Volkov & Partners

About Us

Volkov & Partners
Our Clients
Ukrainian Digest of International Trade Law

  Download PDF Brochure



 ENG   РУС  УКР   
About UsOur PracticeLawyersCareerNewsSearch
Home  / About Us

Publications - Deemed interest: cross-border elimination of tax liabilities

Deemed interest: cross-border elimination of tax liabilities

Journal "The In-House Lawyer", #163, September 2008

IN THIS ARTICLE WE WILL EXPLAIN THE procedure and legal grounds for charging deemed interest on an interest-free loan provided to a resident of Ukraine in accordance with Ukrainian legislation.

Under Ukrainian law companies may be financed either by means of equity, share capital contributions, or through debt financing, usually by a parent-company loan. Interest loans or interest-free loans may be provided by local or international companies. For the
purposes of this article we will draw a distinction between the terms ‘interest loan’ and ‘interest-free loan’. Under Ukrainian law an interest loan is a type of financial transaction when monetary funds are being lent to a borrower by a lender, which the borrower pays back with interest. An interest-free loan is a type of transaction where the borrower receives an amount of money from a lender, but the lender receives no interest when the funds are repaid.

Ukrainian legislation places certain restrictions on the provision of loans by residents. Loan extensions and financial operations with subsequent interest payments are the strict prerogative of financial institutions, eg banks. However, any non-resident company that does not have financial institution status under Ukrainian or foreign law is allowed to extend funds to the Ukrainian companies under the terms of a loan.

As stated above, an interest-free loan may be granted by any company, whether local or international, but the loan should meet the following requirements:

• it shall be granted on the repayable basis; and

• ?no interest is payable on the loan.

In the case of non-compliance with these requirements, the granted funds will be considered as an interest loan or a non-returnable interest-free loan, which is subject to inclusion in gross income in the full amount (ie, the amount would be included in the tax base of the

The most common tool for local inter-company financing in Ukraine is therefore the provision of an interest-free loan by the parent company. However, upon obtaining an interest-free loan Ukrainian companies may still face a lot of difficulties, as there are several significant requirements that should be taken into consideration before obtaining such a loan.

First of all, it is very important that interest-free loan is repaid within a three month period (quarter) from the moment it was granted. Ukraine law stipulates that any amount of the interest-free loan that is not repaid by the end of the tax reporting period (for corporate profits tax the period is three months) is subject to deemed interest. Such deemed interest will be included in the gross income of the company.

The mechanism for calculation of deemed interest is as follows. First, the number of days that the interest-free loan was used will be multiplied by The National Bank of Ukraine (NBU) prime rate, which is currently 12%. The result will then be divided by 365 calendar days and multiplied by the amount of non-repaid interest-free loan (which could either be a part or the whole amount of the loan) to obtain the amount of deemed interest. This amount is the amount to be included in the gross income of the company-borrower.

Please note that for the purposes of deemed interest calculation, the rate that should be used is the respective prime rate of the NBU that was effective in the period during which the company was using the interest-free loan. Below we will explain the whole mechanism

Worked example 1
Suppose a Ukrainian company obtained an interest-free loan of $2m. After a time, the company had repaid only $1.2m. By the end of the tax reporting period it failed to repay the interest-free loan in full and $800,000 remained to repay. This $800,000 would be subject to
deemed interest calculated as follows:

• ?The NBU prime rate of 12% will be multiplied by the number of days the company was using the interest-free loan, say for 97 days (97*0.12). This gives us a figure of 11.64;

• that will be divided by 365 calendar days (11.64/365), giving us 0.0319.

• ?finally, this will be multiplied by the $800,000 owed (0.0319*800,000), to produces a final figure of $25,520.

This $25,520 shall be included in the gross income of the company and corporate profits tax shall be deducted from this amount.

Worked example 2
Let’s take a look at another example of deemed interest calculation. The conditions of the interest-free loan are the same as described above, however, the NBU prime rate changed during the use of the loan. The company still enjoyed the interest-free loan for a total
of 97 days, but during the first 35 days the NBU prime rate was at 10%, and then rose to 12%. In this situation, deemed interest will be calculated as follows:

• The NBU prime rate at 10% will be multiplied by the number of days (35) the company was using the interest-free loan when the 10% rate was effective (35*0.1), which gives us 3.5;

• then the NBU prime rate at 12% will be multiplied by the remaining 62 days (62*0.12), which gives us 7.44; the figures will be added together (3.5 + 7.44), making a total of 10.94.

