Consultations on Controlled Foreign Companies

Engaging in international business and investment fosters collaboration between countries, creating effective partnerships. However, alongside these opportunities, jurisdictions face challenges, including the need to adapt their tax systems. In this context, the concept of Controlled Foreign Companies (CFCs) serves as a critical tool for combating tax violations, helping to ensure fair conditions within the taxation system. Against this backdrop, legal consultations on CFCs in Ukraine have become highly sought after. In 2021, Ukraine introduced CFC regulations at the legislative level, requiring individuals or entities controlling foreign enterprises to submit timely notifications to tax authorities. These notifications may pertain to the establishment of trusts, funds, liquidation of companies, or other matters.

Compliance with these regulations is mandatory for all controlling persons, whether they are companies or individuals. The experts at our AA Lawrange are ready to assist in ensuring full compliance with Ukraine’s CFC legislation. Our services include preparing reports, filing notifications with the State Tax Service, and more. With our support, you can reduce tax expenses, organize the necessary documentation, and implement a range of legal measures to maintain the relevance and profitability of your foreign company.

The Concept of CFCs and the Importance of Compliance

Controlled Foreign Companies (CFCs) play a vital role in international business structures and tax planning strategies. In Ukraine, the concept of CFCs is defined by Article 39-2.1.1 of the Tax Code.

A controlled foreign company refers to a foreign legal entity officially registered in any country other than Ukraine (including partnerships or funds that do not have legal entity status) that is directly or indirectly owned by a citizen or tax resident of Ukraine.

Criteria for Defining CFCs

Determining who qualifies as a controlling person of a foreign company is crucial for compliance with regulatory requirements and tax assessment. According to Ukrainian tax legislation, a controlling person (controller) can be either an individual or a legal entity, provided they meet at least one of the following conditions:

• Ownership of 50% or more of a foreign company.
• Ownership of 10% of a foreign company, where at least 40% of shares are held by individuals or entities with Ukrainian residency.
• Joint control over the foreign enterprise alongside other individuals or entities.

It is important to understand who qualifies as a tax resident of Ukraine. Tax residents are individuals who:

• Own permanent housing in Ukraine.
• Have family, business, or employment in Ukraine.

Furthermore, Ukrainian residency is determined even when leaving Ukraine, if a working sole proprietor (FOP) remains in the country.

With Ukraine’s adoption of international BEPS standards, the regulation of foreign business has become stricter, aiming to minimize the risks of financial fraud and abuse. The CFC legislation, enacted in 2021 and effectively starting in early 2022, also includes several additional criteria for determining direct control over a foreign enterprise:

• A power of attorney issued by the company for one year or more.
• A Ukrainian resident identified by the bank as the company’s beneficiary.
• The ability to make decisions on behalf of the company without approval from the board of directors.
• The right to receive a share of the company’s income.
• Transactions with the company are conducted through negotiations without board approval.
• The ability to perform operations on the company’s bank accounts, including the ability to block specific transactions.

CFC Obligations

Companies that meet the above criteria are obligated, first and foremost, to promptly notify the tax authority of the establishment of a CFC – within 60 days from the moment an individual or legal entity is considered a controller. Additionally, the controlling person is required to:

• Submit reports on the foreign company, as well as related financial statements, by May 1 of each calendar year. These reports must include the annual tax declaration.
• Pay the applicable taxes as per legislation by August 1 of each calendar year (unless exempt from taxes or subject to other applicable tax schemes).
• Notify the tax authority in cases of:
  • acquisition of a specific share in a foreign company;
  • establishment or acquisition of property rights in assets, income, or profits without legal entity status;
  • relinquishment or loss of a share in a foreign company;
  • disposal of a share or cessation of control over the enterprise;
  • loss or relinquishment of rights to shares in assets, income, or profits of a company without legal entity status.

The necessary notification to the regulator must be submitted through the taxpayer’s electronic cabinet. If the controlling authority has reason to doubt the presented financial reports, it may require a written opinion from an auditor who can confirm or refute the submitted information.

Important! When a company is legally established abroad but operates physically within Ukraine, the tax and permanent establishment rules are applied. In such a case, the enterprise is considered a Ukrainian tax resident, subject to an 18% corporate tax.

Risk Factors:

• A workforce in Ukraine providing services to non-residents for more than 183 days a year.
• Managing a foreign company from Ukrainian territory – this is often perceived by the regulator as an indication of permanent establishment.

