United States-Ukraine Tax Treaty
Ukraine’s International Tax Compliance Rules
Quick Summary. Ukraine imposes an income tax on worldwide profits earned by Ukrainian entities. Non-resident entities are subject to Ukrainian income tax on Ukrainian-sourced income. Resident individuals are subject to tax upon their worldwide income. Non-resident individuals are subject to tax on their Ukrainian-sourced income.
The Ukrainian Parliament (the Verkhovna Rada of Ukraine) has enacted tax legislation providing for a number of significant changes in 2020, including transfer pricing; tax depreciation; withholding taxes; permanent establishments and 0ther taxes. In addition, beginning in 2021, legislation implements changes with respect to controlled foreign companies and thin capitalization rules.
U.S.-Ukraine Tax Treaty
Ukraine Tax Treaty. Convention between the Government of the United States of America and the Government of Ukraine for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, together with a related Protocol, signed at Washington on March 4, 1994
Currency. Ukrainian Hryvnia (UAH)
Common Legal Entities. Limited liability company, private and public joint stock company, branches.
Tax Authority. State Fiscal Service of Ukraine
Tax Treaties. Ukraine is party to 74 tax treaties.
Corporate Income Tax Rate. 18%
Individual Tax Rate. 18%
Corporate Capital Gains Tax Rate. Taxed at ordinary income rates.
Individual Capital Gains Tax Rate. Varies based upon source of gain.
Residence. Multi-step analysis based upon location of permanent home, center of vital interest, physical presence, and/or nationality.
Dividends. 15% (nonresident)
Interest. Generally 15% (nonresident)
Royalties. 15% (nonresident)
Transfer Pricing. Generally based upon OECD Transfer pricing guidelines.
CFC Rules. No.
Hybrid Treatment. N/a
Inheritance/estate tax. Up to 18%.
This analysis below sets out a technical explanation of various provisions of the Convention and Protocol between the United States and Ukraine (the “Convention”).
The treaty’ principal purposes are to reduce or eliminate double taxation of income earned by residents of either country from sources within the other country, and to prevent avoidance or evasion of the income taxes of the two countries.
Taxes Covered (Article 2)
In the case of the United States, the Convention applies to the Federal income taxes imposed by the Internal Revenue Code, but not including the accumulated earnings tax or personal holding company tax (which are considered penalty taxes) or social security taxes. It also applies to the excise taxes imposed with respect to the investment income of private foundations. The non-discrimination provisions of Article 25 apply to all taxes imposed at all levels of government. Article 25 is the only article that applies to state and local taxes. The exchange of information provisions of Article 27 apply to all Federal level taxes, including estate and gift and excise taxes to the extent that such information is relevant to enforcement of the Convention or of any covered tax as long as such tax is applied in a manner that is not inconsistent with the Convention.
In the case of Ukraine, the Convention applies to the taxes on profits and income provided by the enumerated Ukrainian laws. The non-discrimination provisions of Article 25 extend to all taxes at all levels of government and the exchange of information provisions of Article 27extend to all national-level taxes.
The Convention applies to any taxes that are substantially similar to those described above, and that are imposed in addition to, or in place of, the existing taxes after the date of signature of the Convention. In recognition of the fact that the Ukrainian tax system was evolving at the time of the execution of the Convention, the Convention extends to subsequent taxes imposed by one State that are substantially similar to an existing tax of the other State. For the same reason, the Convention also extends to any national level tax on property subsequently imposed by either Contracting State.
The Convention provides that the Convention may not increase the tax burden of residents of either State compared to what it would be under the respective domestic law provisions. Thus, a right to tax given by the Convention cannot be exercised unless domestic law also provides for such a tax. However, a taxpayer may not select Code and Convention provisions in an inconsistent manner in order to minimize tax.
The Convention also prohibits the restriction of a tax benefit that is conferred by any other agreement between the Contracting States.
