Following the path of implementation of the global anti-BEPS (Base Erosion and Profit Shifting) program, our state can no longer postpone the introduction of CFC reports – controlled by foreign companies. Such regulations are enshrined in Law No. 466-IX, adopted on January 16, 2020, provide for the introduction of additions and amendments to the Tax Code (addition of Article 39-2), and begin to operate on January 1, 2022.
CFC reporting is a new big burden for Ukrainians who own offshore companies. It is both about carrying out correct calculations for taxation and preparing documents , and about building constructive interaction with tax authorities in order to avoid checks and sanctions in the future.
Lawrange Attorneys at Law offers comprehensive assistance in resolving issues of legal support for CFCs: from advice on the possibilities of leaving the status of a controller to preparation a complete package of documentation for submission to the regulatory authorities of Ukraine. With many years of experience in supporting international business, it is not difficult for us to draw up reports in accordance with the requirements of IFRS (International Financial Reporting Standards), and to select non-standard solutions for non-resident enterprises.
The concept of “controlled foreign company”
Important! Following the content of Law No. 466-IX, a controlled foreign company is an economic entity registered in a foreign state with / without legal entity status, which is controlled / is operated by a Ukrainian resident (enterprise / individual).
*** Note: Structural entities that do not have the status of a legal entity mean: a) partnerships (including English and Scottish); b) funds; c) trusts; d) other organizations , the creation and activities of which are regulated by a transaction and the legislation of a foreign state.
For your information! According to the generally accepted definition, a controlled foreign company is a legal entity operating in one country (offshore), but owned or controlled by tax residents of another state. Often, such enterprises are created in jurisdictions with minimal taxes – the so-called “tax havens (havens)”. There are blacklists of tax haven (tax haven blacklists), falling into which the country loses opportunities for full-fledged foreign economic activity and international financial transactions.
Which entities fall within the definition of “controlling person”?
Important! The definition “controlling person” refers to individuals and legal entities with Ukrainian residence, direct owners / indirect (indirect) controllers of a foreign business entity (offshore, mid-shore, onshore).
*** Note: Regarding an individual, having Ukrainian citizenship is not a prerequisite. In this context, we are talking about tax residency.
The criteria for determining the status of the controller by law are as follows:
- owning more than half of shares in a non-resident legal entity (from 2023 – 10%);
- ownership of shares of more than 10%, when the total share of all Ukrainian residents exceeds 50% (for 2022-2023 – 25%);
- actual control over the legal entity (solely / with related persons – residents of our country).
“ shares ” in this context means corporate rights, other similar powers, which secure:
- influence on a significant percentage of votes in the general meeting;
- receiving a portion of income ;
- receipt of part of the assets upon liquidation, termination;
- blocking the decision to redistribute profits .
When an offshore company is not a legal entity, control is determined by the following statuses:
- in partnership – member status (with a sufficient stake to control);
- in the fund – the status of the owner of the property (or its essential part);
- in the trust – the status of the founder.
For your information! The controller’s status can be confirmed by such documents as a declaration of trust, a general power of attorney, a nominee service agreement, and so on.
By “ effective control ” over an offshore is meant:
- specifying the subject as a founder when the company opens bank accounts;
- corporate account management;
- issuance by a person of orders binding instructions to management;
- conclusion of significant transactions on behalf of a legal entity.
For your information! The SFS is responsible for proving effective control.
What are the responsibilities of the CFC controller?
The goal of introducing CFC reporting in 2022 is to prevent the leakage of monetary profits from our country to offshore zones, primarily to low-tax ones. Accordingly, Ukrainian residents are obliged to disclose their ownership or control over foreign companies, and the subsequent payment of taxes on retained earnings.
For your information! Resonant law № 466-IX was adopted in the framework of the global trend towards “deoffshorization”. We are talking about joining the Common Reporting Standard (CRS), as well as harmonizing legislation with the antiBEPS plan and “FATCA laws”. On the eve of the introduction of stricter tax control in the country (the adoption of the law “on indirect methods of tax control”), special preferential programs are being implemented for taxpayers – “tax amnesty” and “tax-free” liquidation of CFCs. But then the inevitable toughening of the “rules of the game” will follow, both for Ukrainian and international business, for which one should prepare.
