укр eng рус est


Recent news
Chambers Europe

“The team was recently visible advising on a number of pharmaceutical cases. Sources agree that the team is “moving in the right direction” and are particularly impressed by its work in the pharmaceutical sector”.


Tax Risks in the Activities of Representative Offices of Pharmaceutical Companies


Galyna Melnyk, Tax Lawyer at Ilyashev & Partners Law Firm
Artem Orel, Attorney at Law at Ilyashev & Partners Law Firm
Source:  Apteka

Recently the fiscal authorities express increased interest to pharmaceutical companies represented in Ukraine. Our publication requested the lawyers of Ilyashev & Partners Law Firm to tell about the tax risks in work of the pharmaceutical companies and comment on the current situation.

Galyna Melnyk, tax lawyer at Ilyashev & Partners Law Firm told about tax risks in the activities of non-profit representative offices of pharmaceutical companies.

Non-profit representative office is a quite common form of legal presence of foreign pharmaceutical companies in Ukraine. It is conditioned by the possibility of representative offices in our country to perform some auxiliary functions for business of a foreign head office without paying Ukrainian profit tax. Nevertheless the right to use such privilege is strictly limited by activities of the representative office, which can not go beyond the “preparatory and auxiliary” functions in relation to the activities of the head office. Whereas the criteria for determining such activity at the legislative level have not been set, in practice a number of disputes with the tax authorities arise, which are related to requalification of non-profit representative offices to the permanent representative offices of non-residents (which are the payers of profit tax) with subsequent accrual of the respective amounts of tax liabilities.

Analysis of recent case law in such disputes proves that in general courts and tax authorities follow the approach to the definition of “preparatory and auxiliary activities”, which is set out in the OECD Commentary to the OECD Model Convention on Avoidance of Double Taxation. According to the Commentary, a representative office retains its non-profit status if it (a) does not carry out activity identical to the main activity of a foreign head office, and (b) has no commercial relationship with any third party, that is the only source of funding is the cash flow from head- office, any services to third parties are excluded.

Below we present the key recommendations to minimize the risks of requalification of non-profit representative offices of foreign pharmaceutical companies to the permanent representative offices taking into account the judicial practice.

Typical activities that are specified during registration of non-profit offices of pharmaceutical companies in the bodies of statistics and do not raise  questions of the tax authorities are market research and public opinion, advising on business and management, advertising.

In addition to the above activities, the provisions on a representative office can include the following: consulting and information services for the head office; analysis and study of the data associated with the activities of head office; implementation of registration procedures with respect to intellectual property rights of head office; obtaining permits and registration documentation in respect of products manufactured and sold by head office; participation in exhibitions, seminars and conferences in the field of pharmacy; representation of head office in courts.

The provision on a representative office must clearly provide for the non-profit nature of its activities (funding only through the head office without the right to enter into commercial transactions and receive payments from third parties).

To preserve their non-profit status representative offices of pharmaceutical companies must ensure that only a head office is a direct recipient of the results of their ancillary activities. Considering it, any activities of a representative office in respect of medicines, which are not produced by the head office (advertising, marketing, registration, participation in pharmacovigilance procedures, etc.), must be excluded.

It is also important that regulation on a representative office, job descriptions of employees, positions of such employees in the staffing and names of divisions, powers of attorney issued, documents effecting business trips of employees, internal accounting systems of a representative office in no way implied the possibility of commercial transactions or activities, which relate to the core business of the parent company in accordance with its founding and registration documents.

In particular, commercial activities of a representative office and coincidence of activities of a representative and head office can be evidenced by the following:

  • provision to a representative office of rights of participation in production/distribution of medicines in the territory of Ukraine, including for management of sales of products through distributors;
  • presence in the staffing of positions related to sales of products (sales representatives, sales managers, etc.);
  • presence of sales department;
  • indication in internal documents (business trip orders, job descriptions, powers of attorney) that specific individuals have the authority to enter into the commercial transactions aimed at generating income by a representative office (contracts for the supply of medicines, contracts for the provision of services to third parties, e.g. advertising of products produced not by the head office);
  • reference to the representative office as a party in the contracts for the supply of medicines concluded by the head office;
  • availability of a system for recording the movement of goods.

