First step to a better transfer pricing administration: Ukraine allows advance pricing arrangements with tax authorities

Ukraine has introduced new rules on transfer pricing, due to take effect in 2013, which will align it more closely with OECD states. The following article discusses the upcoming changes and the implications for transfer pricing in Ukraine.

For many years Ukraine has been a state not much concerned over transfer pricing issues. Ukrainian conglomerates were the ones who especially benefited from such a state of affairs by allocation of their profits to offshore and low tax jurisdictions. But times seem to be changing and the Ukrainian government is keen on implementing transfer pricing methods and compliance practices as followed by OECD states. It is no secret that fiscal deficit is the principal driver of such governmental effort.

Transfer pricing agreements are usually perceived as an administrative tool fashioned to avoid tax disputes. It is still a question whether newly adopted regulations will make transfer pricing an effective instrument to achieve this goal. In any event, transfer pricing agreements shall be viewed in the context of the whole transfer pricing regulatory system and, therefore, we should have a quick look at the Ukrainian transfer pricing regulations first.

I. Current transfer pricing rules

The tax laws that were in the operation for almost a decade, and continue to be in force till the end of 2012, require that pricing in transactions between related parties correspond to the so-called ’usual price'. The 'usual price' defined as a fair market price, which is defined by independent parties who are well informed about relevant market conditions.

Interestingly, the 'usual price' requirement applies to a majority of transactions in Ukraine, even when conducted by unrelated parties. This is because of VAT regulations under which the tax basis of VAT-able transactions shall be a price not lower than the 'usual price'. Since most sales of goods, works and services in Ukraine are subject to VAT, the 'usual price' requirement emerges almost everywhere.

The law stipulates a presumption that unless it is proved otherwise, a price of an agreement constitutes a fair market price, i.e., the usual price. The burden of proof that the price does not correspond to the usual price rests with the tax authority. This authority may challenge the contractual price based on data on prices of identical or similar goods and services that are sold in the corresponding market conditions. The law does not elaborate much on official sources of pricing information considered acceptable for the purposes of the 'usual price' test. Instead, it just mentions auctions, public offerings, stock exchanges and reports of licensed appraisers. Basically, the law establishes the transfer pricing method similar to the comparable uncontrolled price method.

A taxpayer receiving a request from a tax authority to substantiate its prices may either respond or seek refuge in the statutory presumption that a contractual price is deemed to be the 'usual price'. In the latter instance the tax authority will have to make the case based only on its sources of information.

The regulations do not provide for any other transfer pricing methods and the above currently constitutes the core of Ukrainian transfer pricing rules. Under such unsophisticated regulation advance transfer pricing agreements may not be of a great help to taxpayers.

II. New transfer pricing rules

Adoption of the new Tax Code in late 2010 brought Ukraine a little bit closer to OECD-based transfer pricing practices. The new rules concerning transfer pricing will take effect from January 1, 2013. Under these rules the ‘'usual prices'' will be determined by the tax authorities using the following transfer pricing methods (the ''List''):

· comparable uncontrolled price method;

· resale price method;

· cost plus method;

· transactional profit split method; and

· transactional net margin method.

The law enlists official sources of pricing information. Among them are statistical data of state authorities, specialised auctions and stock exchanges, commercial periodicals (including electronic) and reports of economic departments of the Ukrainian diplomatic missions. It is also possible for the parties to engage a licensed appraiser to evaluate the fair market price, if there is no official data allowing them to apply the above transfer pricing methods.

As in the previous version of the law, the burden of proof that the price is unfair rests with tax authority. The taxpayer is not legally obliged to substantiate the price upon request from the authority.

Importantly, the law permits deviation of the contractual price from the 'usual price', but it should be less than 20 percent. Respectively, any deviation within this threshold may not serve as a basis for tax authority to challenge the contractual price and claim additional tax. Still, as in the previous version of the law, the 'usual price' requirement will practically apply to the majority of transactions even between unrelated parties, since the 'usual price' serves the basis for VAT.

A positive development is that this new version of the law allows parties to enter into the transfer pricing agreement with the tax authority.

