New rules for CFC: reporting on all income and millions in fines

In 2024, Ukrainians who are controllers (beneficiaries) of controlled foreign companies (CFCs) will face many changes.

In fact, legislation on the application of CFC rules in Ukraine came into force on January 1, 2022. But in 2022 2023 there was a kind of transition period.

During this period, the State Tax Service (STS) did not apply penalties for failure to submit reports on controlled companies.. Therefore, controllers who did not provide tax information about the CFCs they owned during 2022 and 2023 will not face any liability.

Everything changes in 2024. Until May 1, 2024 inclusive, CFC controllers must submit reports on such companies for 2022 along with declarations for 2023. Moreover, this will not just be a notification that a specific person is associated with a specific CFC. This is a full-fledged tax reporting indicating the amount of profit of a foreign company for 2022, which must be included in the corresponding declaration for 2023.

For failure to submit reports and for concealing data on CFCs, serious fines are provided, amounting to hundreds of thousands and even millions of hryvnia.

attended a Q&A meeting with the State Tax Service, which was organized by the law firm ID Legal Group and concerned the nuances of filing reports on CFC. Based on the results of this meeting, we will try to figure out what awaits CFC controllers in 2024.

What is a CFC — in brief. Controlled foreign companies are companies that are registered outside of Ukraine, but which are controlled by Ukrainian residents, legal entities or individuals. For example, the owner of company “A”, which is registered in Kyiv, opens a representative office “B” in Poland. From the point of view of Ukrainian legislation, such a representative office is a CFC.

1. The controller of a foreign company is considered to be a person who owns a share in the capital of 50% or more.

2. Controllers include a group of persons (residents of Ukraine) who collectively own 50% of the company. True, this requires that each of these Ukrainian controllers own a share of more than 25% (from 2024, the share of one controller will be reduced to 10%).

3. A controller is a person who exercises actual control over a foreign company (influences management bodies, has a power of attorney from the CFC to conduct transactions, etc.). d.).

Taxation of profits (income) of CFC controllers is as follows:

the controller-legal entity pays income tax at a rate of 18%; a controller-individual pays personal income tax at a rate of 18% and 1.5% military tax.

If the income of all CFCs to which the controller is related does not exceed 2 million euros per year, he is exempt from paying taxes on profits/income. But you still need to file reports on controlled companies.

Filing reports on CFC and taxation of foreign companies is regulated by the norms of the Tax Code, which were introduced into it by laws No. 466-IX, 786-IX, 1117-IX.

How do CFC controllers report to the tax authorities? As Ekaterina Ryzhenkova, director of the Transfer Pricing Department of the State Tax Service, said during the Q&A meeting, in total, by the end of 2023, the tax office “saw” 4,500 CFCs that are affiliated with Ukrainian controllers.

Of this number, 33% of companies are located in Poland, 15% in the UK, 13% in the USA, 11% in Cyprus and 8% of companies are registered in Estonia.

Ryzhenkova clarified that as of December 1, 221 counterparties reported to the tax authorities. 389 CFC reports were submitted in the short form and 298 reports in the full form. The volume of declared profit of controlled companies is UAH 89 million.

How does the State Tax Service detect controlled companies? Representatives of the tax service believe that not all controllers have yet reported their CFC. This may be due both to the mentioned transition period and to the banal reluctance of beneficiaries to disclose data about businesses outside of Ukraine.

According to our estimates, there are many more controlled companies that must report. Based on this, it is important for us to form a certain base of CFCs, the controllers of which are residents of Ukraine. That is, we are talking about creating sources of reliable information about CFCs and creating a pool of controlled companies that fall under tax control in Ukraine,” Ryzhenkova explained.

Therefore, the State Tax Service intends to use all available tools in order to create such a base. In particular, these are:

processing transfer pricing reports (TP) and CFC reports that taxpayers submit independently; analysis of declarations of property and income of those persons who declare foreign income; information received from the competent (tax) authorities of other states; analysis of data from open sources, including from the media.

