Ukraine impoverished by abuses in transfer pricing

May 24, 2019

By Igor Kossov

The State Fiscal Service building in Kyiv, photographed in August, 2018. The service's tax authorities have been trying to crack down on aggressive transfer pricing practices by companies. Photo by UNIAN

The State Fiscal Service building in Kyiv, photographed in August, 2018. The service's tax authorities have been trying to crack down on aggressive transfer pricing practices by companies. Photo by UNIAN

Tax evasion has helped to impoverish Ukraine and enrich the country’s elite. But it’s getting more difficult, say tax experts.

Increasing global adoption of rules governing Base Erosion and Profit Shifting, or BEPS, is making many aggressive tax avoidance schemes more complicated and less effective. Still, significant gaps remain.

Ukraine is among the many countries that are trying to better regulate the main avenues of tax avoidance: deals among commonly-owned companies, also known as transfer pricing.

Aggressive use of transfer pricing has been a major tool in pumping profits out of Ukraine and into low-tax jurisdictions. This allowed some companies to avoid billions of dollars in taxes. International cooperation is helping to stop some of these practices.

However, some organizations warn that large companies stay ahead of the new rules by using techniques that aren’t yet regulated. These include the use of intangible assets such as royalties on intellectual property to move value across national boundaries and avoid taxation. This is especially true among companies with digital platforms and services.

“BEPS made marginal progress to attack the low-hanging fruit,” Tommaso Faccio, head of the secretariat at the Independent Commission for the Reform of International Corporate Taxation, told the Kyiv Post. However, it “failed to deal with the major issue of tax avoidance by multinationals which is the use of transfer pricing.”

The Organization for Economic Co-operation and Development, which created the 15-point BEPS Inclusive Framework for countries to follow, has recognized these limitations and is debating ways to update the framework. In the meantime, some countries are going ahead with their own solutions.


The BEPS Inclusive Framework isn’t a law but contains a series of guidelines. Countries that don’t adopt a minimal number of BEPS actions risk being blacklisted by compliant countries, who may impose stricter tax regimes on companies with affiliates in non-compliant jurisdictions.

Ukraine had previously committed itself to adopting four of the OECD’s 15 recommended BEPS actions. But these didn’t include actions number 8 through 10, which concerned transfer pricing.

Then, later, the Ministry of Finance recommended that Ukraine adopt these as well. In January, Ukraine updated its tax legislation, which now contains elements of actions 8–10, according to Mykola Mishin, a transfer pricing expert with the global audit firm KPMG.

One such element is the “substance over form” principle. This gives Ukrainian tax authorities the discretion to tax deals based on what they determine to be the transaction’s true nature, rather than what has been reported by the company.

For example, “if a company acted as a purchaser but signed an agency agreement… tax authorities may treat it as a purchaser of goods and not as an agent,” Vadim Medvedev, a partner with the Avellum law firm, told the Kyiv Post.

Yuriy Netskiy, head of tax at the Ukrainian branch of audit firm Mazars, said that the country has updated its transfer pricing laws regularly since they were introduced in 2013, plugging gaps and making the laws fairer for compliant companies. With only six years of experience, Ukraine’s transfer pricing laws are not as sophisticated as those of more developed countries, but local expertise is growing.

Multiple experts told the Kyiv Post that Ukraine, much like other developing countries, has limited resources to devote to transfer pricing monitoring and enforcement, which can get so complicated that Medvedev likens it to “rocket science.”

Still, it helps that BEPS regulation is a global phenomenon. Mishin says that he has seen other countries providing Ukraine with information that will help local tax authorities make informed decisions on how transactions should be priced for the purpose of taxation.


Multiple experts spoke of the weakness of the BEPS Inclusive Framework in regulating aggressive transfer pricing and other profit shifting. In March, International Monetary Fund chief Christine Lagarde wrote an op-ed in the Financial Times, where she asserted that developing countries are especially exposed to profit shifting.

Countries that are not members of the OECD — an international organization largely made up of high-income states — collectively lose about $200 billion in revenue per year due to companies shifting profits to tax havens, she said. Lagarde added that, despite recent efforts to combat this problem, vulnerabilities remain.