• that 10.94 will be divided by 365 calendar days (10.94/365), which equals 0.03 (this has been rounded up);

• finally, the $800,000 owed is multiplied by 0.03 to give us a final amount of $24,000.

This $24,000 will be included in the gross income of the company and corporate profits tax will be deducted from it.

Taking into account everything mentioned above, it is clearly important that any interest-free loan issues should be under the control of the management of the company or the company’s group. However, it may be that the company-borrower would not be able to repay the interest-free loan to the lender without any tax consequences. We will now describe some legal approaches that would help the company to avoid deemed interest liabilities.

First approach: refinancing credit
This approach may be used when the borrower isn’t able to repay the interest-free loan at all. Until the interest-free loan is repaid and until the end of tax reporting period, the borrower can enter into a loan agreement for refinancing purposes. Under the prospective loan
agreement the borrower would obtain funding for further refinancing of its debt and would pay a certain amount of interest.

Under Ukrainian law, non-residents may provide loans to residents, regardless of whether the non-resident is a financial institution. Thus the loan may be provided by a non-resident, ie the parent company of the group or any other company. Such approach may be implemented within the company’s group for long-term refinancing in order to defer interest-free loan payments and to mitigate undesirable tax consequences. It is also worth mentioning that the interest payable by the resident-borrower is tax deductible, i.e. included in the gross expenses of the company. As a result, generating expenses would decrease the tax base of the company and consequently its prospective tax liabilities.

Second approach: cession agreements
It should be mentioned that the second approach to be described is rather complicated, cumbersome and ambiguous from the NBU’s point of view. However, the approach is as follows: until the interest-free loan is repaid and until the end of tax reporting period, the borrower and the lender enter into cession agreement.

Under a cession agreement, the lender, a resident of Ukraine, assigns its rights of demand to another, non-resident company. Please note that simple assignment of rights and changing the initial creditor to a non-resident would not release the company-borrower from
deemed interest. As was previously mentioned, for tax purposes and deemed interest calculation it is not important who the creditor is until the interest-free loan would become a credit (i.e., would be subject to interest), as a result entering into a cession agreement would not be enough. This is due to the rule that simple substitute of creditors would not release the debtor from deemed interest. For release purposes the nature of the relationship and the nature of the obtained money should be changed. It may be changed by the following steps.

Upon entering into cession agreement, the parties (borrower-resident and creditor non-resident) simultaneously sign a supplementary agreement to the interest-free loan agreement, pursuant to which the parties shall establish an interest for received money, which means
that the company-borrower will charge and pay to the creditor an interest for the obtained money. After such actions the interest-free loan debt would become a debt of interest loan nature.

Consequently, under Ukrainian law, before the loan from the non-resident is received by the resident company, the loan agreement is subject to NBU registration. It is at this stage that the ambiguity begins.

For the loan service the borrower must assign a bank and after that would register the loan with the NBU. From our experience with this approach, the NBU does not see any grounds for loan agreement registration, due to the fact that physically no money is transferred
from the non-resident creditor to the borrower. The NBU is therefore likely to reject the loan agreement registration due to the absence of legal grounds for such registration. Loan service banks may also refuse to service the loan payments (interest payments and other expenses) without a registered loan agreement. At this point clarification should be requested from the NBU.

To summarise, cross-border financing is a widely used instrument for inter-company financing that provides opportunities for flexible and efficient financing, as well as for cash-flow structuring. If the company’s group has a wide network the financing and refinancing issues should be heavily chased by the respective management, due to the possible undesirable tax consequences and expenses.

Please note that while the approaches described in this article are typical to some extent, they should not be used as a template. The approach to solving each issue should be undertaken individually, with regard to every single circumstance.

By Taras Rozputenko, associate,
Volkov Koziakov & Partners.

To top

Releated Publications


Дайджест правовых новостей: Корпоративное право. Выпуск № 3 (октябрь - ноябрь 2017)


Legal News Digest: Medicine and pharmacy. Release № 2 (August – Sept. 2017)


Legal News Digest: Energy. Release № 2 (August – Sept. 2017)


Legal News Digest: Company law. Release № 2 (August – Sept. 2017)

About Us   Our Practice   Lawyers   Career   News   Search   
cheap naltrexone Cheap Terbinafine cheap sildenafil cheap tadalafil cheap cigarettes
© 2006 Волков i Партнери. Site Map