Controlling persons from now on (from 01.01.2022) must:
- Notify tax authorities about foreign assets.
- Submit annually a special CFC report .
- Submit offshore financial statements prepared in accordance with IFRS.
- Pay taxes on retained earnings of each CFC in our country.
- Notify the SFS within the statutory timeframe on liquidation, changes in the ownership structure of the CFC.
*** Note: The IRS should be notified of both the sale and purchase of corporate rights and the acquisition or termination of effective control over a CFC.
For your information! It is likely that, starting from 2023, the fulfillment of the obligations of Ukrainian beneficiaries to disclose information and pay taxes on foreign assets will be monitored by the tax authorities through the CRS tax information exchange tool in within the framework of Ukraine’s accession to the MCAA (Multilateral Competent Authority Agreement). Although, in the first two years of filing CFC reporting , no penalties are envisaged.
If such obligations are unacceptable for the Ukrainian beneficiary, there are options for changing the legal status of the company or the owner (controller) itself. “Tax-free” liquidation can be implemented only until December 31, 2021. And this is a fairly acceptable way of solving the offshore issue. Although the option with “tax-free” liquidation is also not completely free from risks. In particular, we must not forget about the financial monitoring of the bank when placing funds and the threat of criminal liability in connection with non-compliance with AML requirements, and so on.
Now you can implement the following options for optimizing the tax burden in the presence of an offshore:
- change the jurisdiction of company registration: select a state that meets the criteria for tax exemption;
- change the tax residence of a legal entity to Ukraine;
- combine operating and holding activities to comply with tax exemptions.
This list cannot be considered exhaustive. There are no standard algorithms that will suit everyone and everyone for solving such a problem. Lawrange JSC experts are ready to analyze the specifics of your business and develop an individual option.
CFC Tax Regulations
The new law clearly states: the taxpayer of a non-resident economic entity is a controller. The object of taxation is a part (percentage) of the adjusted profit of a given entity in proportion to the share that belongs to the payer by the end of a specific reporting period of time.
Adjusted profit – income of the organization in the jurisdiction of registration before tax (EBITDA) according to unconsolidated financial statements for the year. The procedure for calculating the adjusted profit subject to taxes / fees in our country is regulated by regulatory legal acts. The profit of the organization is adjusted by deducting certain income to avoid double taxation, and adding it using transfer pricing methods (meaning the so-called tax differences). The offshore profit in foreign currency should be converted into hryvnia at the rate of the National Bank on the date of CFC reporting.
For your information! Even when the legislation of any jurisdiction does not establish the obligation to maintain and submit financial reporting to state bodies, the payer in Ukraine should ensure that such documentation is drawn up by a non-resident organization in accordance with international standards financial statements (IFRS).
Tax rates for CFC profits are as follows:
- for a legal entity – 18%;
- for an individual, when the profit is not distributed (dividends are not paid) – 18% + one and a half percent military fee;
- for an individual, when dividends are received from abroad from an offshore organization before the submission of a special report – 9% + one and a half percent military fee.
The tax calculation formula is as follows: (EBITDA +/- tax differences) * controller’s share * tax rate.
Tax exemption conditions
Under certain circumstances, entities that fall under the definition of a CFC are exempted from the obligation to pay tax in the Ukrainian tax jurisdiction. This opportunity is allowed to be used if:
- the total annual income of the controller from all CFCs is up to a maximum of EUR 2,000,000;
- the company does not carry out commercial activities, in particular, it is engaged in charity work, does not distribute income in favor of beneficiaries;
- is a public company and is listed on a reputable stock exchange;
- there is one of the following agreements between our country and the state of registration of the offshore: DTT (on the avoidance of double taxation), on the exchange of tax information;
- in the jurisdiction of registration, a business entity pays corporate tax eighteen percent + (as in Ukraine or higher);
- a minimum tax of 13% is paid in the state of registration (the difference with Ukraine is maximum 5%);
- less than half of the company’s total profit from all sources is passive income.
