How to avoid tax consequences of additional income accrual if a company sells real estate to an individual?

When a business entity sells real estate to an individual, there are three values associated with the property:

• The value stated in the sales agreement.
• The value at which it is recorded on the business entity's balance sheet.
• The market value (actual value).

Typically, both parties aim to complete the transaction at a price that aligns with the agreed-upon value in the sales agreement, which is usually lower than the market value. The key question is how feasible this is and whether it might attract any negative response from tax authorities or other regulatory bodies.

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Taxes on the sale of real estate for business entities

When a business entity sells real estate, whether it operates under the general taxation system or the simplified taxation system (also known as the single tax), there are significant differences in how the income from the sale is taxed.

For business entities under the general taxation system, the entire amount from the real estate sale is considered taxable income for profit calculation purposes, while the balance sheet value of the property is treated as an expense. Essentially, the profit tax is only imposed on the difference between the sale price and the balance sheet value. If the business entity is registered for value-added tax (VAT), an additional tax obligation arises, which is 20% of the balance sheet value of the property.

Business entities under the general taxation system are required to report the income from the real estate sale at a value no lower than the appraised value of the property. This means that they are legally bound to adhere to the real market value of the property.

However, in practice, this requirement is sometimes disregarded, and the sale is documented at the price specified in the sales contract. During an audit, such a transaction may result in the assessment of additional income (based on the difference between the sale price and the appraised value) and corresponding taxes for the business entity, including: 

• Corporate income tax at a rate of 18%.
• VAT at a rate of 20% (if the business entity is registered as a VAT taxpayer).

Additionally, according to tax laws, the business entity is obligated to act as a tax agent when there is a difference between the real market value and the contract price. In other words, the entity must withhold and pay a personal income tax (PIT) of 18% and a military fee of 1.5% from the individual buyer, referred to as additional benefits.

For business entities under the simplified taxation system, the taxable income from the sale of real estate is determined differently. If the property has been owned for no more than 12 months, a single tax rate (2%, 3%, or 5% depending on the chosen rate) is applied to the total sales amount. If the business entity, operating under the simplified system, has owned the property for more than 12 months, only the difference between the sales amount and the residual value of the property is included in the tax calculation.

Regarding the sale price for business entities under the simplified taxation system, the Tax Code does not require adherence to the condition of selling the real estate at a price no lower than its appraised value, meaning that the parties can execute the sales transaction based on the contract price without the need for an appraisal.

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What does this look like in practice?

Let's take a real-life example of a company called LLC "A" that decided to take advantage of the different tax approaches we discussed when selling non-residential properties (apartments) to individual buyers. After carefully examining the legal requirements related to property valuation and considering their VAT status as an active business entity, they realized that switching from the general tax system to the simplified system for just one transaction wouldn't be beneficial. As a result, they came up with two options:

1. Create a new company and contribute the apartments as part of its capital. However, this approach raises concerns about VAT payment because transferring assets from one VAT-paying company to another is considered a sale.

2. Establish a separate entity by spinning it off from the existing company and transferring the properties to it. Although this process is more time-consuming and complex than registering a new company, it offers the advantage of avoiding VAT on the transfer of real estate to the spun-off entity.

Ultimately, they chose the second option and later transitioned to the simplified tax system. 

The LLC successfully sold the properties without VAT, without the need for a formal appraisal, and at a price below the market value. The entire process was closely monitored by legal and accounting professionals. Once the objective of selling the properties without VAT and without reaching the market value was achieved, the spun-off entity concluded its operations after conducting a few minor transactions.

It is essential to determine the precise reason for selling the properties below their actual value, as it could be driven by either tax savings for the company (profit tax, VAT) or the buyer's financial capacity.

For instance, if the property's book value is 10 million UAH and the company sells it for 10.1 million UAH, the actual profit for the company would be 100,000 UAH, resulting in a profit tax of 18,000 UAH. Assuming the seller is not a VAT taxpayer, the profit tax might seem relatively small. However, the buyer might not have the necessary income to afford the property at the higher market value of 10.1 million UAH.

Nevertheless, it's important to note that selling properties below their real value can have some potential complications. Therefore, it's advisable to seek advice from professionals before committing to any specific sales scheme.

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