New business purpose test in Ukrainian tax law

The Ukrainian tax code has contained the definition of the reasonable economic purpose (business aim) of transactions since its adoption back in 2010. Yet this definition was unclear, and the methods for its practical application were limited.

Law 466-IX (in force since May 2020) introduced comprehensive changes into the Tax Code of Ukraine including the implementation of the BEPS three-tier reporting standard. Alongside these important changes, the rules on business purpose were also amended.

According to the definition, a “reasonable economic purpose (business aim)” is that which may occur if a taxpayer aims at reaching a certain economic goal as a result of business activities.

Law 466-IX supplemented this definition with the explanation of what such an economic goal may be and which transactions should be deemed as not having “reasonable economic purpose”. An economic goal (effect) particularly but without limitation should mean an increase (saving) of the taxpayer’s assets and/or of their value in the future.

At the same time, for taxation purposes a transaction with a non-resident is considered not to have a reasonable economic purpose if:

→ Its principal aim or one of them is non-payment (underpayment) of taxes and/or a decrease of the profit tax base.

→ In comparable circumstances, an entity would not be prepared to sell (purchase) such goods, works or services, intangible assets, or other items from an unrelated party.

The Law 466-IX also specified how the business purpose test may influence the tax position.

Thus, new adjustment of the profit tax base was introduced into Article 140.5 of the tax code. According to this, the taxpayer shall increase the amount of taxable profit by the amount of expenses incurred in transactions with non-residents if such transactions lack a business purpose. The burden of proof here lies with the tax office.

In other words, in Ukrainian interpretation the business test would be applicable to any purchases from non-residents. And if the tax office challenges the business purpose, such expenses may be disregarded when calculating the profit tax base.

The only difference for the transactions falling under TP control is that taxpayers will have to add to their TP documentation a justification of the business purpose of expenses for services, works, IP and other items that are not goods. Respective amendments were introduced into Article 39 of the tax code setting forth Ukrainian TP rules. Hence, for the controlled transactions the burden of proof effectively lies with the taxpayer.

The effective date of this material is considered by the Ukrainian Parliament to be draft law 4065 of 09/07/2020. According to this draft law, the application of the business purpose test would be limited to transactions with goods, works, services and the payment of royalties in controlled transactions with related non-residents or non-residents which are subject to TP control because they fall under the list of “low tax” states (territories) or the list of organisational forms of non-residents, adopted by the Cabinet of Ministers of Ukraine.

To conclude, irrespective of the adoption of the above draft law, taxpayers subject to TP control or dealing with non-residents from one of the lists of the Cabinet of Ministers should be prepared to provide justification of the business purpose of expenses. If these amendments are not passed, then the same is valid for any Ukrainian taxpayer dealing with non-residents.

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