Review of key individual tax rulings and court decisions on non-resident income taxation and CFC rules

In the period from 1 October to 31 December 2023, the State Tax Services of Ukraine published a series of individual tax rulings (ITR) on non-resident income taxation and controlled foreign companies (CFC) rules.

Our team of experts has prepared an overview of these ITRs and key takeaways and added comments on certain aspects that require additional explanation.

Also, we offer a summary of recent decisions by the administrative appellate courts regarding issues related to the non-residents’ economic substance and their recognition as beneficial owners of income earned in the form of interest payments and compliance with the requirements for application of a preferential tax rate to payment of bond dividends.

Individual tax rulings

All individual tax rulings are available in the Unified Register of Individual Tax Rulings at the link and can be found by their relevant numbers.

Summary of the tax authorities’ positions regarding the CFC rules

The practical application of CFC rules is now coming to the force and the first CFC reports have to be submitted by 1 March or 1 May 2024 (depending on whether the controller is a legal entity or an individual). However, the long-awaited Draft Law No. 8137 has not yet been adopted and its adoption still remains an urgent challenge. Below, we have summarized the tax authorities’ recent standpoints regarding CFC following the current provisions of the Tax Code of Ukraine (TCU):

• Regarding the procedure for submitting copies of financial statements (ITR No. 3466/ІПК/99-00-24-03-03-09 dated 09 October 2023)

When financial statements are submitted in English, they need not be translated into Ukrainian. However, documents in languages other than English are required to be translated into Ukrainian and properly certified in accordance with Article 78 and Article 79 of the Law of Ukraine “On Notary”.

• Regarding the liability for late submission of a CFC Notification (ITR No. 3552/ІПК/99-00-24-03-03-09 dated 13 October 2023)

Para. 120.7 (current version), Article 120, Section ІІ of the TCU does not provide for a penalty for late notification by the controlling person of acquisition of share in a foreign legal entity or an entity without a legal entity status, or of the beginning of actual control over a foreign legal entity, or of the termination of actual control over a foreign legal entity. However, Draft Law No. 8137 may introduce changes in para. 120.7 of Article 120 of the TCU that provides for a penalty for late notification.

• Regarding the need for a CFC to submit a notification after the redomiciliation procedure and whether the redomiciled legal entity should be considered as a new legal entity (ITR No. 3835/ІПК/99-00-24-03-03-09 dated 30 October 2023)

The submission by the controlling person of the Notification after the completion of the legal entity redomiciliation procedure is not required in the subpara. 39-2.5.5, para. 39-2.5, Article 39-2, Section I of the TCU. However, the controlling person remains under obligation to submit a CFC report with a direct presentation of information that has been changed due to the transfer of a foreign legal entity to another jurisdiction.

The redomiciled entity may be considered as a new legal entity taking into account the specifics of the jurisdiction to which such entity has been transferred.

• Regarding the certifying of a copy of financial statements with an electronic signature (ITR No. 3869/ІПК/99-00-24-03-03-06 dated 31 October 2023)

Given that the properly certified copies of the CFC’s financial statements are submitted in electronic form together with the CFC Report via electronic communication means in compliance with the law on electronic document workflow and a qualified electronic signature, they (electronically signed copies of the financial statements) will have legal effect and be deemed duly certified since the person that applies an electronic digital signature certifies the accuracy of the information contained in the electronic document, in particular, in the CFC’s financial statements.

• Regarding the definition of the “total comprehensive income” within the meaning of subsubpara. 39-2.4.2.1, subpara. 39-2.4.2, para. 39-2.4, Article 39-2 (ITR No. 3937/ІПК/99-00-24-03-03-09 dated 03 November 2023)

According to International Financial Reporting Standards 1, the total comprehensive income includes all components of “profit or loss” and “other comprehensive income”.

For the purpose of elaborating a unified approach to the “total comprehensive income” defined in subpara. 39-2.4.2.1, para. 39-2.4, Article 39-2 of the TCU, and a calculation algorithm, the STS will prepare the relevant request to the Ministry of Finance of Ukraine.

• Regarding the correct completion of data in Columns 10.1 and 14.1 in the CFC Notification regarding companies of the Republic of Cyprus (ITR No. 3938/ІПК/99-00-24-03-03-06 dated 03 November 2023)

When filling in the CFC Notification form, it is required that the Taxpayer Identification Number (TIN)—not registration number in the Registrar of Companies Cyprus—be specified in Column 10.1 Taxpayer’s Code in the country of registration and Column 14.1 Information about persons who exercise indirect ownership.

