have the status of a legal entity.
The notification is sent to the supervisory authority within 60 days from the date of such acquisition (beginning of actual control) or alienation (termination of actual control).
PREPARATION OF THE CFC REPORT
Controllers will need to submit to the State Fiscal Service of Ukraine appropriate notifications about the acquisition or termination of ownership of shares and control over a CFC. In addition, controlling persons are required to file a CFC report and all required financial statements. The unconsolidated financial statements of a CFC must be filed in accordance with International Financial Reporting Standards. Also, reporting can be prepared in accordance with the national standards of the CFC jurisdiction within the time frame provided for the preparation of such reporting in a foreign jurisdiction. The reporting period for such CFC financial statements is a calendar year. If the reporting period does not coincide with the calendar year, then reporting is submitted for periods that end in the corresponding calendar year.
In cases where the supervisory authority doubts the reliability of the submitted financial statements, it may require an opinion from the audit company. This opinion is provided by an auditor licensed in the relevant foreign jurisdiction.
The supervisory authority may also request the CFC controller to provide primary documentation about the operations of a foreign company. In addition, in special cases, the tax office has the right to request transfer pricing documentation if controlled transactions have been performed.
The reporting period for filing reports is one calendar year, or any other period that expires in a calendar year.
Controllers need to submit a CFC report electronically to the supervisory authority. The report is submitted together with:
- an annual declaration of property and income (if the controller is an individual, then the deadline for filing is May 1 of the year following the reporting year);
- income tax return for the relevant year (if the controller is a legal entity, then the deadline for filing is March 1 of the year following the reporting year).
The CFC report must be accompanied by certified copies of the CFC's financial statements confirming the amount of the CFC's profit for the reporting year. If the deadline for the preparation of financial statements in the relevant foreign jurisdiction expires later than the deadline for filing the annual return in Ukraine, then such copies of the CFC's financial statements are submitted together with the annual return for the next reporting period.
In cases where the controller cannot ensure the preparation of financial statements for the controlled foreign company and / or cannot calculate profit before the deadline for filing the annual declaration, then he submits such a CFC report in an abbreviated form. Then, the controller have to submit a full CFC report at the end of the next calendar year.
The abbreviated form of the CFC report must include:
- CFC name, address, organizational and legal form, tax number, state registration number;
- the structure of ownership of shares in a CFC with indirect ownership;
- the size of the share that belongs to the controlling person;
The full report on the controlled foreign company includes all the information as in the abbreviated report, but also additionally:
- information on the amount of the CFC's income, profit from operating activities before taxation on financial statements;
- calculation of adjusted profit;
- the amount of dividends received by the CFC directly or indirectly through the chain of controlled legal entities from Ukrainian legal entities;
- the number of CFC employees at the end of the reporting year;
- information on the grounds for exemption from taxation of profits;
- the amounts of the CFC's profits that were actually paid to the controlling person;
- the list of CFC transactions with related non-residents, as well as non-residents and the Lists of the Cabinet of Ministers of Ukraine (we are talking about the so-called “lists of offshore zones” determined by the Cabinet of Ministers of Ukraine);
- information on the amounts of the CFC's profits received from the permanent establishment in Ukraine.
Not all profits of a controlled foreign company are taxable, but only a part of the adjusted profit of a CFC, which is proportional to the profits owned or controlled by the controller as of the last day of the reporting period.
It should also be understood that the adjusted profit of the CFC is considered to be the profit of the CFC before tax. This is in accordance with the data that was provided in the unconsolidated financial statements. Further, the CFC's profit before tax is adjusted by deducting some income to prevent double taxation and adding income in accordance with the Ukrainian transfer pricing control methods if the CFC has been doing business with companies from the list of low-tax jurisdictions.
Depending on the reporting period, in Ukraine, adjusted earnings may be taxed at rates of 5%, 9% and 18%. Also, the rate depends on the characteristics of profit payments and its distribution. In addition, a military duty is paid at a rate of 1.5%.
Thus, the controlling person includes the CFC's adjusted profit in the total taxable income, which is shown in the annual tax return and is taxed at the base rate of 18%.