The Conventions contains a traditional “saving” clause, which provides that each country may tax in accordance with its domestic law, without regard to the Convention, its own residents, and in the case of the United States, its citizens, and former citizens. “Residence,” for the purpose of the saving clause, is determined under Article 4 (Residence). Thus, for example, if an individual who is not a U.S. citizen is a resident of the United States under the Code, e.g., a “green card” holder, and is also a resident of Ukraine under Ukrainian law, and the tie-breaker rules of paragraph 2 of Article 4 determine that he is a resident of Ukraine, he will be entitled to.U.S. benefits under the Convention. The paragraph also permits the taxation of certain former citizens by the United States whose loss of citizenship had as one of its principal purposes the avoidance of U.S. tax, in accordance with section 877 of the Internal Revenue Code.
Residence (Article 4)
The Convention establishes rules to determine whether a person is a resident of a Contracting State for purposes of the Convention. Determination of residence is important because as a general matter only residents of the Contracting States may, subject to the Limitation on Benefits provisions, claim the benefits of the Convention.
Residence is determined by looking first to a person’s liability to tax as a resident under the respective taxation laws of the Contracting States. For this purpose, liability to tax is interpreted as subject to the taxation laws; thus, a tax-exempt entity may be a resident of a Contracting State. A person who, under those laws, is a resident of one Contracting State and not of the other need look no further. That person is a resident for purposes of the Convention of the State in which he is resident under internal law. Consistent with U.S. treaty policy, the Convention includes citizenship as one of the criteria of residence. Thus, a U.S. citizen resident in a third country is entitled to the benefits of this Convention on the same basis as an individual residing in the United States. If, however, a U.S. citizen or resident (e.g., a “green card” holder) is also a resident of Ukraine under its taxation law, the individual must look to the tie-breaker rules, which attempt to assign one State of residence to such a person for purposes of the Convention. A U.S. citizen would continue to be subject to U.S. taxation under the saving clause of paragraph 3 of Article 1 (General Scope), but a green card holder’s residence would be determined only under this Article for purposes of Convention benefits.
The Protocol provides that a partnership, estate or trust will be treated as a resident of a Contracting State in accordance with the residence of the person liable to tax with respect to the income derived by the partnership, estate, or trust, i.e., to the extent that the income is taxed as the income of a resident, whether in the hands of the person deriving the income or in the hands of its partners or beneficiaries. This rule is applied to determine the extent to which the partnership, estate or trust is entitled to benefits with respect to income derived from the other Contracting State. Under Ukrainian law a partnership is generally taxed as an entity, and trusts and estates are not used. Under U.S. law, a partnership is not (except for certain publicly traded limited partnerships and partnerships that are reclassified as associations under Treas. Reg. §301.7701-2), and an estate or trust is often not, a taxable entity. Thus for purposes of the Convention, income received by a U.S. partnership need only be treated as received by a U.S. resident to the extent included in the distributive share of partners who are U.S. residents (looking through any partnerships that are themselves partners). Similarly, the treatment under the Convention of income received by a U.S. trust or estate will be determined by the residence for taxation purposes of the person subject to tax on such income, which may be the grantor, the beneficiaries, or the estate or trust itself, depending on the particular circumstances.
If, under the laws of the two Contracting States, an individual is deemed to be a resident of both Contracting States, a series of tie-breaker rules is provided to determine a single State of residence for that individual. These rules derive from the OECD Model. The first test applies if the individual has a permanent home. If that test is inconclusive because the individual has a permanent home available to him in both States, he will be considered to be a resident of the Contracting State where his personal and economic relations are closest, i.e., the location of his “center of vital interests.” If that test is also inconclusive, or if he dies not have a permanent home available to him in either State, he will be treated as a resident of the Contracting State where he maintains an habitual abode. If he has an habitual abode in both States or in neither of them, he will be treated as a resident of his Contracting State of citizenship. If he is a citizen of both States or of neither, the competent authorities are instructed to resolve his residence by mutual agreement.
Permanent Establishment (Article 5)
The Convention defines the term “permanent establishment.” The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for that State to tax the business profits of a resident of the other Contracting State. Articles 10, 11 and 12 (dealing with dividends, interest, and royalties, respectively) provide for reduced rates of tax at source on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base which the recipient has in the source State; if the income is or was attributable to a permanent establishment, Article 7 (Business Profits) applies (and if the income is or was attributable to a fixed base, Article 14 (Independent Personal Services) applies).
