New regulations adopted by the Ukrainian Cabinet dealing with withholding tax permit Ukrainian resident paying entities to apply privileged tax treaty rates without prior authorisation. Previously, non-resident taxpayers had to apply under Resolution No 825 to obtain advance clearance of a payment at privileged treaty rates, or had to apply after the event for a refund. Anyone familar with Ukrainian business practices will immediately understand that neither option was practicable, or at the minimum would require extensive bribery or unimaginable bureaucracy and quite possibly both.
The Ukrainian Corporate Tax Law provides that a foreign legal entity carrying out business activities on the territory of Ukraine either through a local legal entity or through a "permanent establishment" is subject to tax on all profits generated by the activities of such entity or permanent establishment. A permanent establishment is defined under the Corporate Tax Law as (i) any structure in Ukraine which is not a legal entity through which a foreign legal entity either partially or fully carries out business activities in Ukraine or (ii) an individual who represents and is employed by a foreign legal entity in Ukraine. This wording includes the Representative Office, which is the local structure typically adopted in Ukraine by foreign companies.
Profits in either case are subject to a 30% tax. For a permanent establishment profits for purposes of this tax are deemed to be those profits which it would have obtained if it were a separate independent enterprise and had acted independently with respect to its foreign owner.
In the event it is not possible to determine such profit, an alternative method may be negotiated with the Ukrainian tax inspectorate. In practice, the most common method is for a permanent establishment to pay a 30% tax on a deemed profit equal to 30% of the expenses attributable to such permanent establishment.
Dividends received by a Ukrainian enterprise are for the most part not included in taxable income. Capital gains are treated as taxable income.
'Enterprises With Foreign Investments' (EFIs) registered before 1995 have enjoyed a 5-year profits tax holiday, but this regime is now terminated. There is a category of tax-exempt legal entities in Ukraine that fulfil the following conditions:
Payments by Ukrainian companies to non-residents are subject to a withholding tax at the rate of 15% for EFIs, and 20% otherwise. However, Ukraine adheres to the tax treaties entered into by the former USSR until it agrees a tax treaty of its own. At present, Ukraine has ratified its own treaties with approximately 30 countries.
Most Ukrainian tax treaties in fact have quite favourable withholding tax rates, particularly where there is a significant participation. Dividend withholding rates are usually 5%, and the rates for royalties and interest are often zero. The rules for applying withholding tax are therefore important, and the new measure, if it is applied in practice, will be beneficial for foreign investors.
However, under some recently issued rules, many types of passive income and some types of trading income are excluded from the operation of tax treaties, including income from portfolio investment in interest bearing and discounted bonds and treasury bills, revenue from freight, from reinsurance and insurance premiums, advertising activities and dividends. These rules contradict the Corporate Profits Tax Law which states that international double tax treaties prevail over domestic legislation.
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