• Regarding the need to submit a CFC Report in case of liquidation of a foreign entity during the reporting period (ITR No. 4741/ІПК/99-00-24-03-03 dated 19 December 2023).

Article 39² of the TCU regulates the obligation of residents of Ukraine, both individuals and legal entities, to submit a CFC Report, provided that they are the controlling individuals/entities as of the end of the reporting period.

That is, if the controlling individual/entity has lost control over the CFC before the end of the reporting period, they are not under obligation to submit the CFC Report together with their annual income return for such reporting period; yet, they must submit a Notification of termination of their participation in the CFC due to its liquidation.

Deloitte’s comment. Since the tax authorities’ standpoints and approaches change quite often and may differ in different territorial bodies, we continue to keep a close watch on ITR practices.

We hope that Draft Law No. 8137 On Amendments to the TCU regarding the improvement of CFC Taxation will be finally adopted and resolve some of the current issues.

In the meantime, regarding the existing legislative uncertainties, we can recommend that: 1) individual tax ruling should be obtained on behalf of the controllers of your CFCs, at the least, in order to avoid fines if the tax authorities’ position changes and/or 2) arguments to support a certain position you have taken/are planing to take (so called “defense file”) should be prepared for cases when the tax authorities may have questions. This is where we will gladly help you.

Regarding how payment of non-resident’s income earned under an agreement for sale and purchase of another non-resident’s shares is taxed in Ukraine

(ITR No. 4054/ІПК/99-00-21-02-02-06 dated 09 November 2023)

The taxpayer inquired from the controlling authority whether the income paid by a resident of Ukraine under an agreement for sale and purchase of equity rights (100%) of a legal entity, resident of Cyprus, is subject to taxation in Ukraine (i. e. a Ukrainian company purchases non-resident’s shares from another non-resident).

The tax authority replied that payment for equity rights of a non-resident legal entity, which 1) neither directly nor indirectly owns and does not use any real estate located in Ukraine on a long-term leasehold basis, and 2) the value of corporate rights of non-resident is not derived from shares/ interest in a Ukrainian legal entity owning real estate in Ukraine, is not subject to tax on non resident’s Ukraine-sourced income.

However, if this transaction is controlled in terms of transfer pricing and the payment amount exceeds the arm’s length amount, the resident will be required to withhold the tax on non-resident’s income (taxation of so-called “constructive dividends”).

Deloitte’s comment. Formally, the position taken by the tax authority regarding the absence of a taxable amount is in line with provisions of the TCU. However, in practice, the tax authorities (as well as Ukrainian banks that process relevant payments) may have additional questions regarding such transactions; therefore, the abovementioned ITR can be used as arguments, should this happen.

It should be borne in mind that, in addition to “constructive dividends” (even in case of uncontrolled transactions), the tax authorities may apply a 30% adjustment based on Article 140.5 of the TCU, in particular, to transactions with corporate rights/shares. Therefore, we advise you to take this into account when performing such operations.

Regarding the taxation of dividends paid under an assignment of claims agreement

(ITR No. 3628/ІПК/99-00-21-02-02-06 dated 17 October 2023)

The taxpayer (Company) applied to the controlling authority regarding the application of the preferential rate under the Convention between Ukraine and Poland when paying dividends to a new creditor.

A legal entity, resident of the Republic of Poland (Non-resident), owns 25% of the authorized capital of the Company. According to the tripartite assignment of claims agreement, the Non-Resident assigns to a legal entity, resident of Ukraine, which is not a member of the Company, the right to claim payment of dividends based on the 2021 results of the Company’s activities.

The tax authority stated that the transfer of funds to the resident (New creditor) is considered (in view of its economic substance) as payment of income in the form of dividends in favor of the non-resident founder.

At the same time, with reference to para. 103.3 of Article 103 of the TCU, the tax authority noted that, according to the Convention, the preferential tax rate does not apply for the payment of dividends in favor of a non-resident executing an assignment agreement for the right to claim payment of dividends in favor of another person-resident of Ukraine.

Deloitte’s comment. The tax authority considered the transaction based on the substance-over-form principle and actually equated the assignment of the right to claim dividends to payment of dividends to a non-resident in the mentioned situation.

