Appendix I. Tax Treaties and the Multilateral Instrument (Action 15)
195. A tax treaty is an international agreement between two or more countries (referred to as “Contracting States”). In broad terms, the effect of a tax treaty is to allocate taxing rights (and, therefore, tax revenues) in respect of income or gains arising from economic activity occurring between the Contracting States. Essentially, this is done by a tax treaty limiting the taxing rights of a Contracting State as a source country. Ukraine is a party to 73 tax treaties currently in force.1 This is a significant number of tax treaties and means that, in many cases, the application of Ukraine’s international tax rules is impacted by tax treaties.
196. The implementation of some BEPS recommendations, particularly in relation to BEPS Action 6 (abuse of treaty), Action 7 (avoidance of PE), and Action 14 (MAP), will require amendments to existing tax treaties. The Actions 6 and 7 amendments are designed to protect against abuse of treaty and strengthen source country taxing rights. A tax treaty is normally amended by the two Contracting States negotiating a protocol to the treaty. However, this would be a resource-intensive and time-consuming process for implementing BEPS changes, particularly for a country like Ukraine that has a significant number of existing tax treaties. To avoid the need to negotiate protocols to existing tax treaties, BEPS Action 15 involved the development of the MLI as the mechanism for the timely implementation of the BEPS amendments to existing tax treaties.
197. Ukraine signed the MLI on July 23, 2018 and has recently lodged the instrument of ratification with the OECD. While signing the MLI will allow Ukraine to implement the BEPS treaty amendments in relation to existing treaties in a timely manner, the MLI is a complex document that requires careful consideration of its implications for existing tax treaties and the negotiation of future treaties. It is important, therefore, that the implementation of the MLI is done as part of a broader strategy of developing a tax treaty policy and updating the Ukraine Model Treaty. A tax treaty policy will guide decision making concerning the scope of application of the MLI to Ukraine’s existing tax treaties, and also guide decisions concerning future treaty partners and the content of new treaties. The updating of the Ukraine Model will be an important component of the tax treaty policy and will strengthen Ukraine’s position in the negotiation of future tax treaties.
198. It is desirable that there is a moratorium on the negotiation and signing of new tax treaties. This will allow the MoF to focus on developing a tax treaty policy, updating the Ukraine Model Treaty, and applying the MLI to existing tax treaties. It will also ensure that, as far as possible, there is consistency between existing and future tax treaties. The discussion below considers first the development of a treaty policy and updating the Ukraine Model, and then the application of the MLI to existing treaties.
The label ECT can be misconstrued since an exit tax in other countries has a different meaning, related to a capital gains tax when the taxpayer changes residence. Also, the name would seem to imply that the tax applies to all capital withdrawn from the corporation, including the initial capital contributed by shareholders, which should not be subject to a tax when reimbursed to investors.
There has been some discussion to adopt the ECT for small taxpayers only. This is not analyzed here since it would involve an assessment of the simplified tax regime, which is beyond the scope of this report.
The IMF Capacity Development Mission on Tax Policy, Schatan, R., M. Grote, and M. Kobetsky, 2017. Rethinking Dividend Distribution Tax, Rationalizing Simplified Taxes, and Adopting BEPS Measures (Washington, DC), evaluated and commented extensively on the DPT.
Disallowing past losses creates a disadvantage for ‘old’ capital versus new investors, which is manifested as a loss in value of assets that have not fully amortized those losses.
Reanimation Package of Reforms Team, 2018. Roadmap of Reforms for 2019–2023, see Chapter on Tax and Budget Reform, and related PowerPoint Presentations, Kiev.
The lowest level of corporate tax revenue was in 2001, the first year the DPT was in force, registering less than 0.7 percent of GDP. However, CIT revenue had been dropping fast before 2001, so this low number cannot be entirely imputed to the tax policy change.
From 2019 onwards, a lower 14 percent CIT rate applies for companies making regular profit distributions.
Figure 4 compares Ukraine’s CPT revenue performance since 2001 – 2018. CPT collections have recovered since 2014 remarkably, being slightly above the average for EU-28, OECD member states, and Balkan states. Hence, the resilience of the Ukrainian CPT is a virtue and it is a key tax instrument needed for maintaining fiscal balances.
Moldova is sometimes referred as another example when it instituted a zero rate for CIT in 2008. However, the reform is not equivalent to substituting CIT for a DPT since withholding on dividends was not increased in the expectation to compensate revenue. The zero rate on CIT was ended in 2012.
