Ukrainian business requests the authorities to postpone the declaration of their foreign entities

24.10.2023, Forbes Ukraine

As from the spring of 2024, Ukrainian entrepreneurs who own at least 50% of shares in foreign legal entities must report on them to the State Tax Service. These foreign legal entities are referred to as controlled foreign companies (CFCs). The Union of Ukrainian Entrepreneurs (UUP) approached the Verkhovna Rada with a request to waive the mandatory reporting on CICs during the period of martial law. Andriy Servetnyk, Deloitte Partner and a subject-matter expert, commented for Forbes Ukraine on the current CIC rules and the UUP’s request.

What exactly does the UUP stand against?

Against the CIC rules established in the Tax Code, which boil down to the obligation of every Ukrainian who owns or controls a foreign company (i.e. holds a substantial interest in or is actually in control of) to annually report on such company in Ukraine. The CIC report is submitted to the tax authorities together with the controller’s personal tax return (in case the controller is a natural person) and should contain, among other things, information on the CIC’s income, if any.

Are these new rules?

The Verkhovna Rada of Ukraine adopted changes to the TCU regarding CIC in 2020, which came as part of the internationally recognized BEPS plan aimed at “deoffshorization”—the fight against tax evasion in offshore countries.

The CIC rules actually came into force in 2022 and will soon have been in effect for two years. In 2023, some brave Ukrainians reported on their controlled companies for 2022. Those who have not done so (according to my observations, this is the majority of the Ukrainians who owns foreign companies) must submit this report by 1 May 2024.

And pay taxes in Ukraine?

Not always. The CIC rules are developed so as to avoid creating new taxes but ensure the payment of existing taxes.

As a thought experiment, let’s say that a Ukrainian national has a successful and profitable company abroad. The company works and generates income. If the Ukrainian owner takes income in the form of dividends, they must pay PIT of 9% and the military tax of 1.5% on the amount of the received dividends in Ukraine.

Alternatively, where the shareholder chooses not to receive dividends and keeps the income abroad, the CIC rules are there for the Ukrainian authorities. The rules require that the entrepreneur pay PIT at the rate of 18% on the retained earnings, despite the fact that funds remain de jure in the company’s possession and are not transferred into the owner’s Ukrainian or foreign accounts.

Thus, the state forces the owners to accelerate the distribution of profits and payment of personal income tax.

Does this apply to all Ukrainian-owned foreign companies?

Not at all. The law provides for many benefits. Zero tax is imposed on retained earnings of:

• a business with relatively small revenues, up to €2 million for all CICs owned by the same person;
• a company that is “active”, for example engaged in active trade, and located in a “civilized” country that has concluded a double tax treaty with Ukraine (as of today, there are more than 70 such countries, including EU countries, the USA and Canada);
• public companies and companies that receive dividends from Ukraine.

In addition, the tax paid by a CIC in the country of its residence can be deducted from the Ukrainian PIT payable by the Ukrainian shareholder. For example, a Cyprus-based company pays taxes of €1 million and transfers dividends of €10 million to its Ukrainian owner. Ukrainian PIT would be €900,000 (9%). Since the CIT paid in Cyprus exceeds this amount, the Ukrainian shareholder does not have to pay PIT but is still required to pay the military tax which cannot be set off against foreign taxes.

Consequently, a “tax threat” looms over CICs located in offshore low-tax jurisdictions. Not in every instance, though. For the majority of Ukrainians who control CICs, taxation occurs in the same way as before – only upon receiving dividends.

So, what is it that entrepreneurs don’t like? Why does the UUP request for the postponement of CIC reporting?

As a matter of fact, the UUP’s request lists concerns for business.

First, CIC reporting is an administrative burden. Business owners have to involve their employees or hire professional consultants to have reports prepared up to professional standards. Waste of money and time. Not to mention the need for high-quality preparation of financial statements of all foreign companies, which also have to be filed with the Ukrainian tax authorities.

Second, the final report submission deadline is approaching. At the beginning of 2024, business owners will have to report on all their CICs for 2022 and, possibly, for 2023 unless the legislator makes changes to the TCU. Though, this will be a challenge.

Finally, the most important thing is distrust in the authorities. The UUP’s request focuses on unscrupulous law enforcement officers who put pressure on businesses; therefore, entrepreneurs are reluctant to provide them with too many details. Moreover, the eventual disclosure of Ukrainian business secrets to enemy intelligence agencies should not be ruled out.

It might have been the recent actions of the security forces (in particular, the search in the office of the restaurant holding “!Fest”) that caused Ukrainian businessmen to unite to resist the authorities.

But the CIC rules were introduced back in 2020. Why didn’t the business react then?

I do not have a clear answer. Perhaps, the authorities enjoyed more trust, so Ukrainian businessmen had less fears to face inadequate actions of law enforcement officers.

The year 2020 brought a spate of complex challenges, from the pandemic to the escalation of the war. Throughout this time, Ukrainian business had more important things to worry about than lobbying for changes in the tax legislation.

Will the authorities take it on board now?

Predicting changes in the Ukrainian legislation is a hopeless undertaking. We can hardly imagine that parliamentarians will positively respond to the message of business, “Dear government, we do not trust you. Postpone or cancel CIC reporting!” But we would like to believe that common sense will prevail.

However, times have changed, and the Ukrainian legal field is now being closely monitored by international partners. They may see any relaxation of tax rules as Ukraine’s compromising the principles of the fight against tax evasion.

Unfortunately, Ukraine took on unnecessary and excessive obligations during the implementation of the BEPS anti-offshore plan. In particular, Ukrainian legislators have implemented the CIC rules for individuals, although these norms are not applied in many civilized countries. This gives rise to a question: is it possible to soften the TCU requirements without putting Ukraine conflict with international partners.

Supposing the Verkhovna Rada will not cancel the CIC rules and postpone CIC reporting, will it be a disaster?

Most likely, no. Anyway, even if the CIC-reporting campaign takes place in 2024 as was planned, the current legislation will need to be improved by then, because it contains a lot of controversial and imperfect norms.

This is the purpose of draft law No. 8137 (currently under finalization): to improve the taxation of controlled foreign companies. The desired changes include postponing 2023 CIC reporting from 2024 to 2025.

May a Ukrainian owner of a foreign business not report on CIC?

Current legislation provides for two options.

In the first scenario, an individual can leave Ukraine (if there are no legal restrictions) and, under certain conditions, obtain tax residency in a foreign country. This lifts the obligation of CIC reporting in Ukraine but entails a noteworthy conflict of laws.

For example, taking into account that in 2024 a Ukrainian resident is required to submit CIC reporting both for 2022 and 2023, it remains unclear how to report on CIC if a person was a Ukrainian resident in 2022 but changed their status in 2023. What a non-resident should now do in such a case is still up in the air.

Conservative tax consultants recommend that such “migrants” grab their relatives and take them outside Ukraine: the current version of the TCU allows a Ukrainian to be recognized as the controller of a CIC, even if the company is in their foreign relative’s ownership.

A real-world example: a young Ukrainian created a startup in the USA and manages it locally and without any ties to Ukraine. Ukrainian tax authorities can recognize this startup as a CIC and the owner’s parents or brother still residing in Ukraine as its controllers.

The second scenario implies that the entire foreign business is transferred to a trust. A true, irrevocable, discretionary trust in which the former owner will no longer have ownership or control.

Not every Ukrainian is willing to lose control completely, even with the absence of a CIC declaration as the “prize”.

Source: Forbes Ukraine