Problems of transfer pricing in Ukraine

The Ukrainian tax authority quite often interprets transfer pricing control norms in a biased manner in its favor

The Ukrainian practice of transfer pricing control by the Ukrainian tax authorities is often full of manipulations and arbitrary interpretation of the rules. Although transfer pricing can hardly be called a clearly defined mechanism with clear quantitative approaches, business wants to see less bias in the actions of regulatory authorities.

This was stated by Ivan Shynkarenko at the roundtable discussion «Problems of Exporters in Time of War: Regulatory Challenges» organized by GMK Center.

Imperfection of the transfer pricing control system

The worst expectations of business regarding the imperfection of the transfer pricing control system are now starting to be realized. We see that our tax authorities were not ready to properly use the transfer pricing tool, which allows for a certain range of estimates of what can be considered market transactions and what cannot. But this is exactly what the OECD guidelines set out. We also have a clear fiscal bias, which is mostly difficult to justify with certain arguments, budget deficits, or anything else.

It is important to remember that transfer pricing is not a purely local issue of determining the tax base in a particular country. Historically, transfer pricing rules emerged as part of a system of international rules aimed at avoiding double taxation, which mainly concerned the regulation of relations between associated enterprises and provided for the possibility of adjustment.

Thus, adjustments to the tax base under transfer pricing rules potentially lead to double taxation. For example, our tax authorities increase the company’s income without a symmetrical increase in expenses in the country of a non-resident purchasing a certain product. This results in double taxation of the amount of this adjustment in Ukraine and the country of the non-resident, which is a party to a double tax treaty.

The treaties provide a mechanism for avoiding double taxation in such cases, i.e., the counterparty country often has to grant the right to make a symmetrical reduction of the tax base. However, such a reduction is not automatic – in the course of consultations, it is necessary to convince the competent authority of the counterparty’s country of registration that the adjustment in Ukraine was made taking into account generally accepted approaches to transfer pricing. And if the approaches are “unilateral” and openly contradict such approaches, it will be quite difficult to convince the fiscal authority of another country.

In other words, arbitrary approaches to transfer pricing will potentially lead to double taxation of Ukrainian businesses. And this is bad for the economy, as evidenced by the extensive network of agreements aimed at avoiding double taxation.

At the level of agreements, there are special procedures designed to resolve such contradictions between the fiscal authorities of countries – the mutual agreement procedure.

In other words, it is now possible to initiate a mutual agreement procedure, in which case our tax authorities, which often distort facts, will no longer be able to manipulate transfer pricing rules before judges, who cannot always fully appreciate all the complex aspects of transfer pricing, but before their foreign counterparts with their fiscal interests.

An example from court practice

As an example from the court practice in terms of approaches that raise big questions, I will cite the case of Olympex Coupe International, a grain transshipment terminal in the port of Odesa. This case, after a second review, ended in favor of the taxpayer.

The transfer pricing analysis was carried out using the net profit method – comparing the taxpayer’s profitability with the market range of profitability of Ukrainian companies engaged in similar activities. The tax authorities took a creative approach to the matter – they formed the selection criteria for 2014-2015 in such a way that the sample for 2014 included three companies with a net profitability in the bottom quartile of 13.37%, and 44.39% in 2015 (according to only two companies).

In other words, the tax authorities believe that such a huge rate of return is normal and market-based, and they are ready to go to court with these arguments. However, this rate of return on grain transshipment services is twice as high as in the most profitable sectors of the US economy in 2015. This approach of the tax authorities to the calculation of the tax base is only surprising.

Solution options

Transfer pricing rules are not a transparent algorithm with clearly defined numbers. However, businesses would like to see less manipulation and arbitrary interpretation of transfer pricing rules from the Ukrainian tax authorities.

We hope that we will be able to overcome this trend on the part of our regulatory authorities in the courts. Another area of focus is the development of mutual coordination procedures involving the relevant authorities of the countries where our non-resident partners are located.