As Ukraine integrates with the world economy, experts say it must bring its taxation system in line with international standards and better abide by rules that are championed globally.
Doing so is in the country’s best interests. Ukraine’s allies and financial supporters also expect Kyiv to align its taxation policies with best practices worldwide.
Thus, the Organization for Economic Cooperation and Development and the European Union, supported by the International Monetary Fund and the World Bank, are pushing for the initiative known as BEPS (Base Erosion and Profit Shifting), part of which addresses transfer pricing rules. The goal of BEPS is to ensure that taxes get collected “where economic activities generating the profits are performed and where value is created.” In turn, rules aim to ensure that companies set prices for their “in-firm transactions” at market prices so that such transactions can be properly taxed.
What is transfer pricing?
The internal price of transactions involving “goods, works, services between connected economic entities” is the issue, said Ivan Shynkarenko, of the Kyiv-based WTS Consulting firm.
“In principle, this opens possibilities for manipulating prices in order to shift profit to be taxed into other jurisdictions” with low or no taxes.
Transfer pricing regulations started in the United States in the 1930s, accelerated after World War II when a global financial framework emerged. Developed economies saw an emerging trend in which enterprises wanted to shift their profits into low-tax countries, sparking the need for state regulation.
Without the enforcement of rules, some countries are starved of tax revenue while low-tax jurisdictions collect revenue from production centers located all over the world.
But more countries are complying with the BEPS global initiative to redress the unfairness. Compliance takes place in the form of raising taxes in low-tax jurisdictions and through improved exchange of information among fiscal authorities.
To prevent profit shifting, the European Union lists tax havens and calls them “non-cooperative tax jurisdictions.” Currently, there are 15 countries on the list. The EU has been keeping the list since 2017 and it “has proven its worth in promoting… the EU’s agenda of improving global tax practices, fighting tax avoidance and improving good governance and transparency,” Romania’s Finance Minister Eugen Teodorovici said on March 12.
Starved of taxes
In Ukraine, it is hoped that the enforcement of rules can replenish the coffers of a state with a national budget of only $40 billion annually. The State Fiscal Service of Ukraine claims that since 2013 it has managed to grow the tax base in Ukraine by 8.2 billion hryvnias, or about $311 million, thanks to better implementation of transfer pricing rules.
Simply prohibiting “in-firm transactions” regulated by transfer pricing rules will not solve the issue, Andriy Reun of the Kyiv-based EVRIS Law Firm explains:
Transfer pricing is a source for increasing the payments of enterprise profit tax all over the world. By prohibiting transfer pricing the state will just fail to collect money needed for development of infrastructure and other socially important projects. So, prohibition is definitely not a solution.
Svitlana Musienko of the Sayenko Kharenko law firm has been working in tax law for 20 years and says that enforcement of transfer pricing rules, including audits performed by fiscal authorities, “requires so much expertise from both the business and the state auditor that this always takes time.”
Businesses are at an advantage against the state, because firms can move faster by “employing an expert, training him, or hiring an external advisor,” Musienko explains.
The state moves at a slower pace. But it’s worth the investment. Shynkarenko says international experience shows that “each euro invested into development of the fiscal service in the sphere of profit shifting brings 10 (additional) euros of paid taxes.”
Reun believes that, since the moment transfer pricing was introduced to Ukraine in 2013, the State Fiscal Service has undergone a serious transformation into a service-centered organization aimed at assisting businesses: “What they are doing now really looks more like a service function. But when they are starting an audit, then” things can go badly, Reun said.
Reun said tax authorities have understood that it is much easier to persuade business to pay taxes in full voluntarily than to enforce them in courts.
Musienko is confident that if the State Fiscal Service keeps developing a service-centered culture that respects confidential information, companies are likely to reciprocate with better cooperation. This will build trust in the state, Musienko suggests: “Sensitive information to be exchanged by fiscal authorities must remain protected by rules and not get sold at a (black) market in Kyiv,” she said.
Transfer audits, ruling
Transfer pricing expert Olga Trifonova of PwC believes that the tax authorities do not act irrationally when selecting businesses for transfer audits but use a risk assessment method in picking their target companies. “Indeed, tax authorities select those tax payers with risk areas based upon the results of documentation analysis and visit them spot on,” she said.
Musienko said that “currently 90–95 percent of transfer pricing cases in courts have been dealing with procedural issues” rather than with significant violations. However, the appearance of cases being considered on their merits makes lawyers feel optimistic, as court decisions will eventually build case law on transfer pricing.
Musienko praises the Supreme Court of Ukraine for passing its first final ruling on a transfer pricing dispute in Ukraine based on the merits of the case. The dispute was resolved by the Supreme Court of Ukraine on March 5. The fiscal services and a company called SIS GROUP clashed in the case, in which the court supported the position of the Ukrainian taxpayer. In particular, the court supported the company’s position that market prices had to be established at the moment of entering into a transaction, and not while the title was transferred from seller to buyer.
The court also ruled that tax authorities needed to rely on several methods for establishing market prices and use several sources of information for doing so. Plus, the judges ruled that operations performed after July 27, 2017 with British partnerships had to be considered as controlled operations.
This and other final decisions in Ukrainian courts on the subject of transfer pricing will help both the business community and the fiscal authorities in properly understanding the law, and in their correct structuring of transactions.
In general, however, the courts still need to build up their expertise.
Trifonova explains: “Unlike the tax authorities, which have had six years to learn about transfer pricing and its application, our courts regrettably are not well aware of the approaches in application of transfer pricing rules.” The fact that transfer pricing is more of an economic than a legal category can also account for slow learning pace of Ukrainian judges.
But Trifonova is confident that the Ukrainian judges will learn eventually. “In Eastern and Central Europe transfer pricing rules have been in place for a while and judges decide on the merits and not on the formalities.”