Ukraine is undergoing the tax reform nowadays, which is quite inconsistent, unpredictable and sometimes may bring instability to the business environment. The legislator is introducing significant changes to the Tax Сode and in a few months after, adopts other laws that change the rules established before. There were three different editions of the Tax Сode provisions in respect of taxation of non-residents in Ukraine in 2020, the draft law No 4065 ("Draft") may introduce the fourth one. The Draft was adopted by the Parliament on 03 November 2020 in first reading and non-residents are again on the verge of possible changes to the Tax Code.
How it was before 01 July 2020
Before 01 July 2020 the Tax Code provided that non-resident's profit from the sale of shares in Ukrainian entity shall be taxed in Ukraine.
The law provided for a procedure for such taxation only for the situation when a buyer of shares is a Ukrainian legal entity or a permanent establishment of a non-resident. The transactions between non-residents were outside the scope of the Tax Code at all as well as transactions with Ukrainian individual buyers of shares.
A buyer should have withheld a tax on seller's profit from the sale of shares at a rate of 15% unless otherwise was provided for in double tax treaty ("DTT").
For instance, the DTT between Ukraine and Cyprus in the wording effective until 28 November 2019, stipulates that profit gained by Cyprus resident from the sale of shares in Ukrainian entity shall be taxed in Cyprus. Ukrainian tax payers could have applied provisions of similar DTTs not to withhold or pay taxes in Ukraine at all.
Transactions with shares in foreign entities holding Ukrainian assets were not covered at all.
From 01 July 2020
From 01 July 2020 the sensational Law of Ukraine No 466 ("Law 466") outlined the case when the sale between non-residents of shares in a foreign company holding Ukrainian real assets is subject to taxation in Ukraine and established the procedure for such taxation. For this rule to apply the shares ("Investment Asset") at any time during 365 days preceding the alienation shall directly or indirectly derive at least 50% of their value from real estate located in Ukraine based on accounting information of the companies involved.
The Law 466 provided that it is a non-resident buyer's obligation to withhold a tax on non-resident seller's profit from the sale of the Investment Asset at a rate of 15% unless otherwise is provided for in the applicable DTT. For example, the Cyprus DTT defines that an income received from alienation of the Investment Asset by a resident of Cyprus may be taxed in Ukraine. Thus, the provisions of the Tax Code and the provisions of Cyprus DTT stand for the same, for the taxation of non-residents in Ukraine.
The Law 466 did not detail a procedure for taxing a transaction when a non-resident entity alienates shares in a Ukrainian legal entity directly, i. e., without involvement of a foreign holding company. For some reason the respective provision was removed at the stage of the second reading of the draft law in the Parliament.
Consequently, the sales of shares in Ukrainian companies between non-residents were still beyond the taxation in Ukraine even in case such companies hold real estate.
From 08 August 2020
Another Law No 786 has introduced further amendments to tax regulations relevant to non-residents in Ukraine from 08 August 2020 and provided for the procedure for taxation of profit from alienation of shares in Ukrainian entities between non-residents in case if Ukrainian entities directly hold real estate.
Thus, as of now there are only two cases ("Tax Events") in which the profit from the sale of shares between non-residents may be taxed in Ukraine:
- sale of shares in a foreign entity directly or indirectly holding shares in Ukrainian entity which in its turn owns or uses real estate in Ukraine; or
- alienation of shares in a Ukrainian entity which holds real estate directly.
The Tax Code seems not to cover the procedure for collecting the tax on shares sale between non-residents in a Ukrainian company which does not possess any real estate in Ukraine, including the case when such entity is a shareholder in another Ukrainian company which in its turn does own or use real estate in Ukraine ("Exception").
Changes that the Draft may introduce
In case the Draft enters into effect the Tax Events would cease being taxable in Ukraine at all in 2020. The Draft is designed to have retroactive effect in this case with effect from 01 July 2020. The Draft provides that the provisions concerning the Tax Events would apply from 01 January 2021 only.
In case the Draft is adopted, a question arises, what will happen to those entities that have already paid taxes from transactions based on tax provisions in effect and how to get the paid tax back. Unfortunately, the Draft does not give any specific answer. The Tax Code sets out a general procedure for return of wrongly paid amounts of taxes. It is also provided that wrongly paid taxes are the taxes paid by the entities which are not payers of such taxes. It seems that non-residents may use this rule to return the taxes paid, however the question remains how the tax authorities would apply general rules to the retroactively cancelled taxes.
The Draft would not affect the Exception, which allows us wonder whether to expect further amendments to the tax regulations after the Draft again.
Chance to slip through
In case the Parliament adopts the Draft soon enough, non-residents might get a last chance to complete transactions with Ukrainian assets by the end of 2020 without paying local taxes in Ukraine.
Another option is to structure the transaction with use of the Exception by putting a Ukrainian company as immediate shareholder on top of another Ukrainian company which holds real estate. However, logically, this looks like another formal omission by the regulator and might be changed in future.
Therefore, year 2020 appeared to be rather controversial for non-residents' operations with shares in holding companies of Ukrainian assets. Taxation approach has changed three times already and may change again. The key conclusion is that from 01 July 2020 Ukrainian taxes may arise in almost any transaction, especially in regard of Ukrainian real estate ultimately, even those conducted between non-residents without any formal representation in Ukraine and even in cases, when Ukrainian assets are held by foreign vehicles. There once again might appear a short time period before the end of the year to finalize the earlier planned transactions free of Ukrainian taxation. On the other hand, the regulator might further specify the tax events to leave no chances to slip through. Ukrainian tax advice has finally become important part of foreign-to-foreign transaction structuring. Moreover, we even need to double-check the applicable regulations several times during the course of lasting transactions to keep our clients safe.
Published: Lexology, 25 November 2020