Disclaimer
This article provides a comprehensive overview of selected tax matters arising under the laws of Ukraine, Hong Kong and Bulgaria. As tax specialists based in Bulgaria, with strong professional ties to Hong Kong, we have sought to present the relevant tax considerations and assumptions as objectively and accurately as possible.
The information concerning Ukrainian taxation is provided for illustrative purposes only and should not be considered a substitute for advice from a qualified Ukrainian tax adviser.
Accordingly, this article is for general informational purposes only, does not constitute tax or legal advice, and should not be relied upon as such.
Fiscal considerations for a Ukrainian tax resident using a Hong Kong company
More and more Ukrainian entrepreneurs are building ties with Bulgaria. Some have even obtained Bulgarian citizenship while remaining Ukrainian tax residents. As part of more aggressive tax planning, some are considering routing part of their cash flows through third countries with zero or low tax rates. In this article we will analyse whether this is a good idea, or rather how good this idea is.
Citizenship is not (always) equal to tax obligation
Citizenship and tax residency are not the same. A person can hold both Ukrainian and Bulgarian citizenship and still be a tax resident of Ukraine. Even without Ukrainian citizenship, the person can have tax liabilities in Ukraine on his non-Ukrainian income. This can have a major impact on how business income and dividends are taxed.
Andrey – dual citizen of Ukraine and Bulgaria, tax resident of Ukraine
In this article, we examine a practical case. The individual, who we will call Andrey, is a Ukrainian tax resident and holds both Ukrainian and Bulgarian citizenship. He wants to run an international business through a company registered in Hong Kong.
Andrey’s goal is to generate income while paying all taxes due, with the structure optimised for tax efficiency and full legal compliance. Ultimately, he should be able to demonstrate 100% legally verifiable, officially declared income, with all taxes duly paid. This is his goal. Let’s see how it can be best achieved.
We will look at the main ways he can receive money from the Hong Kong company, including dividends and management remuneration. Then we will examine the Ukrainian CFC rules and the potential Hong Kong tax implications.
We will also assess whether Andrey could become liable for tax in Bulgaria. This includes potential Bulgarian tax residency and other Bulgarian tax obligations, arising from Andrey’s Bulgarian citizenship.
The analysis will then be compared with a hypothesis, under which Andrey becomes a Bulgarian tax resident. We will look at corporate tax, personal income tax, dividend tax and the relevant double taxation treaties.
The goal is to understand the actual tax cost of each scenario. We will also consider the main advantages and risks of using a Hong Kong company, with Andrey being a Ukrainian or Bulgarian tax resident.
Taxation of the profits by the Hong Kong company
Incorporating a company in Hong Kong does not automatically mean that its profits are tax-free. Hong Kong uses a territorial basis of taxation. Profits arising in or derived from Hong Kong can be subject to Hong Kong profits tax. However, genuinely offshore profits may fall outside Hong Kong profits tax. The source of the profits is therefore absolutely critical.
Another important question is where the business is actually conducted and managed?
In the case of Andrey, as he plans to run the HK company remotely and no profits will be originating from the island, we can conclude that the HK company will not be taxed on its profits by the Inland Revenue Department:
If the Hong Kong company is managed and operated outside Hong Kong, and the activities that generate its profits are also performed outside Hong Kong, its profits may qualify as offshore profits and therefore fall outside Hong Kong Profits Tax. However, this is a factual determination. The place of incorporation and the location of management alone do not determine the source of profits.
Ukrainian Controlled Foreign Company (CFC) regulations
Because Andrey is a Ukrainian tax resident and controls the Hong Kong company, the company will potentially qualify as a controlled foreign company (CFC) under Ukrainian law. A Ukrainian resident individual is considered to be a controlling person when he holds more than 50% of a foreign company.
However, as Andrey will not generate more than 2 million Euro annual income in all his CFC companies combined, including the HK company, he will be exempted from the CFC tax in Ukraine. Reporting requirements in Ukraine however will be still applicable.
Getting the money out of the HK company
There are essentially two main routes to get the money out of the Hong Kong company. The first and most logical one is if Andrey distributes himself dividends from the HK company. In this case he will be liable to pay 9% tax on his foreign dividends in Ukraine plus additional 5% military tax. This makes a total of 14% on the amounts received as dividends from the Hong Kong company.
There is also an option to receive a management remuneration from the HK company, but this will entail a higher Ukrainian tax of 18%, so we will not analyse this option here.
Bulgaria – the eventual tax implications for Andrey and his HK company
Although Andrey is a Bulgarian citizen, Bulgarian citizenship alone does not make him liable to Bulgarian personal income tax. Assuming he is not a Bulgarian tax resident and remains solely a Ukrainian tax resident, the Hong Kong dividend should generally not be subject to Bulgarian personal income tax. In another article we have explained in detail who is considered to be a tax resident in Bulgaria.
The catch
Unfortunately however, there may be some complications. And these complications may be due to a chain of seemingly unrelated circumstances that could potentially lead to tax issues for Andrey with the Bulgarian tax authorities.
