Trust and Confidence
With the rapid changes in Ukrainian legislation, rules of doing business undergo the same dynamic mode. This results in the necessity to keep a close eye of adopted novelties and examine their application in practice. The UJBL conducted a fruitful discussion with Yaroslav Romanchuk, managing partner of International legal center EUCON and chairman of the Public Council at the Ministry of Revenue and Taxes across sensitive regulatory achievements and current state of play.
UJBL: How would you evaluate the current legislation of Ukraine in the area of corporate relations?
Yaroslav Romanchuk: Ukraine lacks an efficient corporate law doctrine. The legislation in this area develops randomly, spontaneously, without a systematic approach. It misses areas of law or superstructures with the secure mechanisms protecting asset ownership.
UJBL: In other words, owners of corporate assets are not protected?
Y.R.: I would put it in a less dramatic way. They are not fully protected. Ownership is very sensitive, and therefore it is very attractive to all kinds of “collectors” of somebody else’s assets. Until recently, all those involved in business were thinking how to make money, how to accumulate capital, and no one in particular thought about another important objective — assets protection.
UJBL: And what are the options in protecting corporate assets?
Y.R.: Ukraine does not have “assets protection” as a separate legal practice. At the same time, the international practices developed a whole distinctive area called Asset Protection. The concept of protection planning should be based on legitimate and legal basis and it should not breach rights and interests of third parties. We have developed a range of preventive measures for corporate security. Our main objective during its implementation is not to do harm. When planning measures to protect against hostile takeover of assets, one should not forget the importance of protecting business owners themselves. A common form of corporate warfare is starting two simultaneous “fronts” — against the company and against its owner. Currently, joint stock companies are the most vulnerable in terms of organizational forms. However, one should understand that the “right” legal organizational form does not completely protect business owners against possible takeover scenarios.
UJBL: And how are JSCs vulnerable?
Y.R.: I have to admit that stock companies make a progressive form of business organization, especially for those who plan IPO. Currently in Ukraine, after corporatization and privatization of state-owned enterprises, there are about 28 thousand JSC, and the vast majority controlling shareholders did not do anything to minimize the risk of hostile takeovers. This way or other, each JSC has its real owner, who receives economic benefits from using assets of the company and minority shares. The latter is a litmus test for raiders. I call them “professional hunters”. In their practice they use loopholes in the legislation, naivety, negligence, carelessness of owners of corporate assets. Skillfully and professionally, they use the legal system to find ways to identify and seize valuable assets. The business based on shareholding in Ukraine is a factor that makes a company vulnerable and less protected against hostile takeovers. Therefore, my advice is if you do not dream of international listings, “run away” from the joint stock form as soon as possible.
UJBL: Is it only in view of raiders that you need to protect assets?
Y.R.: Of course, not. A hostile takeover is only a special case in the sense of logic of the property redistribution process. The fact that you have valuable assets is known and remembered by creditors, competitors, senior managers, employees, relatives, neighbors, wives, mistresses and lovers, etc. All of them can potentially claim your property. Therefore, planning of the protection strategies should occur in a tranquil setting with a careful analysis of possible risks. This is possible only when there is understanding and desire of the owner, a professional legal adviser, and full mutual trust between them.
UJBL: What is problem of a business based on mutual trust of its owners?
Y.R.: Trust in business is the basis of relations between owners, but such relations sooner or later come across a conflict of interest within a company. Therefore, you need to come to an agreement “on the shore” before getting aboard the boat, and not then when you reach the middle of the river. The basis for this should be agreements set forth in writing, based solely on the law and prepared by professional legal counsels. In my strong opinion, there is no alternative to the system of ownership, corporate assets protection other than on the formal and legal basis.
UJBL: How to avoid risks and eliminate involvement in redistribution process?
Y.R.: “Redistribution” of property is a continuous historical process when ownership is regularly transferred from weak to stronger owners. These are objective things and they are inevitable. And, of course, they are influenced by political, macro- and microeconomic processes. But the owners of corporate assets should understand and realize that in today’s environment, security of their assets is the main priority, and they have to decide themselves, if they are able to accomplish this task, or if they need to engage external advisors. If one does not care about risks, they inevitably occur; it is only a matter of time. Understanding the logic of “redistribution” of property is very important for developing a protection strategy planning.
UJBL: What are the main mistakes business owners make?
Y.R.: I believe that all first mistakes are not of legal or economic origin. They come down to a few things: too much self-confidence, innocence and a desire to always negotiate with the authorities, including law enforcement agencies, even if they are outside the legal field. By and large, this is not even the fault of business. It is rather the global problem of the country, where the system has been developing for years and prevented investments to the economy. When one talks to business owners, senior executives, one understands that the majority of mistakes they make are made contrary to their will. Everybody has learned that a successful business depends on administrative resources and businesses targeted government, but there is little room there, so mainly representatives of big capital get there. And this alliance of large capital and administrative resources creates the nuclear power capable of absorbing any successful business that does not have such resources.