That is, as defined in the TCU, this is formally considered as payment of income to a non-resident’s authorized agent with an obligation to withhold a tax at the time of payment of such income to the agent. At the same time, the TCU also allows an “end-to-end approach” to determine the beneficial owner of income. In case of replacement of the creditor, income will, from legal standpoint, arise for the new entity-resident of Ukraine, but the actual (economic) owner of the dividends is the Polish company. Therefore, in view of the fiscal approach of the tax authorities, it is possible to try to justify the application of the reduced rate to payment of income under the Convention between Ukraine and Poland (which is essentially correct).

Since this is quite an urgent and disputable issue, especially amidst current currency restrictions, we recommend performing a separate analysis for each case.

Regarding how to determine the tax residency status of a Ukrainian company if its actual place of management changes

(ITR No. 4695/ІПК/99-00-21-02-02 ІПК dated 18 December 2023)

The taxpayer applied to the controlling authority regarding whether the change of residence of the head of a Ukrainian LLC (from Ukraine to Austria) is a change of the place of effective management and whether this leads to a change in the LLC’s tax residency status.

The tax authority came to the conclusion that the tax residency criteria specified in Article 4 of the Convention between Austria and Ukraine for the avoidance of double taxation (the “Convention”) are used to determine individuals/entities covered by the Convention, and are applied rather to implement its provisions than to determine or change the tax (residency) status of such individuals/entities, since the status is determined by each of the countries-parties to the Convention (Ukraine and Austria).

Also, the tax authority emphasized that the provisions of the Convention regulate the taxation rules applied to income arising in the tax relations between Ukraine and Austria and do not constitute legal grounds for determining or changing the tax (residency) status of a certain individual/entity in the relevant state.

In addition, the tax authorities point out that the LLC’s residency is determined in accordance with the local (in this case, Ukrainian) legislation; therefore, it should be the same as the LLC’s place of registration in Ukraine. However, the actual place of stay and residency of the director of the LLC may lead to creation of a permanent establishment in Austria, in which case the LLC may also be subject to taxation in Austria in respect of the income generated from activities of such permanent establishment.

Deloitte’s comment. In view of the forced relocation of key employees of Ukrainian companies, the actual place of management is the issue of the day.

In general, it is advisable to avoid a situation where a company is registered in one jurisdiction but actually managed from another jurisdiction; even if this does not lead to the risk of its being fully recognized as a tax resident of such other jurisdiction, which depends on each individual country and its rules for determining the residency of companies, such other jurisdiction may claim taxes on all or a part of the foreign company’s income through recognizing it as a permanent establishment.

At the same time, the mentioned tax authority’s ITR is extremely controversial, since tax consequences directly depend on what jurisdiction is determined as a individual’s/entity’s tax residency jurisdiction. Unless a single country of tax residency is determined, it is impossible to correctly implement provisions of the special articles of the convention on taxation of certain types of income, and, therefore, the provisions of Article 4 of the Convention shall prevail over provisions of the local legislation of the countries-parties to the Convention.

Court practice

Decision of the Second Administrative Appellate Court regarding the taxation of non-resident’s income in the form of interest

(Resolution dated 15 November 2023 in case No. 440/8798/22)

The taxpayer paid interest for the use of credit facilities in favor of a company from Great Britain and applied the preferential rate under the Convention for the Avoidance of Double Taxation between the Government of Ukraine and Great Britain.

After the audit performed, the STS challenged the economic substance of the non-resident company, to which the interest was paid in Britain, and stated that payment of interest to such company does not pass the principal purpose test.

The court considered the following:

• the non-resident company, to which the income was paid, is a resident of Great Britain, and relevant certificates have been provided;
• loan agreements with a non-resident do not provide for the non-resident’s obligation to transfer the interest to third parties or contain no other stipulations regarding the use of funds;
• a letter from the HMRC:
• no available information about any tax case investigations involving a non-resident company;
• a non-resident company timely performs all its obligations as required by the legislation on taxation of labor income;
• the non-resident has no obligation to use any part of the funds received by the company to repay certain debts;
• according to the HMRC international tax expert who signed the aforesaid letter, the non-resident is not a conduit company, i.e. it does not have beneficial ownership of income. According to the expert, the company neither took nor provided loans to obtain improper advantages under conventions for the avoidance of double taxation in Great Britain;
• the non-resident is more than an artificial legal entity; it has employees, pays them remuneration and has other income.