In cases where the profits of foreign companies are distributed to the controller and he actually receives this profit, then:
- A tax rate of 9% is applied in the event that the controlling person receives the profit of the CFC (or part of it) before the submission of the CFC report and the inclusion of this part of the profit in the total taxable income;
- If the controller makes a profit after filing the financial statements of the CFC and adding this profit to the total income that is taxed and recorded in the annual return until the end of the next calendar year after the reporting year, taxes are recalculated in relation to the actual income received. They are subject to a 9% rate and an updated income tax return is submitted;
- If the controlling person receives the profit of the CFC (part of it) after the submission of a response about the CFC and the inclusion of this part of the profit in the total taxable income, which is displayed in the annual tax return after the end of the second calendar year following the reporting year, the recalculation of tax in relation to the income actually received carried out, and the tax is paid at a base rate of 18%.
The amount of personal income tax payable on the profits of the CFC (both distributed and unallocated) is reduced by the amount of corporate tax or other similar tax payable in accordance with the legislation of a foreign state, which was actually paid by the CFC, including the amount of taxes withheld at the source of payment from the amount of income received by the CFC.
The amount of such tax is the total amount of tax actually paid by the CFC based on the results of the corresponding reporting (tax) period (corporate tax or other similar tax that is levied in accordance with the legislation of foreign states - paid during the reporting period), in proportion to the share of the controlling person in such CFC shown in the CFC report.
This provision refers to both the tax paid based on the results of the period and the tax paid during the period, which in practice can lead to a literal interpretation by the fiscal authorities. In particular, if, in accordance with the legislation of the jurisdiction of the CFC, corporate tax is paid at the end of the reporting period, then formally the amount of such tax is considered unpaid during the reporting period and the possibility of offsetting it to reduce personal income tax remains questionable.
In the case when a controlled foreign company (for example, a Cypriot holding company) owns a subsidiary in Ukraine (for example, a limited liability company), the amount of CFC profit received in the form of dividends from legal entities of Ukraine (both directly and through the chain of controlled legal entities) are considered the amount of dividends received from Ukrainian legal entities directly by the controlling person. This amount is included in the total taxable income of the controlling person for the reporting period during which the CFC received dividends and is taxed at the following rates:
- 5% - in case of receiving from legal entities of Ukraine - payers of income tax (except for institutions of general investment;
- 9% - in case of receipt from general investment institutions, business entities that are not payers of income tax.
WHEN THE CFC TAX IS NOT NECESSARY TO PAY
The profits of a CFC may be exempt from taxation if two conditions are met simultaneously below:
- Between Ukraine and the foreign jurisdiction in which the CFC is registered there is an agreement on the avoidance of double taxation or an agreement on the exchange of information; and
- Any of the following conditions is met:
- The CFC actually pays income tax at an effective rate of at least 5% of the base corporate income tax rate in Ukraine. In other words, the effective income tax rate paid by the CFC must be at least 13%;
- The share of passive income of the CFC is no more than 50% of the total amount of the CFC's income from all sources.
Regarding to passive income, there is a clause according to which passive income of a CFC can be recognized as active income if there is sufficient economic presence (substance)in the country of registration of the CFC, namely:
- The CFC actually performs essential functions;
- The CFC bears risks and uses assets in operations, which leads to the receipt of corresponding active income;
- The CFC has the necessary resources to perform these functions, manage risks and use assets (qualified personnel, fixed assets owned or used, sufficient equity capital).
Also, regardless of the conditions mentioned above, the adjusted profit of a CFC is not subject to inclusion in the income of the controlling personif any of the conditions below are met:
- The total aggregate income of all CFCs of one controlling person from all sources according to the financial statements does not exceed the equivalent of 2 million euros at the end of the reporting period;
- CFC is a public company;
- The CFC carries out charitable activities and does not distribute income in favor of the founders (participants).
In such a case, the controlling person is exempted from the obligation to calculate the adjusted profit of the CFC.But this does not exempt from the obligation to notify the fiscal authorities of the acquisition of an interest in or control over the CFC, as well as from filing a report on controlled foreign companies.