UJBL: You depicted a gloomy picture. Is it all so bad?
Y.R.: It was not me who made the picture. It evolved as a result of the failing legal system, legal nihilism, office abuse, and the problems with protection of rights and interests in courts. But it is not totally bad, as there are other options. One needs to use countermeasures, asymmetric technologies, which we as a team of lawyers and auditors proved to be true more than once. Although I believe that the protection of assets should begin from the moment a company is established, and one should not mix asset ownership with operational business, there should also be diversification of both assets and risks. In the current situation, I like the formula “run the business without possessing assets”. Because, if you do not own something, no one can take it away from you.
UJBL: Every company has intellectual property rights. Historically, business owners lack proper attention to protection of intangible assets, which include, in particular, intellectual property. Why is that?
Y.R.: Indeed, the value of assets of a business is determined also by its intellectual products. In my opinion, this attitude of business owners is caused by the lack of understanding of the importance and economic value of intellectual property. We were one of the first firms to offer our clients not only the search for intellectual property rights and registration, but also their “economization”.
UJBL: What do you mean by “economization”?
Y.R.: Assessment of intellectual property, introducing it to the balance sheet as intangible assets to increase capitalization of the entity, investment attractiveness. The assessed intellectual property objects may serve a contribution to the share capital; they can be a collateral to receive a bank loan. An owner of intellectual property may execute a license agreement, assign his rights, and get paid royalty.
A very important aspect is the use of assessed intellectual property objects for tax planning. Sometimes, a client would address us when there is already an infringement of its intellectual property and the client needs protection.
UJBL: Do clients often demonstrate demand for this new area of practice? When was the last time you did this kind of audit?
Y.R.: I would not say this is a separate area of practice. Our company specializes mainly in the areas of tax, corporate, international private law, and asset protection. Therefore, HR audit is our option we additionally offer to our clients, and quite often clients request it themselves.
When they receive legal support on the permanent basis, clients tend to secure their businesses in all areas, including in the HR area. Because, as you would agree, there are no trifles in asset protection. And that is our approach.
UJBL: Recently media published your articles on labor relations. Was it caused by frequent “conflicts” of your clients with labor legislation?
Y.R.: An illegally dismissed employee, a short delay of payroll, an improperly designed staffing, — all these would not constitute a significant threat to businesses. That is the way the majority of our domestic clients think, and therefore they believe it is possible to address these issues at the corporate level. However, the current changes in the labor legislation require better attention to the labor relations area. More powers of regulatory bodies, higher penalties, enabling employees to squeal on their employers, legislation on “bleaching” wages — these are just a few “incentives” that draw attention of employers since recently. We need to understand that the problem of filling the state budget is being solved in all directions. And the business is constantly keeping abreast of the pursuit of profit and therefore it cannot be ready to face an attack from the “rear” of labor relations.
UJBL: And what about the powerful HR departments of major companies? Aren’t they created for the owner to be confident that everything is OK in that sphere?
Y.R.: Sure, that is the purpose they are created for. However, experience shows that even in the companies with strong HR departments not everything is as good as it sounds. I am not even sure what reasons are predominating: the lack of time to keep track of current legislative changes, ignoring the legal regulations, or elementary negligence. As an alternative to the audits by supervisory authorities, we offer our clients our HR audit.
I should admit that during that audit, our experts identify the threats that arise not only from violations of labor laws, but also those that may give grounds for law enforcement agencies to conduct inspections based on evidence of crime. On the other hand, based on the audit we point out the aspects that may lead to claims by employees.
UJBL: Not so long ago the legislation was enacted humanizing responsibility for economic crimes. Don’t you think that the legal support is no longer needed for such crimes?
Y.R.: Not only me but probably the majority of professionals providing services in this area would disagree. Of course, the mentioned legislation brings elements of humanity. For example, the large scale tax evasion does not imply huge risk of imprisonment for ten years any more, and a person would need to pay a fine of up to half a million Hryvnas. At the same time, one should understand that all that is not as good as it seems at first glance. Firstly, when one fails to pay a penalty, imprisonment is still possible. Secondly, apart from the humanized economic crimes, there is a number of other offenses that are similar with commercial ones (e.g., misappropriation, embezzlement through office abuse of his office, fraud, forgery, use of forged documents, etc.). But punishments for such crimes are far from being humane ...
UJBL: Starting on September 1, amendments to the Tax Code regarding transfer pricing became effective. They dramatically alter application of the usual prices. What transactions would the new legislation apply to?
