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Why Are Our IT Professionals Determined to Escape and What Options Are They Considering?
The new law, better known as “Bill 1210,” divided the experts and the business community into two camps. Some (including government officials) argue that the new rules protect business interests.
Others, mainly entrepreneurs, are massively interested in the opportunity to change their country of residence. “Minfin” was trying to figure out who was right.
The law, which is also called the small tax reform (No. 466-IX), has a difficult fate. At first, it was protested for a long time in parliament. Then the document was gathering dust for months, waiting for the signature of the president.
The need to accept it was explained by two reasons. The first one was to block the most common capital withdrawal schemes used by large businesses.
The second was to eliminate legislative gaps that provoked numerous conflicts between business and tax authorities.
In fact, the result of the legislators’ work turned out to be completely different. A lot of norms have appeared in the document, which will only strengthen the fiscal press. For example, now all transactions will be assessed in terms of having a business purpose.
Let’s say, if a company sells goods to a foreign counterparty at a market price, the transaction has a “reasonable economic reason”. If the price is too low, the transaction is carried out for the purpose of tax optimization, and now it will have very serious financial implications.
“The criteria established in the law allow any operation, even one that is correctly executed, to be considered devoid of reasonable economic reasons for its implementation,” explains Nina Betz, Lawyer at Ilyashev & Partners Law Firm.
An unpleasant surprise for employers will be the increase in the period for which tax authorities can check the adequacy of the calculation and payment of wages.
“From 2021, the tax authorities will be able to charge tax liabilities no later than 2555 days (now this number is 1095 days). In addition, during the audit, tax authorities will be able to take explanations from employees on the subject of formalizing labor relations, paying salaries, and so on. Employers must prepare for this,” warns Ihor Reutov, Head of the Department at Gramatsky & Partners.
However, the biggest resonance was caused by the fact that the new legislative norms will tighten the screws for thousands of Ukrainian start-ups, including representatives of the IT industry. Moreover, the law creates such unbearable working conditions for them that in professional communities, possible options for emigration have become the main topic for discussion.
The first problem. It concerns the owners of companies abroad, among whom there are many representatives of the IT sphere. The law establishes the rules when a foreign company can be recognized as a resident of Ukraine. The relevant regulations come into force on January 1, 2021.
“A foreign company will also be considered a resident tax payer if the place of its effective management is in Ukraine. The problem in this case will be that such a company will simultaneously be a tax resident at the place of its registration, and will also be obliged to pay taxes in Ukraine. That is, the owners of such a business will in fact face double taxation,” says Nina Betz from Ilyashev & Partners.
Signs that good governance is in Ukraine under the new law are as follows:
bank account management from Ukraine,
personnel management from Ukraine,
accounting from Ukraine,
management holds meetings in Ukraine,
management resides and actually manages from Ukraine.
The second problem. It concerns cases when a resident of Ukraine controls a foreign company (CFC), which is more common in our reality. Now the fiscal rules within the framework of such relations have changed dramatically.
A controlled person is a resident of Ukraine who:
owns a 50% or more of a share in a foreign company,
owns more than 10 percent (25%) of shares in a foreign legal entity together with other persons, and their aggregate share is 50% or more,
independently or jointly with other residents of Ukraine – related persons, exercises actual control over a foreign company.
In order not to dwell on how innovations will affect the work of our start-ups, we will consider three work situations and their tax implications.
Situation 1: Foreigners Invest in Our Start-up
Let’s say our startup attracts funding from non-residents for development, which happens often. Will it be necessary to pay tax in Ukraine on such transactions? Supporters of the new law say no, in most cases.
After all, the rule of a controlled company is valid only when Ukrainian firms (individuals) own foreign companies, and not vice versa. But there are also exceptions.
“If funding for a start-up is provided by an offshore company, and even at high interest rates, then part of the debt service payments may indeed not be taken into account in the start-up’s expenses. However, if we are talking about real funding for a start-up, from a respected jurisdiction, and not from the tax haven, there will be no problems,” says Artur Mrihlod, Junior Lawyer of Moris Group JSC.
