CFC medicine: tax-free liquidation

Source: НВ Бизнес

On July 14th, the Verkhovna Rada has adopted new amendments to the Tax Code and presented the “capital amnesty” for offshore lovers.

Tax-free liquidation

The rule on “tax-free liquidation” of foreign companies was expected like manna from heaven. Paying personal income tax 18% or even 9% and military duty 1.5%, or only military duty 1.5% on accumulated and often undeclared income – the difference is significant. Some people might say that’s unfair – those who kept their money on foreign accounts and in offshore, without any taxation in Ukraine, will get preferences again. On the other hand, how else can we stimulate wealthy Ukrainians to disclose information about their financial position and assets? Perhaps this rule is the “capital amnesty” as promised by the President, though not with a zero-tax rate.

Objectively, the amnesty project announced by the government with tax rates of 18-9-5-2.5% will not be acceptable by savvy business people. If there will be at least a little chance not to pay taxes legally, it will certainly be used and the assets will remain “in the shadows” again. This is still possible. Unfortunately, there is no confidence in either financial or legal system of Ukraine. Promises to exempt from criminal and administrative liability and financial sanctions are not conclusive enough – hence the reluctance to transfer funds to Ukrainian banks, especially with the payment of 5% tax.

Another matter is direct rule of the law with a temporary permission not to include all assets, received as result of foreign company liquidation in the total taxable income for  2020-2021 periods. To take advantage of this rule, two conditions shall be met:

1) the procedure for the liquidation of a foreign company shall be started from January 1st, 2020 and completed to December 31st, 2021;
2) the individual, being a shareholder, participant, partner or controller of the liquidated company, is obliged to submit to the tax office an application for tax exemption of such income, indicating the details of the company and the assets received.

If foreign (or offshore) company was created solely to accumulate and keep assets out of sight of the Ukrainian regulatory authorities, and does not perform any other essential functions and the owner is ready mentally to declare the assets, but is not ready to pay taxes, then it’s time to liquidate such offshore company. As result the beneficiary will get tax declaration with specified assets and pay a small amount of tax – 1.5% military duty.

It seems to be an ideal solution for offshore beneficiaries. But only if you ignore the risks. Every businessman should estimate the risks of each specific case.

Risks of tax-free liquidation

Cancellation risk. Given the speed and frequency of amendments to the Tax Code adopted, there is a high risk that the rule might be leveled at any time and the taxpayer will not have enough time to mitigate. The company will be liquidated, and the assets will not be declared. As a result, the income received shall be subject to personal income tax at a rate of 18%. To reduce the risk is possible only by postponing the liquidation process and complete it on the New Year’s Eve, when amendments can no longer be adopted. And submit the declaration as early as possible in the next year.

Risk of conflict of laws. Clause 170.131 of Article 170 also provides the possibility of tax-free liquidation and tax exemption of income and assets received as a result of liquidation. But the conditions for this are slightly different – the decision on liquidation shall be made before July 1st, 2020, and the liquidation shall be completed by December 31st, 2020, and the income and assets after liquidation shall be received not earlier than 2021 (since the rule will come into force only starting from 2021). Nevertheless, we expect that the government will correct this clause, as it slightly contradicts common sense: the norm will come into force in the future, but it relates conditions of the past events. If both rules will remain in force, then we will not avoid of double interpretation and legal collisions and, as a result, tax disputes. An option for reducing the risk is to ensure the liquidation and distribution of assets in a such timeframe as meets both rules.

Risk of investigation and criminal cases. Since, along with the application, it is necessary to disclose details of the foreign company and the characteristics of the property and assets, the tax authority will receive a huge massive of data that might be used for investigating other crimes. For example, if liquidated foreign company has traded with and received income from Ukrainian company, the last might fall under investigation on tax avoidance. Therefore, penalty and additional tax liabilities might be imposed to Ukrainian company. If, for example, the income of a foreign company is not transparent and has dubious origin or was obtained from virtual assets, then the individual might fall under suspicion of financing terrorism under Art. 209 of the Criminal Code of Ukraine. In addition, the Antimonopoly Committee of Ukraine might have questions to business if it participated in the procedures for obtaining permits for concentration or lack of concentration under Art. 24 of the Law of Ukraine “On the Protection of Economic Competition”.

“Tax-free liquidation” is not a medicine for everyone and has side effects. It is important to make a deep diagnostic based on the holistic and sustainable manner. Each beneficiary shall choose the most effective way to exit the CFC, assessing the possible risks, their likelihood and possible consequences.