Corporate Profit Tax Assessments: When Expenses Are Disallowed

A tax audit often ends the same way: part of a company’s expenses is disallowed, the financial result is “adjusted” upward, and corporate profit tax — together with penalties and interest — is assessed on the difference. Behind these adjustments sit specific rules and figures that can be checked and rebutted. Below I explain the grounds on which expenses are disallowed, how the tax differences of Section III of the Tax Code of Ukraine (PKU) work, and where forensic economic examination comes in.

How expenses affect corporate profit tax

The object of corporate profit tax is not derived “from expenses” directly. It is built on the pre-tax financial result calculated under accounting rules — either national accounting standards (national P(S)BO) or IFRS. That financial result is then adjusted by the tax differences set out in Section III of the Tax Code of Ukraine (PKU). In simplified form the chain runs:

• pre-tax financial result (per the accounting books)
• ± tax differences (Section III of the PKU)
• = the object of taxation, on which the tax is calculated.

Hence there are two distinct levers by which the State Tax Service (DPS) increases the tax: either disallow the expense in the accounting itself (raising the financial result), or assess a tax difference (where the expense is recognised in the books, but the Code requires it to be “returned” to taxation). These two mechanisms must not be confused — they rest on different grounds, and each calls for a different defence.

Two main grounds for disallowing expenses

Lack of support by primary documents

The first and most common objection: the expense is not backed by proper primary records. Article 44 of the PKU expressly requires a taxpayer to support the data in its tax reporting with primary documents, accounting registers and financial statements. The logic is simple — no document, no basis for the figure in the reporting, and therefore none for the expense that figure forms.

In practice, inspectors disallow expenses when a contract, a delivery note or an act of completed works is missing; when a document is drawn up with defects in its mandatory particulars (Article 9 of the Law of Ukraine “On Accounting and Financial Reporting in Ukraine”); or when the primary records exist but contradict themselves. It matters to distinguish: a defect of form does not, by itself, mean the expense never occurred. Where the transaction is real and its result followed, flaws in form can often be cured or explained by further evidence.

”Goods-lessness” and the unreality of transactions

The second, far harsher ground is when the authority asserts that the transaction never happened at all and the documents merely imitate something that did not occur. These are so-called goods-less (fictitious, “paper”) transactions. Here the objection is framed not as “it was drawn up incorrectly” but as “there is no real business fact behind this figure.”

The consequence for profit tax is direct: if a transaction is treated as goods-less, the expense is disallowed in full, the financial result rises by the whole amount, and tax is charged on it. Frequently the VAT tax credit for the same transaction “falls” alongside it. That is why the sharpest part of tax disputes turns on the reality of transactions.

Adjusting the financial result for tax differences

Even where the expenses are documentarily flawless and the transaction is real, the Code may require part of them to be “returned” to taxation through the tax differences of Section III of the PKU. This is not a taxpayer’s mistake but a deliberate construction of the law. The differences on which assessments are most often built:

Group of differences	What it concerns
Depreciation	The gap between accounting and tax depreciation of non-current assets
Provisions and reserves	Costs of creating reserves that are not recognised for tax until actually used
Interest on debt	Limits on interest expense in transactions with related non-residents (thin capitalisation)
Certain non-residents and non-profits	An increase in the financial result by part of the value acquired

It helps to remember: companies with annual income below the threshold set by the Code may choose not to apply most differences (except the loss carry-forward one), while for large taxpayers the differences are mandatory. So the first question in any defence is whether the difference the authority assessed should have applied at all.

The 30% difference on “risky” non-residents and non-profits

I single out one adjustment that produces many assessments in practice. Under Article 140 of the PKU, the financial result is increased by 30% of the value of goods, works or services acquired from non-profit organisations and from certain “risky” non-residents — in particular those registered in low-tax jurisdictions or in special organisational-legal forms from the lists approved by the Cabinet of Ministers.

The key point: this difference does not apply where the transaction was a controlled one, or where the price is confirmed on the arm’s-length principle under transfer-pricing methodology, and also where the volume of transactions does not exceed the established threshold. In my expert work, a large share of such assessments is disputable precisely because the authority mechanically added the 30% without allowing for the fact that the taxpayer has a market-price justification, or that the counterparty did not fall under the relevant list on the date of the transaction.

Business purpose and the link to economic activity

For expenses to “hold,” paper alone is not enough: the transaction must be connected to the company’s business activity and have a reasonable economic cause (business purpose). This concept is fixed in the PKU, and authorities increasingly invoke it, arguing that expenses were incurred with no real economic benefit for the taxpayer.