Features of CFC Reporting

A CFC report is a document characterized by high complexity and substantial volume. It is quite common to make errors when filling it out independently, especially considering that this is a relatively new type of tax reporting. For this reason, consultations on controlled foreign companies (CFC) from the lawyers at our law firm will be extremely helpful, as our specialists are familiar with all the nuances of preparing and submitting this type of report.

Non-consolidated financial statements for CFCs are submitted in accordance with international standards or according to the national standards of the jurisdiction where the company is registered. The reporting period is one calendar year. If the reporting period does not align with the calendar year, reports are submitted for periods ending in the relevant calendar year.

If the tax authorities have doubts about the accuracy of the submitted information, in addition to requiring an auditor’s report from a licensed foreign jurisdiction, there may also be a need to provide primary documents related to the operations carried out, as well as documents on transfer pricing (in the case of controlled transactions).

Reports must be submitted electronically. The controlling authority must be provided with the annual declaration of assets and income. A tax declaration for profit tax for the specific period is also required. These documents must be accompanied by notarized copies and financial statements for the CFC to confirm the declared profits for the reporting period.

It is also possible to submit a shortened CFC report. This is allowed if the controller is unable to calculate the profits or prepare the documents before the annual declaration deadline. A shortened CFC report must necessarily include the following:

• Information on the CFC’s income and profit.
• Calculation of adjusted profit.
• The total amount of dividends received by the company, directly or indirectly, from Ukrainian legal entities.
• Data on the number of employees at the controlled enterprise at the end of the reporting period.
• Information on the amount of profit paid to the controller. Consultation on CFC matters allows for a detailed discussion of these and other points, as well as the specifics of submitting the shortened form of the report.

CFC reports, along with tax declarations, must be submitted:

• By May 1st – if the controller is an individual.
• By March 1st – if the control over the foreign company is held by a legal entity.

Important! Correct taxable profit/income figures must be submitted, without any understatement, since due to the CRS standard for exchanging tax information, the State Tax Service (STS) will be able to access the real data of the CFC if needed. Ukrainian tax authorities are particularly interested in foreign accounts held by Ukrainians, especially those with significant balances or transactions related to real estate purchases abroad. In the case of undeclared income, taxation will be immediately applied, along with penalties (25-50% of the unpaid tax). The list of countries with which Ukraine exchanges financial information under CRS includes 118 jurisdictions.

CFC Taxation Method

Fiscal obligations should be fulfilled not on the entire profit, but only on its adjusted portion — the proportion of the profit owned by the controller at the end of the reporting period. Adjusted profit is determined before tax payment. The basis for the calculations is the data contained in the non-consolidated financial statements.

The adjustment of CFC profit before fiscal payment is carried out by:

• deducting certain income as part of protection against double taxation.;
• adding income considering transfer pricing control options in Ukraine (when the CFC cooperates with enterprises from offshore jurisdictions).

The rate of adjusted profit is influenced by the reporting period, the specifics of salary payments, and its distribution. As a result, rates of 5%, 9%, or 18% may apply. Additionally, a military levy of 1.5% is paid.

Personal income tax (PIT) is paid on both distributed and undistributed profit of the CFC. This amount should be reduced by the corporate or other taxes applicable to the CFC in the foreign state for the relevant reporting period. The PIT levied must be proportional to the controller’s share in the foreign company as indicated in the report.

Legal Ways to Be Exempt from CFC Taxation

By meeting certain conditions, the CFC’s profit can be exempted from fiscal burdens in Ukraine. This is possible primarily when both countries (Ukraine and the foreign jurisdiction) have signed a double taxation avoidance agreement. It can also be achieved by paying corporate tax on the CFC’s profit or by restrictions on passive income generated by such a company. Additionally, fiscal relief can be obtained if the aggregate income of all controlled foreign companies does not exceed a certain threshold or if the CFC operates for charitable purposes.

The following conditions may also apply:

• The foreign enterprise’s profit is taxed at an effective rate that is not lower than the tax rate for Ukrainian firms.
• No more than 50% of the total income comes from passive income.
• The annual turnover does not exceed EUR 2 million.
• The CFC is a public company with listed shares.

If passive income exceeds the 50% threshold, it is considered active income if the company:

• Continues to carry out its direct functions, using assets within transactions that generate corresponding profit.
• Uses all possible resources to perform its functions.

