“Business Purpose” Concept Extended: Proving the Expediency of Transactions
Although business communities have repeatedly asked the President to veto or amend the Bill #1210, yet the Law of Ukraine "On Amendments to the Tax Code of Ukraine to improve tax administration, eliminate technical and logical inconsistencies in tax legislation" (hereinafter - "Law #466”) entered into force on May 23, 2020.
In general, this tax reform and a number of related legislative acts (such as the Law on Financial Monitoring) adopted recently are aimed at fighting shadow economy and illegal withdrawal of tax revenues, reduce schemes involving offshore zones and transfer of capital to other countries, at increasing tax transparency and at a number of other goals, which will bring Ukraine's tax system closer to OECD standards. Time will tell how effective the innovations will be and whether it is expedient to implement these changes at a difficult time for the country's economy. The best option is to assess all the risks for your business now and make a further action plan. And the best way to start is by determining the concept of a "valid economic reason" (hereinafter - "business purpose").
The concept of "business purpose" is not a new one, it could be seen in the previous versions of the TCU, but only in the “Basic Concepts” section and for general information only. However, tax authorities would sometimes use this concept in controversial matters, e.g., proving the expediency of a transaction in terms of unprofitability. But with the adoption of Law #466, the definition of the "business purpose" concept has been expanded, i.e.:
Transactions with non-residents will not have a valid economic reason (business purpose), in particular, but not exclusively, if:
- their main purpose and / or result is non-payment (incomplete payment) of the amount of taxes and / or reduction of taxable income;
- under comparable conditions, a party would not be able to buy (sell) such works (services), intangible assets from unrelated parties (to unrelated parties).
If the transaction meets the requirements of this paragraph, according to the tax authorities, the pre-tax financial result is increased by the amount of expenses incurred by the taxpayer in transactions with non-residents. Although it is stated that these rules apply to transactions with non-residents, it is possible that the "business purpose" concept will be used for other transactions, as this paragraph introduces a subjective assessment factor that may lead to abuse and lawsuits. In other words, tax inspectors will be able to correct the amount of income tax liabilities if they believe that a particular transaction has had no business purpose.
Actions to be taken in this situation:
- reviewing and analyzing agreements with non-residents (especially with related parties);
- analyzing business structures and assessing the economic effect of transactions;
- preparing documentation that proves the existence of a business purpose.
Also, this norm is indirectly linked to the newly introduced concept of "Controlled Foreign Companies", which will come into force on January 1, 2021, and which is formed to identify offshore businesses owned by Ukrainian residents and force them to pay taxes in Ukraine. Next year, it will be required to file reports on foreign companies to tax authorities.
So, there are still more questions than answers: how to evaluate assets, how to objectively determine comparable conditions, how to take a specific business strategy into account when determining the main purpose of the transaction, and whether each loss transaction has no business purpose. It is currently impossible to predict whether tax reform will be able to achieve its goals without making foreign companies exit Ukrainian. But the fact that innovations will fall on the shoulders of every segment of business, and that they may affect your business if you do not learn about the changes and adapt to the innovations, is objective and predictable.