Posts Tagged ‘advance pricing agreement’

New Ukraine Transfer Pricing Rules

December 26, 2012

ImagePrior to 2012, Ukraine had not been overly concerned about transfer pricing issues. But recently, in the era of fiscal deficits, the Ukrainian government has been more focused on implementing transfer pricing compliance practices in accordance with OECD member countries.

 Transfer Pricing NEWS

On December 4, 2012 the Parliament of Ukraine registered the draft bill “On amendments to the Tax Code of Ukraine with regard to transfer pricing”.  The draft bill may become effective as early as on July 1, 2013, according to STSU chief Oleksandr Klymenko.

Which transactions are affected (controlled transactions)?

  1. Related party1 transactions with non-Ukraine affiliates (counteragents) who pay corporate income tax at a rate of at least 5% less than in Ukraine, or such counteragents domiciled in a country with a corporate income tax at least 5% less than Ukraine (i.e., 14% as of January 1, 2013); and
  2. The total sum of transactions with a counteragent exceeds 50 million Grynia per year.


The draft bill requires big taxpayers to submit a report on operations and documents related to transfer pricing before May 1st of the year following the year in which transactions occurred.2 Smaller taxpayers must only notify the STSU of their controlled transactions (also, before May 1st of the year following the year in which transactions occurred). The documentation for big taxpayers should contain: detailed information about transactions, counteragents, risk analysis, justification for the selection of a transfer pricing methodology, and determination of the transfer price. Penalties of 5% of the sum of the controlled transactions will be assessed for failure to provide the notification of controlled transactions or the documentation report.3

Prescribed Transfer Pricing Methods

Article 39 of Ukraine’s Tax Code contains a list of five methods for determining the arm’s-length price: comparable uncontrolled price, resale price, cost plus, (transactional) profit split, and transactional net margin. The revised code will also allow for a ‘method of last resort’ (i.e., an unspecified method in cases where there is insufficient data to apply other transfer pricing methods). The method of last resort is typically an independent evaluation by a certified appraiser. This method can be employed only if there is insufficient data to apply the five specified transfer pricing methods. The comparable uncontrolled price method is described in the detail, while the others are not. Finally, it is acceptable to use a combination of two or more of the above transfer pricing methods. Although all the methods are put in a certain order, the Tax Code does not mention a hierarchy of methods.

Safe Harbor

The new transfer pricing rules allow for a 5% safe harbor on certain commodities4.  Tax reassessments are not permitted if the contract price deviates from the “arm’s-length price” by less than 5%. In this case the “arm’s-length price” consists any price from a list of official sources of information, such as data from state authorities, banks, specialized commercial publications, or exchange quotations.

Transfer Pricing Audits

The STSU must provide taxpayers 10 days’ notice of a transfer pricing audit. The maximum duration of the transfer pricing audit is 1 year, consisting of an initial 6-month time-limited audit, and a potential 6-month extension. Taxpayers have 20 days to appeal assessments in tax audits.

Transfer Pricing INSIGHTS 

  • Ukraine realizes it does not have the staffing (nor, more generally speaking, the expertise) to focus on smaller audits at this time. This is a near-term opportunity for multinationals with Ukraine intercompany transactions on certain commodities especially. For example, on Ukraine outbound intercompany commodity transactions to lower tax countries, taxpayers may want to determine transfer prices that are slightly less than (<5%) prices from any of the official sources of information (i.e., data from state authorities, banks, specialized commercial publications, or exchange quotations). Selecting one of the lower prices in the numerous official sources, and then reducing it by almost 5%, can increase tax savings considerably, especially on large transactions (same logic applies with higher tax countries, only higher prices would be advantageous).
  • Likewise, on Ukraine inbound intercompany transactions with lower tax countries, taxpayers may want to determine contract prices that are almost 5% greater than the prices in any of the official sources of information, so long as the price for the imported goods is not less than the customs value. Admittedly, Ukraine is a net exporter of the specified commodities, so this importing strategy is not as applicable as the exporting strategy above.
  • Ukrainian exporters (primarily raw materials) should be most concerned with the new transfer pricing rules. Historically, many Ukrainian exporters sold tangible goods at low prices (e.g., below exchange quotations) to foreign affiliates in lower tax jurisdictions; these foreign affiliates then sold the same goods at higher market prices to third party purchasers, with the profit left in the low tax jurisdiction.
  • MNEs operating in Ukraine may not want to unnecessarily spend money on transfer pricing documentation from expensive professional services firms, since the Ukraine transfer pricing reports, if required, are simplistic, and the STSU does not require a exacting format. All taxpayers must at a minimum notify the STSU of the controlled transactions. Big taxpayers are required to submit more documentation than smaller taxpayers. If the STSU requests additional documentation, the taxpayer has 30 to 60 days to provide it. Compiling Ukraine transfer pricing reports and documentation in-house and/or with a cost-effective independent transfer pricing advisor is a practical solution.
  • Once a taxpayer has determined and implemented a transfer price, the burden of proof that the price is unfair rests with tax authority. The taxpayer is not legally obliged to substantiate the price upon request from the authority.
  • Since the new transfer pricing rules provide that the arm’s-length price for imported goods must be equal to or greater than customs value, it will be interesting to see how this affects how MNEs treat pricing for damaged goods and promotional goods.
  • While Ukraine’s new transfer pricing rules now allow for Advance Pricing Agreements (APAs), the STSU is too unsophisticated on transfer pricing for an APA to be worth the cost of preparation. Since APAs are new to Ukraine, negotiating one is likely to be a time consuming headache for the taxpayer, and even if your company is the first to have a unilateral Ukraine APA, it may not be too helpful since transfer pricing enforcement efforts are lax, and a taxpayer seeing an APA likely has more advanced transfer pricing know how than the STSU. Further, only unilateral APAs are currently allowed, and if these later necessitate competent authority, the STSU is ill equipped for such discussions.


