Crux (#4 April 2018)

Legal Digest

The previous month was notable for a number of legislative initiatives, among which are cancelation of the requirement for in-depth analysis of financial operations of subsidiaries and affiliated companies-residents of international corporations from the list of Forbes Global 2000; extension of options to repatriate dividends on corporate rights and shares accrued for 2017 for foreign investors; approving a new prudential standard for Ukrainian banks Liquidity Coverage Ratio; suspension of tax bills registration and calculations of adjustments in the Unified Register. Our team also remembered to ask experts about suggested draft laws On Bankruptcy Procedures No.8060; On the High Anti-Corruption Court No.7440; On Amendments to the Tax Code of Ukraine Regarding Tax on the Withdrawn Capital and others.

By its Resolution No.16 of 22 February 2018, the National Bank of Ukraine canceled the requirement for in-depth analysis of financial operations of subsidiaries and affiliated companies-residents of international corporations from the list of Forbes Global 2000. How do you assess this decision?

Oleksandr Melnyk Associate, Head of Odessa branch, GOLAW

The NBU has made the right decision, which will undoubtedly have a positive effect.

The international companies from the Forbes Global 2000 are giants of the global economy which carry out their activities in accordance with the best world standards and transparency principles. Accordingly, their subsidiaries and affiliated companies, wherever they are situated, follow the same policies.
It allows them as well as transactions they are involved in to be considered as low-risk. Therefore, it is not unexpected that transactions with their participation should have been included in the list of exceptions from the subjects to detailed financial intelligence procedures.

The adoption of the recent amendment means that a legal inaccuracy which
existed earlier has been eliminated.

According to the previous wording of the Regulation, transactions involving only non-resident subsidiaries and affiliated entities of the Forbes Global 2000 international companies were relieved of detailed analysis. Thus, transactions with residing-in-Ukraine subsidiaries of Forbes Global 2000 companies were still subject to detailed financial intelligence procedures: banks had to suspend transactions, request additional documents and information about the transaction and its participants, information about sources of funds, etc. Via the means of adopted amendments, from now the exception is applicable to entities residents of Ukraine.

Although none of the Ukrainian-originated companies are included in the Global 2000 list yet, plenty of their subsidiaries and affiliated entities reside in Ukraine: INDITEX, GAP, Philip Morris, Sanofi, Bayer, Nestle, British American Tobacco, MetLife, Vodafone, UniCredit Group, Sberbank, VTB Bank, etc.
So in general, the amendments will mainly affect only them, may facilitate the implementation of financial transactions involving companies from the list and will improve the investment climate in Ukraine.

Through its Resolution No.19 the National Bank extended options to repatriate dividends on corporate rights and shares accrued for 2017 for foreign investors. How will these changes affect investment attractiveness? Will the new rules ease formalities when trying to attract financing?

Andriy Nikiforov Counsel, Head of Banking & Finance, Kinstellar

The changes introduced by NBU Regulation No.19 in relation to dividend distributions are somewhat important for existing foreign investors into Ukrainian equity but not that much for new-money lenders of Ukrainian borrowers. Lenders always compete with shareholders for the borrowers available cash. Lenders, therefore, usually restrict dividend distributions this way or another. Therefore, a regime that permits unlimited payments to the lender under a loan agreement but restricts dividend distributions perfectly suits any lender. That said, if the borrower is an offshore company of the group and is mainly financed by the dividend distributions from Ukrainian operational companies, then the amendments introduced by NBU Regulation No.19 do matter for a lender. From the lenders perspective, the faster and the more cash may be funneled to the borrowers level from Ukrainian companies, the quicker the borrower can respond to any changes in its liquidity position and, eventually, the lender runs less risk in terms of debt servicing.

The NBU approved a new prudential standard for Ukrainian banks Liquidity Coverage Ratio (LCR). How can introduction of this standard affect the investment attractiveness of the banking system?

Sergii Papernyk Head of Banking & Finance and FinTech, EVRIS

Continuing to apply the Comprehensive Program of Ukrainian Financial Sector Development Until 2020, on 15 February 2018 the National Bank of Ukraine approved the new prudential requirement for Ukrainian banks i.e. Liquidity Coverage Ratio (LCR).

