On the legality of applying a preferential rate when paying income to a non-resident

The Supreme Court composed of the panel of judges of the Administrative Court of Cassation, while sending the case for a new consideration, noted that in order to confirm the conclusion that the company is a permanent establishment within the meaning of paragraph 5 of Article 5 of the Convention between the Government of Ukraine and the Government of the Republic of Cyprus for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income (hereinafter - the Convention), ratified by the Verkhovna Rada of Ukraine on July 4, 2013 by Law No. 412-VI, the study of evidence regarding the implementation of the Convention is crucial.

The court found that the interests of the non-resident were represented by authorized persons - citizens of Ukraine acting on the basis of powers of attorney. According to the content of these powers of attorney, the non-resident's representatives had full rights to dispose of the non-resident's real estate and finances, and were entitled to acquire shares in Ukrainian companies and alienate them. In addition, the latter used their powers to enter into transactions on behalf of the non-resident, in particular, agreements for the purchase and sale of corporate rights and service agreements.

Also, on behalf of the non-resident, the same persons participated in general meetings of companies whose corporate rights belong to the non-resident, made decisions on dividend payments, and approved the company's charter.

These persons are not agents with independent status, as they are actively involved in the activities of the group of related parties, which includes the non-resident, receive salaries from Ukrainian companies that are members of the group of companies that includes the non-resident, are beneficial owners of the non-resident and Ukrainian companies, and did not receive any income from abroad for representing the non-resident's interests, which is a direct sign of a permanent establishment in accordance with the provisions of Article 5(5) of the Convention.

Taking into account the above, as well as the fact that all investments of the non-resident company are located in Ukraine and are managed from Ukraine by individuals - citizens of Ukraine, in accordance with Article 10(4) of the Convention, as well as Article 7 of the Convention, Ukraine taxes the non-resident's income on the basis of tax legislation.

Thus, in accordance with paragraphs 23 and 24 of the official commentary to the OECD Model Convention, the activities of a representative office cannot be considered to be of an ancillary nature if it primarily performs the same functions as the parent company. In other words, if the main activity of the representative office is identical to the activity of the non-resident (parent company) as defined in the statutory documents of the non-resident, the representative office is treated as a permanent establishment for tax purposes.

In order to distinguish between a "permanent" representative office and a "non-permanent" (non-commercial) representative office, it is necessary to identify the key characteristics that serve as the basis for their distinction. First of all, the activities of a non-permanent representative office are exclusively preparatory or auxiliary in nature to the activities of a non-resident company and must be distinct from the statutory functions of the parent company. A similar legal position was expressed by the Supreme Court in its resolutions dated 21.12.2022 (case No. 200/7051/20-a) and 15.03.2016 (case No. 826/14127/14).

The panel also noted that "in order to recognize a non-resident's representative office as having the status of a permanent establishment, a prerequisite is that it conducts commercial activities.

In essence, this term is equivalent to the term "economic activity" used in the Tax Code of Ukraine, as well as in a significant number of other international treaties.

Thus, clarifying the nature of a non-resident's economic activity is important for the purpose of defining a permanent establishment.

The term "economic activity" is defined in sub-clause 14.1.36 of clause 14.1 of Article 14 of the Tax Code of Ukraine as the activity of a person related to the production (manufacture) and/or sale of goods, performance of works, provision of services, aimed at generating income and carried out by such person independently and/or through its separate subdivisions, as well as through any other person acting in favor of the first person, in particular under commission, power of attorney and agency agreements.

Therefore, business activity is characterized primarily by its focus on generating income, as well as certain organizational efforts made in the implementation of the relevant activities (including organizational, financial, human, etc.).

Thus, if a representative office carries out business activities in Ukraine, including, but not limited to, activities aimed at providing services to third parties (consultations, promotions, etc.) and other actions that may indicate the "economic" or "commercial" nature of the representative office's activities, the representative office acquires the characteristics of a permanent establishment and is obliged to pay income tax on income received from a source in Ukraine.

Taking into account the types of activities of the non-resident (...), and taking into account the activities of the plaintiff (...), such actions of the plaintiff indicate the economic nature of the functions performed. Letters signed by the head of the Representative Office, contained in the case file, stating the fact of conducting business activities and concluding agreements with various state institutions, further confirm this qualification.

The defining feature of a permanent establishment is also the presence of a specific place of business. In order for a place of business to have the character of a permanent establishment, it is not necessary that such a place has a certain formalization in the form of a separate subdivision. In particular, (...) not only a branch, but also another place of management, office, factory, workshop, mine, oil or gas well, quarry or any other place of exploration may be considered a permanent establishment."

Summarizing the above, the Supreme Court considers the conclusions of the courts of previous instances to be erroneous, premature and made without examining all the evidence in the case.

In addition to the above, the panel of judges of the Administrative Court of Cassation believes that "the conclusion of the courts that a documentary unscheduled tax audit on the grounds provided for in subparagraph 78.1.1 of paragraph 78.1 of Article 78 of the Tax Code of Ukraine could not be initiated and the initiated one should have been stopped, is unfounded, since Article 78 of the Tax Code of Ukraine is the basic norm that, if there are appropriate grounds, entitles the controlling authority to conduct an audit, in this case on the grounds provided for in subparagraph "b" of subparagraph 69.2 of clause 69 of subsection 10 of section XX "Transitional Provisions" of the TC of Ukraine on taxation of income received by non-residents or other non-residents carrying out business activities through a permanent establishment in Ukraine, and the provisions of sub-clause 69.2 of clause 69 of subsection 10 of section XX "Transitional Provisions" of the TC of Ukraine, in turn, do not limit the grounds for their conduct, which are specified in Article 78 of the TC of Ukraine."

The position of the supervisory authority was also strengthened by the materials received from foreign competent authorities, which once again proves that the exchange of tax information with foreign countries is an important tool for proving the established violations, including in court.

As a result, the taxpayers paid the additional amount of about UAH 50 million.

References to the court rulings: case No. 160/11095/23 and case No. 160/10363/23.