In addition to this, the State Tax Service is looking forward to the launch of the automatic exchange of tax information according to the CRS standard, which should occur in the second half of 2024. The implementation of the CRS will allow the Ukrainian tax authorities to more accurately supervise CFCs and quickly compare the indicators in the reports provided by controllers with the data that will come from the tax authorities of other countries.

What nuances should be taken into account when submitting CFC reports? A CFC report is a complex and voluminous document. Often, errors occur when filling it out, especially since this is a new type of reporting that many taxpayers have not encountered before.

But if no penalties were applied in 2022–2023, then in 2024 they will be imposed for errors.. Participants at the event mentioned some important details that need to be taken into account when preparing and submitting reports.

1. There are some discrepancies in what income needs to be included in the CFC report. “In fact, there should be three main indicators: the volume of products sold, the amount of operating income and income before tax, on the basis of which the adjusted profit of the CFC is calculated,” said Tatyana Savchuk, head of transfer pricing and audit practice at ID Legal Group.

But the position of the Ministry of Finance is somewhat different: the department believes that all income of a CFC should be reflected without exception.

“According to the explanation of the Ministry of Finance, reporting must include all income received by the CFC. This is both revenue and all other income, including passive income (dividends, royalties, interest),” said Alexander Gyurzhi, head of the international activity control department of the Transfer Pricing Department of the State Tax Service.

2. Due to the fact that CFC reports are often submitted by international companies, they are based on international standards (IFRS). At the same time, IFRS contains such a clause as “collapse” of individual items and costs. Such tolerances exist for investment items, exchange rate differences, etc.. d. “There may be cases when a company carries out investment activities and reflects its investment portfolio on a net basis. But the question arises how the State Tax Service will react to this,” commented Tatyana Savchuk.

Ekaterina Ryzhenkova, for her part, explained that the State Tax Service generally focuses on IFRS standards and accepts this reflection of the investment portfolio. “But at the same time, we can ask to “unfold” this portfolio to see what is in it and make sure that there are no abuses on the part of the CFC,” Ryzhenkova said.

3. An important point is the correct display, or rather, understatement of taxable profit/income. From the point of view of some controllers, the Ukrainian tax service will not be able to double-check the real financial indicators of the CFC, since the company is registered overseas, in another jurisdiction.

But representatives of the State Tax Service assure that if you want, you can get to real data on CFC, even though the CRS standard is not yet in effect.

“At a minimum, desk control is carried out, comparing the data of the submitted report with the data that the State Tax Service has. In addition, we still have channels for exchanging information with tax authorities of other countries, through which we will be able to identify transfer transactions,” said Ryzhenkova.

In other words, if the controller, for example, underestimated the amount of taxable profit of his company, which is located somewhere in Switzerland, the State Tax Service, by reconciling the data, will be able to identify the deviation and will inevitably assess additional tax liabilities.

What should CFC controllers prepare for in 2024? The most important thing is the application of fines for violations in the preparation and submission of CFC reports, as well as for non-compliance with tax rules for foreign companies.

Here are just some of the sanctions: fine for failure to submit a notification about a CFC to the State Tax Service — UAH 908,000, for failure to provide a CFC report — UAH 303,000. Concealing data about CFCs in which the controller is a participant, including information about transactions with other jurisdictions, entails a fine of 3% of the CFC’s income or 25% of adjusted profit that is not reflected in the report, maximum UAH 3 million .

In addition, both the tax authorities and business are waiting for the adoption of bill No. 8137 in the second reading. This document was registered in the Verkhovna Rada in the fall of 2022, and the first reading took place only in May 2023.

Its provisions provide for amendments to the definition of what a CFC is in principle; controllers will include persons who solely own a 50% or more stake in a foreign company; the list of criteria on the basis of which actual control is identified has been expanded; provision is made for the abolition of the simplified (abbreviated) form of the CFC report.

“On the one hand, this is an interim bill that does not globally solve the problem of integrating our legislation with European. At the same time, it removes the issue of logical inconsistencies associated with filing CFC reports. Therefore, we, as a service, are interested in this document in order to spend less time on inspections and control,” summed up Ekaterina Ryzhenkova.