During tax audits, the tax authorities often raise questions regarding the justification of the reality of a company’s business operations, including with reference to the “business purpose”. In order to avoid adjustments to expenses and additional income tax charges due to the inability to substantiate your position to the tax authorities, we recommend that you read the information below.
The Tax Code of Ukraine (the “TCU”) stipulates that a reasonable economic reason (business purpose) is a reason that can only exist if the taxpayer intends to obtain an economic effect as a result of business activities (sub-clause 14.1.231 of clause 14.1 of Article 14 of Section I of the TCU).
At the same time, the characteristic features of the economic effect are:
- increase in assets (their value);
- preservation of assets (their value);
- creating conditions for the growth (preservation) of assets in the future.
Please note that the absence of an economic effect does not indicate the absence of a business purpose, since the key to the concept of a business purpose is the intention to obtain an economic effect. At the same time, the taxpayer is not relieved of the obligation to properly substantiate the objective reasons that led to the absence of such effect.
The tax legislation identifies the following grounds for a transaction not to have a reasonable economic purpose (business purpose):
- If the main purpose or one of the main purposes of the transaction is non-payment (incomplete payment) of taxes and/or reduction of the taxpayer’s taxable profit ( subpara. 4 of subpara. 14.1.231 of para. 14.1 of Article 14 of Section I of the TCU);
- if in comparable circumstances the person would not be ready to purchase (sell) such goods, works (services), intangible assets, other items of business transactions other than goods from unrelated parties (subpara. 5 of subpara. 14.1.231 of para. 14.1 of Article 14 of Section I of the TCU), for example:
–if a certain transaction differs from those transactions carried out by the taxpayer in the ordinary course of business (differences in the essential terms of contracts, functions of the parties to the transactions and risks assumed by the parties).
— in case a certain transaction of the taxpayer differs from those that other taxpayers usually carry out within the same type of activity as the taxpayer.
— in case of acceptance by the taxpayer of risks which he cannot control.
–In the event of a significant difference in the timing of fulfilment of obligations under the agreements, if the taxpayer does not receive adequate compensation for the risks assumed in any form.
The concept of business purpose is applied in the context of tax legislation:
- to controlled transactions;
- when making adjustments to the financial result of uncontrolled transactions with non-residents registered in jurisdictions specified by the Resolution of the Cabinet of Ministers of Ukraine No. 1045 dated 27.12.2017 and non-residents that do not pay income tax (corporate tax) in accordance with the Resolution of the Cabinet of Ministers of Ukraine No. 480 dated 04.07.2017;
- in transactions of royalty accrual in favour of non-residents.
To properly substantiate the existence of a business purpose, we recommend preparing an appropriate evidence base in which to investigate and disclose the goals, intentions and expectations of the business transaction, for which:
- Prepare documentation to confirm the reality of the transaction: a duly executed contract, documents providing information on the circumstances and conditions of the transaction (specifications, additional agreements), payment documents on settlements, terms of transportation, customs declarations, etc;
- Develop documentation to confirm the economic feasibility of the transaction: business plans, justification of the work model (feasibility of involving intermediaries, justification of purchase prices, etc.), review and analysis of market conditions (to justify the purchase of goods (services) on certain conditions), calculations of possible losses, a list of measures in case of loss-making transactions, correspondence with counterparties, calculations confirming the growth of the company’s financial indicators, increase in profitability, etc.
We can conclude that the subjective factor (goals, intentions and expectations) plays a key role in the concept of business purpose.
That is why, in order to successfully justify your position before the tax authorities, you need to document the terms of the business transaction in detail, form the necessary evidence base, analyse business plans and assess the economic effect in the context of all participants involved in the business transaction.
The Smartsolutions team is ready to provide you with high-quality legal support and prepare a proper justification for compliance with the concept of business purpose in business transactions.
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