Basically, the LCR refers to highly liquid assets held by financial institutions to meet short-term obligations. The ratio is a generic stress test that aims to anticipate market-wide shocks. The liquidity coverage ratio is designed to ensure financial institutions (i.e. banks) have the necessary assets on hand to ride out short-term liquidity disruptions. The LCR is an important part of the Basel Accords, namely Basel III, which Ukraine is implementing step by step.

Compliance with the ratio confirms that the bank has sufficient liquidity to discharge liabilities during a 30-day crisis period. According to EU standards, the LCR value for banks is set at 100%.
The period required to reach the said value by banks will be prescribed by the NBU according to results of trial calculation.

The LCR will be calculated from 1 June, 2018 on a trial basis, then compliance with the LCR will be obligatory for banks. For some period, the quick liquidity ratio (N4), the current liquidity ratio (N5) and the short-term liquidity ratio (N6) should be applied along with the LCR, but then they will be replaced.

Of course, the new approach of banking regulation is the great step towards the EU and world standards. Along with the new risk-based assessment policy, the LCR will allow the Ukrainian banks to become more transparent and more attractive for foreign investors and international financial institutions.

Certainly, many NBU regulations and even laws of Ukraine should be brought into line with the new ratio requirements. For instance, legislative acts can prescribe some incentives for current liquidity ratios for commercial banks in the certain situations. Therefore, there could be a question of how banks may use current incentives for liquidity ratios (N4, N5, N6) and, at the same time, not to infringe LCR requirements.

The Draft Code of Ukraine On Bankruptcy Procedures No. 8060 has been submitted to the Verkhovna Rada of Ukraine. How do you assess the proposed novelties?

Vadym Kizlenko Attorney, Insolvency Receiver, Ilyashev & Partners

I consider the legislative regulation of the procedure applied to the bankruptcy of individual persons to be the main positive aspect of the Draft.
It will make it possible to settle (in a civilized manner and within a legal framework) disputes between creditors and borrowers (individual persons). As a result of the said regulation creditors will reliably have their claims satisfied (in full or in part), and the borrowers will be able to start their lives from scratch (although with certain limitations in the course of five years after the bankruptcy such individuals persons shall be suspended from practicing entrepreneurial activities, taking loans, acting as pledgors, etc.).

The Draft Code stipulates the sale of bankrupts assets only via electronic auctions. Moreover, the Draft also provides for coordination of the terms of sale of assets (composition of property assets, initial price, bidding steps, text of the publication, etc.) with the creditors committee and the pledges lenders. These legislative novelties reduce possible abuses on the part of the auctions participants to a minimum, decrease the number of appeals against the auction results and ensure the highest sale price.

The bankruptcy procedure will become more transparent due to the new provisions according to which the official receivers will have to be accountable to the creditors committee not only for remuneration and expenses, but also for their work, progress of bankruptcy proceedings, and will be obliged to render the information about the financial state of debtors to the creditors (even in the course of performance of the financial rehabilitation procedure).

Among the shortfalls of the Draft are the provisions stipulating that for the institution of a bankruptcy case a creditor will need just to have a court decision on debt recovery, while the sum of such indebtedness, as well as the inability to enforce such decision, will not matter. The said means that, having received a court decision on recovery of debt in the amount of as little as UAH 1,000, any creditor will be able to initiate a bankruptcy case in relation to his counterpart.

To my mind, among the arguable points are the provisions of Article 25 of the Code, which are related to the powers of the creditors meeting (first, follow-up, subsequent). According to the said provisions a follow-up meeting of creditors is considered to be duly competent if it is attended by the creditors who represent at least 1/4 of the creditors votes, which makes it possible for the creditors, who represent more than 3/4 of the creditors votes, to disrupt the general meeting as a matter of principle.

