Unexpected know-how of Ukrainian tax authorities: transfer wages-pricing

Tax issues: Inspections by state tax and fiscal agencies Kyiv

Complainee: Main Department of the State Fiscal Service in Kyiv (MD SFS)
Complaint in brief: The Council received a complaint from a financial company that disagreed with fines of the MD SFS amounting to UAH 800k.
The co-owner and executive director of this company, dealing with car purchase financing, is a foreigner. He is officially employed in Ukraine, receives high official salary and pays heavy taxes to the budget from it. For two years of working in Ukraine, his salary, taking taxes into account, reached 6 mn.
Clearly, the tax authority got interested in such big payments. It initiated an audit and concluded that, under the Tax Code’s (TC) rules payment of salary to a non-resident employee could be considered a “controlled operation” for transfer pricing purposes (TP) because the law did not directly state the opposite. 
Transfer pricing is the sale of goods or services to interdependent enterprises at intracompany prices, which differ from market ones. This is a fairly common international tax planning scheme, often aimed at minimizing taxes to be paid. It allows a total profit redistribution in favor of businesses located in countries having lower taxes. 
The signs of transfer pricing noticed by the SFS in payment of wages to the foreign director were:
•    transaction with a non-resident counterparty
•    the transaction volume exceeded UAH 5 mn
The SFS insisted that the director’s relations with the company were not labor, but civil-law, since he spent little time in the workplace during working hours. The tax authority found a confirmation thereof in the foreigner’s passport – he rarely came to Ukraine. Therefore, as the SFS further stated, it was not a salary payment, but a transfer pricing scheme (TP) and, when applying it, a special report had to be submitted to the tax authority. It was clear that a company that in no way used this scheme did not prepare or submited such a report. 
Hence, the company was additionally charged UAH 800k for not submitting a report. A shocked complainant appealed to the Council. 
Actions taken: The Council’s investigator impartially examined materials of the case and respective legislation norms. He pointed out that tax authority changing director’s labor relations to civil-law was limited only to the fact of his being mostly absent in Ukraine. However, the legislation does not prohibit to work remotely and, indeed, with due to modern technologies and means of communication one can perform all labor functions and responsibilities remotely at many positions.
Referring to the relevant legislation, the investigator also tried to convince the tax authority officers that wages payment cannot be treated as transfer pricing and the company’s employee – as its counterparty. According to the OECD Guidelines, on which regulation norms are actually based, this scheme applies to relations between businesses, but not individuals. 
The Council also emphasized that it was no use for the company to overestimate the payroll to minimize income tax, since wage taxes are very high: personal income tax (18%), military levy (1.5%), a unified social tax (22% of the maximum base), while corporate income tax in Ukraine makes up only 18%.
Moreover, the form and procedure for completing a report on controlled transactions are not adapted to be included in the payroll transactions report, since actually no column can be applied to such transactions (in particular, country of origin of the subject of transaction, delivery terms under Incoterms, trademark, manufacturer, transfer of ownership date, etc. – all this does not apply to salaries).
However, tax authority officers continued pressing their point by referring to the fact there was no rule in the Tax Code of Ukraine that would directly exclude salaries from transfer pricing.
The Council participated in the company’s complaint consideration at the SFS. Taking into account a potentially systemic nature of the problem, the Council’s investigator also met SFS auditors for TP and the Ministry of Finance representatives.
Result achieved: The Council upheld the Complainant’s position and pointed out the reasons for the tax authority’s to cancel the decision. However, the decision was left unchanged by the SFS of Ukraine and the Complainant had to further challenge it in court. Having exhausted all available means of influence on government agencies, the Council had to discontinue the investigation. 
A positive outcome of this case is just thanks to this case a previously unknown “payroll” TP issue gained publicity, become known to TP expert community. This case was highlighted in many publications and even in a letter to the Ministry of Finance dated February 01,2019, No. 11420-08-63/2874. As a result, a business employing highly -paid non-resident employeeswill be able to predict risks associated with the “payroll” TP in the future, and avoid large fines by timely submitting required reports.

Next case:: VAT limit arrest for cooperation with suspicious counterparty