  1. Related parties are defined in Ukrainian tax law as legal entities and/or individuals, whose relationship may affect the terms and economic results of their activities or activities of persons represented by them. An entity qualifies as a related party if ownership of at least 20 percent of shares; based on voting power; share capital; are under common control.
  2. Ukraine has an official register of big taxpayers. Entities are included on this list if either A) Income for the past four consecutive quarters exceeded UAH 500 million or B) Tax payments for the same period were greater than UAH 12 million.
  3. If a transfer pricing adjustment results in additional tax liabilities, the STSU can assess penalties of up to 200 percent of the tax underpayment. However, historically, transfer pricing adjustments have rarely been enforced.
  4. Commodities include: animal oils, grain crops, in-organic and organic chemical products, metals and ferrous metal goods, mineral fuels, ore, and vegetable oils.

Additional Resources:


Featured Article – Changes to Australia’s Transfer Pricing Rules

December 18, 2012


Transfer Pricing NEWS:

An exposure draft of legislation was released on November 22, 2012, “Tax Laws Amendment (Cross-Border Transfer Pricing) Bill 2013: Modernisation of transfer pricing rules—proposing changes to Australia’s domestic transfer pricing rules,” to introduce new Australian transfer pricing rules with significant self assessment and documentation requirements. The start date for these new rules has not been announced, but it is expected to be the date of Royal Assent of the amending legislation.

Apparently, these new rules are a response by the Australian Commissioner of Taxation (Commissioner) to recent losses in tax court. The most prominent example is the SNF case last year. In that case the Commissioner unsuccessfully argued for the use of the transactional net margin method of adjusting transfer prices over the comparable uncontrolled price method. It looks like the Commissioner is convincing the Federal Government to legislate the Commissioner’s interpretation of the old rules as the new rules.

The Exposure Draft proposes the repeal of Australia’s existing transfer pricing rules in Division 13 of Part III of the Income Tax Assessment Act 1936 and the insertion of their replacements, as Subdivisions 815-B to 815-E of the Income Tax Assessment Act 1997. Specifically:

  • 815-B: Arm’s length principle for cross-border conditions between entities
  • 815-C: Arm’s length principle for permanent establishments
  • 815-D: Record keeping requirements (Documentation)
  • 815-E: Special rules for trusts and partnerships.

This blog post will only focus on Subdivisions 815-B and 815-D. Of the four, I see these two as having relatively more consequence for taxpayers. For more information on 815-C and 815-E, please refer to the Exposure Draft (link to Exposure Draft at end of posting).

The new transfer pricing rules will operate on a self-assessment basis, unlike the old rules, which required the Commissioner to make a determination of an assessment. This burden has shifted to the taxpayer, who will need to assess its own transfer pricing arrangements to determine whether they comply with the new rules. If a taxpayer identifies that it has a non arm’s-length arrangement creating a ‘tax benefit’ in Australia, it should self-assess a transfer pricing adjustment to increase Australian taxable income to reflect an arm’s-length result (downward adjustments are not permitted under the proposed rules).

Arm’s Length Conditions

The draft legislation focuses on the ‘conditions’ that exist between entities and whether these are consistent with the ‘arm’s length conditions’. Arm’s length conditions are the conditions that may be expected between independent entities dealing wholly independently with one another in comparable circumstances. In identifying arm’s length conditions, regard must be had to the economic substance of what was actually done. Where the economic substance of what was done does not match the legal form, it is the economic substance that determines the ‘arm’s length conditions’.

The arm’s length conditions are to be determined using the most appropriate and reliable method. The method must be selected based on the comparable data available, and a comparability analysis must be performed. Five comparability factors (the comparability factors in the OECD Transfer Pricing Guidelines) must be considered in this analysis. The five comparability factors are:

  1. Characteristics of property or services
  2. Functional analysis
  3. Contractual terms
  4. Economic circumstances
  5. Business strategies

An arrangement could be considered non-arm’s length if it does not contain a condition that third parties would have normally included in a comparable arrangement. Likewise, if a related party arrangement contains a condition that third parties would not normally agree to, this may also constitute a non-arm’s length arrangement. Note: There is great uncertainty as to how the Commissioner will apply this test in practice.

