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France – Ukraine DTT Protects Against Deduction Discrimination in the Ukraine
Ukraine's Tax Code of 2 December 2010 provides for the limit / restriction of deduction for license fees (royalties) and certain service fees if the recipient is a non-resident entity. In a number of cases such limitation can be viewed as deduction discrimination. Taxand France and Taxand Ukraine comment on double taxation treaty dated 31 January 1997 (the Convention) that protects against deduction discrimination under the Convention between France and Ukraine.
With effect from 1 April 2011 Ukraine's Tax Code provides for the limit / restriction of deductions in respect to cross border service fees. Namely, limitation applies to
(i) consulting, marketing, advertising fees
(ii) engineering fees
(iii) license fees / royalties
No deduction is allowed if the recipient of the fees is located in jurisdictions that qualify as "offshore" (blacklisted). In the case of other jurisdictions, deduction is not allowed if the Ukrainian entity pays service fees to a non-resident service provider and the amount of fees (expense) exceeds the following thresholds:
- For consulting, marketing, advertising fees - 4% of the buying's entity revenue for the previous reporting year.
- For engineering fees - 5% of the customs value of the respective equipment imported to the country. The recipient of the fees should qualify as the beneficial owner of such engineering fees.
- For royalty in respect of use of trademarks, patents and know-how - 4% of licensee's revenue of the previous reporting year. No deduction is allowed if royalties are not subject to tax in the recipient's home country.
In a number of situations, the Ukrainian business entity may not be allowed to deduct the above types of fees merely due to the fact that the recipient of the service fee is a non-resident. If the service fees are paid to a resident entity or a permanent establishment of a foreign entity, then a deduction will be allowed. Cases where the Ukranian entity would be disallowed a deduction include:
(i) where the entity has zero or inconsiderable revenues in the previous calendar year (e.g., a newly established entity)
(ii) where the entity conducts advisory business and its business model dictates subcontracting foreign service providers
(iii) where the entity conducts major real estate / development projects, which require considerable input from foreign service providers.
The above cases can be viewed as discrimination and the Convention can be used to prevent such discrimination. It is important to note that Article 3.2 of the Tax Code provides that an effective double taxation treaty overrides provisions of Ukrainian legislation. Therefore, the "Non-discrimination" clause of the relevant double tax treaty can be applied directly.
The France-Ukraine Convention: Non-Discrimination Clause
Article 24, paragraph 4 of the Convention provides for protection against deduction discrimination:
"4. Except where the provisions of paragraph 1 of Article 9, paragraph 7 of Article 11,or paragraph 7 of Article 12, apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State [Ukraine] to a resident of the other Contracting State [France] shall, for the purpose of determining the taxable profits of such (Ukrainian] enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State [Ukraine]...".
Words "other disbursements" in the above clause cover any service fees that are paid by a Ukrainian company to the French service providers. The "Non-discrimination" clause also explicitly covers royalties. Thus, the "Non-discrimination" clause can be applied to prevent deductibility restrictions introduced in Ukraine for marketing, advertising, consulting, engineering and license fees. The provisions of Articles 9.1, 11.7, or Article 12.7 deal with special relations between associated enterprises and, generally, do not impact the above conclusion.
The above clause deals with discrimination cases where Ukrainian resident entities (regardless of ownership for their capital) pay license and service fees to French resident companies. The Convention also has special conditions regarding deductibility of royalties by the Ukrainian entity that is controlled by French residents as explained below.
The France-Ukraine Convention: Royalties Deduction Under the Protocol
Paragraph 10 (a) of the Protocol to the Convention establishes special requirement for deduction of royalties:
"For the computation of the amount of tax due on its income or profits, a company or other taxable entity which is a resident of Ukraine and of which at least 20 % is held or controlled by one or more residents of France shall be entitled to deduct: (i) ... royalties borne by such company or entity for the purposes of its business activity ...; however, such deduction may not exceed the amount which would have been agreed upon in the absence of a special relationship between the borrower and the beneficial owner of such income;"
This clause allows the deduction for royalty expense to Ukrainian companies that are controlled by French residents regardless of the residence of licensor.
In order to deal with cases of discrimination in respect of deductibility of licence and service fees French investors operating in Ukraine via a subsidiary are advised to:
- Review cross border service fee arrangements of the Ukrainian subsidiary in order to identify cases of potential discrimination.
- Verify whether in your specific circumstances the Convention can protect against discrimination.
- Take timely actions to implement provisions of the Convention.
Risk of dispute with the Ukrainian tax authorities cannot be ignored. Article 52 of the Tax Code of Ukraine provides for the possibility of obtaining a tax ruling from Ukrainian tax authorities, which may help to manage the risk of dispute.
Your Taxand contacts for further queries are:
T.+33 1 70 39 47 81
T. +380 44 492 8282
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