CFC IN UKRAINE - HOW IT ALL STARTED
In 2017 Ukraine has undertaken to implement a minimum standard of the BEPS (Base Erosion and Profit Shifting) plan. It aims to counteract tax evasion and shifting profits from taxation.
Such a step was rather expected from the government of the country. Without implementing the minimum standard, Ukraine had a good chance of being blacklisted by the OECD (Organization for Economic Cooperation and Development).
Therefore, in 2018 an Law was passed implementing the BEPS plan in Ukraine. The Law provided for the implementation of 8 steps of the BEPS plan. In particular, the third step directly referred 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 private individuals in the list of persons who could be regarded 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 simply followed the path of the Russian Federation, where the same CFC rules for individuals have been in place since 2015.
WHAT IS A CONTROLLED FOREIGN COMPANY
In simple terms, a CFC (controlled foreign company) is a structure that is incorporated abroad and owned or controlled by a resident of Ukraine.
Such a resident of Ukraine (controller) has a number of duties, i.a. to declare his foreign controlled company in Ukraine and submit reports. Residents of Ukraine are also obliged to pay taxes in Ukraine (in some cases) on the retained earnings of the CFC.
The controller can be either an individual or a legal entity.
A controlled foreign company can be a corporate legal entity (like an LLC for example), but also an entity which does not have all the signs of the legal entity (e.g. LP or trust under English Law).
WHO IS THE CONTROLLER
A controller is a resident of Ukraine (either individual or a company) who:
- owns at least 50% of the foreign company;
- owns at least 10% of a foreign company, provided that residents of Ukraince collectively own more than 50% of the foreign company. There is also some sort of transacional period during which in 2022 and 2023 the ownership threshold is considered to be 25% instead of 10%. The 10% thresholdd shall be effective starting from 2024.
- actually controls the foreign company.
WHO IS THE RESIDENT OF UKRAINE
If either pint listed below applies to you, you are considered to be a tax resident of Ukraine:
- Residing in Ukraine during 183 days in a calendar year;
- Permanent domicile (place of residence) in Ukraine;
- Center of vital interests in Ukraine (job, business, family).
Also note, that in case you are registerred as a private entrepreneur in Ukraine this migh also affect your tx residency status in Ukraine. Even if you have moved outside of Ukraine.
WHEN CFC RULES BECOME EFFECTIVE - 2022
The controlled foreign companies regime becomes effective in Ukraine starting from 1st January 2022. This means that individuals and legal entities directly or indirectly owning a share 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 2023 (in some cases 2024), it will be necessary to submit the first CFC report based on the results of the year 2022.
The controller has the following obligations:
- Preparation and filing of annual CFC reports (as explained in details below);
- Payment of taxes on retained earnings of the CFC (as also explained in details below);
- Submitting notices to the Ukrainian tax authorities:
- on acquiring a share in a foreign company or the commencement of control over a foreign legal entity;
- on the incorporation or acquiring property rights to a portion of the assets, income or profits of entity without the status of a legal entity (e.g., trust or LP);
- on the loss of a share or on the waiver of a share in a foreign company;
- on the alienation of a share in a foreign legal entity or on the termination of actual control;
- on the loss or waiver of property rights to a portion of the assets, income or profits of an entity that does not have the status of a legal entity.
The notice is submitted via the E-cabinet to the tax office within 60 days from the date of event (commencment of actual control) or alienation (termination of actual control).
HOW TO PREPARE THE CFC REPORT
Controllers will need to submit to the State Fiscal Service of Ukraine relevant notices on the acquisition or termination of ownership of shares and control over a CFC. In addition, controllers are required to file a CFC report and the financial accounts. The unconsolidated financial accounts of a CFC must be prepared in accordance with International Financial Reporting Standards. The financial accounts can be prepared in accordance with the national standards of the CFC jurisdiction within the time frame provided for the preparation of such accounts in a foreign jurisdiction. The reporting period for such CFC financial aaccounts is the calendar year. If the reporting period does not coincide with the calendar year, then financial accounts are submitted for the periods ending in the corresponding calendar year.
In cases of doubts regarding the submitted financial accounts the Tax Office may require an opinion from the audit company. This opinion is provided by an auditor licensed in the relevant foreign jurisdiction.
The Tax Office may also request from the CFC controller to provide primary documentation about the operations of a foreign company. In special cases, the Tax Office has the right to request transfer pricing documentation in case of transactions with controlled parties.
The reporting period for filing accounts is a calendar year, or any other period that expires in a calendar year.
Controllers need to submit a CFC report electronically to the Tax Office. The report is submitted together with:
- an annual declaration on income (if the controller is an individual, then the deadline for filing is May 1 of the year following the reporting year);
- annual 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 accounts confirming the amount of the CFC's profit for the reporting year. If the deadline for the preparation of financial accounts in the relevant foreign jurisdiction expires later than the deadline for filing the annual report 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 has 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 and operational profit before taxation according to financial accounts;
- calculation of adjusted profit;
- the amount of dividends received by the CFC from Ukrainian legal entities directly or indirectly through the chain of controlled legal entities;
- the number of CFC's 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's transactions with related non-residents, as well as non-residents from the lists of so called "offhore jurisdictions" defined 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 companies 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.
The adjusted profit of the CFC is considered to be the profit of the CFC before taxation. This dat is taken from the unconsolidated financial statements. Further, the CFC's profit before taxation is adjusted by deducting 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 (offhores).
Depending on the reporting period the adjusted profit may be taxed at rates of 5%, 9% and 18%. The rate also depends on the specifics 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 should be submitted;
- If the controlling person receives the profit of the CFC (part of it) after the submission of the CFC report 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 case when a controlled foreign company (for example, a Cyprus holding company) owns a subsidiary in Ukraine (for example, a limited liability company), then 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) is considered to be 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 corporate income tax (excluding general investment institutions);
- 9% - in case of receipt from general investment institutions, business entities that are not payers of corporate income tax.
WHEN THE CFC DOES NOT IMPOSE ADDITIONAL TAXES
The profits of a CFC may be exempt from taxation in Ukraine provided the two conditions are met:
- Ukraine and the foreign jurisdiction in which the CFC is registered have an active tax treaty for the abolishment of doouble taxation or an agreement on the exchange of information; and
- Any of the following conditions is met:
- The CFC actually pays corporate income tax at an effective rate which is not more than 5% less than the base corporate income tax rate in Ukraine (which is 18%). 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 the 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 own assets in its 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).
Please read the links below to get a better understanding of what substance really means in some foreign jurisdictions:
Regardless of the conditions mentioned above, the adjusted profit of a CFC shall not be included to the income of the controlling person if any of the conditions below are met:
- The total aggregate income of all CFC's of a single controlling person from all sources according to the financial accounts does not exceed the equivalent of 2 million EUR 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 (shareholders).
In such a case, the controlling person is exempted from the obligation to calculate the adjusted profit of the CFC. But this does not terminate the obligation to notify the tax authorities regarding the acquisition of an interest in or control over the CFC, as well as from filing a report on controlled foreign companies.
PENALTIES FOR VIOLATION OF CFC RULES 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). For example, you can become tax resident in Georgia. 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 should also relocate. Moreover, the legislation of Ukraine does not provide for a special procedure for termination of the tax residence. Thus, it will not be easy to exit the tax residency of Ukraine;
- Dissolve the 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 advise from the tax consultant to prepare a detailed step by step plan.
Want to know more about owning a foreign company and CFC? Just leave a request for consultation on our website.