1. What are the CFC rules and where do they come from?
In plain English, the CFC rules are a mechanism enabling the State to tax the profits of foreign companies that are actually controlled by its residents.
Thus, the law obliges Ukrainian residents (companies and individuals) to report on profits of their foreign companies to tax authorities and pay taxes in Ukraine.
These rules are needed to implement one of 15 actions of the BEPS Action Plan, which Ukraine joined in 2017.
2. What are CFC and controlling person?
There are two new concepts included in the Tax Code – a controlled foreign company (CFC) and a controlling person.
The CFC is a foreign company (including an unincorporated foreign structure - a fund, partnership, trust, etc.), which is controlled by a Ukrainian resident (individual or legal entity).
A controlling person of the CFC is any individual or legal entity resident in Ukraine:
(А) whose interest in the company exceeds 50%; or
(B) whose interest in the company exceeds 25% (10% starting from 2023) if the aggregate interest of several Ukrainian residents in such company is at least 50%; or
(C) who separately or jointly with other related parties resident in Ukraine exercises actual control over the CFC.
A usual power of attorney issued by a foreign company to a resident of Ukraine for a term of over 1 year authorising to enter into material agreements shall be the sufficient ground for establishing that control is in place.
3. Exceptions to the rules
The CFC rules are primarily aimed at passive income and income received in low-tax jurisdictions. The law is more friendly to the CFCs that do not earn passive income. In the cases below, controlling persons are only required to disclose information on CFCs without paying any tax on their profits:
(А) the CFC is registered in a state with which Ukraine has a double tax treaty and any of the following conditions are met: (а) the CFC actually pays a corporate income tax at the rate of at least 13% or (b) the CFC’s passive income does not exceed 50% of its total income; or
(B) the total annual income of all CFCs of one controlling person does not exceed EUR 2 million; or
(C) the CFC is a public company whose shares are listed on a recognised stock exchange; or
(D) the CFC is a charitable organisation that does not distribute income among its participants.
4. How much will one have to pay?
An individual is expected to pay tax at one of the following rates:
(А) 19.5% ([18% PIT + 1.5% military tax) - if the CFC does not distribute profit; or
(B) 10.5% (9% PIT + 1.5% military tax) - if the CFC distributes profit and an individual actually receives dividends.
Furthermore, the amount of PIT to be paid by the controlling person on the CFC’s profit (whether or not distributed) shall be reduced by the amount of corporate income tax or any other similar tax, which the CFC is required to pay under the laws of the country of its registration.
The CFC’s profit in the form of dividends from a Ukrainian company shall reduce the CFC’s financial result before tax. Such dividends shall not be taxed as CFC's profits in Ukraine.
In case of legal entities, the CFC’s adjusted profit shall be taxed at the rate of 18%.
5. Reporting deadlines
Controlling persons shall be required to submit an annual report on CFCs to tax authorities simultaneously with filing an annual tax return on assets and income (until 30 April) or a corporate income tax return (until 1 March) together with copies of CFC's financial statements.
If the deadline for preparing financial statements in the respective foreign jurisdiction expires later than the respective deadline in Ukraine, copies of the CFC’s financial statements shall be filed together with the annual tax return for the next reporting period. E.g., financial statements of a Cypriot company may be submitted in 2 years. If a controlling person does not prepare the CFC’s financial statements and/or does not calculate the CFC's adjusted profit until the financial statements filing deadline, the controlling person shall submit an abbreviated report on CFCs. In such case, a full report must be submitted until the end of the calendar year following the reporting year.
Additionally, residents of Ukraine are required to notify controlling authorities of each acquisition of an interest or control in a foreign company, which results in recognising them as controlling persons, and of each such disposal or termination of control no later than 60 days after such acquisition or disposal.
6. Liability for violation
The Law provides significant penalties for violation of CFC reporting and disclosure rules. In particular:
(А) for failure to submit a report on CFCs – UAH 210,200 for each violation;
(B) for undue submission of the report on CFCs – up to UAH 105,100;
(C) for failure to provide information on CFCs – 3% of the amount of CFC’s transactions or 25% of the CFC’s adjusted profits not reflected in the report but no more than UAH 2,102,000 for each violation; and
(D) for failure to notify of the acquisition or disposal of a CFC – UAH 630,600.
The amount of fines is based on a subsistence level for a person capable of working.
As far as the CFC rules are concerned, the Law will become effective on 1 January 2021. At the same time, the Law does not explicitly specify from what exactly period the reporting must be filed. However, considering that the provisions on CFCs will become effective in 2021, it is logical that the first report for 2021 should be submitted in 2022. We hope that this issue will be clearly resolved in the near future.
Additionally, the Law establishes a transitional period (2021-2022), during which penalties and default interest will not be applied. Furthermore, during the transitional period, the taxpayers and their officials will not face administrative or criminal liability.
8. How will a tax authority learn about the existence of a foreign company under control of a Ukrainian company (citizen)?
Nowadays, the main data source continues to be the inquiries made abroad by Ukrainian tax authorities. However, Ukraine is now actively introducing automatic information exchange mechanisms, which will, in particular, help tax authorities obtain information about CFCs of Ukrainian companies (citizens).
Actually, businesses have 6 months (before the effective date of the provisions on CFCs) to evaluate possible implications for them and prepare for the changes.
Initial steps should be as follows:
(А) analyse what foreign companies controlled by you may be recognised as CFCs;
(B) analyse whether such companies include tax-exempt ones;
(C) evaluate financial implications associated with such CFCs (administration, financial statements preparation, tax, and other expenses);
(D) analyse the functions of each individual CFC and consider the expediency of its existence in new fiscal conditions – possibly, some companies should be abandoned.
The Law allows to liquidate CFCs without tax implications for individuals who will receive income as a result of liquidation of CFCs. Such tax-free liquidation is possible until 31 December 2020 (in some cases, until 31 December 2021).