The Devil Is in the Detail
In 2017, while reporting to the State Fiscal Service of Ukraine (SFS) about controlled transactions, representatives of the agricultural sector were supposed to use (for the first time) the list of goods with stock exchange quotation and the list of world commodity exchanges in order to determine the conformity of conditions of controlled transactions with the arm’s length principle.
The above novelties were preceded by two events:
- August 13, 2015 – The Law No. 609-VIII of July 15, 2015 supplemented Article 39 of the Tax Code of Ukraine (TCU) with Subitem 126.96.36.199, according to which in transactions with goods with stock exchange quotation one needs to apply the comparable uncontrolled price method and use the range of prices for such goods formed on the commodity exchange. The list of goods with stock exchange quotation and the list of world commodity exchanges were to be defined by the Cabinet of Ministers of Ukraine (CMU) by November 13, 2015.
- September 16, 2016 – The Resolution of the CMU No. 616 of September 8, 2016 determined the List of Goods with Stock Exchange Quotation and World Commodity Exchanges (hereinafter referred to as “the List”).
The goods exported by agricultural businesses in the largest volumes – wheat, sugar, corn, oats, barley, and rye – were included in the List as goods with stock exchange quotation. Thus, when compiling reports on controlled transactions for 2016, producers had to use data from the world exchanges defined by the List and compare their own prices with the prices formed on the stock exchange based on the comparable uncontrolled price method.
However, if we carefully analyse how these norms are applied, there immediately arise many details that are yet difficult to figure out.
Difficulties of Using the Prices of World Exchanges for the Ukrainian Market
Each agreement concluded on the world commodity exchange is characterised by its special conditions caused by the market participants’ demand and supply, which are different from those existing in Ukraine (conditions of delivery, qualitative characteristics of goods, terms of delivery, etc.). Also, trading on stock exchanges is carried out using the derivatives where, for example, futures are concluded not for the purpose of real acquisition of goods, but for getting profit from their so-called further resale via offsetting transactions. Moreover, the price of a derivative may differ significantly from the real value of the goods (the underlying asset), since the parties agree on the price at the time of its conclusion, and the product itself will be delivered in the future, when the real price of the asset on the market may be quite different.
The given situation has nothing in common with the fact that the Ukrainian AIC carries out export transactions, which are absolutely real and conducted under the conditions that differ from those offered by the world exchanges. Let’s try to figure out what options for actions payers have and what they can expect from their implementation.
Orientation to Stock Exchange Quotations and Adjustments
In the event transactions do not allow to fully compare the price in the controlled and uncontrolled transactions, a taxpayer may make adjustments to the divergent indicators of transactions (Subitem 188.8.131.52 of Article 39 of the TCU).
In the given situation, first, lack of information for adjustments and, secondly, dispute with the tax office as regards the acceptability of such adjustments and the selected range of prices in general can prevent the successful completion of the process of reporting on transfer pricing.
In the first case, it goes about the situation when, for example, we do not know what share of transport costs is included in the cost of goods, or it is impossible to determine precisely how the quality of goods in the controlled transaction influences its price, if the uncontrolled transaction involves products the quality thereof is determined by other standards. Unfortunately, the TCU does not include comments on how a payer should make adjustments to the indicators.
The second case relates to the fact that even if a comparative uncontrolled transaction has already been identified, adjustments have been made, a report has been drawn up, and documentation has been provided, there is no guarantee that the SFS will be satisfied with such data and will not propose its own version. Although currently there is no judicial practice of dealing with transactions with goods that have stock exchange quotation, from some examples of disputes it is possible to understand the conclusions made by the tax bodies when analysing price comparisons.
What Does the SFS Advise?
In its letter No.1021/6/99-99-15-02-02-15 of January 19, 2017, the SFS points out that the norms of the TCU do not contain restrictions on the use of forward or futures stock exchange quotations for calculating the price range in the application of the comparable uncontrolled price method for the purposes of this Subitem. The only important reservation is the restrictions of the period of stock exchange quotation of the respective goods, which should be used for the calculation of the range, namely, only stock exchange quotations for the decade preceding the controlled transaction (the date of transferring the ownership of the goods in a controlled transaction). Thus, the tax officers will pay special attention to the dates of conducting transactions.