The Permanent Establishment provisions are similar in most respects to the corresponding Article of the OECD Model.
The Convention provides the basic definition of the term “permanent establishment:” the term means a fixed place of business through which a resident of one Contracting State either wholly or in part carries on business activities in the other Contracting State. It is not necessary that the resident be a legal entity. In the case of an individual, Article 14 (Independent Personal Services) uses the concept of a “fixed base” rather than a “permanent establishment,” but the two concepts are considered to be parallel.
The Convention contains a list of examples of fixed places of business that constitute a permanent establishment: a place of management, a branch, an office, a factory, a workshop, and a mine, well, quarry or other place of extraction of natural resources.
The Convention also contains certain exceptions to the general rule that a fixed place of business through which a business is carried on constitutes a permanent establishment. For example, certain activities may be carried on through a fixed place of business, but nevertheless, not give rise to a permanent establishment. The use of facilities solely to store, display or deliver merchandise belonging to an enterprise will not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another enterprise will not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for purchasing goods or collecting information for the resident, or for carrying out any other activity of a preparatory or auxiliary character for the resident, such as advertising, the supply of information, or certain research activities, will not constitute a permanent establishment of the resident.
The Convention specifies when the use of an agent will constitute a permanent establishment where a permanent establishment does not otherwise exist under the provisions. A dependent agent of an enterprise will be deemed to be a permanent establishment of the enterprise, if the agent has and habitually exercises an authority to conclude contracts in the name of that enterprise. If, however, his activities are limited to those activities specified above, such would not constitute a permanent establishment if carried on directly by the enterprise through a fixed place of business, the agent will not be a permanent establishment of the enterprise.
Moreover, an enterprise will not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting in the ordinary course of his business.
The Convention clarifies that a company that is a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting State. Whether a company is a permanent establishment of a related company, therefore, is based solely on the relevant factors and not on the ownership or control relationship between the companies.
Business Profits (Article 7)
The Convention provides the rules for the taxation by a Contracting State of the business profits of a resident of the other Contracting State. The general rule is that business profits of a resident of one Contracting State may not be taxed by the other Contracting State unless the resident carries on or has carried on business in that other Contracting State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated in the latter State. Where that condition is met, the State in which the permanent establishment is situated may tax the business profits attributable to the assets or activity of that permanent establishment.
The Protocol to the Convention provides an example of the “attributable to” concept. The example concerns a company that is engaged in oil production through wells located in the other State. The company also carries on exploration activities at another location in that other State using assets and employees not connected with the production activities; the activities last less than 6 months. The company also occasionally leases drilling equipment to third parties. The three activities are separate. The oil production constitutes a permanent establishment and the resulting profits are taxable in that other State. The other two activities do not constitute permanent establishments, and any resulting profits may not be taxed in that other State.
The Convention provides that the Contracting States will attribute to a permanent establishment the profits that it would be expected to make if it were an independent entity, engaged in the same or similar activities under the same or similar conditions, and dealing wholly independently with the enterprise of which it is a permanent establishment and any other enterprise that is an associated enterprise within the meaning of Article 9 (Associated Enterprises). Profits so attributable to a permanent establishment are taxable in the State where the permanent establishment is situated or was situated at the time the profits were made. This rule incorporates the rule of section 864(c) (6) of the Internal Revenue Code with respect to deferred payments, which is also reflected in the provisions of Articles 11 (Interest), 12 (Royalties), 14 (Independent Personal Services) and 21 (Other Income) dealing with amounts attributable to a permanent establishment or fixed base. If the income was attributable to a permanent establishment or fixed base when earned, it is taxable by the State where the permanent establishment or fixed base was located, even if receipt of the income is deferred until the permanent establishment or fixed base has ceased to exist.
The profits attributable to a permanent establishment may be from sources within or without a Contracting State. Thus, certain items of foreign source income described in section 864(c)(4)(B) or (C) of the Code may be attributed to a U.S. permanent establishment of a Ukrainian resident and subject to tax in the United States. The concept of “attributable to” in the Convention is narrower than the concept of “effectively connected” in section 864(c) of the Code. The limited “force of attraction” rule in Code section 864(c)(3), therefore, is not applicable under the Convention.
