Crux (#07-08 July-August 2018)

Legal Digest

The UJBL editorial team has monitored recent legislative initiatives and changes that may be of particular interest. This month we asked our experts for comment on thelong expected Law On Currency and Currency Transactions; draft law No.8331-d introducing financial sector improvement amendments to certain Ukrainian laws; Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. Our team also inquired about the electronic auction system for the sale of land lease rights using the ProZorro.Sales system; draft law On Amendments to the Tax Code of Ukraine and Certain Legislative Acts Regarding the Criteria for Determining Individuals with High Income.

On 21 June the Ukrainian Parliament passed the Law On Currency. How will liberalization of foreign exchange regulation and control affect business operations? To what extent will this simplify debt financing?

Kateryna Breduliak Senior Associate, Evris

The long-awaited Law On Currency and Currency Transactions (hereinafter the Law) is quite liberal in relation to business. The extension of business deadlines for export and import transactions payments for more than 180 days will improve the competitive position of Ukrainian exporters and importers and, absolutely increase the space of consensus with regard to terms of payments among trading partners. The Law cancels sanctions in the form of penalty and termination of foreign economic activity in case of violation of the closing terms of contracts (currently a penalty of 100% of the transaction amount). Such innovation as the withdrawal of individual licenses for investing abroad also expands the opportunities for residents to carry on foreign economic activity.

The Law allows Ukraine to move to freedom of conducting foreign exchange operations according to European standards. Such changes have a positive impact on the cooperation of Ukrainian residents with European financial intermediaries, and the terms of cooperation will be similar to those of European ones.

It is anticipated that a company should attract loans from abroad without registering this with the National Bank of Ukraine.
The company must only notify the regulator of the fact of receipt of the loan, and such information will be used only for statistics. Thus, Ukrainian companies and banks should attract customers not only within the country, but also in European countries.

However, liberalization does not mean the absence of control. With the adoption of the Law, the NBU and banks will have the right to require documents on operations conducted by companies and individuals. And the NBU and State Fiscal Service should conduct audits on currency legislation issues.

Despite such revolutionary changes, the financial stability of the Ukrainian currency market depends on the NBUs restrictions and requirements, and even with the adoption of the Law, the regulator has retained the right to dictate the rules of the game at any time.

The Ministry of Economic Development and Trade and the Ministry of Agrarian Policy announced the launch of the electronic auction system for sale of land lease rights using the ProZorro.Sales system. It is envisaged that the State Service of Ukraine for Geodesy, Cartography and Cadastre will be able to use external electronic platforms for selling lease rights for state-owned lands designated for agricultural use. How would you evaluate this initiative?

Alexey Kot Dr. Sc. In Law, Managing Partner, Antika Law Firm

At the moment, a key and very uncomfortable point for a potential buyer of rights to lease land plots relates to the fact that quite often the land contractor and land plot are located in different regions. This, in turn, complicates the process of submitting qualification documents for participation in bidding in terms of both time and money. Provided that the potential participant wants to monitor the filing process in order to respond in time if the package of documents collected by him is insufficient/incomplete, or does not meet the requirements of bidding rules for other reasons.

The proposed system of electronic bidding is, in our understanding, a big step forward for two reasons. Firstly, the lack of the need to search for premises for holding bidding, attracting a lot of staff to organize the process of holding the bidding, making physical copies of documents, delivering them to the address of the bidding performer, physical presence at the location of land auctions will significantly reduce the costs of both bidding organizers/performers and their direct participants.

Secondly, for the most part people have already got used to and understood the principles of operation of both the ProZorro system and ProZorro. Sales, as the logic behind their construction is very similar.

At the same time, the experience of the functioning of ProZorro and ProZorro.Sales shows that it is very difficult to overcome the corruption component and "negotiated" auctions. And the problem is not so much in the system itself or its inability to resist attempts at unauthorized access by organizers/performers/participants, but in the human factor.

Therefore, the initiative of electronic bidding in relation to the implementation of land rights should be supported in every possible way. Unfortunately, we should not hope that the transition to the electronic format of selling land rights will become a panacea for corruption and that by itself it will drastically change the existing order of things in this segment without systemic changes at the level of legal awareness.

The Central Bank of Cyprus announced strict requirements for business relations with foreign companies by sending the related Circular Note to Cyprus banks. What changes can companies from Ukraine that have long enjoyed this jurisdiction for business operations expect?

