New claims of the Ukrainian Tax Authorities to Ukrainian international groups:

The first instance judgment in court case No. 804/3794/18 has been published: it was issued by the Dnipropetrovsk District Administrative Court in a dispute between taxpayer  OJSC ‘YuGOK’ and the Ukrainian tax authorities. The taxpayer won the case in the first instance court, but the depth of the investigation of the issue and the type of claims by the tax authorities is fundamentally new. This creates new  risks for many Ukrainian groups using foreign companies in their structures.

The facts of the case:

From the text of the judgement it appears that in February 2014 the taxpayer OJSC ‘YuGOK’ acquired 100% of corporate rights of Ukrainian LLC ‘Metalotechnika’ from several foreign companies including Cypriot FABCREST LIMITED and TROSILIA HOLDINGS LTD.

Based on the data from the open sources, it appears that the acquired company has been the shareholder of the taxpayer itself, and as of today it is or has been at the stage of liquidation, therefore business rational of the transaction is not entirely clear.

The income paid to the Cyprus companies was not subject to withholding tax in Ukraine in accordance with para 4 of Art. 13 of the Double taxation treaty between Ukraine and Cyprus (hereinafter - DTT) since the Cyprus companies were the tax residents of Cyprus.

Arguments of the Ukrainian Tax Authority:

The State Fiscal Service of Ukraine (the SFS) upon the audit of the Ukrainian buyer made tax adjustment in respect of  withholding tax since in accordance with its view the Cyprus companies had  permanent establishments in Ukraine, and therefore, in accordance with the DTT, the profit from such alienation of shares should be taxed in Ukraine.

The conclusion of the SFS was based on the following:

- Cyprus companies did not have a permanent place of business in Cyprus neither owned or rented;

- All principal actions were performed by individuals from Ukraine on the basis of powers of attorneys;

- the CEO of one of the Cyprus companies is also a director of ten other Cyprus companies.

Arguments of the taxpayer

The taxpayer denied the existence of a permanent establishment and considered the additional charge of withholding tax unjustified.

Decision of the court

The court ruled in favor of the taxpayer based on the following:

- the letters received by the SFS from the Cyprus tax authority confirmed that the sellers were the residents of Cyprus as they were managed and controlled from Cyprus;

- the Ukrainian buyer received certificates of the sellers’ tax residency in Cyprus;

- the Ukrainian buyer received a letter from the SFS that confirmed that its payments to Cyprus companies should be free from withholding tax.

Our comments

This court case, despite the fact that it is decided in favor of the taxpayer, establishes a dangerous precedent.

A rather serious argument in favor of  the taxpayer was the already issued positive clarification of Ukrainian tax authorities, but very few taxpayers could demonstrate such clarifications  in comparable cases.

The case does not contain materials on questioning of the directors of the Cyprus companies regarding the circumstances and objectives of the transaction, despite the existing instruments allowing the Ukrainian Tax Authorities to obtain such information.

According to the Cyprus Registry of Legal Entities the Director of FABCREST LIMITED since December 26, 2013 has been THEODOROS K PARPERIS. Search by this name delivers, among others, the link to CV of PWC Cyprus Partner. 

Director of TROSILIA HOLDINGS LTD since September 23, 2013 has been Andrea Sofokleous. Search by this name delivers, inter alia, partner of a law firm Andreas Th. Sofokleous.

Perhaps these are coincidences, and Cyprus directors with such names could made independent decisions  with full understanding of the specifics of the Ukrainian iron-ore business, which, however, is not typical of many comparable structures. According to the financial statements for 2014, the TROSILIA HOLDINGS did not appear to pay any wages, therefore the probability of absence of personnel capable of preparing and carrying out this transaction may be rather significant. 

There is also no information in the published judgement about the questioning of the Ukrainian individuals involved in the transaction and the management of PJSC ‘YuGOK’ on details of and reasons for preparing the transaction. If such responses demonstrated that the management of Cyprus companies was carried out from the territory of Ukraine, this could also be a strong argument in favor of the existence of a PE.

We fully agree with the abovementioned court decision. However, this decision indicates that the SFS brought forward a strong case and was using sensitive information obtained from foreign tax authorities as a basis for additional tax charges.

Considering the above we recommend:

- to establish the real presence (substance) in foreign companies including establishin operational office, staff and employing real decision-making managers. If the foreign company has no personnel in the country of its residence, it is obvious that the activity is carried out by other persons, and if such persons are located in Ukraine – checking by the Ukrainian tax authorities whether a permanent establishment exists is only a matter of luck that taxpayers should not gamble on. 

Although in this particular dispute the SFS (for the time being) has lost the case, the comparable 'Phoenix Capital' case, where it was established that Cyprus company had been actually managed from Ukraine, demonstrates that the efforts of the Ukrainian SFS in comparable cases can be more successful;

- to keep communication line open with related non-resident companies (this is relevant not only for Cyprus, but also for other jurisdictions), in order to ensure the provision of correct responses to the tax authority requests initiated by the SFS;

- to ensure that activities of such non-residents do not constitute a permanent establishment in Ukraine in accordance with the Tax Code of Ukraine and/or the DTT (for example, the presence and continuous activity in Ukraine of individuals authorized to act on behalf of such non-resident, etc.).

It should be clear that at present the Tax Authorities may easily obtain complete information about counterparties and the circumstances of the transactions, and if the real picture carries signs of aggressive tax optimization - such claims of the Tax Authorities may be difficult to challenge.

Our experts have extensive experience in the analysis of cross-border transactions and judicial defence of taxpayers in similar cases.

We will be pleased to discuss the specifics of your case and provide the necessary recommendations in preparing for the possible charges by the tax authorities.

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