It should be noted that the provisions regarding the terms of the bankruptcy procedures also require revision and adaptation. Having established the limiting deadlines of such procedures, the authors of the Draft failed to define the consequences of missing such deadlines. In addition, evidence from practice (which dates back to 2013) shows that it is often impossible to meet the deadlines stipulated by the Bankruptcy Law due to various reasons (possession of large volumes of assets by major enterprises undergoing bankruptcy proceedings, the necessity to take measures to return the assets from the debtor to third persons, appealing against the procedural documents by the parties to a bankruptcy case, etc.).

In general, the Draft Code of Ukraine On Bankruptcy Procedures contains a fair amount of progressive and innovative ideas, which enables keeping pace with international standards of bankruptcy proceedings.

Draft Law On the High Anti-Corruption Court No.7440, submitted by the President of Ukraine, was adopted as a basis. How do you assess this presidential initiative? Does this draft comply with the recommendations of Western partners?

Vyacheslav Krahlevych Partner, EQUITY

As currently one of the most discussed bills, presidential Draft Law No.7440 has caused a number of controversial opinions regarding its compliance with requirements of international partners. The first and most controversial comment
international institutions, including the IMF and the Venice Commission, insist on accepting recommendations of the specially established Public Council of International Experts as compulsory for High Qualification Commission of Judges when selecting judges. Taking into account that the Draft Law (as well as recommendations of international partners) is aimed at enlisting foreigners into the activities of the said Council, in such case, the binding nature of its decisions is opposed to the constitutional principle of sovereignty, which simply means interference in a states internal affairs. Understanding the necessity of unfailing fulfillment of obligations to foreign partners, which Ukraine undertook, we consider that a proper and proportionate measure for resolving contradictions may be introduction of amendments to the Draft Law in part of necessity to have the votes of all members of the High Qualification Commission of Judges to make a decision on selection of judges, if it different from the one suggested by the experts. The second comment, which should be taken into account at the stage of elaboration of the draft before the second reading, is to specify requirements for the person to work as a judge of the High Anti-Corruption Court, refusal from valuation provisions that should characterize the person to work as a judge. The legislative authority should also pay attention to the jurisdiction on criminal proceedings of the High Anti-Corruption Court and take into account recommendations, in particular, of the Venice Commission, as to limiting such jurisdiction to high-level corruption. In view of the aforementioned, it should be noted that, in spite of certain noncompliance of the adopted Draft Law On the High Anti-Corruption Court with recommendations of Western partners, in its concept, the draft takes into account the majority of requirements of international institutions, and comments to it should be taken into account by introduction of changes and amendments to the document proposed by the President of Ukraine.

On 21 February 2018 Resolution No.117 of the Cabinet of Ministers regulating suspension of tax bills registration and calculations of adjustments in the Unified Register was approved. What are the main innovations foreseen by it?

Larysa Antoshchuk Head of Tax Dispute Resolution group, KPMG Law Ukraine

On 22 March, 2018 business will start dealing with a new Procedure on suspending the registration of tax bills (please refer to Resolution No.117 On Approval of the Procedures for the Suspension of Registration of the Tax Bill / Calculation of the Adjustment in the Unified Register of Tax Bills).

The state control of tax bills and adjustments registration shall fall under the criteria of risk, applicable to the taxpayer or its transaction, and considering of positive tax history indicators. The latter indicators shall be calculated by the State Fiscal Service on a monthly basis and be available for taxpayers in their electronic offices.

Meanwhile, the details on risks shall be further developed by the tax authorities jointly with the Ministry of Finance of Ukraine. A few Members of Parliament have already set a condition the new Procedure shall come into force only provided that all the above-mentioned required regulations are adopted.

Upon the new Procedure, monitoring of tax bills where the amount of supply does not exceed UAH 30 million will be hold under the one-level verification with further listing in the relevant Registry. The tax bills exceeding the above limit shall be verified by regional and state tax offices (two-tire verification system).

The new Procedure provides immunity on blocking of tax bills for companies whose Tables with the codes on transactions starting from 1 July, 2017 were taken into account by the tax authority. The authors of the document have expectedly renewed the undisputed right to the tax credit requirement, however, a full package of primary documents proving the fact of the goods delivery or services providing.