Exemption applies to all CFCs within consolidated financial statements, as well as other foreign companies connected to the public CFC concerning dividends. If the controlled company pays dividends to a non-public company, this amount must be included in the calculation of adjusted profit on general terms.

Changes in CFC Legislation

Since May 2023, a foreign company is considered a CFC if, by December 31 of the relevant calendar year, the controlling person is a resident of Ukraine and owns a share in the CFC:

• Exceeding 50%.
• At least 10%, if other Ukrainian residents also own shares in the company, collectively reaching 50% or more.

Moreover, actual control can be exercised solely or jointly with other related parties. The status of the controller is recognized only until the end of the year, and if the CFC loses this status, reporting is not required (however, the obligation to submit notifications remains).

Another change is a slight reduction in the ownership threshold. Previously, control status was granted for ownership of at least 51% of shares, but now it is 50%. Another change concerns the duration of the general power of attorney, which allowed disposal of assets worth 10% or more without additional approval. Previously, such a document was valid for 1 year; now, the term does not exceed 183 days.

Important! After the legislative changes regarding CFCs, unscheduled tax inspections may be triggered if there is evidence of undeclared foreign enterprises.

Changes have also been made regarding fines and reporting rules. You can learn more about these issues during a consultation with our specialists.

Consequences of Non-Compliance with CFC Rules

Failure to comply with CFC legislation can result in fines:

• 100 minimum wages (approximately UAH 302,800) for not submitting the required reports;
• 1 minimum living wage (UAH 3,028) for each overdue day if the report is submitted late. The maximum fine cannot exceed 50 minimum living wages;
• 3% of CFC income or 25% of adjusted profit (whichever percentage results in the highest amount), but not exceeding 1,000 minimum wages. This fine is imposed if certain information is omitted from the report.

Considering all of the above, we strongly recommend not delaying the submission of reports and preparing for the process as early as possible.

Important!  Due to the mistakes made during the first CFC reporting campaigns, a legislative decision was made to temporarily refrain from applying the specified penalties, namely during the period of martial law and for six months after its conclusion.

Consultations at AA Lawrange on CFC Legislation

The rules for controlled foreign companies (CFC) introduced in Ukraine have led to significant changes in business behavior on the international stage. Our attorneys and lawyers are well-versed in all the nuances of CFC regulation in Ukraine. We are ready to provide the necessary assistance to reduce potential risks and implement effective methods to ensure the stability and success of your foreign business. Our services will be beneficial for Ukrainian residents who have established a company abroad or are its beneficiaries, as well as legal entities acting as CFC controllers.

Analysis of CFC Structure and Determining Controller Status

The practical implementation of the CFC reporting regulation began in 2022. Since then, authorities have regularly introduced updates in our country that align with BEPS requirements. Consultations on controlled foreign companies with our specialists will help determine whether you are the controller of a foreign entity. If this status is confirmed, you will receive comprehensive information regarding your obligations to the State Tax Service.

Consultations on Reporting and Taxation

A Ukrainian resident with controller status must comply with reporting rules and pay taxes on CFC profits. Lawrange attorneys will explain in detail which documents need to be prepared, how and where to submit them. They will also calculate the tax base and amount, as well as prepare the CFC report on your behalf. With the help of our experts, you will gain a clear understanding of each step of the reporting process to the State Tax Service.

Determining Grounds for Exemption from CFC Taxation

Our firm’s lawyers will check the CFC for any grounds for exemption from taxation in Ukraine. This will allow your company to legally ensure effective tax optimization and increased profits. We will verify that the foreign company meets all possible conditions to relieve it of fiscal obligations in Ukraine.

Why You Should Turn to AA Lawrange

We have been providing CFC consultations since the introduction of relevant provisions in Ukrainian legislation. We are thoroughly familiar with all the nuances that directly or indirectly affect the tax status of the controlling entity in Ukraine. Working with us will allow you to take advantage of significant benefits:

• Experienced legal team – Every member of our law firm has a wealth of experience in solving any issues related to CFCs.
• In-depth knowledge of Ukrainian and international law – Consultations on CFC legislation ensure the correct and timely submission of reports, as our specialists are well-versed in both national and international legal frameworks.
• Understanding the specifics of each case – We will thoroughly analyze your situation, identify all nuances, and ensure that your assets and foreign business are protected from any risks.

Contact us today to get the answers to all your CFC-related questions. Our experts are ready to provide professional assistance in consulting and solving any legal issues.

FAQ

ORDER A CONSULTATIONS ON CFCS