Recommendations from Lawrange JSC on preparation for submission of CFC statements
For entities that meet the criteria of controlling persons, we recommend that they immediately undergo legal advice, and then develop an algorithm for actions to optimize the tax burden, if such a need arises.
Important! In consultation with a Lawrange JSC specialist, you can get answers to the following questions:
- Do you meet the definition of a controller?
- Can I take advantage of the tax exemption?
- What is the amount of adjusted profit that is subject to taxes and duties in Ukraine?
- Is there an urgent need to implement algorithms of actions to reduce the tax burden?
- What option for optimizing the tax burden can be applied in compliance with the situation?
- What actions should be taken and within what time frames to comply with the requirements of CFC legislation?
- How not to fall under the sanctions of the tax authorities?
Terms and specifics of reporting
- The first reporting year for compiling a CFC report is 2022.
- Report for 2022 can be submitted in 2024 immediately for 2022 and 2023
- Such a special report should be submitted to the SFS simultaneously with one of the declarations :
– on property status, income – until May 1 (the calculated tax will need to be paid before August 1);
– for corporate income tax – until March 1st.
- Adjusted profit of the offshore is indicated in the declaration.
- Statement of profit / losses of the offshore covers a single calendar year.
- A special report should be submitted even if:
– the offshore company is in a “dormant state” (no economic activity is being carried out);
– there are justifications for tax exemption;
– there is a negative profit value.
- A document is sent to the SFS in digital form by means of online communication (in accordance with the requirements of the law on electronic document management, and using a qualified digital signature).
- The special report must be accompanied by a copy of the financial statements of the economic entity, confirming the profit or losses incurred.
- Controllers from January 1, 2022 must send notifications to the State Fiscal Service regarding the receipt (purchase of corporate rights), termination of participation in the offshore.
*** Note: A new field 06.1 has been added to the income tax return form.
Requirements for the content of the special report
A special report on a non-resident organization for the SFS should contain the following information:
- Name, legal address, indication of organizational form, registration number, tax number of a business entity.
- Ownership and management structure, inclusive – indication of the indirect ownership scheme.
- Amount of the controller’s share in the authorized capital.
- The amount of profit before taxes according to the financial statements – proceeds from the sale of products, performance of works, provision of services, operating activities.
- Calculated in relation to adjusted profit.
- Dividends received from Ukrainian business entities, when available.
- Income from the representation of a business structure in our country, if any.
- Amounts of profit actually transferred to the controller.
- Transactions with non-resident counterparties from jurisdictions classified as offshore zones.
- Number of employees at the end of the tax year.
- Justification for tax exemptions, where available.
Important! A copy of the organization’s financial statements with proper certification, confirming the amount of income for the reporting year, is attached to such a special offshore report.
In addition, at the request of the SFS, the following are submitted:
- CFC explanations;
- documentation of controlled transactions performed;
- conclusion of an independent and authoritative audit organization, if there are doubts of the SFS representatives about the truthfulness and correctness of financial statements.
The SFS has the right to send a request to request additional explanations when:
- Ukrainian tax resident is a controller and did not submit a special report on CFC;
- the statements in the special report do not reflect the real situation, contain significant inaccuracies and errors.
Explanations upon request should be prepared and submitted within 2 months from the date of receipt of such a request. The response to the SFS request must contain explanations and arguments on the facts mentioned in the request, and also be supported by copies of the documentation with proper certification.
The Auditor’s report must be provided by an audit organization with the appropriate permission to audit financial statements in a particular foreign country. Submission of a negative opinion by the State Fiscal Service or refusal to issue an opinion is not allowed.
Special report in abbreviated form
Sometimes, in some exceptional cases, the legislation allows for the possibility of submitting a special report in an abbreviated form to the SFS. Reasons for this:
- the entity is not able to provide preparation of financial statements;
- the entity cannot make correct calculations regarding the adjusted profit before the maximum allowable date for filing a declaration of property, income or income tax.
