In its Letter No. 406/6/9999150302-15 of January 4, 2018, the State Fiscal Service (SFS) of Ukraine expressed an interesting position, according to which domestic pharmaceutical manufacturers still have to pay VAT related to transactions that are clearly exempt from taxation by 2019. The SFS has come to such a conclusion following its “systematic interpretation” of the tax legislation, curiously enough, in its own favour.
The essence of the matter is the VAT taxation of transactions on supplying medicines/medical products in Ukraine by their manufacturers under agreements concluded with specialised procurement organisations. Clause 38 of Sub-section 2 of Section XX of the Tax Code of Ukraine (TCU) clearly stipulates that such transactions shall be exempt from taxation until March 31, 2019, provided a specialised organisation is included in the list according to the Law of Ukraine “On Public Procurement”.
According to the SFS, a pharmaceutical manufacturer has to accrue VAT liabilities pursuant to Clause 198.5 of Article 198 and Clause 199.1 of Article 199 of the TCU, since medicines/medical products start to be used in tax-exempt transactions. Proceeding from this position, manufacturers of medicines have to adjust the generated tax credit when purchasing raw material for producing such medicines.
In our opinion, such a position of the SFS is premature and does not comply with the norms of the Tax Code.
The norm of Clause 198.5 of Article 198 of the TCU, which obliges a taxpayer to adjust their tax credit, clearly stipulates that the adjustment of tax liabilities should be conducted in view of the tax base determined according to Clause 189.1 of Article 189 of the TCU.
At the same time, Clause 189.1 of Article 189 of the TCU establishes the tax base for goods/services – on the basis of purchase thereof. Herewith, Clause 189.1 of Article 189 of the TCU does not establish a separate tax base regulating the definition of the tax base for the direct production of goods, and not for purchase thereof.
In this regard, it is unclear how a pharmaceutical manufacturer should accrue VAT liabilities in case they supply their own manufactured products under supply agreements concluded with specialised organisations according to Clause 38 of Sub-section 2 of Section XX of the TCU.
Moreover, the application of the norms of Clauses 198.5 and 199.1 of the TCU in this case will contradict the basic principles of tax legislation.
In particular, according to Clause 4.1.8 of Article 4 of the TCU, the principles of taxation in Ukraine include the neutrality of taxation, that is, establishment of taxes and duties in a manner not affecting the increase or decrease in the competitiveness of a taxpayer.
At the same time, the application of the norms of Clauses 198.5 and 199.1 to Ukrainian pharmaceutical manufacturers creates competitive advantages for foreign manufacturers, which import pharmaceutical products from abroad under supply agreements concluded with specialised organisations, or further sell these products to such organisations, without paying any VAT liabilities.
Also, in view of the lack of clear rules for determining the tax base for the accrual of tax liabilities for the production of goods, we consider that the application of the norms of Clauses 198.5 and 199.1 to domestic pharmaceutical manufacturers supplying goods according to Clause 38 of Sub-section 2 of Section XX of the TCU will violate the principle of presumption of legality of decisions of a taxpayer, as enshrined in Clause 4.1.4 of Article 4 of the TCU.
In particular, according to Clause 4.1.4 of Article 4 of the TCU, the presumption of legality of decisions of a taxpayer shall apply, if the rule of the law or other regulatory legal act adopted on the basis of the law or the rules of different laws and different regulatory legal acts allow for ambiguous (multiple) interpretation of the rights and duties of taxpayers or regulatory authorities, leading to possibility to take a decision in favour of the taxpayer as well as in favour of the regulatory authority.
Based on the analysis of the above norms, we can conclude the following:
1. Transactions conducted pursuant to Cause 38 of Sub-section 2 of Section XX of the TCU are exempt from VAT, and there is no obligation to pay it. That is, when domestic pharmaceutical manufacturers supply their products under agreements concluded with specialised organisations according to the requirements of Clause 38 of Sub-section 2 of Section XX of the TCU, no VAT should be accrued;
2. Application of the norms of Clause 198.5 of Article 198 and Clause 199.1 of Article 199 of the TCU to transactions specified in paragraph 1 (above) will contradict the general principles of the tax legislation of Ukraine.