The dispute between a representative office of the German pharmaceutical company and the State Tax Inspectorate of the Shevchenkivskyi district in Kyiv in case No. 826/8147/13-a can serve as an example of requalification of a representative office in a commercial entity due to non-compliance with the above recommendations can result in (resolution of the District Administrative Court of Kyiv of 10.07.2013, resolution of the Kyiv Administrative Court of Appeal of 09.05.2013, ruling of the High Administrative Court of Ukraine of 11.11.2014).

A representative office of the German pharmaceutical company was declared as commercial (permanent) in view of the following: the representative office advertised medicines that were produced not by the parent company and conducted market research in relation to such medicines (the tax authority studied the respective medicine registration certificates); moreover, a representative office along with the head office was a party to the contract on sale of medicines in Ukraine.

Although decision of the first instance approved in favor of the tax authority was revoked by the appellate instance (and the High Administrative Court of Ukraine shared this position), this case demonstrates the potential points at issue in the activities of representative offices. Tax risks connected with the circumstances of this case remain valid also considering another dispute with participation of a representative office of the pharmaceutical company, in which the court took into account that the representative office did not have commercial relations with third parties.

Thus, when resolving in favor of a representative office of the pharmaceutical company from Great Britain, the High Administrative Court of Ukraine noted the following in ruling in case No. 2a-15754/12/2670 of 13.10.2014. According to the information provided by the UK tax authority, the principal activities of the head office are research, implementation, production and sales of pharmaceutical products. While the purpose of the Ukrainian representative office was organizational support and assistance to the head office during registration of medicinal products and dissemination of information about medicinal products in Ukraine. The court noted that such activity does not coincide with the main activities of the head office, is necessary for further sales of pharmaceutical products by the head office in Ukraine, so that it is preparatory and auxiliary, i.e. does not to create a commercial representative office.

The court also noted that the tax authority did not prove economic relations of the representative office with non-residents – manufacturers of pharmaceuticals, as such medicines were sold in Ukraine exactly by the head office as the owner, as evidenced by the contracts between the non-residents and the head office (in which a representative office was not mentioned), and registration certificates of such medicines (in which the head office, and not the third parties, acts as the applicant).

We would note that a correct recording of activities of a non-profit representative office of the pharmaceutical company with a focus on its preparatory and auxiliary character is a key factor in minimizing the risk of declaring such representative office as a commercial (permanent) entity.

As it is known, in the course of recent months a number of pharmaceutical companies have been facing problems related to suspicions of fiscal authorities regarding tax abuses. The situation is highlighted by Artem Orel, Attorney at Ilyashev & Partners Law Firm.

Based on which legal/legislative acts the Prosecutor’s Office (or another competent law enforcement agency) may initiate a criminal case when an administrative dispute has not been ceased?

An investigation body may initiate a criminal investigation, i.e. to enter information about a criminal act into the Unified Register of Pre-Trial Investigations (the URPTI), first and foremost, according to provisions of the Criminal Procedure Code of Ukraine (the CPCU). Continuing administrative dispute with fiscal authorities by no means influences introduction of information to the URPTI and does not exclude the possibility of initiating criminal proceedings. Among the grounds for initiating criminal proceedings, for example, under the Article 212 of the Criminal Code of Ukraine (the CCU) (evasion of the payment of taxes, duties, official dues) may be represented by notifications about criminal acts, reports, statements and other documents provided by tax inspectorate. As a rule identification of additional charges in considerable amounts (exceeding 607 thousands hryvnias) stipulated in disposition of Part 1 Article of the CCU constitutes a ground for initiating criminal proceedings.

Today there is a tendency when investigation authorities of the State Fiscal Service of Ukraine (the SFSU) initiate criminal proceedings not only on the basis of decision notices. Also by violating rules of investigative jurisdiction stipulated by Article 216 of the CPCU investigation bodies exercising control over compliance with tax legislation (investigation bodies of the SFSU) initiate and investigate criminal proceedings subject to investigative jurisdiction of the police (the Ministry of Internal Affairs of Ukraine). For example, proceedings may be opened under the Article 358 of the CCU (forgery of the documents, investigative jurisdiction of the police) with a hope to further find evidence under the Article 212 of the CCU. In spite of the fact that the CPCU establishes that only in the case when investigation was initiated under the Article 212 of the CCU and a criminal act was identified under the Article 358 of the CCU such proceedings must be investigated by investigators of investigation bodies exercising control over compliance with tax legislation.