III. Transfer pricing agreement procedure

The transfer pricing agreement procedure will enter into force on January 1, 2013. At the first glance the procedure is quite simple. Only Ukrainian legal entities, which are included in the official register of big taxpayers, are eligible to initiate transfer pricing negotiations. To be on this list the entity's income for the past four consecutive quarters shall exceed UAH 500 million (approximately USD 62.5 million) or its tax payments for the same period shall be more than UAH 12 million (approximately USD 1.5 million). The big taxpayers register is administered by the tax authority and for the 2013 year the authority listed 1,486 Ukrainian entities.

To start the process, the taxpayer shall approach the tax authority and file a request to conclude the transfer pricing agreement. This request shall state (i) the full and short legal name of Ukrainian entity, (ii) its administrative district and registration number as well as (iii) a list of goods, works and services to be under the scope of the transfer pricing agreement, (iv) the proposed transfer pricing method and official source of pricing information to be used for ''usual price'' purposes.

Apart from the above request the company shall file (i) the draft transfer pricing agreement, (ii) copies of its charter and relevant product/services supply agreements, and (iii) information on the related parties. The draft transfer pricing agreement shall contain a list of goods, works and services subject to the arrangement as well as suggested methods and official sources of pricing information. Interestingly, each method on the above List may be claimed in the draft agreement only if it is impossible to determine the 'usual price' by application of the previous method in this List.

The tax authority has 20 days to review the filed documents and notify the taxpayer of its decision. The authority is permitted to take an additional 30 days to check the filed information or to obtain additional data from other Ukrainian and foreign authorities.

Currently, the procedure implies that only bilateral agreements may be concluded (i.e., between a tax authority and a single taxpayer, not a group of companies) and does not allow for foreign entities to apply for it.

IV. Content of transfer pricing agreement

The Ukrainian government has approved a template of the transfer pricing agreement. Surprisingly, this is only a three-page document. In the subject matter section the parties shall agree on transfer pricing methods and official sources of the information that would apply to the goods, works and services supplied by the company. The agreement concerns only sale prices and does not deal with purchase prices.

The rights and liabilities section stipulates the taxpayer's obligation to set up its sale prices in accordance with the agreed transfer pricing method and official source of pricing information. Similarly, the tax authority is required to apply the same method and source when conducting statutory tax audit of the company. As a side comment, all Ukrainian companies are subject to statutory tax audits that cover all taxes. Usually these are conducted every 2–3 years.

Among the rights of the taxpayer are the rights (i) to claim termination of the agreement, provided that the tax authority violates its terms and conditions, (ii) to extend its validity period, and (iii) to request advance tax rulings, if these are necessary to comply with the agreement.

The tax authority has the right (i) to claim termination of the agreement, provided that taxpayer violates its terms and conditions, and (ii) to receive information from the taxpayer necessary to comply with the agreement.

The final sections of the agreement stipulate the validity period, amendment and termination procedures. The template also contains blank fields for inserting 'other conditions'. But currently it is not clear how tax authorities would react to suggestions of taxpayers inserting something that is not in the approved template.

V. Conclusion

The advance transfer pricing mechanism remains largely underdeveloped. Currently, it is not possible to enter into multilateral agreements (i.e., between a group of companies or foreign tax authorities) and the text of the approved template agreement is very unsophisticated. Lots of hurdles are also expected when it comes to administration. The tax authorities' behaviour will likely be very cautious, as the people who work there usually are not eager to test new unfamiliar instruments and procedures. Furthermore, these transfer pricing methods and procedures are very new ''technology'' for Ukraine.

Still this first try is a positive development. Starting from 2013 the tax authorities will be entitled to use various official sources and transfer pricing methods during statutory tax audits, and the pricing figures in the tax authority's version may vary dramatically. Putting even such a simple advance agreement mechanism into operation will allow the taxpayers to at least have at some clarity on transfer pricing methods and information sources to be applied by the tax authority to them.

The government continues to pursue efforts to develop more sophisticated transfer pricing regulations that may bring more comfort to the taxpayers. Time will show how it works.