First Results of the First CFC Reporting

Article on “Minfin” Financial Portal of 12.06.2024

How Many Ukrainians Own Foreign Companies and How Much They Earn 

April 30 was the deadline for natural persons to submit reports on controlled foreign companies (CFCs). Thousands of tax resident citizens of Ukraine have officially declared foreign assets, including corporate rights of non-resident companies, accounts in foreign banks, securities, real estate, etc. Now it is possible to summarize the first results of this campaign.

In fact, we are speaking about the first CFC reporting process in Ukraine. Submission of such reporting was provided for by legislation as early as 2023, but the number of declarants who took advantage of the opportunity was at the level of statistical error.

What Information Tax Officials Can Obtain Now

We will discuss the numbers a little later, the main focus of interest is three interesting details.

For the first time, some CFC controllers were simply forced to submit a corresponding report, since it is submitted exclusively as an appendix to the declaration of property status. Discomfort was felt by politically exposed persons (PEPs), because the declarations that state officials and deputies of all levels had previously submitted to the National Agency on Corruption Prevention did not always contain information about foreign companies controlled by them and their assets.

The CFC report itself, as well as the financial statements of the foreign company attached to it, do not contain detailed information about the company’s assets and the movement of funds in bank accounts. However, according to the legislation, tax officials have the right to demand from the CFC controller an audit of the financial report of the company owned.

And such a report (with attached primary documents) already has such analytics. The first thing that will certainly interest tax officials is the corporate rights of Ukrainian enterprises owned by a foreign company, and therefore, indirectly, by the controller-declarant, which does not always correspond to the information on the ultimate beneficiary of Ukrainian enterprises in the state registers.

Bank statements, in addition to the movement of funds related to the economic activities of the controlled foreign company, will also eloquently testify to the bank transfers to the own accounts of the beneficiaries and family members, including the name of the bank and the number of the account.

The vast majority of such accounts were not listed in previous personal declarations. In addition, confirmed information about the control over the CFC, which, for example, has business ties with a Ukrainian company related to the same person, gives tax officials every reason to apply the full range of penalties provided for by transfer pricing legislation.

Where Ukrainians Have Businesses and How Much They Earn from Them

We now clearly know how many legalized owners of foreign companies are in Ukraine — 11,391 people. On average, one controller has two CFCs. For 2023, most CFC reports were submitted in a shortened form, which is understandable, given the fact that tax authorities can focus on the report for 2022 and have the option to adjust the CFC report for 2023.

For some reason, more than a thousand controllers filed reports after May 1. More than half of the countries where CFCs are registered have tax preferences in their legislation or are simply offshores (Estonia, UK, Hungary, Cyprus, Belize, etc.). It is no surprise that 25% of all CFCs are registered in Poland, these are new businesses of Ukrainian citizens or relocated enterprises. The revenue of all CFCs is over UAH 21 trillion. According to the results of the declarations, UAH 1.776 billion of taxes were paid.

What Will the State Tax Service Do Next?

The reaction of tax officials to the first results from the CFC reporting was an expected one. Considering the volume of submitted reports, the STS decided to concentrate on large taxpayers and industrial groups: in each region lists of top enterprises have been formed, on which tax officials will primarily focus.

The STS places great hopes on the prospects of automatic exchange of tax and financial information within the framework of CRS with its foreign colleagues and banks. According to the Director of the Department of Transfer Pricing of the State Tax Service of Ukraine, Kateryna Ryzhenkova, the Service is already successfully using information exchange with foreign tax authorities of many countries.

The administration of the process of submitting requests to foreign bodies has been brought into order, the automation of translations and the drafting of requests is planned in order to reduce the procedural time from one month to several days. Taxpayers are aware that obtaining information from company registers in other countries will not always have a result (especially if they are some island states of the Caribbean).

Another matter is the information from the banks where the “island” companies have accounts, and they are mostly located in Europe, while the companies’ files contain complete information about the beneficiaries. Moreover, the STS plans to use the OSINT (Open Source Intelligence) system.

Next, it would be logical to involve artificial intelligence such as ChatGPT. The general idea of such innovations is to maximize the usage of all possible mechanisms for the return of capital to Ukraine. In the same line, there is an initiative of the STS to extend the statute of limitations (in the context of conducting inspections and determining the amounts of monetary obligations) from seven to ten years.

The STS begins electronic mailing to the electronic offices of taxpayers who are identified as controllers of Ukrainian companies (through non-resident companies) in state registers or in banks and have not submitted CFC reports. In the future, there will be a check of the grounds for exemption from taxation stated in the CFC reports, whether it meets the requirements of tax legislation and real facts.

According to tax officials, trusts are the weakest topic for them, so the STS will actively investigate it. The fact is that, on the one hand, it is not possible to establish the right of ownership of assets by the beneficiary in discretionary trusts, and the legislation of Ukraine provides for such a situation when it is impossible to establish the ultimate beneficiary. On the other hand, a certain number of Ukrainian assets are owned by such trusts, and the controllers mostly did not submit CFC reports on them.

Most Common Mistakes When Preparing CFC Reports

Taxpayers have identified the most frequent mistakes when preparing CFC reports. Among the technical ones are:

– confusion over the definition of actual or legal control (the object of taxation in Ukraine also depends on this),

– the financial year of the controlled company’s reporting was incorrectly determined,

– confusion with the use of the hryvnia exchange rate when listing the financial indicators of the controlled company.

Among the more serious ones are mistakes during or even omission of the filling of columns 31-33, related to transfer pricing. The STS insists on correcting the submitted 2023 reports by the end of 2024, otherwise fines will be applied. In general, both tax officials and the declarants themselves agree that the forms of the CFC report and its appendices are imperfect and contain many inaccuracies.

The same applies to the regulatory framework. Clause 120.7 of Article 120 of the Tax Code of Ukraine is especially noticeable in this regard, as it provides for a fine of 3% of the income of the CFC for not disclosing information on the number of employees of the controlled company in the report. It is not clear how this affects the taxation of the CFC income in Ukraine.

Amendments to the Tax Code (Bill No. 8137), which eliminate some of the shortcomings, have not yet been considered in the second reading. In particular, the issues of determining the controlling person, increasing the deadline for submitting CFC reports, reducing the amount of fines must be clarified. The new Law No. 10168−2 effectively postpones the application of fines until the end of martial law. Nonetheless, tax officials insist that they are not canceled at all, and in due time everything will be calculated.

What about Declarants Themselves?

One may get the impression that some of the declarants hesitated about submitting reports or postponed this issue for as long as possible. At the same time, it was not taken into account that the CFC report is preceded by the preparation of the financial report of a non-resident company. The problem is that in some jurisdictions such reporting is not provided at all, and it had to be drafted from zero. In the meantime, consider that, in Cyprus, let’s say, an auditor’s opinion must be attached to the financial report.

These reasons led to a significant extension of the reporting period. For example, our company has been urgently drafting hundreds of financial and CFC reports in recent months. A certain number of domestic entrepreneurs – owners of foreign controlled companies are abroad, have received a residence permit and local tax numbers there, and decided not to report in Ukraine.

It is unlikely that this issue was deeply analyzed by everyone, taking into account the CFC legislation of the countries of new residence and conventions on the avoidance of double taxation.

Currently, we are all waiting for the first official reactions of the STS based on the results of the submitted CFC reporting.

Volodymyr Harkusha
Director of Audit Firm “Kyiv Audit Service”

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