The letter of the SFS No. 3698/6/99-99-12-03-07-15 of February 22, 2017 is devoted to the adjustment of transaction indicators. The controlling authority explains that the stock exchange quotations of a particular exchange should be used with due regard to the comparability criteria determined in Subitems 184.108.40.206 and 39.2.2 of Item 39.2 of Article 39 of the Code. In particular, the economic conditions of activities of parties to the transaction, including the analysis of relevant commodity markets (geographic location of the markets), which significantly influence the prices of goods, as well as characteristics of the goods that are the subjects to the transaction and are listed on the stock exchange. A payer has to provide explanations on the implementation of such adjustments in the relevant transfer pricing documentation.
Judicial practice: decision of the Poltava Circuit Administrative Court of May 25, 2017 in the case No. 816/515/17. In this case, the Court analysed the controversial transfer pricing report submitted in 2014, when there existed the list of official sources of information approved by the CMU for the comparison of transactions. It is interesting that the panel of judges came to the conclusion that “... taking into account the impossibility of ensuring comparability of controlled and uncontrolled transactions, the official sources of information specified in Subitem 220.127.116.11 of Item 39.5 of Article 39 of the Tax Code of Ukraine cannot be used for the analysis of prices in controlled transactions”.
Also, the Court was not satisfied with the arguments of the tax authority, because:
- “... none of these dates corresponds to the dates of conclusion of agreements, dates in January, and incompletely reflect the average monthly price of the goods”;
- “... the delivery basis indicated in the information available in the officially determined sources of information does not correspond to the delivery basis of controlled transactions, namely: the delivery in controlled transactions was carried out under the terms of CPT Elevator and CPT Port, while according to the officially determined sources of information the delivery of goods was carried out under the terms of EXW Elevator, CPT, FOB”;
- “... during the calculation of price variance from the level of normal prices, the controlling authority used different prices to deliveries under the same agreement”;
- “... during the price analysis, the lowest data on the terms of delivery of Franco-Elevator EXW was used, while the delivery under the terms of the agreements concluded between the plaintiff and Agrotech-Garantia, LTD was carried out at the expense of the seller, and the goods were delivered to the buyer’s address”.
The above decision was upheld by the court of appeal, which left the complaint of the SFS unsatisfied. Currently, the proceedings in the case are commenced at the High Administrative Court of Ukraine (HACU). We hope that the HACU will also come to the conclusion that the taxpayer has the right not to use the officially approved sources, in case it is impossible to ensure comparability of transactions, and also take into account the economic substance of the process of comparing.
The fact that the taxpayer provided the results of the expert analysis of the price terms of the agreement, under which the controlled transactions were conducted, and the opinion that the agreement prices remained within the market price range/interval at the time of conclusion of the contract, and that those were correctly taken into account by the first instance court deserves particular attention in this decision.
Thus, in the judicial disputes on the issues of transfer pricing, in particular, on the use of individual indicators in comparable transactions, it is necessary to provide additional evidence, such as the opinion of auditors, economists, etc.
Does the Taxpayer Have the Right to Use Another Method?
According to Paragraph 4 of Subitem 18.104.22.168 of the TCU, in order to apply any method, other than the comparable uncontrolled price method, it is necessary to submit to the SFS (by May 1 of the year following the reporting one) written information in no particular form with data on all persons, who are related to the taxpayer and participated in the chain of sale and purchase of such goods (up to the first unrelated counterparty). However, there is one thing to be noted: if, in the opinion of the tax authority, the above information is not enough, the payer will still have to compare prices in the transactions. Taking into account, in general, the SFS approach to assessing the completeness and credibility of the data provided by the taxpayer, we can conclude that there is little chance of obtaining the right to use another method.
Separately on Forwards and Futures
The pricing standards for transactions for goods with stock exchange quotations have been further amended. In particular, if the payer plans to conclude a forward or futures agreement, they have to notify the SFS within 10 days from the date of this conclusion. The form of such a notice was approved by the Order of the Ministry of Finance of Ukraine No. 621 of July 3, 2017, and has to contain information about the underlying asset, its code, volume, and value, terms of delivery in accordance with the Incoterms rules, as well as the terms of execution.
The amended rules, according to which the payers reported in 2017, are rather ambiguous; therefore, it is possible that new controversial issues with the supervisory authority will subsequently appear. In view of the existing judicial practice on transfer pricing, the obligation to prove the conformity of a transaction with the arm’s length principle is entirely placed on the payer. Therefore, chances of winning the case already in the court fully depend on how convincing and substantiated the legal position is.