Oleksandr Zinevych Associate, Konnov & Sozanovsky

It is well known that businesses from the CIS often prefer Cyprus as an EU jurisdiction with a loyal tax regime (compared to other EU jurisdictions) as well as jurisdiction with good territorial accessibility (Cyprus is closer to CIS and EU countries than, for example, the British Virgin Islands). With this background, a lot of CIS businesses use Cyprus companies in their ownership structures or at least bank accounts in Cypriot jurisdiction. Those companies and bank accounts are used widely by CIS business for economic activities with the EU.

Nevertheless, the latest news from the Central Bank of Cyprus (CBC) could impede well-established business activity. The CBC announced its intention to incorporate the definition of a shell company/letter box company in local legislation. This specification of such companies is aimed at mitigating the risks related to money laundering schemes.

The announcement from the CBC states that those trading companies that have no substance (effective place of business activity and management) will not be permitted to maintain bank accounts in Cyprus. Moreover, the CBC stipulated that foreign companies incorporated in so-called tax heaven jurisdictions
(e.g. BVI, Seychelles and Marshall Islands) will be required to become tax resident in other tax jurisdictions if they want to continue to be clients of Cypriot banks.

In order to react to such possible amendments to Cypriot legislation, Ukrainian business has to reconsider the way it sets up a companys group structure. If a business operates in Cyprus through companies from one of the above-mentioned tax heaven jurisdictions, then the best way is to incorporate a company directly in Cyprus (but other jurisdictions are also acceptable e.g. UK, Singapore) and provide real business activity in Cyprus (in case of incorporation in Cyprus). The other way is to perform a transfer of the companies from another jurisdiction to Cyprus. Moreover, companies are also required to have real employees (just a nominal director and secretary will be a bad match), so this leads to the necessity to obtain work permits for foreign employees (if any).

The Draft Law On Wealthy Ukrainians, which the Ministry of Finance has been withdrawn for further reworking, is already being called a headline-maker. How do you assess this initiative?

Tetyana Ivanovych Attorney, Counsel, ADER HABER

We evaluate the legislative initiative of the Ministry of Finance of Ukraine as generally consistent with established world practice and the recent global trends of deoffshorization. However, it should be emphasized that the application of measures aimed at strengthening control or imposing additional duties on individuals whose incomes can be classified as high, in the version proposed by the Draft Law of Ukraine
On Amendments to the Tax Code of Ukraine and Certain Legislative Acts Regarding the Criteria for Determining Individuals with High Income (hereinafter the Draft Law) is not formally included in the mandatory steps provided by the BEPS Plan, as stated by the developers of the Draft Law.

In the author`s view, the Draft Law affects one of the most important guarantees, that of protecting banking secrecy. In particular, this relates to the question of amending the Law of Ukraine On Banks and Banking Activities regarding the disclosure of information containing banking secrets at the written request of the authorities of the State Fiscal Service of Ukraine regarding the balance of funds in the accounts of an individual with high income at a specific date, and write-off transactions from and/or payments into the accounts of such an individual for a specific period of time. Furthermore, the Draft does not specify for what period of time the tax authorities will be able to check statements from accounts. It also raises issues of the proportionality of the objectives of the Draft to verify the completeness and timeliness of paying personal income tax with the extension of the tax authorities up to the possibility of receiving extracts from accounts for an indefinite period of time. After all, according to the Tax Code of Ukraine, the tax object is income rather than an account balance, which only reflects the outcome of certain financial transactions that did not necessarily generate income in the sense of the Tax Code of Ukraine. Will the tax authorities use indirect methods to determine the tax base that would be consistent with world practice?

It should also be noted that the Draft Law does not establish an increased tax rate for "individuals with high income". By comparison, in 2018, in the United Kingdom, for income exceeding GBP 150,000 (approximately USD 196,500), the rate of 45% is applied; in Switzerland, the tax rate depends on the source of income and can reach 46%. According to the Draft, one of the criteria for being categorized within the high-income group is income exceeding UAH 50,000,000 (approximately USD 1,853,000), which is significantly higher than the amount established by European countries.

The Draft also provides for the inclusion of information on "individuals with high income" to the State Register of Individuals-Taxpayers. The maintenance of such registers is also consistent with global practice, and in most countries other than Great Britain, such registers are not public.

A law (submitted as Draft Law No. 8331-d), aimed at improving the financial sector by raising the level of corporate governance in state-owned banks, was adopted. How will this affect the efficiency of publicly-owned banks?

