How to declare income to avoid double taxation

In our previous articles, we have looked at the general rules for income declaration and determination of tax residence status of individuals. In this article, we will focus on the avoidance of double taxation.

As was mentioned earlier, the Ukrainian tax residents are subject to personal income tax on their worldwide income, whereas non-residents are subject to taxation on the Ukrainian-sourced portion of their income only.

It should be noted that the Ukrainian-sourced income also includes income paid by a foreign employer, if such income is paid for labor activities carried out in Ukraine.

Subject to the effective double tax treaty, income of a non-resident received from a foreign employer for labor activities carried out in Ukraine may be exempt from taxation in Ukraine if the criteria of the treaty are met. These criteria generally include the period of stay in Ukraine during the year (not more than 183 days), income paid by a foreign employer, as well as the fact that a permanent establishment or permanent representative of a foreign employer located in Ukraine does not incur expenses associated with the payment of such income.

The Ukrainian tax residents can receive a tax credit in Ukraine in respect of foreign income taxed abroad. Taxation of foreign income abroad does not exempt the taxpayer from declaring such income in Ukraine. However, the amount of accrued tax liability may be reduced by the amount of foreign tax that has already been paid abroad. A key condition for this is a valid double taxation treaty signed between Ukraine and the respective state, and the document confirming the payment of tax abroad.

It should be noted that in order to obtain a tax credit (reduction of the amount of Ukrainian tax by the amount of taxes paid outside Ukraine), this document should meet the requirements of the Tax Code of Ukraine. In addition, it should be issued (or certified) by tax authorities of the country where foreign income was received, as well as contain information on the amount of tax paid and the amount of income from which tax was paid. The document should also be legalized (except for countries with which Ukraine has signed the legal assistance treaties that eliminate the need for legalization). As regards countries that are parties to the Hague Convention, consular legalization was replaced by apostille. Similar to the certificate of residence, the document confirming the amount of taxes paid abroad should be translated into Ukrainian and notarized.

Obtaining of the required document in the appropriate format will require some time as the taxpayer will need not only to request and obtain the document from tax authorities of other state, but also to certify it properly, which is not always possible to do within four months of the income declaration period. That is why the deadline for submitting declarations may be extended until 31 December of the year following the reporting year.

This is where an unpleasant surprise awaits the taxpayers. First, the extended period is still not enough for some countries to issue, let alone to legalize, the documents. For example, obtaining of the certificates from tax authorities of Austria, Belgium or the Netherlands can take up to three years, whereas in some countries, such as the USA and Canada, tax certificates are not subject to legalization (apostille). This basically negates the double taxation mechanism provided for by the treaties. Despite the fact that the taxpayer has paid income tax abroad and received the certificate confirming the amount of tax paid, and there is a valid double tax treaty in effect, еру tax authorities will still be unable to accept such certificates because they are not legalized. Thus, the taxpayer will have to pay taxes again, this time in Ukraine, and in full amount.

If the reporting year of the country where foreign income was received differs from the calendar year (as, for example, in the UK), the taxpayer will need to obtain two certificates in order to reflect income received during the calendar year. It is also required to insure that such income (and respective tax) is reflected on a monthly basis. Therefore, it is very unlikely that the taxpayer will be able to obtain and legalize both documents by 31 December of the year following the reporting year.

The quarantine measures implemented in most countries of the world only exacerbate the situation, since the deadline for submitting the annual declaration has been moved not only in Ukraine. Therefore, the expected period of obtaining all required documents from abroad is being automatically extended, whereas the deadline for submitting annual declaration in Ukraine remains unchanged – declarations are to be submitted by 31 December of the year following the reporting year.

On the contrary, many countries have a more friendly foreign tax credit mechanism. Depending on the country, the taxpayer can state in the declaration the preliminary information and then provide the official certificate or provide a certificate from the employer (which is much easier and faster to obtain than from the tax authorities). Moreover, many countries do not require the legalization of such certificates.

Unfortunately, Ukraine is in no hurry to simplify the procedure. The number of people declaring income in Ukraine would be much higher if they could credit the taxes paid abroad against the Ukrainian tax liability without spending a year (or even more) on obtaining the required documents.

We hope that the situation will improve with Ukraine introducing a simplified procedure. In the meantime, we are preparing our next article in the series that will be dedicated to tax discount that allows a taxpayer to refund a portion of tax withheld from the salary.

This article was prepared jointly with Victoria Chornovol, Tax & Legal Partner at Deloitte Ukraine