What to attend to in advance:

• Connection to the activity. The goods or services acquired must be used (or intended for use) in the company’s own business — in production, sales or management.
• Business purpose. The transaction must be explained by a reasonable economic cause, not merely a wish to reduce tax. This applies especially to consulting, marketing and information services, whose reality and usefulness are hardest to prove by an act alone.
• Proportionality. A clear mismatch between the price and the market, or between the volume of services and the real needs of the business, is a marker the authority will use against you.

Evidence of the real receipt of goods and services

The strongest defence of expenses is not legal argument but a body of evidence of the real movement of goods or services and their subsequent use. In goods-lessness disputes, it is the absence of this evidence that destroys the taxpayer’s position. What to keep and be able to show:

1. Contracts, specifications, invoices — the terms and subject of the transaction.
2. Outgoing and incoming delivery notes, acts of completed works — the fact of handover and acceptance.
3. Consignment notes (tovarno-transportni nakladni, TTN) and route sheets — the physical movement of the goods. A missing TTN in a supply case is one of the most telling signals against the taxpayer.
4. Warehouse and quantity records — stock cards, inventory descriptions: whether the goods actually “passed” through the warehouse.
5. Bank statements — the reality of the settlements.
6. Evidence of subsequent use — write-offs to production, resale, cost calculations, reports on the result of services. Goods acquired and then “vanished” raise the most questions.

The role of forensic economic examination (specialty 11.1)

When a dispute comes down to figures, a forensic economic expert is engaged under specialty 11.1 — the examination of accounting, tax-accounting and reporting documents. The expert’s work is governed by the Law of Ukraine “On Forensic Expert Activity,” and the ordering and conduct of studies by the Ministry of Justice’s Instruction No. 53/5. The expert is entered in the state Register of Certified Forensic Experts, and it is this that gives the opinion its procedural weight — both in a tax dispute under the Code of Administrative Procedure (KAS) and in criminal proceedings under the Criminal Procedure Code of Ukraine (KPK), where the investigation is led by the Bureau of Economic Security (BEB).

In corporate-profit-tax assessment cases the expert checks:

• whether the expenses were correctly formed and supported by the primary documents and accounting data provided;
• whether the pre-tax financial result was correctly determined;
• whether the tax differences applied were justified and the object of taxation correctly calculated;
• whether the sum assessed in the audit act corresponds to the accounting and reporting data, and how an error in the base calculation flows through to the derived penalty and interest.

What the expert does not do. The expert does not assess the lawfulness of a tax assessment notice (podatkove povidomlennia-rishennia, PPR), does not establish intent or guilt, does not qualify conduct as “evasion,” and makes no legal conclusion about the “fictitiousness” of a transaction — that is the exclusive competence of the court. The correct wording is therefore “the expenses are not documentarily supported” or “the transaction is not confirmed by the documents provided,” not “the transaction is fictitious.” Well-framed questions to the expert are half the battle, and here the joint work of the lawyer and the expert at the preparation stage is critical.

Common mistakes that cost companies their expenses

• No organised primary records. The documents exist but are scattered, incomplete or drawn up late — restoring them after the fact and convincingly is hard.
• Betting on the act and returns alone. Tax reporting is submitted for examination without contracts, TTNs or warehouse records — there is nothing to confirm the reality of the transaction.
• Ignoring business purpose. Services are documented by a formal act with no evidence of their real provision and use.
• Divergence from the accounting policy. The order for recognising expenses, depreciation or reserves in the accounting-policy order does not match the actual accounting — which gives the authority a foothold.
• Treating differences mechanically. The taxpayer either failed to apply a mandatory difference or, conversely, did not challenge an imposed difference (such as the 30% one) despite having every ground to do so.

What to do if your expenses are disallowed

1. On receiving the audit act and the PPR, immediately check the deadlines for administrative and judicial appeal.
2. Separate the objections: where an expense was disallowed in the accounting, and where a tax difference was assessed — the defence differs.
3. Gather the primary records, registers and evidence of real movement and use for the disputed period.
4. Order a pre-trial economic analysis of the calculations to see which sums can be contested, and why.
5. Together with your lawyer, formulate the position and, if needed, correct questions for the forensic examination.

If your company has been assessed corporate profit tax after part of its expenses was disallowed, do not rely on legal objections alone — the authority’s calculations also need a professional check. I would be glad to help with an economic study of whether the expenses and the object of taxation were correctly formed, and with preparing a well-founded position for the appeal.