The new turn of monitoring promises is a further challenge for business requiring time resources for re-blocking activities. The current court practice, however, in most cases is positive for taxpayers.

Draft Law On Introduction of Amendments Related to Value Added Tax Rate Reduction, Simplified Tax System Reforming, Accounting and Reporting and Increase of Payment Transactions Transparency taking into Account European Practices is registered under No. 8089. How do you assess this initiative? Will reducing the basic VAT rate from 20% to 16% destroy VAT evasion schemes?

Constantin Solyar Partner, LL.M. (Harvard), Asters

The lawmakers who proposed this Draft Law believe that it will help to shrink the size of Ukraines shadow economy, which in line with some estimates exceeds 40% of Ukrainian GDP. They target VAT and the Ukrainian simplified tax system (flat tax). For the VAT the only measure they suggest is cutting the rate to 16%. No other tax anti-avoidance provisions and policies are being proposed.
The authors of this Draft hope that because the price that the "VAT-fictitious" intermediaries charge for helping to evade the tax is reportedly 10-12%, lowering the tax rate a bit closer to illegal "charge" will incentivize people to pay the tax. Unfortunately, this is a layperson's way of thinking. Studies and experience of some other countries show that simply lowering a tax without tightening enforcement of its payment does not always increase fiscal revenues.
Human nature is such that nobody likes paying tax and most people even in the much more developed countries stay tax compliant because they are afraid of financial and criminal penalties. In short, this is a risk vs. benefit analysis in most instances. Just reducing the tax without increasing the risk of being caught and facing real penalties will not help to achieve the goal of reducing the shadow economy. Instead of trying to give up billions of revenues by cutting the tax rate, the Government should think about investing much lower amounts in creating an uncorrupted and professional tax administration and law-enforcement bodies. In Ukraine successful tax evasion is usually fueled by corruption. It is either corruption helping fictitious tax intermediaries to operate or corruption that allows taxpayers who were caught to get away from the being held responsible. President Petro Poroshenko, recently announced that he will not support this Draft Law. Though this draft contains some other initiatives that are worth consideration, in general we should stop talking about tax rates only, and invest in building rules of fair play that will apply to everyone.

Ukrainian President Petro Poroshenko presented the Draft Law On Amendments to the Tax Code of Ukraine Regarding Tax on Withdrawn Capital. How do you assess the initiative? How will this draft affect the terms of doing business in Ukraine?

Maryna Tomash, Counsel, Head of Tax Consulting and Accounting Services Direction, ADER HABER

First proposed in 2015, legislative initiatives for introduction of a tax on withdrawn capital in Ukraine have since then remained unsuccessful. Finally, the discussion grew more active with the publication of two drafts, one developed by the Ministry of Finance in the fall of 2017, and the other presented by the President in March 2018.

The main idea of the Draft provides for a tax on withdrawn capital to replace the corporate profit tax. To ensure the effectiveness of its adoption, the authors of the legislative initiative turned their attention towards similar
experience in Estonia.

The difference between the tax on capital drawn and the corporate profit tax is that the first one is not levied on profits received by the taxpayer, where the profit is equal to income minus expenses; in fact, it is levied upon the payment of dividends or making payments and transactions equivalent to the distribution of profits.
The draft introduces three basic tax rates: 5%, 15% and 20%.

The presidential initiative seems quite logical, since according to the provisions of Law No.1797-VIII of 21 December 2016, on implementing tax reform, the Cabinet of Ministers was obliged to submit the corresponding Draft Law to Parliament by 1 July, 2017.

However, the Draft has not still been submitted to Parliament. Moreover, work on the presidential draft was postponed due to the letter received from the IMF. The letter expressed serious concerns about the expected loss of state revenues, due to the absence of any reliable compensation measures in the draft, which would negatively affect one of the most ambitious goals of the IMF-supported program of Ukraine: to ensure tax stability.

With the annulment of corporate profit tax, corresponding advance payments of it would also be cancelled. Thus, the tax on the withdrawn capital greatly simplifies tax administration. Moreover, reducing the tax burden on business can really improve the investment attractiveness of Ukraine.