Situation 2: Working Through a Foreign Company
Here, the situation is more interesting. After all, it concerns cases when our start-ups create a foreign company (CFC) and conduct business through it. Now the owner of the CFC will have to pay taxes on its profits in Ukraine in proportion to their share of ownership.
Still, it is not always so, and this point is being actively promoted by the defenders of the new law. You will not have to pay taxes in Ukraine if:
the annual income of the owner of the company did not exceed 2 million euros. Start-ups rarely have such earnings,
the CFC is located in a state with which Ukraine has a double taxation avoidance agreement,
the company pays income tax at a rate of at least 13%,
the share of passive income of the CFC is no more than 50%. As a rule, a start-up also does not receive much income from dividends, interest or royalties at the beginning of its activity.
What Is the Catch?
The problem is that, in reality, it is quite difficult to fulfill all the conditions that allow not to pay tax for a CFC.
“Many software developers have worked through Estonian, British, American and other companies, including offshore companies such as Hong Kong and the United Arab Emirates. These companies not only accepted payments, but also registered software developments and trademarks, which protected them from potential raiding,” says Volodymyr Harkusha, Managing Partner of K.A.C. Group Corporate Lawyers & Tax Advisers.
Now IT experts are absolutely clearly defined as “controllers” of the CFC. The retained earnings of the companies controlled by them are added to the taxable income of the “controller”, a citizen of Ukraine, and is subject to 19.5% tax (income tax plus military duty).
It is also important how taxes will be calculated. And here, too, a lot of questions arise.
“There are IT projects for which payments do not go through banks, but all sorts of payment systems and even cryptocurrency payments. It is impossible to imagine how it is possible to calculate the “retained earnings” belonging to a CFC controller subject to taxation in Ukraine,” explains Volodymyr Harkusha.
Finally, even if a CFC meets all the requirements in order not to pay taxes for it, its “controllers” will still have to report on its activities to Ukrainian tax authorities.
“The provisions of the law require the filing of tax information for each action simply in relation to a foreign company, those on the acquisition or receipt of a share, alienation, etc. And this is irrespective of whether a tax liability arises in connection with this in Ukraine. What for? To ensure total tax control over citizens?” asks Oleksandr Minin, Senior Partner of the KM Partners Law Firm.
Failure to comply with the requirement is fraught with serious fines.
“About $ 170,000 for failure to file a CFC report and $85,000 for failure to disclose each controlled company. At the same time, the payment of taxes and fines is guaranteed by the property of a citizen,” says Volodymyr Harkusha.
Situation 3. Ordering Services from a Non-Resident
Let’s imagine an equally common situation: an individual entrepreneur who is not a VAT payer (this is the legal form that most start-ups work in) orders advertising services, for instance, from Google, or software testing services from a non-resident.
“The place of delivery of such services will be Ukraine. This means that they need to charge 20% VAT on top, report on them and transfer them to the state. The procedure for such reporting and payment has yet to be developed by the Ministry of Finance. However, this clearly does not give enthusiasm to entrepreneurs regarding the purchase of services from non-residents. After all, they will rise in price, plus the burden and administration costs will be added” told Artem Ustiuhov, Leading Lawyer of Moris Group JSC, about the consequences of the new rules.
Start-ups Prepare to Flee
That is why for the last week in professional communities only one topic has been discussed: “where to run away?”
“If the government expects a sharp increase in state budget revenues from innovations, the experience of other countries that introduced CFCs and other similar changes does not mean a jump in profitability. Sometimes it’s even the other way around – business begins to migrate to jurisdictions with more loyal rules. This also applies to individual beneficiaries, who often simply move to another jurisdiction, for example, to Cyprus, which is popular today,”says Vasyl Andrusiak, Head of Tax Law Practice Department at Moris Group JSC.
After the introduction of similar rules, about a third of start-ups left Russia. Our IT specialists are quite realistically considering options for relocating businesses to Estonia, Czech Republic, and Poland.
“One of the easiest ways to get rid of the need to comply with the new requirements may be to change tax residency (without changing citizenship). This is not so difficult to do. In simple terms, this can be reduced, for example, to physically being in Ukraine for less than 183 days a year, to have housing and business in another country. And it is also better if the family mainly lives there,” says Oleksandr Minin.