The Convention provides that the tax base must be reduced by deductions for expenses incurred for the purposes of the permanent establishment. These include expenses directly incurred by the permanent establishment and a reasonable allocation of expenses incurred by the home office, or by other parts of the enterprise company, as long as the expenses were incurred for the purposes of the permanent establishment. Allocable expenses include executive and general administrative expenses, research and development expenses, interest, and charges for management, consultancy, or technical assistance, wherever incurred and without regard to whether they are actually reimbursed by the permanent establishment. As indicated in the Protocol, the expenses may be incurred by the home office of the permanent establishment, other permanent establishments in third countries, or the permanent establishment itself. The permanent establishment must be able to document such expenses, if so requested by the tax authorities of the State in which it is located. In no case, however, will deductions be allowed for amounts paid by the permanent establishment to the home office or other permanent establishments in respect of deductible expenses such as interest, royalties, and service fees. Rather, the permanent establishment will be allowed deductions for such expenses only to the extent they are reasonably allocable to the permanent establishment, as described above.
The Convention provides that no business profits will be attributed to a permanent establishment merely because it purchases goods or merchandise for the resident of which it is a permanent establishment. This rule refers to a permanent establishment that performs more than one function for the enterprise, including purchasing. For example, the permanent establishment may purchase raw materials for the enterprise’s manufacturing operation and sell the manufactured output. While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable with respect to its purchasing activities. If the sole activity were the purchasing of goods or merchandise for the enterprise, the issue of the attribution of income would not arise, because under subparagraph 4(d) of Article 5 (Permanent Establishment) there would be no permanent establishment.
Where business profits include items of income that are dealt with separately under other articles of the Convention, the provisions of those articles will, except where they specifically provide to the contrary, take precedence over the provisions of Article 7 (Business Profits). Thus, for example, the taxation of interest will be determined by the rules of Article 11 (Interest) except where, as provided in paragraph 3 of Article 11, the interest is attributable to a permanent establishment, in which case the provisions of Article 7 apply.
Pensions (Article 19)
Except as provided in Article 18 (Government Service), pensions and similar remuneration in consideration of past employment may be taxed only by the Contracting State of which the beneficial owner is a resident. It is understood that the services need not have been performed by the beneficial owner of the pension; for example, a pension paid to a surviving spouse who is a resident of Ukraine would be exempt from tax by the United States on the same basis as if the right to the pension had been earned directly by the surviving spouse. A pension may be paid in installments or in a lump sum.
Social security benefits and other public pensions paid by a Contracting State, other than in consideration of past employment, may be taxed only by that State. This rule is also an exception to the saving clause of paragraph 3 of Article 1 (General Scope). Thus, a Ukrainian social security benefit will be exempt from U.S. tax even if the beneficiary is a U.S. resident or a U.S. citizen (whether resident in the United States, Ukraine, or a third country).
Limitation on Benefits (Article 22)
The Convention addresses the problem of “treaty shopping” by limiting source basis tax benefits granted by a Contracting State pursuant to the Convention to those residents of the other Contracting State that have a substantial business nexus with, or otherwise have a significant business purpose for residing in, the other Contracting State. For example, a resident of a third State might establish an entity resident in a Contracting State for the purpose of deriving income from the other Contracting State and claiming source State benefits with respect to that income. Article 22 limits the abuse of the Convention by limiting the benefits of the Convention to those persons whose residence in a Contracting State has not been motivated by the existence of the Convention. Absent Article 22, the entity would generally be entitled to benefits as a resident of a Contracting State, although the entity might be denied those benefits as a result of limitations imposed by the domestic law of the source State, (e.g., business purpose, substance-over-form, step transaction or conduit principles). Article 22 and the anti-abuse provisions of domestic law complement each other, as Article 22 generally determines whether an entity has a sufficient nexus to the Contracting State to be treated as a resident for treaty purposes, while domestic anti-abuse provisions determine whether a particular transaction should be recast in accordance with its substance.
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