However, taking into account the practice of cooperation with the supervisory authorities and the provisions contained in the Draft regarding operations equivalent to withdrawn capital, even with a higher tax rate, we can expect increasing attention on the part of the supervisory authorities towards such operations.

Therefore, it is important for Ukrainian business to actively study the proposed innovations and carefully prepare to provide all the primary documents, reports, and contracts confirming payments and expenses.

On 7 March the Government submitted a whole package of Draft Laws (No. 8102, 8103, 8104, 8105, 8106), developed by the Ministry of Economic Development and Trade of Ukraine. They are related to protecting domestic manufacturers from dumping, subsidized imports and other negative phenomena. How do you assess these initiatives?

Anzhela Makhinova Partner, Sayenko Kharenko

It is evident that global trade is on the cusp of a new era of protectionism. We are currently witnessing the closure of foreign markets one-by-one via a variety of different vehicles, even those where compliance with the WTO rules is, at best, questionable. In very near future Ukrainian producers will, unfortunately, lose access to a number of their key export markets. In light of these developments, they must protect their internal market from imports. Trade defense remedies (anti-dumping, safeguard and countervailing) are the most efficient vehicles for the said purposes, which are directly allowed by WTO rules.

Ukraine adopted the relevant laws in 1998 on its path to the WTO. However, as of today, the said laws are very outdated and do not allow for the employment of the said remedies in an efficient way. Therefore, an initiative by the Ministry of Economic Development and Trade of Ukraine (i.e. responsible for conducting investigations in Ukraine) to elaborate a completely new legislative framework in this field is vital for Ukraine. Particularly:

under effective Ukrainian law, safeguards may apply even without unforeseen developments, causing a surge in imports that is in direct violation of Article XIX of GATT 1994. Moreover, Ukrainian law defines subsidies in a different way as compared to the WTO Agreement on Subsidies and Countervailing Measures and thus, considerably complicates application of countervailing measures as an instrument to counteract unfair imports. Draft Laws have brought said provisions into compliance with WTO rules.

Ukrainian laws in effect describe the investigation procedure in a very non-transparent manner. First of all, the laws in question do not define precisely stages of the investigation as well as terms of each stage. Secondly, one of the biggest problems is that effective Ukrainian legislation does not oblige the Ministry to cooperate with participants in the course of an investigation. Thus, in practice, participants of an investigation receive the conclusions of the Ministry only at the final stage of the investigation when it is virtually impossible to improve the situation. Moreover, the Ministrys disclosure comes in such a way that it is practically impossible to fully protect the interests of the participants e.g. calculations of individual dumping margins or of illegitimate subsidy amounts is not provided at all. The worst situation is with safeguard investigations, where the Ministry is not obliged to disclose its conclusions at all. Hence, the participants of any investigation may access them in the course of court proceedings only, even though Ukraine has already lost a case in the WTO
Japan vs. Ukraine passenger Cars, and such practice was declared illegal. Draft Laws completely change the current situation. In case of adoption of the current wording, Ukraine will eventually have a transparent and WTO compliant investigation procedure.

As of today, lots of provisions do not work at all due to the absence of procedural implementation rules, to name but a few: newcomers review and anti-circumvention investigation of the anti-dumping and countervailing duties, reviews of safeguard measures, etc. New Draft Laws will eliminate all relevant loopholes and will allow use of such mechanisms in an efficient way.

Draft Laws stipulate many progressive innovations. For example, it is set that the Ministry will be out able to initiate trade defense proceedings ex officio that is very important to react against urgent situations with unfair imports. In situations when a domestic industry consists of many producers and it is difficult to join all of them to ensure more than 50% support to initiate an investigation, the new Draft Laws directly enable application of selective methodologies to define the domestic industry. This is very important for such industries as footwear, furniture, food, etc. that are currently deprived of the opportunity to initiate trade defense proceedings. Moreover, Draft Laws briefly address market distortions similar to the new EU regulation to counteract hidden dumping e.g. in cases of dual pricing, etc.

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