Is it possible to use back-to-back loans in Ukraine?

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Tax optimization and tax planning in Ukraine (Digital Nomad)
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Many entrepreneurs still use so-called “intra-group mirror” loans in order to obtain financing in Ukraine. To put it simply, this is when an offshore company gives a loan to Cyprus, for example, and the latter, in turn, finances Ukraine. 

However, today the Ukrainian tax authorities are increasingly refusing to apply a reduced tax rate on repatriation of interest payments from Ukraine under this scheme. 

We will tell you why and give you our recommendations for finding a convenient, and most importantly safe, alternative.

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Why is back-to-back loans not the easiest option today?

The thing is that, on the one hand, the Ukrainian tax authorities began to more carefully check whether the recipient of income (Cyprus company) is the real final beneficial owner of the income, and not just an abusive tax shelter. 

On the other hand, the approach of the Cypriot tax service has changed. Thus, if until recently, the Cypriot tax authorities considered“back-to-back” loans acceptable, provided that the “minimum margin” (no more than 0.35% per annum) established by the tax authorities was settled in Cyprus, then in 2017, with the introduction of transfer pricing rules, everything has changed. The taxable margin was raised to 2%, and since then all transactions are checked for compliance with the “arm’s length” principle, i.e. one must prove that these transactions are concluded on market conditions and have economic feasibility. 

From now on, Ukraine’s financing through loans must be carefully thought through, estimating all the risks. 

From the point of view of the Ukrainian tax authorities, the “mirror loans” should be rejected in favor of alternative mechanisms, for example, the Notional Interest Deduction, which in our example involves “entry” of an offshore company in the authorized share capital of a Cyprus company, and then Cyprus provides a loan to Ukraine. In this scenario, Ukraine subsequently pays interest to Cyprus, and Cyprus pays dividends to its lender. 

This mechanism does not allow for complete avoidance of taxes (in Cyprus, they will still be paid at the minimum rate). But this option allows to avoid a mirror loan: the Ukrainian tax office sees that the ultimate recipient of the interest is Cyprus (not offshore), that Cyprus has a sufficient level of equity, and as a result, the application of a reduced rate of tax on the repatriation of DTT becomes a reality. 

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What can we offer entrepreneurs who previously used back-to-back loans?

Depending on the Client’s situation, we offer the safest and the easiest type of financing for the Ukrainian business. Today, the two best options are a contribution to the authorized share capital or a loan. 

Of course, when working out one or another scheme, we face a number of related issues that affect the choice of the scheme. For example, in the case of financing through a loan, we help to solve the following issues:

  • issues of applicable regulation in Ukraine, approval of the loan with the NBU: notification of the NBU via the servicing bank about the conclusion of a loan agreement with a non-resident, the maximum interest rates on loans with non-residents, the requirements of Ukrainian law to loan agreements; 
  • thin capitalization rules, which limit the possibility of charging interest to the company’s expenses; 
  • conditions which allow a reduced tax rate on repatriation in Ukraine. 

We may also develop alternative funding mechanisms (for example, using the mechanism of a “notional interest deduction” in Cyprus), which will provide a tax burden identical to that of the old mechanisms, as well as eliminate the risk of recognizing the Cyprus company as an abusive tax shelter.

Once the chosen scheme is developed, we accompany the implementation of the financing option. 

If you intend to contribute to the authorized share capital, we will provide comprehensive legal support of the following processes: 

  • company registration (setting the amount of authorized capital at the required level, taking into account exchange rate differences); 
  • opening of a bank account; 
  • preparation of documents for the bank for the transfer of the amount of the share capital to the account; 
  • the transaction. 

In the case of a loan, we will: 

  • prepare the necessary package of documents (a loan agreement that meets the requirements of Ukrainian legislation and the requirements of the Cypriot side, etc.); 
  • agree the package of documents with the servicing bank; 
  • develop a schedule for repayment of loans and interest;
  • help with the calculation of the amount that can be charged to the expenses of the Ukrainian company in interest payments;
  • accompany the very financing transaction; 
  • if necessary, we will monitor the timely repayment of the loan and interest, etc. 

A separate service, our company offers support services for the restructuring of outstanding loans to the authorized share capital of the Ukrainian company. As a result, a non-resident becomes a member of the Ukrainian company, and the Ukrainian company has no obligation to return the loan. In this case we offer the following services: 

  • preparation of necessary documents for the bank, as well as for the Ukrainian registrar; 
  • advising on taxation issues (loan and interest); 
  • legal support of registration of the change of members in the Ukrainian registry, etc. 

If you want to find the best option for financing your business in Ukraine, don’t hesitate to contact us. We help foreign and Ukrainian businesses even in times of war.

Please see the legal consultation fees here.

Everything about tax optimization schemes in Ukraine here

Publication date: 22/08/2022

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