In recent years the Organization for Economic Cooperation and Development has been working on measures to combat offshore and aggressive tax optimization. In this sense transfer pricing has always been one of the most effective means of preventing tax base understatement (erosion) and taxable profit shifting to low-tax jurisdictions. In their final version, namely in autumn 2015, the changes were adopted by the Group of Twenty (G20) heads of government as part of the BEPS plan. The plan itself directly involves 15 key measures to combat erosion of the tax base, four points of which are related to transfer pricing (TP). Now the major changes have to be implemented into the national legislations of the countries.
Among these changes, above all, changes related to taxation of income on transactions with intangible assets should be considered:
Firstly, the concept of “economic owner” of such assets is introduced. This means that the formal (legal) owner does not necessarily have the right to receive all the profits from use of intangible assets. For the purpose of profit distribution the contribution of parties in value creation will be analyzed, and associated persons performing essential functions (drawing-up, promotion, protection, development and implementation) should correspondingly receive adequate remuneration for this, not just compensation for their expenses, as is usually provided for in license agreements.
Secondly, associated persons, performing exclusive function of project funding on intangible assets and taking on corresponding financial risks, could only rely on a level of remuneration which is equal to premium for financial default risk.
Thirdly, it is expected to significantly expand the list of methods for determining the value of intangible assets (mainly through methods used in valuation activities).
As for changes in profit distribution, depending on the risks assumed by parties to a transaction, Yaroslav Romanchuk, managing partner of the International Legal Center EUCON, notes that in practice contract terms do not always correspond to the actual functions and actions of the parties to transaction and the risks they assume. Therefore, the principle of “prevalence of essence over form” shall be given a new status. “The terms and conditions of the contract will remain the starting point for the analysis, but the actual risks of the parties will also count. Moreover, for the purposes of transfer pricing the tax authorities have the right to ignore the actions of parties under a contract unless they have some commercial (business) goal”, said the lawyer.
The risk will be considered as assumed by the parties in case of:
— availability of decision-making powers and authorities related to such risk management;
— availability of financial capacities to assume such a risk.
As for transactions with high risks it was also decided to introduce additional measures aimed at preventing understatement of the tax base. In general, transactions with a high level of risk are recognized as transactions with tradable commodities, intra-group and other transactions. For the purpose of transactions with tradable commodities taxation it was decided to determine the price by means of a stock exchange quotation, but at the same time it is allowed to make reasonable adjustments in terms of supply for determining of the comparability of transactions. “It should be noted that in this very aspect Ukrainian tax legislation is almost completely adapted to requirements provided for in the BEPS plan, because norms related to determining prices on tradable commodities transactions that have a stock exchange quotation, meet all agreed OECD regulations. At the same time, we cannot avoid noting that implementation of such norms by Ukrainian taxpayers is somewhat problematic, says Mr. Romanchuk. Firstly, the Cabinet of Ministers of Ukraine cannot approve for more than a year now the List of Exchange Traded Commodities or the List of Global Stock Exchanges, the availability of which is provided for by requirements of Article 39 of the Tax Code of Ukraine. In addition, there are some problems with determining the comparability of goods in a specific commodity group to goods that are traded on world markets”. A striking example of this, according to expert opinion, is the situation with grain crops. State Standard of Ukraine 3768:2010 is in force for wheat in Ukraine. This standard established the quality of soft wheat and durum wheat, according to which soft wheat is divided into 6 Classes (Classes 1-3 — Group A, Classes 4-5 — Group B, and Class 6), and durum wheat — into 5 Classes. Given the heterogeneity of wheat grown on the territory of Ukraine, reduction of the amount of classes seems to be impossible.
Yet, in world practice the quality of grain batches is divided into food grains and feeder grains. At the same time, no additional clarifying options are provided. If one of the grain quality indicators shall not meet the requirements, the grain immediately goes into the category of feeder grains. As a result, the absence of gradation within varieties gives no possibility to find in the international stock exchange the corresponding item to, for example, a commodity item, which is identified in accordance with the State Standard of Ukraine. We, as professionals, who apply the law in practice, have repeatedly informed the Cabinet of Ministers of Ukraine of the existence of a number of problems, and for the elimination of which we proposed to develop a document that would contain information about the comparability of commodity items, that would provide the opportunity to apply legal requirements as for determining prices based on a stock exchange quotation without risks, but there are no improvements on this matter, says Mr. Romanchuk.
And, finally, the major changes shall apply to the completeness of documentation on transfer pricing disclosure. These changes are aimed primarily at the organization of necessary information exchange by the tax authorities of different countries. Preparation of the new format of documentation should ensure a complete understanding of the chain in which the fiscal authorities determine the cost of goods or services.
Drawing-up of the following chapters of documentation on transfer pricing: Master File, Local File, report “country by country” is stipulated for implementation of the transparency principle.
Master File is submitted by the main (parent) company of a group. This report should contain a large amount of general information about the organizational structure of a group, geographical location of units, and description of business activities, including the supply chain of basic goods and services and factors that affect pricing.
Local File is submitted by structural units of a group at their location. This report in essence meets the current requirements for transfer pricing documentation provided for in Article 39 of the Tax Code of Ukraine and contains information on controlled operations, functional analysis, choice of pricing methods, grounds for price levels and so on.
The “country by country” report is submitted by members of a group to the tax authorities of the country where the parent company is registered, and contains detailed information on the economic activities of a group unit. Exceptions are groups whose joint income is less than EUR 750 million.
Yaroslav Romanchuk noted that the Draft On amendments to the Tax Code of Ukraine, which was prepared by the Ministry of Finance in autumn 2015, called for implementation of changes in the part on the requirements for documentation on controlled transactions. Presentation of a Detailed report (Master file) by parent companies and a local report (local file) by the companies of a group was stipulated. But this Draft was rejected for various reasons. BEPS changes, however, cannot be ignored; and obviously they would be adopted a bit later.
These and other issues became the subject of an expert debate held on 24 March 2016 at the “Transfer pricing — 2016” International Forum organized by the EUCON International Legal Center.