New view of tax rules seen as illegal, but wise to prepare and avoid hefty fines
The issue could affect many companies and foreign citizens working in Ukraine. Moreover, it may be wise to prepare now and avoid stiff penalties imposed on those caught violating the new interpretation of Ukraine’s tax laws. If the employer does not withhold the appropriate tax, tax officials warn that 200 percent penalties will be applied.
For those asking themselves what changed and how you may be affected, here are the basics.
Since mid-2009, a number of local tax offices had focused on the employment income of expatriates to generate additional revenues for the budget, which found itself increasingly cash-starved in light of last year’s deep recession. In December, the State Tax Administration of Ukraine further hardened its stance and introduced a more aggressive approach.
The most important changes are:
- interpretation of the qualifying conditions for residency status for foreigners working in Ukraine – foreigners are tax residents of Ukraine only the month after obtaining a Ukrainian tax resident status certificate; and
- the tax rate applicable to the employment income of non-residents is 30 percent instead of 15 percent.
If you haven’t already registered as a tax resident to qualify for the 15 percent rate, you may find yourself taxed twice more for the first half of 2010. Apparently, local tax offices will not accept application for residency until at least July of each year. Ukraine’s central tax office has also instructed inspectors to focus on this issue during tax audits and apply the 200 percent penalty for any non-compliance.
This approach is an extreme interpretation of the legislation. It means that tax residency certificates may be issued to individuals only after they physically spend more than 183 days in Ukraine, and is the only basis of residency. Meanwhile, the 30 percent rate would apply to all income expatriates earn between January-July.
Furthermore, unlike in Russia and other countries that use days in country as the basis for determining the tax rate, there is no clear-cut mechanism to retrospectively claim residency from the year start.
This clearly shows the authorities’ negative approach. It does not correspond to the Ukrainian legislation or international practice. It impacts all entities that employ expatriates and the authorities may assess additional liabilities for the past three years. Taking into account the 200 percent penalty provision, the financial outcome could frighten many potential investors and expatriates.
Is this approach legal? And, what can employers do to avoid paying these huge penalties after tax audits?
What legislation says
Ukraine’s personal income tax law states that a tax resident is an individual who has a place of residence in Ukraine. Simple enough, at least for the majority of taxpayers!
But what if you just moved to Ukraine or also have residence elsewhere?
The law provides so called “tie-breaker” rules for more complicated situations. These conditions are similar to internationally accepted rules:
If an individual also has a place of residence abroad, he or she is considered a resident if place of permanent residence is in Ukraine. If a permanent place of residence is also available abroad, an individual is a tax resident of Ukraine if his or her center of vital interests is in Ukraine. There could be economic or personal reasons for this.
If residency cannot be determined based on the above rules, an individual will be considered a tax resident in Ukraine if he or she spends more than 183 calendar days in Ukraine during the year. The law also provides that an individual can voluntarily declare to be a tax resident in Ukraine.
Therefore, if the individual has sufficient grounds to qualify as a tax resident of Ukraine under the tie-breaker provided by the law, he or she should be treated as such irrespective of any certificate.
The authorities have decided to ignore other conditions and rely solely on the “183-day” rule, and argue that an individual is only a tax resident after 183 days have been exceeded.
Meanwhile, the requirement to obtain a certificate may be very difficult for some individuals. The application should include a number of documents, including a copy of the Ukrainian work permit (or service card, issued by the Ministry of Economy, for individuals working in Ukraine at the foreign companies’ representative offices).
If there is no work permit, your application for the tax residence will be rejected. This may be the case for foreigners who work at representative offices of not-for-profit organizations, or foreign banks which are not registered with the Ministry of Economy of Ukraine.
What to do now?
It is clear, in the view of PricewaterhouseCoopers, that tax officials are using a very narrow interpretation of the law. The situation is not as straightforward as the authorities imply. But it is also clear that if employers do not follow the guidance issued by tax authorities, they are likely to face penalties.
Therefore, employers should consider planned actions on a case-by-case basis for each expatriate employee. This should be undertaken prior to payment of the January 2010 salaries.
For 2010, the most efficient course of action would be for all expatriate employees to obtain their Tax Resident Certificates prior to January salaries payment – if that is possible.
For prior years, if the employers did not obtain the certificate for their expatriates and applied the 15 percent rate, they were in compliance with accepted practice set out by a 2004 clarification approved by the tax administration, namely Order No.50.
But this may be insufficient for future tax audits. Inspectors could demand a tax bill of the additional 15 percent plus 200 percent penalties. If this happens, and if the employer is prepared to challenge the assessment, there are grounds to eventually win the case in court. There are a number of cases that are proceeding through the appeal process and they are likely to be a number of court cases by mid-year.
In addition, a “defense file” should be prepared for each foreign employee. The expatriates who qualified as tax residents in Ukraine for 2009 and whose personal circumstances did not change for the 2010, should be considered tax residents from the beginning of the year. Also, foreign individuals who did not obtain the residency certificate (or obtained it during the year), but met the legislative requirements to qualify as tax residents should be able to claim residency status and defend their position, if they have sufficient evidence – rental agreements, work permits, residence permit, etc.
If the tax administration continues to interpret the legislation in this way, employers should seek advice with a consideration to restructuring the payroll for their expatriates.
Ron Barden is the lead partner with the tax and legal department at PricewaterhouseCoopers Ukraine. He has over 25 years experience in international tax and legal matters, particularly in developing markets. He can be reached at firstname.lastname@example.org. Julia Kadibash is a manager with PricewaterhouseCoopers in Ukraine. She specializes in human resource consulting, immigration services and taxation of individuals in Ukraine. She can be reached via email@example.com.