Ukrainian taxpayers before adoption of the Law devised a number of schemes that can help to bypass its rules

Law on transfer pricing (TP) was signed. Ministry of income and charges received new and powerful weapons to deal with withdrawal of funds abroad. Judging from media reports, business bewildered looking at old schemes of work and preparing for new checks. Do they need to? Will the new law be an effective tool in hands of tax authorities and allow them to reduce the outflow of funds from Ukraine to offshore?

One of the key factors in effectiveness of the new law is willingness to accept by taxpayer and related party contractor to disclose detailed information on their financial statements.

If not recognized - the new law allows tax authorities more tools to combat dishonest taxpayers. For example, special rules for counterparties from “low tax” jurisdictions. "Low tax" is recognized a jurisdiction income with tax rate by 5 percent or more lower than income tax rates in Ukraine. The list of such jurisdictions was adopted by the government. Transactions with any contractors located in such jurisdictions are equal to controlled.

But you should not underestimate the creativity of Ukrainian taxpayers. The law has not even been passed, and they have devised a number of schemes that can help circumventing these rules.

Gaps in the law

Here is an example of one of the schemes. Exporter creates two companies in the low tax jurisdiction. The first company buys a product from him and then resells to other companies with a small margin. And this is the second company sells its products to end users, leaving self fixed income, and the taxpayer is officially declared as a related party only to the first group. At the same time, using for the purpose of transfer pricing the method of net income provides to the tax authorities all information about profitability of the first company, and return will be completely within normal limits.

At the same time the second company is not formally associated with the taxpayer, and because of it has no operations, and then the transfer pricing rules do not apply to it.

The authors of the new law could easily predict such risk and could write that if these contractors in chain of sale or purchase of goods are related with Ukrainian resident, such agreements should be under control as well, and therefore their profitability should be evaluated together. But there is no such rule in the law.

Of course, the tax authorities may try to challenge the choice of transfer pricing. Instead of assessment profitability of contractor, tax authority can compare prices of goods between exporter and the first company with prices of similar products in market.

For such cases, there is another potential loophole in the law. Ukrainian exporter can sell their products, for example, to the Hungarian company which did not relate to it, but agreed to mediate for a small fee. Purchasing goods from Ukrainian exporter, Hungarian company resells it with a small margin to associated counterparty with the taxpayer in low tax jurisdiction and major margin from transactions will settle there. As Hungary is not a low tax jurisdiction and Hungarian company is not an associated company, then the transfer pricing rules do not apply to this transaction. These transactions are not considered as controlled.

About draconian penalties

What about draconian penalties for withholding information from the tax authorities (5% of transaction amount), you say? It would seem that such fines should put off a desire of withholding information from the tax authorities.

The problem is that such penalty shall be applied only in case of failure to submit a report on controlled operations. That is the end of the year (May 1, the next) the taxpayer must submit to the tax authority a report containing information about all transactions with related parties and contractors from low tax jurisdictions covered by control.

If it concealed information about controlled operation, the specified penalty is applied. But in those situations described above - not. After all, exporter hides no information on controlled operations. Just the same transaction does not fall under the Act.

Wider grounds for 5 per cent penalty –those which could stop using the described schemes - have been registered in the first version of the law on TP. But during adoption of the law this provision had be dropped due to tax concessions for Ukrainian business.

On objectives and means

Does this mean that, despite the new law, some members of the Ukrainian business will continue to display in offshore the profits, properly structured by international transactions?

Ukraine has a very large segment of the business that can not afford using a non-transparent scheme. This is international company, Ukrainian public company whose shares are traded on foreign exchanges. They will have to provide the tax authorities with full details and these transfer pricing rules will work as planned.

Those representatives of big business that are not constrained by the rules of public accountability can actually use a creative approach to structuring their operations. However, despite the gaps in the law, tax office will respond them with equally creative interpretation of the law on TP. Operations that under law are not.