Recently obtained Bulgarian (as second) citizenship
First of all, there is one detail about Andrey that we have not mentioned so far. He recently acquired Bulgarian citizenship by naturalisation. At first glance, this may seem entirely unrelated to his tax position. And, strictly speaking, citizenship does not in itself determine tax residence.
However, the circumstances surrounding his naturalisation may be relevant when assessing where his centre of vital interests lies. In Andrey’s case, this could point towards a stronger connection with Bulgaria rather than Ukraine. That said, this fact alone would by no means be sufficient to establish Bulgarian tax residence or, by itself, make Andrey liable to tax in Bulgaria.
The war in Ukraine
Since the outbreak of Russia’s full-scale invasion of Ukraine, millions of Ukrainians have sought refuge across Europe, with most receiving temporary protection in their host countries. Andrey, however, is not among them. Nevertheless, the circumstances in Ukraine may lead the Bulgarian tax authorities to question whether Andrey is, in fact, genuinely living there.
On its own, however, this would still not be sufficient to establish Bulgarian tax residence. But the questions surrounding Andrey’s tax position are beginning to pile up.
Schengen
Bulgaria is in Schengen and there are no internal borders, as we all know. This, however, puts the 183-day tax rule to the test. For Andrey, proving that he has not been present in Bulgaria for 183 days would not be easy, especially if he frequently travels within the EU.
Hong Kong company – basically an offshore company
Bulgarian authorities, and the tax authorities in particular, dislike one thing in particular: aggressive tax planning. This includes, among other things, the use of offshore or zero-tax business entities. The use of such structures by a Bulgarian citizen who is claiming to be tax resident and paying taxes elsewhere, such as in Ukraine, may raise many eyebrows in Bulgaria.
This alone may not have any direct tax implications, but it could potentially weigh on the overall assessment of Andrey’s situation. In theory, it is even possible that the Bulgarian authorities could initiate an investigation into potential money laundering or tax evasion.
Under the Bulgarian Penal Code, Bulgarian citizens, including Andrey, may be held criminally liable for offences committed abroad. And let us not forget that Bulgaria has a remarkably low threshold at which certain forms of tax evasion can constitute a criminal offence. Tax evasions that exceed 1533 EUR are considered a crime in Bulgaria.
All of this does not mean that Andrey will be liable for taxes in Bulgaria. Certainly not. But the risk is there, especially in light of the ever-growing regulatory requirements and the increasing exchange of financial and tax information between jurisdictions.
Andrey, of course, has a second layer of protection: the Bulgaria–Ukraine Double Taxation Agreement. However, applying the treaty can create a fair amount of confusion, particularly if its provisions are not considered and applied in advance.
A question of credibility and perception
There is also another issue with the setup we have described above. Andrey’s goal is to be able to demonstrate 100% verifiable income, and in that respect, this setup is not necessarily the ideal one. Having received dividends in Ukraine from a Hong Kong company that has paid no corporate tax does not sound particularly convincing, does it?
But what if there is another arrangement that Andrey could use. One that would give him both greater credibility and an even lower tax burden?
What if Andrey was a Bulgarian tax resident?
Becoming a Bulgarian tax resident is more difficult than many people believe. Given its ultra-low tax rates, Bulgaria can be quite selective when it comes to foreigners seeking to leave their high-tax jurisdictions. But Andrey is not a foreigner. Moreover, he is also a Ukrainian citizen – and this makes a significant difference.
According to art.4, p.2 of the Bulgaria–Ukraine Double Taxation Agreement:
If, under the provisions of paragraph 1 of this Article, an individual is a resident of both Contracting States (Bulgaria and Ukraine), his status shall be determined as follows:
(a) He shall be deemed to be a resident of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which he has the closer personal and economic relations (centre of vital interests).
In other words, in order to become (tax) resident in Bulgaria, Andrey should have a home in Bulgaria. If he also has one in Ukraine, then he would need to prove where his centre of vital interests are. But if he doesn’t have a home in Ukraine – it’s end of story – he will be considered a Bulgarian tax resident. And this will make a lot of difference for his taxes.
Only 5% on his dividends from the HK and no CFC concerns
Too good to be truth? Not really. As a Bulgarian tax resident, Andrey will be only liable to pay 5% dividend tax on his dividends from the HK company, as opposed to 9% in Ukraine. There are no CFC regulations that apply to private individuals in Bulgaria, so no worries here too.
As Bulgarian tax resident, the whole tax burden for Andrey will be only 5% – fully paid to an EU state for extra credibility and perception.
Much better perception
While the dividends will be still coming from a Hong Kong company, the 5% tax will be paid to an EU tax office. This is without a doubt much better when Andrey has to prove the origin of his funds anywhere in the world.
Sustainable business model, rather than a one-time dividend payment
In a situation where Andrey becomes Bulgarian tax resident, this could become a sustainable business model for his future revenues.
Bulgarian vs Hong Kong company
As a further step to cement his tax position, Andrey could eventually consider skipping the Hong Kong setup altogether. The days of offshore business may be coming to an end.
Routing his business entirely through a Bulgarian company would result in a total effective tax rate of only 14.5%, combining corporate and dividend tax. By paying just 14.5% in total tax on his profits (not on his turnover) Andrey can pocket the remaining net profit, all within the EU. No offshore companies, no monkey business.