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Associate Partner, Tax & Law, People Advisory Services, EY Ukraine
Manager, Tax & Law, People Advisory Services, EY Ukraine
Personal Income Tax Compliance
With recently adopted controlled foreign companies (CFC) tax rules Ukraine has taken another step in the direction of tax transparency and deoffshorization. The new CFC rules will affect Ukrainians and foreigners, who became Ukrainian tax residents, and who own companies abroad. The said rules will put additional reporting obligations and potential tax burden on the individuals and shall come into effect, at least partially, starting 1 January 2022.
In this article we shall take a look at who is liable to file a personal tax return in Ukraine, how various income types are taxed in Ukraine, how to claim a tax discount if you have eligible expenses and will take a deeper dive into the new CFC legislation, including new types of reporting for individuals.
When Do you have an Obligation to File a Personal Tax Return
Compared to other countries of the European region, it is not that common for private individuals in Ukraine to file annual personal tax returns. According to the tax authorities’ statistics only around 572k private individuals filed annual personal tax returns in Ukraine in 2020.
However, what not many people know is that it is a constitutional duty of citizens to submit the tax return to the tax authorities each reporting year, but according to the tax law the duty is deemed fulfilled if all the individual’s taxes were already paid to the state budget by the tax agent, e.g. when employers remit taxes from employment income under Pay-As-You-Earn system, or when banks remit taxes from an individual’s interest income.
Still, an obligation to submit an annual tax return remains, among others, in the following cases:
- when an individual receives taxable income not from tax agents (e.g. from other individuals);
- when an individual receives income from transactions with investment assets;
- when an individual receives income from abroad;
- when a foreigner becomes a Ukrainian tax resident;
- under the CFC tax rules.
Even if a taxpayer’s obligation to submit a tax return is deemed fulfilled, a taxpayer may choose to submit a tax return voluntarily. For example, if one wants to claim a tax deduction and receive a rebate from the tax authorities.
It is important to remember that Ukrainian tax residents pay taxes on their worldwide income, whereas tax non-residents only out of Ukrainian-sourced income (i.e. income derived from activities performed on the territory of Ukraine, including remuneration paid by non-Ukrainian employers for work in Ukraine).
How Income is Taxed
The general tax rates applicable to most types of income are 18% personal income tax (PIT) and 1.5% military levy (ML). However, certain types of income are taxed at 0%, 5% or 9% tax rates.
Employment Income and Foreign Income
These income types are taxed at the general tax rates — 18% PIT and 1.5% ML. Taxable employment income consists of all the individual’s remuneration, including salary, bonuses, premiums, as well as most of the additional benefits, such as hardship and cost of living allowances, compensation for children’s education, meal allowance, etc.
Certain additional benefits provided by employers may be exempt from taxation in Ukraine, such as, among others:
- amounts paid to Ukrainian educational institutions to cover educational costs for the training of their employees connected with business activities, subject to certain limitations;
- amounts paid to cover medical assistance to employees, subject to certain limitations;
- contributions to non-state pension funds, subject to certain limitations.
Passive income in the form of royalties and capital gains, as well as interest income received by individuals from deposits in Ukrainian banks, is subject to tax at the general tax rates of 18% PIT and 1.5% ML. Dividends received by individuals from resident companies are taxed at 5% PIT and 1.5% ML, while dividends received from non-resident companies or collective investment institutions are taxed at 9% PIT and 1.5% ML.
Income from Government Bonds
Previously income derived from government bonds was exempt from personal income tax but was still subject to 1.5% ML taxation. According to the recently adopted tax changes, such income is now completely tax-free, which makes this financial instrument more attractive to investors than regular bank deposits.
Income from the Sale of Movable and Immovable Property
The first sale of a car, motorcycle or motor bicycle during the year is exempt from taxation. Otherwise, the income is taxed at the 5% rate.
The first sale of immovable property, such as, for example, residency house, apartment or a single room is also tax-exempt, however, only under the condition that the seller owned the respective property for more than 3 years before the sale (the 3-year ownership condition is not applied if the property is inherited). Otherwise, the income is taxed at the 5% rate.
What if a Person already Paid Taxes Abroad?
Ukraine has signed Double Taxation Treaties with a large number of jurisdictions, aimed at the elimination of double taxation of income.