Data provided by the German Advisory Group on all four countries group point in the same direction, a significant drop in tax revenue after adopting the DPT. See D. Saha, et al, Taxation of Distributed Profits: International Experience, Institute for Economic Research and Policy Consulting, May 2017.
In Georgia CGFCF dropped the year DPT was adopted, but since only one-year data is available, this is not very meaningful.
IMF, Ukraine—Policy Note for the 2019 Article IV consultation and first review under the SBA, May 2019.
Schatan et al (2017), p 14.
Seminal paper on this topic is A. Harberger (1962), The Incidence of the Corporation Income Tax, Journal of Political Economy, 70(3).
See A. Auerbach (2006), Who Bears the Corporate Tax? A Review of What We Know, Tax Policy and Economics; H.A. Vazquez-Ruiz, A New Approach to Estimate the Incidence of the Corporate Income Tax, Dissertation, Georgia State University, 2012; available at: https://scholarworks.gsu.edu/econ_diss/82
Jane G. Gravelle, Who pays the corporate tax? Congressional Research Service, September 29, 2017.
Privatization proceeds should be utilized to reduce the principal amount of public debt and is not a sustainable revenue raiser given its one-off nature.
“Fixed investment” is the purchasing of newly produced fixed capital or the accumulation of physical assets such as machinery, land, buildings, installations, vehicles, or technology.
Nov 27, 2018, Corporate Tax Rates Around the World, 2018, Tax Foundation.
Zucman, G., 2013. “The Missing Wealth of Nations: Are Europe and the US Net Debtors or Net Creditors?”, The Quarterly Journal of Economics, 128(3): 1321–1364.
Bethmann, D. and M. Kvasnicka, 2017. “International Tax Evasion, State Purchases of Confidential Bank Data and Voluntary Disclosures”, Beiträge zur Jahrestagung des Vereins für Socialpolitik 2017: Alternative Geld- und Finanzarchitekturen – Session: Taxation II, No. B19-V3 ZBW – Deutsche Zentralbibliothek für Wirtschafts-wissenschaften, Leibniz-Informationszentrum Wirtschaft, Kiel, Hamburg.
Bethman, et al.
Martin, L. and J. Oldfield, 2017. “Best Practices in Tax Amnesty and Asset Repatriation Programmes”, Transparency International and the European Commission and Le Borgne, E., 2006. “Economic and political determinants of tax amnesties in the U.S. States”, Proceedings of the Ninety-Eighth Annual Conference on Taxation, National Tax Association: Washington, DC.
Transparency International, 2017.
Clauses 205, 212, 212, 366 and 367 of the Criminal Code of Ukraine.
Article 205 refers to setting up a sham business; Article 212 refers to the willful evasion of taxes, duties (compulsory payments) which are part of the taxation system established by law; Article 212–1 refers to the evasion of payment of premiums on obligatory state pension insurance or social security contributions; Article 366 refers to forgery in office; and Article 367 refers to any neglect of official duty by an official causing significant damage to the legally protected rights and interest of individual citizens or state or public interest.
The successful South African foreign asset amnesty (2003)27 imposed a 5 percent levy on the value of disclosed foreign assets that were repatriated and a 10 percent levy on the market value on non-repatriated foreign assets minus any permissible allowed threshold of foreign investments held by a South African resident.
This is an exceedingly generous tax incentive that can hardly be justified as it rewards handsomely all previous exchange control and accompanying tax violations. Indeed, it provides an additional benefit to non-compliant taxpayers vis-à-vis compliant taxpayers, compromising severely the horizontal equity principles. The granting of this tax expenditure should be resisted as the overriding priority is to grow the tax base and regularize foreign asset and portfolio holdings.
Lub, H., 2019. Ukraine—Report on Balance of Payments Statistics Mission (November 12 – 23, 2018), Statistics Department of the International Monetary Fund (Washington, DC).
In terms of VD and asset repatriation amnesties some country experiences suggest a significant growth in tax base: South Africa grew it by EUR 7.8 billion; Argentina by USD 100 billion; Brazil by USD 16 billion; Indonesia by USD 321 billion (see Martin, L. and J. Oldfield, 2017. “Best Practices in Tax Amnesty and Asset Repatriation Programmes”, Transparency International and the European Commission).
The South African VD program with related tax amnesty provided for a joint facilitator application with an amnesty applicant. The objective of this provision was to extend amnesty to parties who rendered assistance to applicants in transferring funds abroad from South Africa without the necessary authorization.