It should be noted that Article 212 of the CCU stipulates for responsibility not for the fact of failure to settle taxes, duties and other compulsory dues within established period, but for willful evasion from their settlement.

As regards to influence of the administrative dispute onto the pre-trial investigation within criminal proceedings I may state that availability of an administrative dispute may influence only the bringing of a person to criminal responsibility, i.e. issuing a notification of suspicion.

In particular, pursuant to Article 56.22 of the Tax Code of Ukraine if a taxpayer appeals the decision of a controlling body under administrative procedure and/or at the court notification of suspecting a person of committing a criminal crime (tax evasion) may not be substantiated solely by the decision of this controlling body until the end of the administrative procedure on review of the appeal or final settlement of the case by the court.

As for the sphere of practical implementation the Plenum of the Supreme Court of Ukraine in its Decree No. 15 “On certain matters of application of the legislation on responsibility for failure to settle taxes, duties and other compulsory dues” as of April 08, 2004 draws attention of the judges that in case of submitting an appeal to the court by a taxpayer against a decision issued by a tax authority suspicion (notification of suspicion according to the CPCU 2012) of a person of tax evasion cannot be based on such decision until final settlement of the case by the court. Exceptions are represented by cases when accusation is based not only upon the appealed decision, but also has been proven on the basis of the additionally gathered evidence according to the requirements of criminal procedure legislation of Ukraine.

Start of pre-trial investigation regarding a taxpayer or notification of its(his) officials about suspicion of a crime cannot serve as a ground for termination of proceedings in case or leaving it undecided or leaving the complaint (claim) of such taxpayer lodged to the court within the procedure of appealing decisions of a controlling body.

Are there any sanctions towards law enforcement bodies if a violation was not proved and the subject suffered losses (computer servers were confiscated, activities of the company ceased etc.) and what the sanctions are? Does the practice in settlement of these categories of cases exist?

Firstly, stipulated is a criminal responsibility for bringing a knowingly innocent person to criminal responsibility by a prosecutor or another authorized person for knowingly unlawful arrest, detention, house arrest, custody, testimonial compulsion, or violation of the right to protection. Secondly, a specified material responsibility of such persons is stipulated by the Law of Ukraine “On the procedure of compensation of damage inflicted to a person by unlawful actions of authorities executing operational and investigative activities, bodies of pre-trial investigation, prosecutor’s and court authorities”. As we see here described is a criminal responsibility born by investigative and prosecutor’s authorities for actions committed towards an individual person.

As for compensation of losses inflicted to a company (legal entity) by unlawful actions of authorities executing operational and investigative activities, bodies of pre-trial investigation, prosecutor’s and court authorities it needs to be mentioned that such possibility is stipulated only by the Civil Code of Ukraine. Such responsibility is quite limited and is not clearly specified.

Suchwise, pursuant to Part 4 Article 1176 of the Civil Code of Ukraine damage inflicted to individual person or legal entity as a result of other actions stipulated by parts 1-5 of this norm (related only to damage inflicted to an individual person, and damage to a legal entity inflicted as a result of upholding an unlawful decision in a civil case), unlawful action, failure to act or unlawful decision of an investigative authority, body of pre-trial investigation, prosecutor’s office or court shall be compensated on the general grounds stipulated by Articles 1166 and 167 of the Civil Code of Ukraine.

In particular, pursuant to Article 1166 of the Civil Code of Ukraine material damage inflicted to material rights of an individual person or legal entity by unlawful decisions, actions or failure to act, as well as the damage inflicted to the property of an individual person or legal entity must be compensated by the person who inflicted the damage in full. The person who inflicted damage shall be relieved from the obligation to compensate damage if it proves that the damage was inflicted through no his fault.

However, the court practice related to compensation by legal entities of losses inflicted by investigation bodies in the process of pre-trial investigations is not sufficiently successful.

© 2020 Ilyashev & Partners / Mobile version