Y.R.: Now, the main two groups of controlled transactions are those with related parties and non-residents. And control applies both to resident related parties and non-resident ones. The only exception will be those related entities residents of Ukraine, who pay income tax at the main rate, stay with the common system of taxation at the beginning of the year, and declared the negative value of income taxation for the previous year. Agreements with non-residents, who are not related parties, get into the category of controlled ones, if in the home country of the non-resident the income tax rate is lower for five percent or more than in Ukraine. For controlled transactions there is a threshold of UAH 50 million for each counterparty in a single calendar year.
UJBL: Does it imply that the usual price for VAT and income tax purposes will be applied only in the case of controlled transactions?
Y.R.: Yes, it does. If the transaction you make is not a controlled one, the taxable amount is determined based on the contract price.
UJBL: How would a taxpayer know if he need to apply transfer pricing rules?
Y.R.: If a company makes transactions within a group and operates under foreign trade contracts, I would advise to promptly conduct an audit of the volume of the transactions and compliance of the counterparties with the established criteria.
UJBL: How will this threshold of UAH 50 million be calculated in 2013, since the legislation becomes effective on September 1 and would cover the period of 4 months?
Y.R.: The taxpayers will need to consider volume of transactions with each counterparty for the entire calendar year, because the act does not provide for any recalculation proportional to the number of months. Also, one needs to remember that all transactions related to purchases and sales of goods, works, and services are summed up.
UJBL: What are the methods to determine the usual price?
Y.R.: These are the same five methods of determining prices, as provided for in the version of Article 39 of the Tax Code of Ukraine effective as of 1 January 2013. Only now the algorithm of their application is described with more detail, which will allow applying them in practice. A taxpayer may use any of these methods, but if there is a possibility of simultaneous application of comparative uncontrolled price (similar sales) and any other method, one should use the method of similar sales. I should admit that these pricing methods are established solely for tax purposes concerning controlled transactions and they should not necessarily be used to come up with the price in an agreement. But practice demonstrates that many companies calculate the price of agreement with their help, and later they are not willing to adjust the tax base.
UJBL: When is the first report on the controlled transactions due?
Y.R.: The reporting period for the purposes of tax control is the calendar year. The report for 2013 shall be submitted to the Ministry of Revenue and Taxes in electronic form before 1 May 2014.
UJBL: There was active discussion on the amount of penalties for violation of the legislation on transfer pricing. What are the penalties provided for in the legislation?
Y.R.: A penalty of 5% of the total amount of the controlled transactions will be charged if a taxpayer fails to submit the report and 100 minimum wages — if he fails to submit the documentation. According to the legislator, such penalties should discipline taxpayers and make the failure to report disadvantageous.
UJBL: In what cases documentation should be filed to verify the level of the usual price?
Y.R.: Those, who have followed evolution of the legislation on transfer pricing, would recall that earlier it provided for mandatory filing documentation by large taxpayers at the time of reporting. The current provisions require submission of the documentation only if requested by a controlling agency. Large taxpayers submit the documentation within two months from the date of such request, and all other taxpayers within one month. The form of documentation is optional. But in case of large taxpayers, the documentation should contain the information specified by law. These are data on related persons and groups, a description of the transactions, their terms, and the factors that influenced the price, data of economic analysis, and much more.
UJBL: Would our taxpayers be capable to cope with the methods of pricing and preparation of the documentation? After all, it is quite serious analytical work that requires some expertise.
Y.R.: Of course, justification of the agreement price and development of the appropriate documentation requires not only knowledge, but also some creativity, a capacity to make independent judgments and choices. This somewhat changes the idea of taxation, because this is the first time that an accountant, who was accustomed to strict adherence to the legislation before, is now given some freedom in choosing the method of pricing, conducting a comparative analysis and making adjustments in the process of comparing the prices of controlled transactions. Now, the main thing is to properly justify the price and the method of justification. It is necessary to learn quickly because the legislators did not leave any time for preparation. By the way, EUCON made a decision to become a cofounder of the Transfer Pricing School together with our partner — the International Auditing Union. This fall, we plan to start classes that would focus on rules and transfer pricing methods. The school will be free for attendees.
UJBL: What was your goal, when you started the transfer pricing school?
Y.R.: First of all, we plan to arrange a course of lectures and trainings for our clients, as many of them are large companies engaged in transactions that fall into the category of controlled transactions. We see that financial and accounting departments are not ready for the new tax rules and therefore we decided to share our experience. We are not going to restrict the school only to our clients, and we invite to the course heads of financial and accounting departments of other companies.
UJBL: Do you think that the new legislation contains answers to all questions that taxpayers may have during application of its rules?
