Taxation of non-resident incomes: lease/rent or royalties?

State Tax Service of Ukraine informs that Sub-paragraph "g" of Sub-paragraph 141.4.1 Paragraph 141.4 Article 141 of the Tax Code of Ukraine (hereinafter – Code) stipulates that leasing/rent payment is income received by non-resident with a source of origin from Ukraine, which is taxed according to and at rates determined by the Code.

Sub-paragraph 141.4.2 Paragraph 141.4 Article 141 of the Code stipulates that resident, including individual-entrepreneur, individual involved in independent professional activity or business entity (legal entity or individual-entrepreneur) who chose simplified taxation system, or another non-resident, who conducts economic activity through a permanent representative office on the territory of Ukraine, who make any payment in favor of non-resident or authorized person from income with its source of origin from Ukraine, received by such non-resident (including to non-resident’s accounts maintained in the national currency), withhold tax from such incomes, specified in Sub-paragraph 141.4.1 of this Paragraph, at 15 percent rate (except for income specified in Sub-paragraphs 141.4.4 - 141.4.5 and 141.4.11 of this Paragraph) of their amount and at their expense, which is paid to the budget during such payments, unless otherwise stipulated by provisions of international treaties of Ukraine with residence countries of individuals in whose favor payments are made, which have entered into force.

Paragraph 3.2 Article 3 of the Code stipulates that if international treaty, binding consent of which was granted by the Verkhovna Rada of Ukraine, establishes other rules than those provided for by this Code, rules of international treaty are applied.

During years 2017-2023, for the benefit of non-residents who are registered in jurisdictions in which term "royalty" includes a fee for the use of equipment, income payments in the form of leasing were made for the total amount of 13 100 million UAH exempted from taxation.

Significant payments are made to companies registered in the Republic of Cyprus (64%), Turkey (11%), Portugal (11%), Estonia (3%), Poland (3%) and others.

In particular, in 27 double taxation conventions (Estonia, Poland, Lithuania, Latvia, Bulgaria, Brazil, Czech Republic, Cyprus, Azerbaijan, Algeria, Vietnam, Egypt, Jordan, Iceland, Kazakhstan, Saudi Arabia, Libya, Morocco, Mexico, Mongolia, Pakistan, Singapore, Slovenia, Thailand, Turkey, Turkmenistan, Uzbekistan) (hereinafter – Convention), according to Article 12, the "royalty" term means payment, in particular, for the use or for granting a right to use industrial, commercial or scientific equipment.

Paragraph 2 Article 3 of Conventions stipulates that when they are applied by a Contracting State, any term not defined in Conventions shall have the meaning given to it by legislation of that State in relation to the taxes to which they apply, unless the context indicates otherwise.

Paragraph 1 Article 31 of Vienna convention on the law of international treaties dated 23.05.1969 (hereinafter – Vienna convention) stipulates that contract must be interpreted in good faith according to the usual meaning that should be given to the contract terms in their context, as well as in the light of object and purposes of the contract.

Article 32 of Vienna convention allows recourse to additional means of interpretation, including preparatory materials and circumstances of treaty’s conclusion, which for purposes of double taxation conventions are Commentaries on the OECD Model Tax Convention and Commentaries on the United Nations Model convention for avoidance of double taxation in relations between developed and developing countries (hereinafter – UN Model convention).

Given that the definition of "royalty" set out in Article 12 of Convention corresponds to Article 12, Paragraph 3 of the UN Model convention, it is necessary to refer to the Commentaries thereto.

Paragraph 13.2 of Commentaries to Article 12 of the UN Model convention stipulates that industrial, commercial or scientific equipment may also include (list is not exhaustive) ships, aircraft, cars and other vehicles, cranes, containers, satellites, pipelines and cables, etc.

Taking into account above specified, applying Convention in Ukraine for purposes of classifying payment (remuneration, compensation) as a payment for "using or granting a right to use industrial, commercial or scientific equipment", the term "industrial, commercial or scientific equipment" must be interpreted in a broad sense, so that it covers any combination of machinery, appliances and tools.

Therefore, Ukraine’s exercise of its right to taxation according to Conventions will require payment of tax in Ukraine at the source of payment on payments made by Ukrainian resident companies to residents of other countries for the use (lease) of industrial, commercial or scientific equipment, including ships, airplanes, cars and other transport means, cranes, containers, satellites, pipelines and cables (list is not exhaustive), as these payments are treated as royalties under Article 12 of Conventions.

Herewith, please note that Sub-paragraph 69.38 Paragraph 69 Sub-section 10 Section XX "Transitional provisions" of the Code stipulates that temporarily, for a period from 01.08.2023 until termination or abolition of martial law on the territory of Ukraine, introduced by Decree of the President of Ukraine "On the introduction of martial law in Ukraine" № 64/2022 as of 24.02.2022, approved by the Law of Ukraine "On approval of Decree of the President of Ukraine "On the introduction of martial law in Ukraine" № 2102-IX as of 24.02.2022, in case of self-correction by the taxpayer in compliance with procedure, requirements and restrictions specified in Article 50 of the Code, of errors that led to an understatement of tax liability, such payer is exempted from accrual and payment of financial sanctions and a penalty provided for in Paragraph 50.1 Article 50 of the Code.

Therefore, the State Tax Service draws attention of payers that voluntary clarification of paid amounts of income tax from income of non-residents will allow business to reduce the burden of paying fines and penalties accrued during the audit.