Transfer Pricing Benefit

There will be a ‘transfer pricing benefit’ where arm’s length conditions are applied and one of the following three outcomes would arise:

  1. The Australian entity’s taxable income for the income year is greater than actual conditions
  2. The Australian entity’s loss is less than actual conditions
  3. The Australian entity’s tax offsets are less than actual conditions


The draft Explanatory Memorandum states that the Commissioner can substitute actual dealings or arrangements if “independent entities would not have done what was actually done given the options that are realistically available to them.” Basically, the Commissioner is granted broad power to reconstruct transactions when the arrangements are not considered “substantially similar” to what would have occurred between independent parties, given the options realistically available to the Australian taxpayer. This statement in the Explanatory Memorandum is somewhat of a departure from the OECD Guidelines, which state:

“[r]estructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured.”

Unlike the OECD guidelines, the proposed rules do not require the existence of ‘exceptional circumstances’ before undertaking a reconstruction.

‘Optional’ Transfer Pricing Record Keeping (aka Documentation)

While the Exposure Draft does not make “transfer pricing ‘record keeping’” mandatory, it is in effect mandatory if the taxpayer wants to have a reasonably arguable position. Subdivision 815-D imposes burdensome self-assessment documentation requirements in order for a taxpayer to obtain a RAP. A RAP limits penalties to 10% (non deductible) versus 25% or more otherwise.

Where Taxpayers prepare robust transfer pricing documentation in accordance with the prescribed process, they should be deemed to have a RAP.

Records to satisfy 815-D:

  • Must be contemporaneous
  • Must explain how 815-B applied or did not apply to the entity
  • Must explain why applying 815-B best achieves consistency with the OECD Guidelines
  • Must identify both the ‘actual conditions’ and the ‘arm’s length conditions’
  • Must detail the method used and comparable circumstances relevant to identifying the ‘arm’s length conditions’
  • Must detail the difference, if any, between the ‘arm’s length conditions’ and the ‘actual conditions’

If documentation does not meet the RAP, taxpayers would be subject to a minimum penalty of 25% of the tax shortfall if the Commissioner makes an adjustment, subject to de minimis thresholds (generally $10,000 or 1% of taxable income). The potential penalty with a RAP is 10%.

Transfer Pricing INSIGHTS:

  1. Taxpayers should review their intercompany legal agreements to assess whether legal form and economic substance are aligned, and whether the terms and conditions are consistent with third party agreements.
  2. The Exposure Draft implies that a single set of arm’s-length conditions will exist. In practice, there is rarely a single arm’s-length price or outcome; taxpayers and tax authorities typically seek to identify a range of arm’s-length outcomes. The use of a range is not directly acknowledged in the Exposure Draft. While this is an area of uncertainty, taxpayers could attempt to refer to the OECD Guidelines to support the use of a range.
  3. Subdivision 815-B applies whether the entities are related or not, allowing the Commissioner to attack collusive behavior between unrelated parties, and potentially requiring the taxpayer who wants a Reasonably Arguable Position to document unrelated party transactions to show they are indeed unrelated party transactions.
  4. The Exposure draft gives the Commissioner great power with regard whether or not to make, and how to make, consequential adjustments. Although Subdivision 815-B operates on a self-assessment basis for the primary taxpayer, it does not operate on a self-assessment basis for any other ‘disadvantaged entity’ taxpayer that might be affected by ‘arm’s length conditions’ replacing the ‘actual conditions’. In such cases, the disadvantaged entity will need to ask the Commissioner to make a determination such as reducing its taxable income, increasing its loss, increasing a tax offset, or reducing the withholding tax payable in respect of interest or royalties. The Commissioner is only required to make such a determination where the Commissioner considers it is fair and reasonable to do so.
  5. The proposed de minimis rule does not provide much relief for taxpayers, since it will be necessary for taxpayers to calculate the value of potential transfer pricing adjustment exposures before they can identify whether their dealings fall below the threshold. A simpler approach – which would have been less onerous to the taxpayer – would have been to provide an exemption from penalties for transactions that fall below a certain threshold.
  6. In future transfer pricing cases, the Commissioner may be able to argue that a significant difference between results produced by a transactional method used by the taxpayer (e.g., the comparable uncontrolled price method), and a profit-based method (e.g., the transactional net margin method), suggests there are factors specific to the taxpayer’s situation that are not taken into account by the transactional method. Then, the Commissioner could rely on a profit-based method to defend an assessment of a ‘transfer pricing benefit’ even where the taxpayer is able to use a transactional method to establish that no such benefit exists (as the Commissioner attempted to do in the SNF case).
  7. For certain large and complex intercompany arrangements, I think the added uncertainty for taxpayers resulting from the Exposure Draft, and the additional documentation burden, increases the appeal of APAs.

Links to the Exposure Draft and Explanatory Memorandum:

Exposure Draft

Explanatory Memorandum

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