CFC Rules in Ukraine: Legislative ChangesKyiv 27 September 2016

Nasos A. KyriakidesLL.B (Hons), DI. M, LL.M, MCI Arb

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F.I. Reporting FATCA CRS

CFC Rules

Tax residencyBEPS

E

Actual recipient DTT Benefits

Beneficial Owner Economic

Substance

Effective tools

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CFC RulesControlled foreign corporation (CFC) rules are features of income tax  system

“Designed to limit artificial deferral of tax with use of offshore low taxed entities”.

Income received:

From investment or passive sources, including

Interest, dividends, royalties from unrelated partiesPurchasing/ selling goods or services to related parties outside CFC's country territory Countries sophisticated/stricter approach on treatment of dividends/interest/royalties

TRC no longer sufficient to guarantee that a Cyprus company enjoys the full DTT benefits.

Jurisdictions that had implemented minimal substance requirements are becoming stricter.

Would now examine if company claiming tax benefits has substance, not just shell company.

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Beneficial Owner ConceptDefinition of Beneficial Owner:

Enjoys benefits of ownership/ entitled to the income of an estate without its title, custody, or control.

OECD Model Tax Treaty context “Beneficial ownership term” is used:

In the dividend, interest and royalty articles to define entitlement of a person to the benefit of those. OECD Model tax Treaty commentary further states that :

“Receipt of income by agent or a nominee does not give rise to double taxation since the income is not liable to tax in the hands of the agent or nominee in the country of residence”.

Klaus Vogel: Definition of Beneficial Owner:

“Is the one who is free to decide and take risk, as to whether or not the capital is be used or made available for use by others, or as to how the yields therefrom should be”. Conduit companies should be denied tax treaty relief/ not beneficial owner of the income.

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Identification of beneficial owner: key factors increasing the risk of income recipient

• No substance in the country of tax residency; • Not bear usual commercial risks related to its activity; • Existence of legal obligations of distribution of income to the benefit of other person; • Nominal directors or limited competency of the board of directors; • «Mirror» transactions or substantially similar conditions (e.g. back-to back financing); • Provide loans, from loans received from countries having no DTT with Ukraine (e.g. BVI).  

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Identification of beneficial owner: General recommendations

• Should have substance of business activity (office /duly qualified employees in residence country); • Should possess a sufficient degree of independence in disposal of income; • Should not distribute income received to companies from countries no DTT with Ukraine; • Should bear risks associated with performed activities;

• Independently take decisions and exercise control over the received income.

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Recent Court CasesRussian Court Decision of March 2016 “The Kapital OOO”

• “Severstal” assets transferred as share contribution to share capital of “Artificial Company” abroad. • Cyprus company/companies controlled by Kapital shifted control of assets to BVI companies. • Kapital failed to withhold tax on Russian source income, distributed by asset transfer to Cyprus- BVI.

• Actual recipient (Beneficial owner) of income following asset transfer were BVI companies.

• In absence of a DTT between Russia and BVI, withholding tax should be charged at 20%.  

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Recent Court Cases Resolution No. А40-241361/15-115-1953 Moscow Arbitrazh Court 3 March 2016  In 2010-2011, Bank paid interest under loan agreements with a Luxembourg sister company.  Bank did not withhold tax on the interest paid under the Russia Luxembourg DTT. Source of cash received from Luxembourg company was a common Italian shareholder, which afterwards received around 70% of the interest income.  Tax authorities applied Russia-Italy DTT and assessed tax at 10% on the whole amount of interest paid from Russia.  Italian parent company was deemed the “Beneficial Owner” of the entire income amount, even though a portion of the income remained in Luxembourg.  Court ruled that the Luxembourg company did not determine the economic future of the income received, when examining the term “actual recipient of income”.

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Objective Economic SubstanceOECD/G20 introduce Base Erosion and Profit Shifting ( BEPS) project

BEPS Provides governments with solutions for modernising international tax rules. 

The importance of the topic of 'substance' has significantly increased as it canminimise the risk carefully contemplated and well advised international tax optimization

Substance demonstrates

a: That the company indeed has its activities based in the country where it is tax resident b: Is not just a “shell” company formed to avoid paying tax in the country where its business is based.

Establishing substance

• use of a fully fledged office as a place of business • registration of utilities water and electricity and other local expenditure in the name of the company • the payment of local professional rates and taxes, IT support, couriers. • employment of staff and payment of the relevant payroll taxes • existence of a telephone number, e-mail and fax in the name of the company • bank signatories being based in Cyprus • accounting and other records such as agreements, contracts, invoices located in Cyprus

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Objective Economic Substance Substance in Cyprus Substance is very useful tool for foreign tax authorities in determining if

“A Cyprus tax resident is entitled to tax benefits under the relevant DTT”. If substance or management and control of the Cyprus company is in their own jurisdiction

a. Not only refuse to allow the enjoyment of DTT benefits .

b. Income of the company may be taxed as income arising in their own jurisdiction.

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Amendments of Cyprus -Ukraine DTT On 15 .12. 2015 Cyprus and Ukraine signed protocol amending the existing Double Taxation Treaty The provisions come into effect as of 1.1. 2019 when the existing Convention will expire. The Protocol contributes to further development of trade and economic links between the countries.

New introductions

“Most favorable nation clause” on taxation of interest, dividends, royalties and capital gains.

If Ukraine enters into a DTT with another country with more favorable provisions than with Cyprus, Cyprus - Ukraine DTT will have to be amended to include these more favorable provisions.

The new provisions would not apply if the disposal relates to shares:

a. listed on an approved stock exchange, or in the process of a corporate reorganisation b. where the immovable property is used for the business of public companies or real estate fundsWould also not apply if the seller is:c. listed on an approved stock exchange ,a public company, a pension, provident or similar fund

Main provisions of the Protocol amending the Double Tax Treaty:

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Existing Double Tax TreatyNew ProtocolDividents

5% withholding tax on dividends if the                  

beneficial owner of at least 20% of the company paying the dividend of the capital

company and has invested at

shares acquisition

15% withholding tax on dividends in all other cases

5% withholding tax on dividends paid, if the beneficial owner of at least 20% of the company paying the dividend of the capital of the paying of the paying company and has invested at least €100.000 in shares acquisition

10% withholding tax on dividends in all other cases      Interest

2% withholding tax                                                

  5% withholding tax

Royalties5% withholding tax                                                 10% in case of royalties from films                      

5% withholding tax;10% in case of royalties from films

Capital Gains Tax

Gains from the disposal of shares (irrespective of whether the gain arises mainly from immovable property in the books of the company) are taxed in the country of which the seller is resident.                               

Gains from the disposal of shares (irrespective of whether the gain arises) deriving at least 50% of their value from immovable property, taxed in the country in which the immovable property is situated (subject to exemptions). .                                                          

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Thank You

Leoforos Spyrou Kyprianou, 67 KYRIAKIDES BUSINESS CENTER

4003 Limassol, CyprusTel.: +357 25 352 352 Fax: +357 25 352 353

info@naklaw.com www.naklaw.com.cy