Practice Areas Review: Tax Controversy

Ukrainian Tax Disputes in 2016: Faster, Higher, Stronger

Sergiy GRYSHKO

Sergiy GRYSHKO

Partner, Head of Dispute Resolution Practice, Redcliffe Partners. Sergiy has a track record of representing clients in arbitrations under various international institutional and ad hoc arbitration rules, including ICACU, LCIA, LMAA, SCC, ICC, UNCITRAL and ICSID. His experience also includes advising oil & gas and energy sector clients in investment arbitrations involving Ukrainian counterparties. He comes recommended for Dispute Resolution and International Arbitration in Ukraine by Chambers Europe and Who’s Who: Ukrainian Law Firms. Sergiy Gryshko is Head of ICC Ukraine’s Commission on International Arbitration and a Council member of the Ukrainian Bar Association Committee on Procedural Law. Mr Gryshko is also listed as an arbitrator at the JSM Permanent Court of Arbitration (Slovak Republic)

PROfile

Redcliffe Partners

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75 Zhylyanska Street,
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Redcliffe Partners was launched as a new brand in Ukraine in December 2015. Before that, the core legal team of Redcliffe had worked together for more than 7 years as the Kiev team of Clifford Chance, handling many of the region’s most sophisticated transactions.

 

Redcliffe’s capabilities across practice areas and industry sectors

Redcliffe focuses primarily on antitrust, banking and finance, corporate and M&A, debt restructuring and insolvency, international arbitration and litigation.

Its sector-focused groups include agribusiness, financial institutions, energy, pharmaceuticals, FMCG and retail, TMT and infrastructure.

 

Reputation

Redcliffe is recommended in its areas of expertise by all international and local directories:

— top-ranked in Energy, Banking and Finance, and Capital Markets by The Legal 500

— recommended in M&A by Chambers Global and IFLR 1000

— No.3 by number of Ukraine’s largest M&A and finance deals in 2015 according to the Yuridicheskaya Practika Deals Tables

 

Clients

Redcliffe’s clients are major international and local companies from various industry sectors, global private equity houses and financial services institutions, including Abbott Laboratories, Amadeus IT Group, BaDM, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, EBRD, FMO, IFC, ING, JPMorgan, Macquarie Bank, Monsanto International, Morgan Stanley, Raiffeisen Bank International, Renaissance Capital, UniCredit Bank, Vitol.

 

Despite high hopes at the start of 2015, the year saw a number of controversial developments in both Ukrainian tax law and practice in Ukrainian courts.

In 2015, a total of 26 amendments were made to the Tax Code, Ukraine’s principal tax statute. As a form of relief came the long-awaited abolition of corporate profit tax payments of CPT in advance, which will take effect on 1 January 2017. In the past corporate profit tax advances were often, quite literally, extorted by the tax authorities. What is also very reassuring is that tax authorities will not be allowed to annul the value-added tax (the VAT) registration of a taxpayer if the latter’s actual corporate seat is different from that registered with the Companies Registry.

Another positive development is that the administration of VAT refunds is expected to become more transparent and predictable going forward, not least because the VAT credit arising from corrected tax returns can now be claimed by taxpayers within 365 calendar days following the underlying correction. The introduction of new VAT refund registers should also help to finally achieve automatic VAT refunds to honest taxpayers. The administration of Ukrainian VAT refunds has been so opaque, discriminatory and corrupt that it has been a nightmare for foreign companies for decades. Overly keen attempts by some US companies to receive their due VAT refunds were even a recent subject of the Foreign Corrupt Practices Act investigation by the US Department of Justice.

Although the number of amendments is impressive, and some amendments are quite comprehensive and long overdue, the Tax Code (or rather the way in which it is used by the tax authorities) still remains a rather cumbersome, user-unfriendly piece of legislation. A number of new taxes have been introduced, but tax collection remains poorly managed and often discriminatory.

In particular, the Ukrainian Parliament tends to ignore the principle of tax legislation stability embedded in Article 4 of the Ukrainian Tax Code. This fundamental rule provides that any amendments to the Tax Code aimed at introducing new taxes and modifying existing taxes must be published at least six months prior to them coming into force. As good as this principle looks in theory, very few amendments to the Tax Code adopted by the Verkhovna Rada, i.e. the Ukrainian Parliament, have to date actually complied with this fundamental rule. Unfortunately, 2015 was no different. 

After dramatically raising the subsoil use fee from 28% to 55% in 2014, which continued into 2015, the Ukrainian Government had to defend the first ever investment claim over a tax increase. Three investors (the UK’s JKX Oil & Gas plc, Poltava Gas Petroleum BV and Ukrainian PJSC Poltava Oil & Gas Company of Ukraine) brought investment arbitration under the Energy Charter Treaty and other investment treaties against Ukraine claiming that, among other things, the spike in the subsoil use fee runs afoul of Ukraine’s international obligation to accord fair and equitable treatment to them and their investments in Ukraine.

