Introduction
It
is well known that the application of tax reliefs and exemptions under double
tax treaties is contingent on the concept of beneficial owner. In order to
qualify for such a relief or an exemption, say, a reduced withholding tax rate
on interest payment, the recipient of the interest payment must be its
beneficial owner. Otherwise, the recipient will be liable to a full rate of
source-country withholding tax.
Ukrainian
tax law does contain the definition of beneficial owner. Under the Tax Code
of Ukraine (para 103.3) a beneficial owner of interest and
other income is defined as a person entitled to such income. It is also
provided for in this para that a person that is even entitled to certain income
cannot count as its beneficial owner where it acts merely as an
agent, nominee or intermediary with regard to this income.
This
article looks at how the concept of beneficial owner is understood and applied
by Ukrainian judicial and tax authorities.
Formal approach
As the
jurisprudence of Ukrainian courts shows, the courts and the tax authorities
have so far been much concerned with the technical side of the definition of
beneficial owner.
On the one
hand, the tax authorities tried to challenge arrangements where a recipient of
Ukrainian-sourced income was in a certain sense an agent or an intermediary.
They were just trying to invoke the direct provision of the above para 103.3 of
the Tax Code of Ukraine excluding agents and intermediaries from the scope of
the definition of beneficial owner. This was by and large done in respect of sublicense
arrangements. The tax authorities were attempting to equate foreign lessees
sublicensing intellectual property rights to Ukrainian taxpayers to agents or
intermediaries.
On the other
hand, the courts, as usual, rejected the tax authorities’ claims on the
following grounds:
1) Sublicense arrangements
are intellectual property-related contracts under Ukrainian civil law. They do
confirm the recipients’ entitlement to Ukrainian-sourced income, thereby
rendering such recipients the beneficial owners of the income;
2) The reference made by
the tax authorities to para 103.3 of the Tax Code of Ukraine is ill-founded, as
the sublicense arrangements are not those governing the activity of an agent or
an intermediary under Ukrainian civil law.
The judgment
of the Highest Administrative Court of Ukraine (the “HACU”) dated 21 May 2013 in the so-called “Semki Case” is a
classic example of such a formal approach to the understanding of the concept
of beneficial owner.
Economic-based approach
In
May 2014 the HACU ruled on the Donbass Aero Case that completely changed the
approach to the understanding of beneficial owner. The full text
judgment in this is available at http://reyestr.court.gov.ua/Review/38106136 (in
Ukrainian).
The case
revolted around a sublease arrangement. A taxpayer which is a Ukrainian airline
leased two aircrafts from two different foreign companies. The companies that
provided the aircrafts into the lease of the Ukrainian airline were not legal
owners of such aircrafts. They leased the aircrafts from other foreign
companies and accordingly subleased them to the Ukrainian airline.
The airline
did not deduct any withholding taxes from the lease payments made in favour of
the foreign lessors by relying on relevant double tax treaties exempting such
income from withholding taxation in Ukraine.
The tax authorities
argued that the exempting provisions of the double tax treaties should not have
been invoked by the airlines, as the foreign lessors could not qualify as the
beneficial owners of the lease payments. The tax authorities pointed out to the
sublease nature of the concerned arrangements making, to their way of thinking,
the foreign lessors in question agents or intermediaries falling outside the
scope of the beneficial ownership concept under para 103.3 of the Tax Code of
Ukraine.
The court
ruled in favour of the airline. It held that:
1) The
term “beneficial owner” of income should not be construed in a narrow and
technical sense. It should be understood in light of the object and purposes of
double taxation treaties. In particular, as follows from international practice
of the application of double taxation treaties, a beneficial owner is a person
that does not only receive income, but also determine its further
economic destiny;
2) The
tax authorities failed to satisfy the court that the lessors were restricted in
their ability to dispose of the leased payments received from the airline. That
is, the tax authorities failed to substantiate that the lessors were unable to
determine the further economic destiny of the Ukrainian-sourced income
received.
Following the solution of
the Donbass Aero Case on 31 October 2014 the State Fiscal Service of Ukraine
(the “SFSU”) published its letter No
9033/7/99-99-10-02-02-17 on the application of the concept of beneficial owner.
In this letter, the SFSU
guided itself by the judgment of the HACU in the Donbass Aero Case. It
committed itself to a wide economic approach to the determination of beneficial
owner set forth in the above judgment. In particular, pursuant to the SFSU’s
letter the term “beneficial owner” should not be interpreted in a narrow
technical meaning. To be considered a beneficial owner, a recipient of
Ukrainian-sourced income must be a person who determines the subsequent
economic destiny of the received income.
OECD
Commentaries
It is noteworthy that the
aforesaid wide economic approach to the understanding of beneficial owner
appears to be in full accord with the 2014 OECD Commentaries to Model Tax
Convention on Income and on Capital (the “Commentaries”).
The Commentaries, namely,
state as follows:
1) The “beneficial owner”
term is not used in a narrow technical sense and should be understood in its
context in light of the object and purposes of double tax treaties;
2) No relief or exemption
under a double tax treaty can be granted to a conduit company. A conduit
company, though the formal owner, it has, as a practical matter, very narrow
powers which render it, in relation to the income concerned, a mere fiduciary
or administrator acting on account of the interested parties;
3) A direct recipient of
the income is not considered the beneficial owner of this income if that
recipient’s right to use and enjoy the income is constrained by a contractual
or legal obligation to pass on the payment received to another person.
Conclusion
The shift from formal to economic-based approach in the understanding
of beneficial owner is sure-fire step ahead for Ukrainian court jurisprudence and administrative
practice. It aligns Ukraine with the countries of the developed world in this respect of the
application of double tax treaties.
At
the same time, the economic-based approach requires much greater efforts from
the tax authorities. The mere interpretation of the Tax Code of Ukraine will no
more work for them. They must resort to an international exchange of tax
information and an economic analysis. Yes, it is time-consuming and difficult,
but there is no other way out for the tax authorities should they really want
to protect the Ukrainian tax base.
