Tricky Tasks

In its attempts to prevent capital outflow from the country, the Ukrainian Parliament has adopted and already amended transfer pricing regulations. Business decision-makers should take this into account in their development strategies just as their external advisors receive the tricky task of combining legal, financial, accounting and economic knowledge. Ivan Shynkarenko, Ph.D. in Economics and partner at WTS Consulting LLC, shared his views on the recent challenges imposed by transfer pricing law, its revealed pitfalls and future prospects.

UJBL.: On 1 September 2013 the legislation on transfer pricing (TP) came into force in Ukraine. What complications did your clients face in this period in the part on applying TP rules?

Ivan Shynkarenko: Obviously, the new transfer pricing rules have dramatically changed the “rules of the game” in terms of pricing control for tax purposes. From this date, the set of reporting and documentation requirements appeared in our tax legislation. These new requirements were a novelty for taxpayers and, frankly speaking, for their tax advisors and our tax authorities.

If we look closely at the rules that came into force in September, we would understand that they in fact represented not very good translation of the rules then implemented in Russia, with some addition of an extremely fiscal nature, even considering that the Russian economy is obviously not based on liberal standards. First of all, I have in mind the strange rules regarding “official” sources of information, which have not started working anyway.

Yet, with these rules on the table, one could not properly rely on internationally accepted practices. For standards of the the Organisation for Economic Co-operation and Development (OECD), since the Ukrainian tax authorities could just invent some official source which would cancel all your sophisticated findings and benchmarking analysis.

These rules created a kind of mess in this sphere and you had to invent the approaches, which could protect your clients in the event of further tax audits. Well, at that time we viewed these new rules as just another instrument to squeeze additional funds from the taxpayers given the general grim outlook of the state-business relationship at that time.

Yet, I must admit the new rules in effect from 1 January 2015 are more clear cut and liberal and generally adhere to the OECD approach. Although these rules are also not ideal, they provide the possibility to work in a more understandable playing field.

Getting back to the issues that clients faced with regard to the new rules, it is possible to mention issues with the first TP reports. The document is rather complex and heavily coded (namely, a lot of information you have to find in codes). But what is more important is that you needed to choose the TP method for the transactions reported even before you composed the TP documentation. That is, actually before the proper investigations could be done. It was like guess work at that time.

The other crucial issue, which I have already mentioned, was related to sources of information on comparables. It was a tricky task.

 

UJBL.:  How did the last changes in legislative regulation of TP impact the work of lawyers? What new issues and needs does business face?

I. Sh.: Well, first of all, I would like to note that the new set of rules on TP introduces an entirely new and unprecedented pricing control system. This is an entirely separate sphere and these rules are not just about the law. When preparing the TP documentation  knowledge of legislation is not sufficient, you need to have financial, accounting as well as economic and statistical knowledge.

The rules of Article 39 are just “the tip of the iceberg”, the proper understanding of which you could obtain only by practical experience. For instance, the OECD Guidelines contain almost 400 pages and they do not give you answers to all the questions, a lot is decided based on expert opinion and this kind of expertise you can get just through practical experience which was scarce before these new rules came into force.

Against the said, you can imagine that this is a rather big challenge. Some of the complex adjustments of comparables require rather sophisticated calculations which are challenging for me too even though I have an economic and financial background.

To recap: the new TP rules created an entirely new market where support in TP reporting and drafting TP documentation is required. Lawyers need to have new knowledge and skills in order to be able to meet this new demand.

The other important aspect is that complex international projects require international cooperation with TP advisors in other jurisdictions. This was one of the reasons for our closer integration with WTS Alliance (an alliance of tax law firms with its center in Munich, Germany), which resulted in our rebranding last year, when we changed our well-known name of KM Partners.

This was a risky step. Yet, closer links with WTS allow us to deal with complex projects and succeed in tenders in competition with well-known international companies, particularly strong in this practice area.

 

UJBL.:  Many experts sound the position that TP regulation has not begun to work in spite of numerous changes adopted in such a short period. What is the reason in your view?

I. Sh.: I do not agree with this statement since it contradicts my experience. Taxpayers do work on compliance with the new rules. We assisted in TP reporting and are now engaged in several projects where we help to draft TP documentation.

As for control. Well, as far as I remember, Mr. Mishyn (head of the SFS department of TP audits) said at one of the meetings at the EBA or ACC that they had conducted 18 TP audits.

Obviously, the fiscal authority also only obtains knowledge and practical experience of applying the new rules and Mr. Myshin is brave enough to accept this.

