On 2 December 2010 Ukrainian Parliament adopted the new Tax Code of Ukraine ("Tax Code"), which became effective on 01 January 2011. Article 103 of the Tax Code provides for conditions under which a Ukrainian resident ("Payer") paying Ukraine-sourced income to a receiving non-resident ("Payee") can apply a withholding tax exemption or a reduced tax rate under a relevant double tax treaty ("DTT") between Ukraine and the country in which the Payee is a tax resident.

By default, the Payer, as a tax agent for the Payee, must withhold tax at a rate of 15% on Ukraine-sourced income of the Payee. The Payee's income can, however, be exempt from Ukrainian withholding tax or taxed at a reduced rate by the Payer provided that certain conditions are satisfied, namely:

  • the Payee is a tax resident in a jurisdiction with which Ukraine has an effective DTT providing for withholding tax exemption or a reduced tax rate; and

  • the Payee has provided to the Payer a tax residency certificate confirming the Payee's tax residency in the relevant jurisdiction (and other supporting documents if required under the relevant DTT); and

  • the Payee is the beneficial owner of the income.

The main novelty of the Tax Code, if compared to the previous rules on withholding tax exemption/reduction, is the introduction of a beneficial ownership concept in the Ukrainian withholding tax regime. Specifically, the Tax Code defines "beneficial (actual) recipient (owner) of income... as a person who has a right to receive such income". At the same time, the Payee will not be considered a beneficial owner of income, even if the Payee has the right to receive that income but is "an agent, nominal holder (nominal owner), or only an intermediary with respect to such income".

One example where application of the beneficial ownership concept can be triggered is the provision of syndicated financing by foreign financiers to a Ukrainian borrower where the Payee acts as a facility agent under the syndicated loan. There is a risk that Ukrainian tax authorities could view such facility agent as not being a beneficial owner of income. Thus, the Payer may be required to withhold tax at a 15% rate without being able to apply a withholding tax exemption or a reduction under the relevant DTT. In order to recover overpaid amounts of withholding tax, each beneficial recipient who would be entitled to an immediate benefit from the DTT on the relevant portion of income but for such income having been paid to the agent would need to reclaim the overpaid amounts of tax from the Ukrainian tax authorities and state treasury. Together with their reclaim application, such beneficial owners will have to provide evidence of receipt of Ukraine-sourced income through an agent. The tax authorities will verify the accuracy of the provided information and documents, availability of benefits under the relevant DTT and amounts of withholding tax paid by the Payer and then decide on the refund of the overpaid amounts to such beneficial owners.

Moreover, the tax authorities may disallow the Payer to apply DTT benefits on Ukraine-sourced income paid not to an ultimate beneficial owner but to a facility agent even if both the facility agent and a beneficial recipient are tax residents in a jurisdiction the residents of which enjoy tax exemption or rate reduction under the DTT with Ukraine. Further, application of DTT benefits by the Payer may be disallowed even where beneficial owners can be clearly identified from the transaction documentation, as in a syndicated loan, but the payment is made to a facility agent. In each such case, a beneficial owner will not be able to enjoy an immediate tax exemption or reduction under the DTT and will have to reclaim its overpaid tax from the Ukrainian treasury.

If the Ukrainian tax authorities interpret Article 103 of the Tax Code along the lines described above, then there is a risk that a foreign Payee will not be able to receive a full and immediate benefit of a withholding tax reduction or exemption under an applicable DTT if such Payee is not the ultimate beneficial owner of the relevant income paid by a Ukrainian debtor. Please note that the Ukrainian tax authorities have not yet formulated their understanding of the newly introduced beneficial ownership concept and its applicability in various business contexts, including international financing. There is also lack of practice of application of the beneficial ownership rules by Payers as such rules have only been in force for less than one month. We will monitor the developments in this area and will alert you about the trends in applying this new concept.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

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The original publication date for this article was 22/01/2011.