Application of the Principal Purpose Test (PPT) when paying income to a non-resident

The State Tax Service of Ukraine informs that paragraph 141.4 of the TCU defines the peculiarities of taxation of income received by a non-resident with a source of origin in Ukraine.

The list of such income is provided in subparagraph 141.4.1 of the TCU.

Subparagraph 141.4.2 of the TCU stipulates that 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 a source of origin in Ukraine received by such non-resident (including to accounts of non-residents), shall be subject to the rate of taxation at the rate specified in subparagraph 4.1 of this paragraph.4.1 of this clause, at a rate of 15% (except for the 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 the persons in whose favor the payments are made, which have entered into force.

The procedure for the application of the international treaty of Ukraine for the avoidance of double taxation regarding full or partial exemption from taxation of non-resident income originating in Ukraine is provided for in Article 103 of the TCU.

In particular, paragraph 103.2 of the TCU provides that tax benefits in the form of tax exemption or application of a reduced tax rate provided by an international treaty are not granted in respect of the relevant type of income or profit if the main or predominant purpose of the relevant business transaction of a non-resident with a resident of Ukraine was to directly or indirectly obtain the benefits provided by the international treaty in the form of tax exemption or application of a reduced tax rate. This provision does not apply if it is established that the receipt of such benefits is in line with the object and purpose of the international treaty of Ukraine. If an international treaty ratified by the Verkhovna Rada of Ukraine establishes rules other than those provided for in this clause, the relevant rules of the international treaty shall apply.

Thus, in particular, some international treaties of Ukraine on avoidance of double taxation contain provisions on application of the "principal purpose test" (PPT) to the above payments (for example, Article 23 "Right to receive benefits" of the Convention between the Government of Ukraine and the Government of the United Kingdom of Great Britain and Northern Ireland for the Elimination of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains (entered into force for Ukraine on 11.08.1993) as amended on 09.10.2017, in Article 24 "Avoidance of Double Taxation" of the Convention between Ukraine and the Kingdom of the Netherlands for the Elimination of Double Taxation with respect to Taxes on Income and on Property and the Prevention of Fiscal Evasion and Avoidance (entered into force for Ukraine on 02.11.1996) as amended on 12.03.2018.

An exhaustive list of them is contained in paragraph 6 a) of the Law of Ukraine No. 2692-VIII dated 28.02.2019 "On Ratification of the Multilateral Convention on the Implementation of Measures Related to Tax Treaties to Prevent Base Erosion and Profit Shifting" (entered into force for Ukraine on 01.12.2019).

For the purposes of interpreting double taxation treaties, international practice uses the Model Double Taxation Convention of the Organization for Economic Cooperation and Development (the "OECD Model Convention"), which is the basis for most double taxation treaties, and the official Commentaries thereto. The need to use the provisions of the OECD Model Tax Convention and the Commentaries is based on the general rules of interpretation of international treaties set forth in the Vienna Convention on the Law of Treaties of 1969.

The Commentary to Article 29(9) of the OECD Model Convention, which interprets the "Principal Purpose Test" and analyzes the specifics of its application, states that the fact that a person does not have the status of beneficial (actual) owner of income does not mean that a certain transaction does not meet the Principal Purpose Test. This conclusion was also reached by the OECD in the Final Report on the implementation of Step 6 of the BEPS (Base Erosion and Profit Shifting) Action Plan: "Preventing the Abuse of Double Taxation Treaties".

Thus, Article 29 of the OECD Model Convention provides for special provisions on limitation of benefits provided by double taxation conventions - the "Principal Purpose Test", which is as follows: "Notwithstanding any provision of a double taxation convention, a benefit provided for in a double taxation convention shall not be granted with respect to income or capital if it can reasonably be concluded, having regard to all the relevant facts and circumstances, that the obtaining of such benefit was one of the main purposes of any arrangement or transaction which directly or indirectly resulted in the benefit, unless it is determined that the granting of the benefit in the circumstances would be consistent with the aim and object of the relevant

In accordance with paragraph 178 of the Commentary to Article 29 of the OECD Model Tax Convention, the conclusion that one of the main/primary purposes of a transaction or structure is to apply the benefits of a double tax treaty should be based on an examination of all the facts and circumstances relevant to such transaction and taking into account the following

1) such conclusion shall not be based on assumptions;

2) the study of all facts and circumstances should not be limited to the study of the tax effect of the transaction related to obtaining benefits under the double taxation convention.

According to paragraph 180 of the Commentary to Article 29 of the OECD Model Convention, the reference to "one of the main purposes" means that obtaining an advantage under a double taxation treaty need not be the sole or dominant purpose of a particular arrangement or transaction. It is sufficient that at least one of the main purposes is to obtain an advantage.

Pursuant to paragraph 181 of the Commentary to Article 29 of the OECD Model Tax Convention, the purpose of obtaining the benefits of a double taxation convention will not be considered to be the main purpose if there are reasonable grounds to conclude, taking into account all the facts and circumstances relating to the particular transaction, that the obtainment of such benefits was not the main factor and cannot justify the performance of a particular transaction which, alone or together with other transactions, resulted in such benefits.

Since the provisions of Article 29 of the OECD Model Tax Convention are essentially the same as the provisions of Article 7(1) of the Multilateral Convention, subpara. 103.2 of Article 103 of the Code and the relevant provisions of other international treaties, it is advisable to use the Commentary to Article 29 of the OECD Model Tax Convention to interpret this provision.

Please note that the list of examples of application of the "Principal Purpose Test" is provided in paragraph 182 of the Commentary to Article 29 of the OECD Model Tax Convention.