Accounting audit of atypical transactions in Ukraine

A successful business can be compared to a machine that runs in a continuous process. The coherence, clarity and simplicity of business processes allow a company to effectively perform tasks and achieve goals. To improve its activities, sometimes it is necessary to step away from the traditional system and involve a new (possibly one-time process) in the work of the company.

What do we mean? For example, a company sells services every day but increases its authorized capital only once in 10 years. Or a company has been operating for 20 years but has raised credit funds only 1 time during that period.

Each of these atypical operations should easily become part of standard operating procedures. But this requires the assistance of specialists.

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What is an audit of atypical operations and why is it used?

Atypical operations include:

• a company uses the property that does not legally belong to it;
• transfer of property to the capital of another legal entity;
• insurance of property interests and professional liability;
• sale or exchange of corporate rights; 
• assignment of claims;
• and many other transactions related to the activities of companies depending on the specifics of the business.

Atypical operations rarely occur in the history of a company. Many owners make the major mistake of giving the command to execute a particular operation without first auditing it for risks and tax loyalty.

Such an approach entails the following risks:

• undesirable additional taxation (for example, a payment was made first, and then it was discovered that the operation is subject to VAT);
• a specific interest of supervisory authorities (atypical operations are included in the list of risky operations).

To avoid such situations, we recommend conducting a preliminary express audit of atypical transactions before they are made.

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How does an atypical transaction with the exchange of corporate rights get audited?

Let's take the example of one of our Clients and see how the audit influenced the owner's decision.

A company that specializes in the construction of non-residential facilities is considering an option to barter its investment, in the form of a share in company A for a share in company D.

So, we need to:

• audit the transaction for riskiness;
• provide a tax calculation.

At the time of the client's application, his long-term investments (corporate rights in the form of a share in the authorized capital) were as follows:

• 48% of company A (the company owning real estate), which amounts to UAH 19,680 thousand; 
• 49% of Company B (the pharmaceutical production company), which amounts to UAH 3,920 thousand; and
• 24% of Company C ( the company owning industrial medical equipment), amounting to UAH 12,960 thousand;.

Our client is interested in the construction business project of company D, but the client is not ready to invest "real money" in the new business. As an option, we consider a barter scheme (exchange) of corporate rights in equal shares between our client and the founder of company D.

Our lawyers have developed the following plan of the audit of the transaction for the exchange of corporate rights:

1. Examine the legal possibilities of selling corporate rights.
2. Analyze the relatedness of legal entities involved in the transaction.
3. Prepare a calculation of the taxation of the transaction.
4. Make a list of documents needed for the transaction.

The purpose of this audit is to maximally explain to the owner the legal and accounting nuances, benefits, and risks of the exchange of corporate rights.

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Atypical operation audit stages

Let's take a closer look at the stages of our work.

Stage 1. Legal options for the sale of corporate rights

Share of the company (in this case we are talking about the most common business structure - LLC) may be sold under the following conditions:

• only fully paid (contributed to the charter capital) shares can be sold;
• all participants agree to the sale of this share (unless otherwise provided for in the Charter);
• other participants have waived their pre-emptive right to sell their shares;
• observance of other restrictions described in the Charter or internal company policies.

The members of all legal entities did not oppose the exchange of corporate rights. There were also no impediments from the constituent and internal documents. All shares of the companies were fully paid up (as confirmed by bank statements) and could be sold without restrictions on the amount of contribution.

Stage 2: Analysis of the relatedness of the legal entities involved in the transaction.

Our specialists requested ownership schemes for each of the members of a possible transaction. As a result of the analysis of these schemes, the relatedness of the persons has not been established.

This fact gives the opportunity to minimize the risks of the transaction, including without the analysis in terms of the application of usual prices between related persons.

Srage 3. Calculation of transaction taxes.

Income tax. The sale and exchange of corporate rights transaction is included in the company's income and is taxed according to generally accepted rules for taxation of financial income.

Profit received from the sale of corporate rights transactions shall be included in income, while the loss shall be included in expenses taken into account in determining the object of taxation.

VAT. Sale and exchange transactions on corporate rights (which are not securities or assets), according to the provisions of the Tax Code of Ukraine, are not subject to VAT.

Our client intends to exchange corporate rights for equal shares (in cash equivalent), namely to exchange: 29,5% (cash equivalent of UAH 12,095 million) of corporate rights of company A for 99,99% of corporate rights of company D (cash equivalent of UAH 12,095 million). After that, his long-term investments should look as follows:

• 18.5% of company A (the company owning real estate), which (after swap) amounts to UAH 7,584.6 thousand;
• 49% of company B ( pharmaceutical production company), which amounts to UAH 3,920 thousand (unchanged);
• 24% of company C ( the company owning the production of medical equipment), which amounts to UAH 12,960 thousand (unchanged);
• 99.99% of company D (construction business), which (after swap) amounts to UAH 12,095,4 thousand;

Exchange of corporate rights in equal shares:

• does not lead to a change in the amount of long-term investments of the company;
• does not lead to additional VAT taxation since it is not an object of taxation;
• does not lead to additional profit taxation, since income = expenses.

Based on the above data, such a transaction is the most profitable in terms of taxation.

Stage 4. List of documents needed for the transaction.

To conduct the transaction you will need:

• A statement notifying participants of the intention to exchange corporate rights.
• A statement of the participants on their refusal to acquire a share by pre-emptive right.
• Minutes of the general meeting of participants regarding the decision to exchange corporate rights.
• Exchange agreement.
• Introduction of amendments to the Charter, data of the Unified State Register of Legal Entities.

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Risks and benefits of the owner from auditing atypical operations

Positive results of the transaction's audit confirmed the owner's expectations, which led to the approval of the corporate rights exchange transaction.

Our specialists provided the Client with full support from initial consultation to the preparation of legal documents and accounting support of the transaction.

The main risks in this example were the owner's insufficient understanding of legal and accounting nuances, which could have entailed:

• violation of the transaction procedure;
• lack of legal documents confirming the legality of the transaction.

If you are a business owner, and you plan to conduct atypical transactions (those transactions that do not run on a regular basis and require additional analysis), we recommend that you conduct an additional analysis of the transaction for its taxation and legal validity.

This audit will allow you to minimize tax risks and time for the administration of the process.

You can find out the audit fees here.