Last month was quite rich in legislature-changing activity and some of these actions caused strong waves of discussion, particularly the Draft Law On Introduction of Amendments to Several Legislative Acts of Ukraine on Strengthening the Protection of Employees’ Rights and Preventing the Use of Undeclared Labor and the Decision of the Constitutional Court of Ukraine on decriminalization of illicit enrichment. Other significant points were ratification of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, adoption of the Law On the Authorized Economic Operatorand some promising draft laws.
The Parliament ratified the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting on 28 February. What are the main advantages of Ukraine joining this Convention, and what changes to our taxation system does it involve?
On 19 March 2019 Ukrainian President Petro Poroshenko signed the Law of Ukraine On Ratification of Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The MLI is an agreement aimed at implementing the provisions of the BEPS Action Plan into the Ukrainian double tax treaty (DTT) network through simultaneous amendments to all of Ukraine’s DTTs covered by the MLI.
Given that the MLI applies only when both contracting states opted to amend the respective DTT, MLI will apply to 43 Ukraine’s DTTs (DTTs with Cyprus, Malta, Luxembourg, Estonia, UK, etc.).
MLI is expected to have a significant impact on the taxation of passive income (dividends, interest and royalties) remitted from Ukraine to foreign companies, of income from alienation of shares deriving their value principally from immovable property, as well as on taxation of permanent establishments (PE).
The minimum standard of the MLI is a set of provisions that shall be mandatorily included in the DDTs for all jurisdictions that signed the MLI. It includes BEPS measures aimed at preventing the granting of treaty benefits in inappropriate circumstances. The major amendment to DTTs provided for under the MLI is the Principal Purpose Test (PPT), under which a benefit under the DDT shall not be granted in respect of an item of income or capital, if obtaining that benefit was one of the principal purposes of any arrangement or transaction.
The PPT will apply to all Ukraine’s DTTs covered by MLI. Therefore, MLI will have a significant impact on IP/holding/financial structures that are commonly used by Ukrainian business. For example, the “back-to-back” structures with the use of foreign intermediary companies (IP holding and/or financing companies) that have no or limited economic substance in their country of residence, and one of the principal aims of establishing the is to apply reduced or nil WHT under the DDTs, will not pass the PPT.
In fact, Ukrainian taxpayers that pay passive income to their IP/holding/financial companies will need to pass the PPT along with the “beneficial ownership” test, which in practice could be difficult or even impossible.
Ukraine opted to apply the following optional provisions of MLI:
MLI will amend the rules on taxation of capital gains from alienation of shares (or comparable interests, such as interests in a partnership or trust) deriving their value principally from immovable property:
MLI provides for a stricter property rich test, as compared to the current edition provided for by the DTTs which Ukraine is a party to: capital gains may now be taxed in the contracting state, if at any time during 365 days preceding the alienation of shares, they derived more than 50% of their value directly or indirectly from immovable property (real property) situated in that contracting state. MLI is aimed at preventing cases of artificial reduction in the immovable property component of the value of shares on a balance sheet through the disposal of such immovable property before the alienation of shares.
This rule should be considered by multinationals planning to dispose of their Ukrainian business (e.g. retail property management business) indirectly via the disposal of shares in Ukrainian companies.
MLI will implement the following anti-abuse rules to counter artificial avoidance of PE status:
— the treaty benefits will not be granted to a taxpayer if the income is allocated to a low taxed passive PE in a third jurisdiction;
— an enterprise shall be deemed to have a PE if a person acts on behalf of an enterprise and in doing so habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise;
— the “independent agent” status will be no longer available if the agent “acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related” (the agent and his principals that are connected by more than 50%, directly or through a common beneficiary);
— rules that will not enable a taxpayer to avoid a PE status by means of splitting contracts (e.g. construction);
— all specific exemptions (having an office only for the purposes of purchasing or collecting information, having a warehouse for storing goods, etc.) will be applied only if each respective activity is of a preparatory or auxiliary nature.
Therefore, certain international sales and purchase structures could be exposed to PE risks. For example, under the current edition of DTTs, which Ukraine is a party to, if an on-line retailer establishes warehouses in foreign jurisdictions in order to deliver goods to local customers, such activity will not constitute a PE as this activity is directly exempt under Article 5 of the respective DTT. Under MLI, such activity will be exempt, only provided that such activity is of a preparatory or auxiliary nature. This means that if a warehouse of goods constitutes a part of the core business of an online retailer that allows the delivery of goods to fulfill purchase orders made by local customers, it is likely that such activity may not be considered as activity of a preparatory or auxiliary character. Therefore, such activity will constitute a PE of such an online retailer.
Given the above, certain Ukrainian business models will be exposed to significant tax risks as discussed above, and may require review in order to address the impact of MLI.
Anastasiya Mosunova, manager KPMG in Ukraine
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