Application of the Principal Purpose Test (PPT) for paying non-resident income

State Tax Service of Ukraine informs that Paragraph 141.4 Article 141 of the Tax Code of Ukraine (hereinafter – Code) defines taxation peculiarities of income received by non-resident with a source of origin in Ukraine.

List of such income is given in Sub-paragraph 141.4.1 Paragraph 141.4 Article 141 of the Code.

Subparagraph 141.4.2 Paragraph 141.4 Article 141 of the Code determines 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 establishment in the territory of Ukraine, who makes any payment to non-resident or authorized person from income with a source of origin in Ukraine received by such non-resident (including to accounts of non-resident maintained in the national currency), withhold tax from such income specified in Sub-paragraph 141.4.1 of this Paragraph at the 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 at the time of such payment, unless otherwise provided for by provisions of international agreements of Ukraine with countries of residence of persons in whose favor payments are made, which have entered into force.   

Procedure for applying Ukraine’s international agreement on avoidance of double taxation regarding full or partial exemption from taxation of income of non-residents with a source of origin in Ukraine is provided for in Article 103 of the Code.

Particularly, Paragraph 103.2. Article 103 of the Code provides that tax benefits in the form of exemption from taxation or application of reduced tax rate, provided for by international agreement, are not provided in relation to relevant type of income or profit, if the main or predominant purpose of carrying out relevant business transaction of non-resident with a resident of Ukraine was direct or indirect receipt of benefits provided by international agreement in the form of exemption from taxation or application of  reduced tax rate. This provision is not applied if it is established that obtaining such benefits corresponds to the object and purposes of international agreement of Ukraine. If international agreement, consent to be bound by which has been granted by the Verkhovna Rada of Ukraine, establishes rules other than those provided for in this Paragraph, relevant rules of the international agreement are applied.

Specifically, some international agreements of Ukraine on the avoidance of double taxation contain provisions on application of the “Principal purpose test” (“PPT”) to the above specified payments (for example, in Article 23 “Right to receive benefits” of Convention between the Government of Ukraine and Government of the United Kingdom of Great Britain and Northern Ireland for elimination of double taxation and prevention of fiscal evasion with respect to taxes on income and on capital gains (date of entry into force for Ukraine 11.08.1993) as amended on 09.10.2017, in Article 24 “Avoidance of double taxation” of Convention between Ukraine and Kingdom of Netherlands for elimination of double taxation with respect to taxes on income and on capital gains and prevention of fiscal evasion and avoidance (date of entry into force for Ukraine 02.11.1996) as amended on 12.03.2018).  

Their exhaustive list is contained in paragraph 6 a) of the Law of Ukraine № 2692-VIII as of 28.02.2019 “On ratification of the multilateral convention on the implementation of measures relating to tax agreements to combat base erosion and profit evasion” (entered into force for Ukraine on 01.12.2019).

For purposes of interpreting double taxation agreements, the Model Convention for Avoidance of Double Taxation of the Organization for Economic Cooperation and Development (hereinafter – OECD Model Convention) is used in international practice, which is the basis for most double taxation agreements, and official Commentaries to it. Need to use provisions of the OECD Model Convention and Commentaries is based on the general rules of interpretation of international agreements enshrined in the 1969 Vienna Convention on the Law of Treaties.

Commentary to Paragraph 9 Article 29 of the OECD Model Convention, which interprets the “Principal Purpose Test” and analyzes specifics of its application, states that the fact of absence or presence of status of beneficial (actual) owner of income does not mean that a certain transaction does not meet the Principal Purpose Test. The OECD also came to this conclusion in the Final Report on the implementation of Step 6 of the BEPS (Base Erosion and Profit Shifting) Action Plan: "Preventing abuse of double taxation treaty provisions".

Article 29 of the OECD Model Convention provides for a special provisions on the limitation of benefits provided for in double taxation conventions – “Principal Purpose Test”, which is as follows: “Notwithstanding any provisions of double taxation convention, benefits provided for in the double taxation convention shall not be granted in respect of income or capital if there are reasonable grounds to conclude, having regard to all relevant facts and circumstances, that obtaining such benefit was one of the principal purposes of any arrangements or transactions which directly or indirectly resulted in that benefit, unless it is determined that granting of that benefit in those circumstances would be consistent with the object and purpose of relevant provisions of the double taxation convention to which the double taxation convention applies”.

According to Paragraph 178 of the Commentary on Article 29 of the OECD Model Convention, conclusions that one of the main/principal purposes of transaction or arrangement is to avail itself of benefits provided for in the double taxation convention must be based on examination of all the facts and circumstances relevant to such transaction and taking into account the following:

1) such conclusion should not be based on assumptions;

2) examination of all facts and circumstances should not be limited to examining solely the tax effect of transaction related to obtaining benefits under the double taxation convention.

According to Paragraph 180 of the Commentary on Article 29 of the OECD Model Convention, reference to “one of the main purposes” means that obtaining benefit under the double taxation agreement does not necessarily have to be the sole or dominant purpose of a particular arrangement or transaction. It is sufficient that at least one of the main objectives is to obtain advantage.

According to Paragraph 181 of the Commentary on Article 29 of the OECD Model Convention, purpose of obtaining benefits provided for in the double taxation convention will not be considered to be the main purpose if there are reasonable grounds to conclude, having regard to all the facts and circumstances relevant to the particular transaction, that obtaining such benefits was not the main factor and could not justify carrying out of a particular transaction which, alone or together with other transactions, resulted in such benefits.

Since provisions of Article 29 of the OECD Model Convention essentially coincide with provisions of Paragraph 1 Article 7 of the Multilateral Convention, Sub-paragraph 103.2 Article 103 of the Code and the corresponding provisions of other international agreements, it is advisable to use the Comments to Article 29 of the OECD Model Convention to interpret this provision.

Please note that the list of examples of application of the “Principal Purpose Test” is given in Paragraph 182 of the Commentary on Article 29 of the OECD Model Convention.