Using the provisions of the Double Taxation Treaty between Ukraine and the respective foreign jurisdiction, an individual, who is a Ukrainian tax resident, may apply foreign tax credit towards Ukrainian taxes levied from the income, which was already taxed abroad. This means that the Ukrainian personal income tax liability may be decreased on the amount of taxes paid by an individual abroad (but in any case, may not be less than zero). That said, Ukraine does not allow foreign tax credit against the military levy.
The procedure of claiming foreign tax credit in Ukraine is more burdensome compared to other European countries and requires obtaining official proof of taxation from the foreign tax authorities, which is to be further legalized or apostilled abroad, then translated into Ukrainian and notarized. This may create a problem with crediting taxes paid in certain jurisdictions, where the tax authorities either do not issue a proof of taxation or issue it only in electronic format, which renders impossible further legalization or apostillization of the document, which is the case with the US.
How to Claim a Tax Deduction
Claiming tax deduction allows receiving a rebate if a taxpayer bore certain eligible expenses during the year. Practice shows that this instrument remains largely underutilized, either because taxpayers are not aware of such possibility or because many think that the process is rather burdensome, which overweighs the potential benefits.
However, for some expenses, a rebate may be quite significant and the process itself mostly narrows to the collection of the documents confirming expenses, such as agreements and payment receipts, and further filing of the tax return with the tax authorities.
Moreover, the deadline for filing a tax return claiming a tax discount is 31 December of the year following the reporting one, contrary to the standard tax return filing deadline of 30 April, which means that there is still time to claim a tax deduction for expenses made in 2020.
The most common grounds for claiming a tax deduction are expenses for a taxpayer’s or his/her immediate family members’ education in Ukrainian universities, schools, kindergartens, as well as expenses with regard to mortgages on immovable property located in Ukraine. However, the list of allowed expenses is much larger, including, among others, charity, long-term life insurance contributions, state services related to adoption, re-equipment of a vehicle to run on biofuel.
The tax authorities process a tax discount claim within 60 days from receipt of the tax return.
Who will be Impacted by the New CFC Tax Rules
The CFC tax rules put new reporting obligations on taxpayers, who have business structures abroad. Any foreign legal entity or entity without legal personality, such as trust, partnership or investment fund, controlled by a Ukrainian tax resident (individual or company) falls under the CFC rules.
Starting 1 January 2022 individuals, regardless of whether they are considered as controllers of a CFC, would have to notify the tax authorities about any direct or indirect acquisition or sale of a part in a foreign legal entity, establishing a legal entity, liquidation of a legal entity. The respective notification should be filed within 60 days from the respective action.
To be considered as a controller of a CFC, the tax resident should meet one of the following criteria:
- hold more than 50% of shares in a CFC
- hold more than 25% (10% or more — after 2023 reporting year) of shares in a CFC, provided that Ukrainian tax residents cumulatively hold 50% or more
- solely or jointly with other Ukrainian tax residents control a CFC, meaning that an individual has a significant or decisive impact on a CFC’s decisions to conduct transactions, manage assets and profits or terminate business.
Controllers of CFCs are liable to pay taxes out of the CFCs’ adjusted profits proportionally to their shares and report such profits in the annual tax return. A CFC’s profits distributed to the controller are subject to 9% PIT and 1.5% ML. Profits derived from dividends paid by the Ukrainian entity are subject to 5% PIT and 1.5% ML.
The controller is not liable to calculate the CFC’s adjusted profit if it is exempted from taxation under the following conditions:
- CFC is registered in a state which is a party to DTT with Ukraine;
- CFC pays corporate income tax at the rate not less than 13% or if less than 50% of CFC’s total income is passive;
- total income of all CFCs controlled by a Ukrainian resident is less than EUR 2 million;
- CFC is a public company, whose shares are listed at one of the recognized stock exchanges;
- CFC is a philanthropic organization and does not distribute profit to its beneficiaries.
Nevertheless, the controller is still liable to file two types of CFC reports — simplified and complete.
In conclusion, although the deadlines for CFC reporting were extended several times already, individuals who have business structures abroad should already start preparing for the new tax rules, analyzing whether the said business structures fall under the CFC definition and what reporting is required. It may also be the best time to think about potential business restructuring or shifting tax residence from Ukraine to another jurisdiction.