In an attempt to save their Ukrainian business from going bust, the investors sought a protective award from an Emergency Arbitrator appointed by Stockholm Chamber of Commerce. On 14 January 2015, the Emergency Arbitrator ordered that pending the arbitral tribunal in the investors’ case, Ukraine must refrain from levying subsoil use fees on Poltava Oil & Gas Company above a rate of 28% rate. This was the first ever Emergency Arbitrator award issued against a sovereign state. The capital’s Pechersk District Court granted leave to enforce the Emergency Arbitrator award to the investors in June 2015, but the Kyiv City Court of Appeal reversed it on public policy grounds a few months later. In February 2016, the Higher Civil and Commercial Matters Court reversed and remanded the case back to the appellate court for a new consideration.

Fortunately, in the meantime, the subsoil use fee was reduced to a more sensible 29% by Parliament in December 2015.

In 2015, taxpayers were as busy as ever suing the Ukrainian tax authorities in administrative courts. Most often, the thrust of taxpayers’ claims were challenges to arbitrary reassessment of corporate profit tax deductions and/or VAT credit entitlements by the tax authorities.

In previous years, the tax authorities tended to reduce the deductible expenses by alleging that underlying transactions were invalid since no actual goods or services were provided to taxpayers. However, after some hesitation, Ukrainian courts took a firm line to the effect that whether the transaction was valid or invalid was of no relevance for corporate profit tax deduction purposes. What matters is only whether the actual delivery of goods or provision of services to taxpayers took place.

The response of the tax authorities was to issue a flood of allegations that taxpayers did not actually receive any goods, services or works and, hence, couldn’t make deductions from their taxable corporate profits. Such allegations came to be commonplace in the practice of Ukrainian tax authorities even though they are rarely based on anything more than suspicion. Unfortunately for Ukrainian taxpayers, the courts tend to lay the burden of proof on the actual delivery of goods (and provision of services) on them rather than to make tax authorities discharge their own burden of proof that the duly recorded deliveries of goods and/or provision of services did not actually take place. Although every case is different, the discernible trend is that taxpayers have to show ultimately that what is on their books is what they actually have or have had.

Another hot topic for Ukrainian taxpayers is denial of the VAT credit where one of companies in their supply chain is found to be a “fictitious entrepreneur” by the tax authorities. The only statutory definition of “fictitious entrepreneurship” is found in Article 205 of the Criminal Code which reads as “establishment or acquisition of legal entities with the aim of covering up illegal activities or carrying out prohibited activities”. As this definition suggests, allegations of “fictitious entrepreneurship” require meeting quite a high burden of proof to show the criminal intent of perpetrators. Moreover, it requires the tax authorities to rebut the presumption of innocence to show the criminal intent. Such rebuttal is only possible where charges of fictitious entrepreneurship result in the criminal conviction of the corporate officers responsible.

However, the tax authorities blatantly disregard the requirements of Ukrainian law; they regularly make allegations of fictitious entrepreneurship based on very scarce evidence, if any. What is even more troubling, they frequently deny VAT credits and/or refunds to innocent businesses based on their “findings”, (actually suspicions) that an intermediary supplier somewhere in the supply chain was a “fictitious entrepreneur”. In other words, the Ukrainian tax authorities prefer to deny law-abiding businesses the VAT privileges which they are entitled to due to their ‘perception’ of wrongdoings by others. In fact, the tax authorities place the responsibility for their own failures to identify and effectively combat fraudsters onto taxpayers.

Even though this practice of making an innocent businessman liable for abuses of others has been condemned as incompatible with the basic notions of the rule of law by the European Court of Human Rights in Strasbourg, e.g. in the Intersplav v Ukraine case,Ukrainian courts did not rush to grant legitimate entrepreneurs adequate protection against tax authorities’ frivolous and manifestly unjust reading of the law. In particular, on 22 September 2015 the Supreme Court of Ukraine raised the evidentiary bar for taxpayers, holding that even where a transfer of goods or provision of services is supported by documentary evidence, such transfer must still be proven beyond any reasonable doubt by the taxpayer.

As a general conclusion, despite numerous attempts by Ukrainian legislators, 2015 will not be remembered for an all-encompassing tax overhaul. Although recent tax amendments may inspire some cautious optimism, Ukrainian tax regulations remain as opaque, unpredictable and inconsistent as ever. The Ukrainian tax authorities and the administration of taxes are both in dire need of urgent reform.