“The cost (to) multinationals to do tax avoidance has slightly increased. But it has not changed dramatically,” said Faccio. He added that, while companies now have to do more to prove they have a physical presence and substantial business transactions in a low-tax country, they can still do it quite easily.

Ukraine is no exception. Last year, Ukraine’s Economy Ministry stated that more than 80 percent of Ukrainian exports are indirect, done through intermediaries. A study by Faccio and fellow researchers estimated that iron ore exporters alone potentially shifted $520 million in taxable profits out of Ukraine between 2015 and 2017.

“Implementing basic transparency rules makes this process of shifting profits less easy for the companies, more complicated, but it cannot stop this process in case somebody would like to benefit from such unfair actions,” said Netskiy.

In the past, aggressive transfer pricing could have been as simple as selling goods to your overseas affiliate at reduced prices. This created a smaller taxable income in the country of origin and a greater income for the foreign affiliate, often based in a low-tax jurisdiction. The affiliate then brought the goods to the global market.

With stricter rules on profit shifting, many tax authorities can now get around this technique and extract bigger taxes from the companies that engage in it. Many companies have moved onto more sophisticated methods, including the use of intangible assets or services that can be more difficult to price.

George Turner, director of British watchdog Tax Watch, emphasized the weakness of many countries’ existing transfer pricing rules with regard to intellectual property.

“We have been talking about taxing royalty payments, especially in the tech world,” said Turner. “Lots of companies move money around by paying large royalties to each other… If you were to tax the royalty payments, you would deal with a lot of the profit shifting.”

In a March report, the OECD wrote that companies, especially those with a heavy digital presence, are creating value in other countries without having to establish physical presence there, allowing them to avoid taxes. One example is companies with web-based platforms that are used by residents in foreign jurisdictions.

Experts told the Kyiv Post that Ukraine’s economy is still dominated by commodity exports whose prices are determined by looking at foreign commodity markets. However, the use of trademarks, patents and royalties is likely to play a greater role in Ukrainian transfer pricing in the future, especially given Ukraine’s growing IT sector.

Even in the past, Mishin said that in his practice he had run into Ukrainian companies that paid affiliates for licensing trademarks that had very little actual value.

While intangible assets in transfer pricing are not currently a priority for Ukrainian tax authorities, if present trends continue, they may very well become a priority in the future.

Suggested Solutions

The OECD is looking at several proposals to create new recommendations for combating BEPS. One is imposing taxes based upon tech companies’ active online user base in a given country, such as with search engines or online marketplaces. Another proposal would recommend a tax on intangible assets that a company markets in that country.

IMF’s Lagarde suggested that ensuring that a company’s home country sets a minimum tax that the company must pay regardless of where the profit is made could be used to reduce profit shifting by multinational companies. She also suggested that taxing inbound investment and taxes on cross-border fees to subsidiaries could allow low-income countries to keep more revenue.

Bank transactions are the most common type of controlled transactions involving Ukraine; the most common jurisdictions in which companies have affiliates are Cyprus, Russia, Swirzerland and United Arab Emirates.

Turner and Faccio suggested that formulary apportionment could be a viable strategy. This is a tax practice that considers a corporation’s total worldwide profit and divides it among the various jurisdictions based on proportions of sales, assets or other factors to determine taxable income. This would simplify the tax regime and make it more difficult for multinational companies to shift profits, they said. However, Medvedev criticized this practice as being too simplistic to be economically fair.

Some countries have taken their own route to taxing business transactions. In 2016, India introduced the Equalisation Levy, a tax on digital transactions, largely affecting foreign e-commerce companies. Faccio said that Brazil, a country that also has a lot of commodity exports, uses a system that sets a fixed minimum level of taxable profit for companies.

For now, no one knows which solutions the OECD will ultimately recommend and which route Ukraine will take as its tax authorities become more sophisticated in the years to come. It’s likely that preventing profit shifting will be an ongoing battle. Still, analysts told the Kyiv Post that they are seeing some encouraging signs.

“The discussions at the OECD level look like they may be ending up with a much more rational system,” said Turner.

ICRICTTommaso Faccio