Oleg Lazovsky ounsel, Asters

On 5 July 2018 the Verkhovna Rada adopted and submitted for approval by the President of Ukraine of Draft Law No.8331-d introducing financial sector improvement amendments to certain Ukrainian laws. Developed with the direct participation of international financial institutions, the draft fundamentally changes the aspects of running of state-owned banks.

Six months after the draft comes into force, Oshchadbank and Ukreximbank will be obliged to introduce their independent supervisory boards (a reminder that such independent supervisory boards have already been introduced at Privatbank and Ukrgazbank). A board is composed of nine members (sixindependent members and three other members appointed at the recommendation of the President of Ukraine, theVerkhovna Rada, and the Cabinet of Ministers). Members are appointed for a three-year period under paid independent contractor agreements.

In addition, the draft provides for significant changes in the formation of executive bodies of state-owned banks with newly-established independent supervisory boards to appoint candidates for the positions of chairs and members of boards of state-owned banks on a competitive selection basis.

We hope that reform of corporate governance at state-owned banks will (i) serve as an extension of the already implemented mechanism for transforming those banking institutions and (ii) strengthen the mitigation of political risks, especially when it comes to issuing loans to state-owned companies and legal entities connected to political figures. This will
enable significant improvement in bank loan portfolios and reduction in the share of non-performing corporate loans (NPL), which currently account for about a half of all bad loans in the market, while raising the attractiveness of state-owned banks to investors.

Furthermore, the adopted draft will finally allow for the completion next year of the EBRD's purchase of shares in Oshchadbank, which started as late as in 2016 with the signing of the Memorandum of Understanding, but was later suspended by the EBRD until the Verkhovna Rada adopted the draft. The draft is also expected to launch the sale to a strategic international investor of the Government's holdings of 95% and 100% in Ukrgazbank and Privatbank, respectively, as announced this February by the Finance Ministry in their Foundations for Reforming the National Banking Sector.

In concluding, we would like to note that the draft made amendments to, inter alia, the Ukrainian Commercial Code (Article 337 is removed) and the Ukrainian Law On Banks and Banking Activity (Article 7 is restated), introducing an updated definition of state-owned bank that should now be construed as a bank that is 100% owned by the Government and can be set up not only by resolution of the Cabinet, but also through the Government's purchase of 100% in an already existing bank, for instance.

The Acting Minister of Finance of Ukraine signed the MLI Convention on 23 July in London. How can this affect the international business structuring, relevant operations and movement of Ukrainian capital abroad?

Oksana Olekhova Director, Tax & Legal, KPMG in Ukraine

On 23 July Ukraine signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI) and so became the 83rd state to sign the respective document. According to this document, Ukraine undertakes to implement the minimum standard for preventing treaty abuse under the OECD/G20 BEPS package. Nevertheless, the respective document still has to be ratified by the Ukrainian Parliament, and the business sector should be aware of the major amendments which it will face in future.

Minimum standard includes four of the 15 BEPS Actions, namely:

Action 5 Harmful tax practices;

Action 6 Treaty abuse;

Action 13 Transfer pricing documentation;

Action 14 Dispute resolution.

From the practical standpoint, the signing of MLI envisages that Ukraine takes the following steps:

application of the principle purpose test.
The Ukrainian tax authorities will have the right to limit benefits granted to the taxpayer under the Double Tax Treaty (DTT) if the main purpose of the structuring/transaction is withholding tax minimization by using DTT and not a necessary measure within the framework of the taxpayers business activity.

capital gains delivered by the taxpayer from alienation of shares or comparable interest may be taxed in that state if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50% of their value directly or indirectly from immovable property located in that state.

Please note that respective amendments should apply only if the second contracting state of the DTT agreed to apply respective approach and duly notified the OECD. Other provisions of the MLI should not apply to the currently valid DTT signed by Ukraine.

Taking into account the fact that Ukraine abstained from reserving or notifying on the majority provisions of the MLI aimed at preventing base erosion and profit shifting ratification of the MLI by the Ukrainian Parliament will hardly significantly influence the current approach of Ukrainian business towards structuring its activities taking into account that information about the ultimate beneficial owners is, as a rule, not publicly available. In addition, the Ukrainian tax authorities previously also applied a principle purpose test by sending requests to the tax authorities of the other relevant contacting states. Therefore, it is likely that the MLI will not significantly influence structures that were developed with the involvement of tax consultants.

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