In-House Produced Food for Employees: Tax Implications

Audit Practice Case

One of our clients approached us with the following question:

Our company regularly plans to treat all its employees with food products of its own production. For example, today they distributed 1 box of this product in connection with the Food Industry Workers' Day. In the future, own-produced products will be distributed to employees on other holidays as well. As justification for such distributions, we plan to issue a company order titled «For achieving significant results based on the first half-year and on the occasion of the Food Industry Workers' Day, company employees will receive a food kit…..».

Question: Can we avoid accruing PIT, military levy, and USC for such operations?

We believe that in this situation, there are chances to utilize the provisions of sub-clause 165.1.39 of the Tax Code of Ukraine (TCU). However, to try and increase these chances to an acceptable level, it is critically important, in our opinion, to grant the food kits to be distributed the status of a «gift» – specifically, a gift not related to the employee's performance of their labor duties.

In our opinion, the following aspects should be considered in this situation:

1. Sub-clause 165.1.39 (as well as the entire Article 165) of the TCU can only be applied if we are dealing with an additional benefit (see clause 164.2.17 of the TCU – «income received by the taxpayer as an additional benefit (except for cases provided for in Article 165 of this Code) in the form of: …»). That is, if any gratuitous distribution of inventory to employees falls under the definition of «salary», then in accordance with sub-clause 164.2.1 of the TCU, such a distribution will be subject to PIT accrual (and automatically – USC and military levy (hereinafter – ML)) – in such a case, we will not be able to use the provisions of sub-clause 165.1.39 of the TCU.
2. The definition of «salary» for PIT purposes is provided in sub-clause 14.1.48 of the TCU – «basic and additional wages, other incentive and compensatory payments paid (provided) to the taxpayer in connection with employment relations in accordance with the law».
3. Traditionally, we look for the interpretation of the concepts of «basic and additional wages, other incentive and compensatory payments» in the Instruction on Wage Statistics, approved by Order of the State Statistics Committee of Ukraine No. 5 dated 13.01.2004 (hereinafter – the Instruction).
4. In accordance with sub-clause 2.2.2 of the Instruction, the additional wage fund includes «rewards of a systematic nature».
5. According to sub-clause 2.3.2 of the Instruction, «other incentive and compensatory payments» include, in particular, «one-time incentives not related to specific work results (for example, for anniversaries and memorable dates, both in monetary and in-kind forms)».

How to reduce the grounds for tax authorities to classify food kits as "salary"

Therefore, to give tax authorities as few grounds as possible to claim that the food kits distributed to employees fall under the definition of "salary", we would recommend considering the following nuances in the relevant orders:

1. Try not to emphasize that these food kits are issued to employees «for achieving significant results based on the first half-year» – such wording, in our opinion, precisely demonstrates that these inventory items were issued to employees as «rewards related to the performance of production tasks and functions» (especially considering that you plan to distribute such inventory on a regular basis). Accordingly, clause 2.2.2 of the Instruction may «apply».
2. Also, it seems to us not a very appropriate idea to use the wording «on the occasion of the Food Industry Workers' Day celebration» in this order – in our opinion, tax authorities may see this as «issuing an incentive for anniversaries and memorable dates» (clause 2.3.2 of the Instruction).
3. And besides, the word «employees» in your order can also be a «red flag» for tax authorities – this can also be interpreted by them as «payment of remuneration within the scope of individuals performing their labor functions».

Considering the above, we would recommend considering the option of using wording in orders for the distribution of food kits approximately as follows:

1. Distribute beer kits (consisting of …) as a gift to the following individuals: Ivanov Ivan IvanovychPetro Petro Petrovych…
2. Taxation of these gifts should be carried out in accordance with the requirements of current legislation of Ukraine, taking into account sub-clause 165.1.9 of the TCU.

What to consider when determining the permissible amount of the "non-taxable limit"

When determining the maximum permissible amount of the "non-taxable limit" under sub-clause 165.1.39 of the TCU, the following should be considered:

• the base amount of the gift should be determined at "ordinary prices" (see sub-clause 164.5 of the TCU) – in our opinion, this means that the possible base for PIT and ML accrual should be considered not the "ex-factory price" or the cost of the relevant food products, but rather the average retail selling price of such products (i.e., taking into account the retail markup, VAT, etc.)
• in case the base amount of the gift exceeds the "non-taxable limit", the PIT amount should be determined by applying the so-called "in-kind coefficient" to it (for ML – without).

However, some consultants believe otherwise

Some consultants believe that "for the purposes of USC accrual, gifts in in-kind and monetary forms, issued to enterprise employees, are considered salary", you can familiarize yourself with this position by following the link. That is, in their opinion, even if PIT and ML do not need to be accrued on gifts, USC will still have to be accrued.

If you need tax consultations or you are planning to conduct a tax audit, please contact us, we will be happy to assist you.