Y.R.: The time will show how perfect the legislation is. In my opinion, there are some norms that require revision and clarification. For example, it is unclear how the norm will be applied for recognition of relied persons not only based on formal signs, but also in cases when there is a possibility that one person may influence decisions of another person. Who would decide that such a possibility exists, or decide that persons are related in such a situation? Would the court, a controlling agency, or a taxpayer himself assess, who can influence his decisions? There are also other aspects that require clarification or procedural regulation. Apart from that, we expect that the Cabinet of Ministers of Ukraine will soon develop and approve a number of additional documents, methodologies, and calculation procedures specified under the transfer pricing legislation.
UJBL: You are the chairman of the Public Council at the Ministry of Revenue and Taxes. Are you able to somehow influence improvement of certain provisions of the Act?
Y.R.: Of course. The Public Council has a Commission on Taxation and Customs Policy that actively works in this area. There is a group dealing with implementation of the legislation on transfer pricing, which accumulates and examines all proposals. Subsequently, the proposals will be sent directly to the legislators.
UJBL: What would you recommend to taxpayers at this time, what actions should they take in the first place?
Y.R.: I believe that they should get ready, not waiting till the end of the reporting period. Companies should develop their internal policies for the purposes of the transfer pricing. It is better to monitor transactions and document evidence of the level of prices during the agreement implementation. Because the tax liability based on the usual prices would need to be declared right away. As to VAT, we do it every month during the year, and each quarter concerning income tax. And later adjustments of already submitted declarations might result in fines.
UJBL: You are the Vice President on Tax and Customs of the International Chamber of Commerce (ICC of Ukraine). Do you have any information on how this issue is regulated in other countries?
Y.R.: I should mention the ICC is the International Chamber of Commerce with a network of national committees in 94 countries with its headquarters in Paris. I am also a member of the ICC Commission on Taxation. The most recent meetings that I attended last autumn in New Delhi (India ) and in spring in Paris (France) were mostly dedicated to the transfer pricing, the fair share of tax payment. Now, it is a global trend.
UJBL: But representatives of business and accounting professionals are not ready for such innovations, and the majority of them do not understand the concept of “transfer pricing”. Do we need to be in hurry with that?
Y.R.: All I know is the Act will be passed soon; I can see that there is political will despite the strong opposition of business.
Understanding this, we will try to help businesses. Together with our international colleagues, we decided to establish the Transfer Pricing School, which will opened in September. Well-known domestic and foreign experts of tax law will teach in the school. Larisa Vrublevska, a recognized expert in Ukraine will manage the School. The main good news for businesses, financial and accounting departments is that the school is free.
UJBL: In one of your speeches you assumed that after this Act is passed all litigations on void legal transaction will recede into oblivion and will be replaced by disputes of taxpayers and tax authorities on the usual prices and transfer pricing.
Y.R.: It’s true. Currently, there is an immense number of disputes on seeking transactions void and charging additional taxes. Very often, these are groundless decisions of the tax authorities that are later cancelled by courts. From my own experience and practices of our company, in 2011, 2012 and in the first half of 2013, we won 98% of all disputes. In early 2013, we worked with more than sixty administrative cases in courts. If all goes well, by the end of the year we will reach the amount of one billion Hryvnas. This is the amount we are going to “win back” in favor of taxpayers.
I do believe and hope that over time this category of disputes will decrease, because businesses work with their counterparties with a more legally balanced approach, thoroughly check them, and the tax authorities gain experience, and analyze the cases they lost.
UJBL: On June 20, together with the London Centralex you held a conference on transfer pricing in Ukraine. What are your plans for the future?
Y.R.: The conference turned out to be very interesting in terms of its content and participation of professional speakers from the Ministry of Revenue and Taxes, Ukrainian specialists, and international experts. We consider an option of holding such a conference every year.
On 27 September, within the Tax Forum II, where I chair the organizing committee, one of the discussion panels will cover application of the transfer pricing legislation. And I can say for sure, that transfer pricing issues will have a significant share of our tax practice.
UJBL: And a few words about your social projects.
Y.R.: Based on our initiative and support, there is a three month internship program for the students of the Law School of the Shevchenko National University in the European Parliament (Brussels, Belgium), including in the office of Marek Sivets. We have a three-tiered selection of applicants to participate in this project. And students also receive a monthly scholarship of EUR 800.
Over the last two years, we support and sponsor the classic tournament of court debates related to the civil and land law. The All-Ukrainian Tournament is held at the Law School of the Shevchenko National University with the participation of law students from all over Ukraine. Winners are awarded prizes and the best player of the tournament has an opportunity of one month internship in one of our offices.
Thank you for the congratulation. All ratings are to some extent subjective. The best and the most pleasant reward is clients’ gratitude for the quality of performed work, and especially when you they say: “We believe in you, we trust you”. When there is trust there is confidence of a positive result.