Acting Minister of Finance of Ukraine signed the Multilateral Convention to Implement Tax-Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (MLI) on 23 July 2018. Ukraine's main focus falls on the Principal Purpose Test (PPT) designed for effectively addressing tax planning strategies that exploit mismatches and gaps in international tax rules allowing artificial shifting of profits to low or no-tax jurisdictions.
Implications for businesses
Application of the MLI is aimed at combating abuse of bilateral tax treaties in a synchronized and efficient way by amending about 40 of Ukraine's treaties. Among other novelties, it introduces the PPT concept, requiring companies seeking for treaty benefits to substantiate the commercial rationale behind relevant transactions. The MLI also broadens the definition of permanent establishment, expanding the profits base taxable in Ukraine.
Ukrainian and foreign entities operating in Ukraine should reassess their current corporate structures to be in compliance with the new rules.
Effect of the MLI
The MLI will enter into effect once ratified by Ukraine and the other relevant contracting states that consented to the same MLI provisions applying in respect of the treaty in question. As of 25 July 2018, Ukraine's tax treaties with the following countries are expected to be amended by the MLI:
United Arab Emirates
Ukraine agreed to its tax treaties being modified in accordance with the Base Erosion and Profit Shifting (BEPS) Action 6 (treaty abuse), Action 7 (avoidance of permanent establishment status), and Action 14 (improving dispute resolution). Notably, Ukraine opted out of implementing Action 2 (hybrid mismatches).
As one of the key changes, the PPT would operate to deny treaty benefits where it is reasonable to conclude that "obtaining that benefit was one of the principal purposes" of the associated arrangement or transaction.
The MLI would also expand the definition of permanent establishment (PE) by introducing provisions that specifically address (i) abusive agency and commissionaire arrangements, (ii) reliance on preparatory or auxiliary activity exemptions, and (iii) fragmentation of activities, a significant step in ensuring that profits are taxed in the country where the added value is actually created.
The MLI also addresses obstacles that prevent countries from efficiently solving treaty-related disputes under the mutual agreement procedure. In particular, it allows a taxpayer to present its case before a foreign tax office.
Actions to consider
Given the magnitude of upcoming changes in tax treatment of international transactions, a new gender of tax disputes involving multinationals operating in Ukraine may mushroom once the MLI comes into force. The complexity of the process and amount of time that may be needed to align corporate models with the new approaches in international taxation necessitate multinational companies taking proactive steps. In this context, we recommend:
- continuously monitoring whether, when and how the applicable tax treaties are affected by the MLI
- reconsidering corporate structures by removing economically unsubstantiated intermediaries from the group
- reexamining international structuring of operations in Ukraine in order to comply with the freshly calibrated PE rules
Points to remember
To summarize, a significant number of Ukraine's double tax treaties will be amended by the MLI. The PPT and the new PE rules are the most significant developments, requiring multinational businesses to take a fresh look at their international corporate structures and cross-border transactions.