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The Fight Against Tax Evasion: Best Practices


Galyna Melnyk , lawyer at Ilyashev & Partners Law Firm


According to the results of the research carried out by the Institute for Social and Economic Change due to the tax evasion the state budget of Ukraine experiences shortfall of as much as UAH 100 billion. Among the most popular tax evasion mechanisms are off-shore schemes, undocumented operations (“grey import”, contraband goods, sale and purchase of goods and services for cash without introduction of data into the companies’ records, “envelope wages”), and use of the services of individual entrepreneurs – payers of individual tax.

What methods of fighting these tax evasion mechanisms may Ukraine borrow from the global practices?

Firstly, the attention must be drawn to financial monitoring. According the global practices the actual obligation to carry out the initial inspection of the legality of the sources of monetary assets and settlement of taxes in the process of doing business is laid on banks. Within the financial monitoring process the banks must establish the sources of the monetary assets deposited by their clients at the bank accounts or transferred via such bank accounts, as well as to ensure that all the taxes have been settled in relation to such assets. Should clients fail to substantiate the legality of the sources of the monetary assets by the supporting documents, as well as to prove the fact of settlement of all the necessary taxes, the banks will refuse to render any services. In such case, the tax evaders lose an opportunity to carry out cashless bank transactions to transfer their unofficially gained monetary assets.

More importantly, within the system of automatic exchange of tax information the banks are obliged to inform the tax authorities at the place of the residency of a certain bank account’s beneficiary (ultimate owner) about the balances of such account. In other words if a citizen of Ukraine keeps his monetary assets at his own account in a foreign bank or at the account of his special foreign “wallet” company (i.e. conventional company which is not involved into active business activities usually used for safekeeping the money or gaining passive profits), the foreign bank shall transfer the information about such account to the Ukrainian tax authorities. The Ukrainian tax authorities, in their turn, may apply an indirect method of determination of profits towards the monetary assets kept at the account of the said person. When it comes to the monetary assets kept at the account of the company controlled by a tax evader, such monetary assets may be taxed in Ukraine via application of a concept of a “controlled foreign company” (CFC).

Taxation of the profits of CFCs is one of the methods of fighting the incomes gained in the low-tax (offshore) jurisdictions, which is used globally. This method is represented by the procedure of taxation in Ukraine of the incomes of the offshore companies (and owned by Ukrainian controlling persons) to the extent that they have not been taxed in the country of source. This method allows to impose taxes in Ukraine to the incomes of offshore companies, which were established by the citizens of Ukraine for the concealment of their foreign incomes and withdrawal of funds from Ukraine for tax minimization purposes.

Another additional method of fighting the unfair optimization of taxes in the trade schemes is represented by the transfer pricing. Their essence is that in the cross-border transactions between the related persons the tax implications for the residents of Ukraine are calculated under the market prices. It allows neutralizing the accumulation of the trading margin in the low-tax jurisdictions, as well as the application of artificial rise in expenses in the process of importation of goods purchased from the related persons.

Worth mentioning is the tendency towards the active application of norms contained in the Agreements on avoidance of double taxation, which is gaining relevancy in the global practices. The mentioned norms lead to repeal of tax benefits provided on the basis of such agreements in case of application of artificial transit structures aimed solely at the tax evasion. This concept also assumes application of the notion of a beneficiary (actual) owner of the passive (unearned) income. Such income may be taxed under the preferential rates only in case of its settlement to the beneficiary itself, but not to the intermediary artificially implemented structures.

In conclusion we must state that the initial steps on introduction of the best global practices have already been made by Ukraine. In particular, the following measures were undertaken: the transfer-pricing mechanism has been introduced and is being perfected; the concept of the beneficial owner (also on the basis of the court precedents) is being developed; two draft laws on the controlling foreign companies have been brought before the Verkhovna Rada; accession of Ukraine to the global system of exchange of tax information is planned; the financial monitoring rules are planned to be toughened.

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