Taxation of non-residents' income: leasing/rental payments or royalties?

According to subparagraph "g" of subparagraph 141.4.1 of the Tax Code of Ukraine, leasing/rental payment is income received by a non-resident with its source of origin in Ukraine, which is taxed in accordance with the procedure and at the rates specified in the Code.

According to subpara. 141.4.2 of the Code, a resident, including an individual entrepreneur, an individual engaged in independent professional activity, or a business entity (legal entity or individual entrepreneur) that has chosen the simplified taxation system, or another non-resident conducting business through a permanent establishment in Ukraine, who makes any payment in favor of a non-resident or an authorized person from income with its source of origin in Ukraine received by such non-resident (including to the accounts of a non-resident specified in subparagraph 4.1 of this paragraph), at the rate of4.1 of this clause, at the rate of 15 percent (except for income specified in sub-clauses 141.4.4 - 141.4.5 and 141.4.11 of this clause) of their amount and at their expense, which is paid to the budget at the time of such payment, unless otherwise provided by the provisions of international treaties of Ukraine with the countries of residence of persons in whose favor payments are made, which have entered into force.

Pursuant to Article 3.2 of the Code, if an international treaty ratified by the Verkhovna Rada of Ukraine establishes rules other than those provided for by this Code, the rules of the international treaty shall apply.

During 2017 - 2023, the Group made lease income payments in the total amount of UAH 13,100 million to non-residents registered in jurisdictions where the term "royalty" includes payment for the use of equipment, which are exempt from taxation.

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

In particular, in 27 conventions for the avoidance of double taxation (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 referred to as the Convention), in accordance with Article 12, the term "royalty" means a payment, in particular, for the use or granting of the right to use industrial, commercial or scientific equipment.

Pursuant to Article 3(2) of the Conventions, when applied by a Contracting State, any term not defined in the Conventions shall have the meaning given to it by the legislation of that State in respect of the taxes to which they apply, unless the context otherwise requires.

Pursuant to Article 31(1) of the Vienna Convention on the Law of Treaties dated 23.05.1969 (the "Vienna Convention"), a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of the object and purpose of the treaty. Article 32 of the Vienna Convention allows for additional means of interpretation, including preparatory materials and the circumstances of the conclusion of the treaty, which for the purposes of double taxation conventions are the OECD Model Tax Convention Commentary and the UN Model Tax Convention Commentary on the Avoidance of Double Taxation between Developed and Developing Countries (the "UN Model Convention").

Given that the definition of "royalties" set forth in Article 12 of the Convention corresponds to paragraph 3 of Article 12 of the UN Model Tax Convention, it is necessary to refer to the Commentaries thereto.

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

In view of the above, when applying the Convention in Ukraine for the purposes of classifying a payment (remuneration, compensation) as a payment for "use or granting the right to use industrial, commercial or scientific equipment", the term "industrial, commercial or scientific equipment" should be interpreted in a broad sense, so that it covers any combination of mechanisms, devices and instruments.

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

At the same time, we note that according to subpara.38 of clause 69 of subsection 10 of section XX "Transitional Provisions" of the Code, temporarily, for the period from August 1, 2023 until the termination or abolition of martial law in the territory of Ukraine, introduced by the Decree of the President of Ukraine "On the introduction of martial law in Ukraine" dated February 24, 2022 No. 64/2022, approved by the Law of Ukraine "On Approval of the Decree of the President of Ukraine "On the introduction of martial law in Ukraine" dated February 24, 2022 No. 2102-IX, in case of self-correction by the taxpayer in compliance with the procedure, requirements and restrictions specified in Article 50 of the Code, of errors that led to understatement of the tax liability, such taxpayer shall be exempt from the accrual and payment of penalties provided for in paragraph 50.1 of Article 50 of the Code, and penalties.

Thus, the STS draws taxpayers' attention to the fact that voluntary clarification of the paid amounts of income tax on non-resident income will allow businesses to reduce the burden of paying penalties and fines accrued during the control and verification work.