Yet, it does not mean that the new rules are not working. They do work and this is the only way to get the necessary expertise. And this is true for taxpayers, tax advisors and fiscal authorities. TP is not some abstract knowledge, which you can get by reading the law or a book. TP requires skills and expertise, which can only be obtained through practical experience.

We all need to understand that TP control is the future of tax control as such and is in the state of flux not just in Ukraine but in other states too. For instance, I can refer to the latest BEPS international initiative, which contains a large set of rules regarding TP. The world is moving forward towards greater emphasis on TP rules and their unification across the globe. And this is understandable given the role that intra-group transactions play in the world economy.

 

UJBL.:  How do you assess the actions of the fiscal authorities in terms of application of the  new TP rules?

I. Sh.: Well, please do not take it as flattery towards the controlling authorities. This is obviously not the way of our firm. We usually heavily criticize them.

However, what I can currently see on the part of the respective officials of the State Fiscal Service (the SFS) makes me enthusiastic about future interaction. Thus, they are ready to open discussion on practical problems. For instance, at the special committees’ meetings of the ACC and EBA. And what is also very important is that I do see the actual work done to build TP control in Ukraine taking into account best international practices and specifically OECD Guidelines.

Still, only time can show how TP rules will actually be used. As another instrument of fiscal pressure on taxpayers and raising funds, or a fair mechanism of establishing a fair tax burden.

Thus, we all remember the approach of customs authorities with respect to customs valuation, which is somewhat linked to TP. I also head the customs practice of our firm and have firsthand knowledge of the approach. Customs offices tended to raise the customs value by double or several fold  with reference to their mythical internal base. This was evidently contrary to  international practice and the rules of the Customs Code as such.

Hopefully, we will not see such an approach in TP control.

 

UJBL.:  On 24 June 2015 the World Customs Organization (WCO) published the WCO Guide to Customs Valuation and Transfer Pricing aimed at assisting customs bodies in settling issues arising out of the interface of customs valuation and TP. What key elements of the WCO Guide is it reasonable to take into account?

I. Sh.: The interrelation of the TP and customs valuation is a very interesting topic, which is now actively discussed internationally, as witnessed by the new WCO Guide, which is one of the documents where the position in this respect is expressed by the WCO.

This matter is interesting for me too, since I have the honor of leading the TP and customs practices in our firm. And so in 2013 I wrote a paper on this particular topic and tried to examine it taking into account Ukrainian reality.

The WCO guide has correctly pointed at the conflicting aims of control over import transactions when we speak of customs valuation and TP. The customs service tries to raise the customs value in order to collect more customs duties and import VAT. In contrast with this, during the TP audit officers are interested in finding cases of overpricing of goods. In this way, they could reduce deductible expenses and assess the profit tax.

My principal idea was then to use the practice used by the customs authorities to raise the customs value without proper argumentation in order to accomplish their fiscal plans.

Thus, if one division of the fiscal authority says that the prices in import transactions are below the market (which must be the main driver for raising the customs value following the customs rules) then there could be no basis for revising the prices during the TP control.

Therefore, there is no need for complex calculations to prove that the prices are at arm’s length. Or we should then officially accept that the customs value was increased without proper grounds.

 

UJBL.:  Your forecast on formation of the first court practice in the area of TP.

I. Sh.: According to the Fiscal Service they have already started the first TP audits (although the Order of Monitoring of Prices has not been adopted as yet). Yet, I do not think that we could see first assessments under the new TP rules earlier than in a year.

As international practice evidences, it is not easy to properly substantiate that prices are at arm’s length, but neither is it an easy task to prove that they are not. And this task is probably even more tricky.

In Russia comprehensive TP rules were implemented earlier. And this practice evidenced that the fiscal authorities frequently fail to prove their assessments in court. Although there is also adverse practice.

As for Ukraine, I do believe that the first assessments we will see in the event of special TP rules established for commodity trading with low tax states. Respective rules make it easier for the fiscal authorities to substantiate assessments. For instance, it has been pointed out that the average quotes at indicated stock exchanges should be regarded as the most comparable. Well, this rule is not in line with TP principles, which are largely formed in the spirit of a liberal economy. And obviously these rules are the easiest way to show that the new TP control is actually working and gives results in raising extra cash for the budget.

With this in mind my advice for taxpayers who may be subject to these rules would be to get ready.

 

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WTS Consulting LLC

Key facts:

Year of establishment 1999

Number of lawyers/partners 25/4

Core practice areas

• Taxation
• Customs Law
• Transfer Pricing
• Contract & Business Law
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