Some amnesty experiences indicate that initially only a small number of applications is lodged but as prospective applicants became aware that the adjudication unit dealing with application grants amnesty without any negative consequences for applicants who applied shortly after the submission period had opened, interest in applying for amnesty will increase. Experience also suggest that the majority of applicants tend to delay the lodgement of their applications until the very last moment, inter alia, because they expected that the deadline for submission would be postponed.
Financial Action Task Force (FATF), 2012. “Best Practices Paper. Managing the anti-money laundering and counter-terrorist financing policy implications of voluntary tax compliance programmes”. http://www.fatf-gafi.org/publications/fatfrecommendations/documents/bestpracticesmanagingtheanti-moneylaunderingandcounter-terrorirstfinancingpolicyimplicationsofvoluntarytaxcomplianceprogrammes.html
Not all tax amnesties do. See Said, E.W., 2017. “Tax Policy in Action: 2016 Tax Amnesty Experience of the Republic of Indonesia”, MDPI Laws, School of Law, Politics and Sociology, University of Sussex, Brighton. The mission received assurances from the NBU that if funds are repatriated to Ukraine, they would be transferred from foreign bank accounts. Thus, it is assumed that relevant source jurisdictions would have carried out AML and CFT compliance checks before fund transferals to Ukraine. When no income/assets are repatriated into Ukraine (disclosure of assets not held in bank accounts) separate AML and CFT procedures appear irrelevant.
BEPS measures are discussed here as a way to strengthen the CPT; they are not discussed in the context of a DPT.
This is a general rule under CFC regimes, although, in the case of Ukraine, there is no unilateral double tax relief.
See Ruud de Mooij, et al, Tax policy to strengthen the revenue base, IMF/FAD, April 2013; R. Schatan, et al, Rethinking dividend distribution tax, rationalizing simplified taxes, and adopting BEPS measures, FAD/IMF, May 2017.
OECD (2017), Limiting base erosion involving interest deductions and other financial payments, Action 4 – 2016 Update, OECD/G20 BEPS Project, OECD Publishing, Paris.
TC, arts 140.1 – 140.3.
MoF, Restrictions on interest deductions (internal document, undated).
An additional advantage of the EBITDA rule is that it does not breach Article 24 of tax treaties as it applies to both residents and non-residents. Traditional thin cap rules require an arm’s length debt exception to avoid breaching Article 24.
The OECD BEPS Action 4 Final Report (2015) advised that the rule based on gross interest expenditure should not apply to the financial sector (par 188). The updated version of this report (OECD (2017)) did not change this conclusion.
OECD (2017), par 507. Exempting the financial sector would be reasonable anyway if the financial regulatory framework in Ukraine is sufficiently robust to avoid base erosion through excessive indebtedness. This assessment was not done by the mission.
OECD (2017), par 513.
OECD (2017), par 506.
SeeThe Taxation of Offshore Indirect Transfers – A Toolkit (2017) by the Platform for Collaboration on Tax accessed at http://documents.worldbank.org/curated/en/322921531421551268/a-toolkit-draft-version-2.
It is noted that Article 7(1) of the UN Model extends source taxing rights to include also income from transactions (sales or services) of the same or similar nature as the transactions undertaken through a PE. Consequently, if Ukraine has tax treaties that follow Article 7(1) of the UN Model, then this will need to be reflected in the sourcing rule in the TC.
Article 14.1.54(i) expressly refers to business activities and independent personal services.
Similar issues commonly arise with “royalties” as the treaty definition may be broader than the tax law definition. For example, the treaty definition may follow the definition in Article 12 of UN Model and include equipment lease rentals, but this may not be provided for in the tax law definition.
Paragraph 124 of the Commentary to Article 5 of the OECD Model.
See Ruud de Mooij, et al, Tax policy to strengthen the revenue base, IMF/FAD, April 2013; Roberto Schatan, et al, Restoring a strategic approach to tax reform, FAD/IMF, March 2015; R. Schatan, et al, Rethinking dividend distribution tax, rationalizing simplified taxes, and adopting BEPS measures, FAD/IMF, May 2017.
OECD (2105), Aligning Transfer Pricing Outcomes with Value Creation, Action 8–10 – 2015 Final Report; OECD/G20 BEPS Project, OECD Publishing, Paris.
