Ukraine revised transfer pricing rules and introduced new reporting and documentation requirements in 2013. Since then, the rules have been changed every year. And three years after the introduction of the new transfer pricing (TP) rules, we are witnessing an increasing wave of TP audits and the first TP disputes.
Ukraine’s Tax Code provides broad grounds for TP audits, making any company which has carried out controlled transactions potentially subject to one.
There are a number of protective provisions for taxpayers. In particular: (1) a general tax audit may not review TP matters; (2) a taxpayer may be subject to only one TP audit per year; and (3) matters which were already reviewed in a TP audit may not be re-opened (except in a limited number of cases).
Generally, TP audits are significantly less stressful for taxpayers then ordinary audits. They are monitored by the central office of the State Fiscal Service and consist of an exchange of documents and explanations. Therefore, even though the TP audit is significantly longer than general audits (up to 18 months compared to 25 business days), it is less intrusive for business.
As mentioned above, a number of TP disputes have been reviewed by courts, most of which involved technical compliance issues. However, several disputes heard by the courts have involved actual TP adjustments, which have brought more clarity to TP rules and provisions.
One such case involved Kernel-Trade – an exporter of sunflower oil based on forward contracts, some of which contained amended amount of supply and contract terms. Under the Tax Code, the arm’s length nature of prices in forward contracts should be confirmed as of the date of the contract. The company confirmed arm’s length nature of prices in its forward contracts as of the date of the initial contract and of the date of relevant amendments. The tax authorities argued that the company had to comply with the requirement that arm’s length prices be confirmed only as of the date of initial contract, based on the literal reading of the law. The court of appeal cancelled the tax assessment and allowed a separate TP study for each amendment to the initial forward contract.
Grain Innovation Systems
In the Grain Innovations Systems case, the company was an exporter of grain and oilseeds. Tax authorities challenged the prices of export contract agreed-on between the company and its purchasers based on information in Ukrainian price monitoring media. However, the courts rejected the tax authorities’ TP assessment for a number of reasons, including, in particular, the fact that the source of the information used by the tax authority did not specify the quality of the purchased goods, the basis of supply, or other material aspects of the transaction.
Sub-Threshold TP Disputes
Another sphere for disputes on TP matters is the purchase of goods or services from low-tax jurisdictions. Such transactions are subject to TP control only if the total value of transactions with a counter-party exceeds UAH 10 million (approximately EUR 320,000). Where the amount of the transactions falls below that threshold, the taxpayer may deduct only 70 percent of its expenses on the purchase of goods or services in its tax accounts. The taxpayer may opt for voluntary TP control by confirming that the value of purchased goods or services was made at arm’s length.
The issue with this is that an ordinary tax audit will control and review whether the taxpayer deducted only 30 percent of its expenses or the whole amount. As a result, in some cases, local tax authorities who are not able to verify whether the transactions were made at arms’ length tend to disregard the taxpayer’s request for voluntary TP control and require the 30 percent adjustment.
Trend and Concern
There is a wave of TP disputes coming. Most already-initiated TP audits are still pending and it is highly likely that many of them will end up in additional TP assessments and adjustments. Such assessments in most instances will be challenged in court, which will require additional expertise in TP disputes.
Even in those substantial TP disputes which have already been completed, the courts have failed to pursue detailed functional analysis, review economic studies, or re-calculate prices or margins. The concern is that the temptation of the courts to delegate economic studies in TP disputes to economic experts will be too high and that the disputes will be ultimately reviewed by the expert instead of the court. So far, the courts have been reasonable in resorting to expert opinions and we hope they will continue in the same manner. Taxpayers in TP disputes should be reasonable in requesting expert opinions as well.
By Mykola Stetsenko, Managing Partner, and Vadim Medvedev, Counsel, Avellum
This Article was originally published in Issue 4.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.