Moreover, although it is stated that the non-resident company must use the interest earned on intercompany loans, it must meet payable expenses using its own finance. This takes place in the same way as in case of any finance company which takes a loan for the purposes of further lending (for example, a bank). Consequently, the company is under no obligation to transfer “income” since it is actually under obligation to make payments from “income”, and this is a different concept.

Also, the tax authority of Great Britain notes that the non-resident is a bona fide taxpayer, is not a fictitious company and is not created for the purpose of obtaining advantages under the convention, but for the purpose of obtaining advantages in the market of London and the United Kingdom.

Therefore, there is no doubt that the company is the beneficial owner of the income and can apply the preferential rate under the convention.

Deloitte’s comment. The status of the beneficial owner is mandatory for application of the preferential rate under the international convention for the avoidance of double taxation in relation to certain types of income. At the same time, this status and the proper economic substance of the company as the beneficial owner of income can be proved by presenting foreign tax authorities’ letters and notices, which are recognized by the court as reliable and sufficient evidence in accordance with Article 75 and Article 76 of the Civil Code of Ukraine.

Otherwise, the court supported the already established approach that the status of the beneficial owner of income exists when the recipient of the income has the right to benefit and determine the further economic fate of such income, and is not bound by contractual or legal obligations to transfer such income to another person.

However, the transfer of a part of the income to third parties does not indicate that the non-resident performs only intermediary functions, if such non-resident actually has sufficient “substance”, performs functions, bears risks, etc.

Decision of the Sixth Administrative Appellate Court regarding the confirmation of the tax residency status of another jurisdiction and the taxation of non-resident’s income from the alienation of securities

(Resolution dated 12 December 2023 in case No. 640/2/22)

The taxpayer paid dividends and transferred funds to a French tax resident under the bond purchase agreements, the price of which included the par value, accumulated coupon (interest) income, and discount. The taxpayer applied a 0% WHT when paying dividends; however, the taxpayer withheld no tax when paying for the bonds.

During the tax audit, the controlling authority insisted that:

• a 0% tax rate was unlawfully applied when paying dividends, since the certificate confirming the status of a French tax resident was issued before the decision on payment of dividends was approved, and the amount of dividends payable was not indicated in the certificate;
• the purchase of bonds is also a transaction that involves payment of Ukraine-sourced passive income (in the form of interest) to a resident of France, consequently, the taxpayer had to separately tax such payment.

The appellate court agreed with the decision of the court of first instance and rejected the appeal of the controlling authority, noting that:

• the taxpayer must make sure that their counterparties had the status of a resident of the relevant jurisdiction before paying income in their favor, and the current legislation does not provide for a specific date (or period) when the residency certificate must be obtained. However, for exemption from (reduction of) taxation, it is allowed to use a certificate containing information for the previous reporting period, received after its end;
• the certificate (730_FR_ANG_SD) provided by the taxpayer is the only form that confirms the status of a resident of France; however, it does not include information, in particular, about the amount of income received. Yet, this certificate is recognized by both Ukrainian and French tax authorities as a proper ground for application of the preferential tax rate to non-resident’s income;
• amounts of accumulated coupon income that the controlling authority treats as interest are a component of the value of and pre-calculated income from the bond, and not interest as such in the meaning of the tax legislation and the Convention, since such interest will be paid by the bond issuer on the date determined in the prospectus. Such indicator of the bond value is determined solely for the purposes of assessing its value and accounting, and is not a basis for recognition of income in the meaning of tax legislation.

In view of the above, when paying dividends to a resident of France, the taxpayer rightfully applied a 0% WHT, and payment of the accumulated coupon (interest) as a part of the bond value to a non-resident is actually an investment, and not a payment of Ukraine-sourced interest.

Deloitte’s comment. Proper confirmation of the tax resident status is one of key requirements for receiving benefits under tax conventions in case of payment of Ukraine-sourced income to a non-resident.

In practice, the tax authorities quite often try to challenge the use of tax residency certificates issued before the income payment date alleging that “backdated certificates cannot certify the residency status for future periods”. However, the mentioned decision yet again confirms the established court practice, the Supreme Court’s practice in particular, regarding the use of such certificates.

According to another standpoint of the court, which is worth mentioning, non-resident’s income, if economically related to Ukraine and results from non-resident’s investments in Ukraine, is subject to taxation. In other words, it is the economic substance of transactions that must be analyzed, rather than its formal components (for example, only the description of income in the documents), which is absolutely in line with the generally accepted substance-over-form principle.

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