“Summary of proposed amendments to the Tax Code of Ukraine in terms of implementation of BEPS Actions 8–10 and 13”, document provided to the mission by Ukraine’s MoF.
The threshold should be used as a risk criterion in risk analysis for selecting tax audits.
It was explained to the mission that in one case an entity had not declared to have transactions with related parties but had a debt to equity ratio above the cited threshold and when audited it was found that it had controlled transactions under the general definition of the concept. Thus, the debt to equity criteria served really as an element to select taxpayers for audit.
For example, when the foreign counterpart resides in a low tax jurisdiction.
OECD TP Guidelines.
Article 18.104.22.168 refers to “business reasons” and Article 22.214.171.124 refers to “rational business reason” and the conditions describing each are different.
This would exclude any arrangement that a priori would make any of the parties worse-off.
OECD (2017), Transfer pricing guidelines for multinational enterprises and tax administrations, OECD Publishing, Paris, chapter VII.
Provisions include eight paragraphs listing examples of services that could be low value-added (and not an exhaustive list) and describes ten types of services that may not be recognized as such (Article 14.1.183), plus another 5 paragraphs describing costs associated with the maintenance of the parent company (Article 126.96.36.199).
Low-value added services would be considered complaint with the ALP when charged with a mark-up of 5 percent over costs (Article 188.8.131.52).
OECD (2017), par 7.9 (2010).
OECD, Comments received on the request for input, Scoping of the future revisions of Chapter VII (intra-group services) of the Transfer Pricing Guidelines, 28 June 2018.
TP for commodities was amply discussed in the 2017 FAD technical report.
While such terms may not be sufficiently defined to settle the issue entirely, the regulation could include specific examples to clarify. R. Schatan et al (2017) contains a more detailed discussion on TP methods and their application to Ukraine’s commodity export.
Costs of port logistics should be part of the selected grain export price for TP purposes (i.e., as if paid by the Ukrainian exporter), so the benchmark should be FOB Black Sea port. Each commodity may require its own type of adjustments.
Article 39.4.10 of the Tax Code
OECD (2015), Making Dispute Resolution Mechanism More Effective, Action 14 – 2015 Final Report, OECD/G20 BEPS Project, OECD Publishing, Paris.
OECD (2017), Convention on Income and Capital, OECD Publishing, Paris.
See OECD (2015), Developing a Multilateral Instrument to Modify Bilateral Tax Treaties, Action 15 – Final Report, OECD/G20 BEPS Project, OECD Publishing, Paris. This is further discussed the appendix of this chapter.
Tax Certainty, IMF/OECD Report for the G20 Finance Ministers, March 2017, p. 57.
BEPS Monitoring Group, ‘Explanation and Analysis of the Multilateral Convention to Implement Ta Treaty Related Measures to Prevent Base Erosion and Profit Shifting,’ reproduced by Tax Analysts (2017), p. 5.
For example, it would be undesirable to have the SFS ruling one way on unilateral APAs and the same issue solved differently under a Bilateral APA through the competent authority. One way to solve this would be to have the SFS as the competent authority, at least for Bilateral APAs.
The adjustment can be documented with a filed modified tax return by the foreign resident.
Experience in other countries indicate that MAP inventory cases often reach problematic levels, which is one of the main reasons motivating BEPS Action 14. It is important therefore to cut down on unsubstantiated MAP applications.
MIL, Article 16.
The statute of limitations for TP audits in Ukraine is seven years. It could be expected that MAP cases would be resolved before that long (targeted average period to solve a MAP by Action 14 is two years). However, not all cases taken up by MAP are about TP and all other cases have a statute of limitations of three years.
70 tax treaties were negotiated by Ukraine as a sovereign nation and 3 treaties of the former USSR continue to apply to Ukraine as the successor to the USSR.
While there is currently only limited taxation under the Tax Code of fees paid to non-residents for services, this may change in the future as many countries now impose withholding tax on management and technical fees paid to non-resident. This taxing right is now preserved under Article 12A of the UN Model. Consequently, Ukraine’s treaties should preserve some level of source country taxing rights over management and technical fees.
OECD Model Tax Convention on Income and on Capital. The first OECD Model was published in 1963 and the Model has been revised regularly since that time. The latest version of the OECD Model was published in 2017.
UN Model Double Tax Convention between Developed and Developing Countries. The first UN Model was published in 1980 and the Model has been amended several times since that time. The latest version of the UN Model was published in 2017.
This may require a modification to the instrument of ratification.