CFC PENALTIES IN UKRAINE
Sanctions for a controlling person for violation of the CFC reporting rules:
- Failure to submit a CFC report by a controlling person shall result in the imposition of a fine in the amount of 100 times the minimum subsistence level for an able-bodied person established by law as of January 1 of the tax (reporting) year. As of 2020, the minimum subsistence level is 2197 hryvnia for an able-bodied person;
- Late submission by the controlling person of the CFC report - entails the imposition of a fine in the amount of one subsistence level for an able-bodied person established by law as of January 1 of the tax (reporting) year, for each calendar day of failure to submit, but not more than 50 times the subsistence level for an able-bodied person established by law as of January 1 of the tax (reporting) year;
- Failure to reflect information on existing CFC in the CFC report by the controlling person and / or failure to reflect information on existing CFCs:
- information on the amount of income (proceeds) from the sale of goods (work, services) of the CFC, profit from operating activities and profit before tax in accordance with the data of the financial statements;
- calculation of the adjusted profit of the CFC, the amount of such profit, which is included in the total taxable income of the controlling person;
- information on the grounds for exemption from taxation of CFC profits;
- amounts of dividends received by the CFC directly or indirectly through the chain of controlled legal entities from Ukrainian legal entities;
- the amounts of the CFC's profit that were actually paid in favor of the controlling person;
- the list of CFC operations with non-residents - related persons, as well as with non-residents registered in states (territories) included in the list of states (territories) approved by the Cabinet of Ministers of Ukraine, as well as with non-residents, the legal form of which is included in the list, approved by the Cabinet of Ministers of Ukraine;
- the number of CFC employees as of the end of the reporting (tax) year,
shall entail the imposition of a fine in the amount of 3 percent of the amount of the CFC's income or 25 percent of the adjusted profit of the CFC for the corresponding year, not reflected in the CFC report, depending on which of the following values is greater, but not more than 1000 times the minimum subsistence level for an able-bodied person, the tax (reporting) year established by law as of January 1, for each fact of non-reflection of a CFC and / or for all amounts not shown.
- Failure by the controlling person to inform the controlling body about obtaining a share in a foreign legal entity, formation without the status of a legal entity, or the beginning of actual control over a foreign legal entity, or alienation of a share in a foreign legal entity, or termination of effective control over a foreign legal entity in within 60 days from the moment of such receipt or alienation, - entails the imposition of a fine in the amount of 300 times the minimum subsistence level for an able-bodied person, established by law as of January 1 of the tax (reporting) year, for each such fact;
- Failure to provide or incomplete submission by the controlling person of transfer pricing documentation, other copies of primary documents on the CFC at the request of the controlling body, - entails the imposition of a fine of 3 percent of the CFC's income for which documentation and / or copies of primary documents have not been submitted , but not more than 1000 sizes of the subsistence minimum for an able-bodied person established by law as of January 1 of the tax (reporting) year;
- Failure to submit a CFC report within 30 calendar days following the last day of the deadline for the payment of financial sanctions (fines) - entails the imposition of a fine in the amount of five times the subsistence minimum for an able-bodied person established by law as of January 1 of the tax (reporting) year, for each calendar day failure to submit a CFC report, but not more than 300 times the minimum subsistence level for an able-bodied person established by law as of January 1 of the tax (reporting) year;
HOW TO AVOID CFC LEGALY
To avoid the obligations imposed on the CFC controller, you can:
- Move to another country for permanent residence (change residence). It should be remembered that Ukraine uses the concept of a "center of vital interests" when determining the status of a tax resident. This means that your family and children will also have to relocate. Moreover, the legislation of Ukraine does not provide for a special procedure for “leaving” the tax residence. Accordingly, it will be another task to prove that you have ceased to be a tax resident of Ukraine;
- Liquidate a CFC. The usual strike off of the company will not be enough, since the company, as a rule, continues to exist. It will take a full-fledged liquidation;
- Revoke broad powers of attorney issued in your name by foreign companies;
- Take advantage of one of the loopholes in imperfect legislation.
Want to know more about what you need to do about owning a foreign company? Just leave a request for consultation on our website.