The special report in an abbreviated form contains only the information specified in paragraphs 1-3 of the requirements for the content of such a document (see the text above). In the case of submitting a report in such an abbreviated form by the end of the calendar year, it is imperative to submit a full report.
Tax control and liability for violations
The Ukrainian authorities plan to introduce sanctions for offenses in the field of offshore taxation gradually. In the 2022-2023 reporting years, fines and other sanctions will not be applied. But there is no need to relax, since already over these two years it will be necessary to submit the corresponding special reports to the State Fiscal Service. In the future, the failure to submit a special report on the CFC, and, accordingly, the lack of data on the company’s adjusted profit in the annual tax return, will be the reason for inspections and the imposition of huge fines.
For your information! Even without automatic exchange of tax information, the tax authorities of Ukraine can exchange information on request (Exchange of Information on Request, EOIR). The peculiarity of such an exchange of information is the possibility of obtaining practically any data significant for taxation (with the exception of those, the provision of which is contrary to national legislation and public order). At the same time, automatic exchange according to the CRS standard provides for a strictly limited format of information – the transfer of data on foreign financial accounts.
In addition, the introduction of open registries of beneficiaries in many countries contributes to the detection of Ukrainian owners of offshore companies.
Offshore tax related fines
For offenses in this area, serious penalties will be applied:
- non-submission of a special report – one hundred times the subsistence minimum for an able-bodied person (PMTL), roughly with reference to 1.01.2022 – 248 100 UAH;
- untimely submission – one PMTL for each subsequent day of delay, but maximum 50 PMTL, 2481 per day, that is, a maximum of 124,050 UAH;
- not displaying statements of all non-resident organizations available to the controller, incomplete display – three percent of income / twenty-five percent of adjusted profit, however, a maximum of 1,000 PMTL for each individual fact or completely for not specified amounts, UAH 2,481,000;
- no notification regarding the acquisition of a share (part, interest in the authorized capital, corporate rights) in an offshore, taking over actual control, alienation (sale, re-registration) of a share, termination of control within the time allowed by law – 300 PMTL for each such fact, 744 300 UAH;
- failure to submit, incomplete submission of transfer pricing documents, other documents upon a specific request – three percent of income for which no documents have been submitted, however, a maximum of 1,000 PMTL;
- failure to submit a special report within thirty days after the last day of payment of penalties – five PMTL for each day of delay, but a maximum of three hundred PMTL.
*** Note: Payment of a fine is not a justification for canceling the taxpayer’s obligation to submit a special report and supporting documents.
Minimizing risks for the controller
From January 1, 2022, Ukrainian beneficiaries of offshore companies need to adapt to live by the new rules. Although the sanctions will not be immediately imposed, the transition period 2022 – 2023 should be used with maximum benefit. At the very least, it is necessary to make a decision: show the offshore company in documents for the tax service or look for a way to avoid the status of a CFC controller.
For your information! It is useless to hope that “abandoned” or “forgotten” non-resident companies will be out of the risk zone. You will have to report on them, otherwise a fine will follow. An end to the history of offshore ownership can only be put through the liquidation of the company. In this case, a company automatically struck off the Register (through the striking off procedure) is not considered liquidated.
In a number of cases, a change in residency status can be considered an acceptable way out of the situation for the controller. In particular, jurisdictions with the absence of CFC reports for individuals, an acceptable level of tax burden for individuals, as well as an acceptable period of residence for obtaining resident status are considered for the acquisition of residency. Among the most efficient jurisdictions for tax migration are Portugal, Andorra, Gibraltar, Switzerland, Bulgaria, Montenegro, and so on.
The issues of leaving the controller status by means of “dilution” of shares, application of the presumption of one hundred percent ownership, whether a scheme with the establishment of a discretionary trust, an umbrella investment fund, and the like, will still be debatable.
If you are a Ukrainian resident, controller of an offshore company, do not delay the decision on the future fate of your business. The experts of Lawrange JSC are ready to delve into your circumstances in order to offer optimal solutions. We are also ready to start tidying up the company’s financial reporting, and then preparing and submitting special CFC reports to the regulatory authorities. New realities require fresh solutions, and we are ready to offer them!