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Validity of Tax Gross-up Clauses May Affect Cross-Border Financing Agreements
The State Tax Administration of Ukraine has questioned the validity of tax gross-up clauses Widely employed in cross-border finance arrangements. Taxand Ukraine discuss how this stance may potentially affect cross-border financing agreements. and identify the the negative risks non-residents should look out for.
In its Letter No 14086/5/22-5016 of November 18, 2009, the State Tax Administration of Ukraine ("STA") in response to request of the National Bank of Ukraine, for the first time, pronounced its position on the validity of tax gross-up clauses widely employed in cross-border loan (financing) agreements involving Ukrainian borrowers.
Under a standard gross-up clause, interest and other amounts payable by the Ukrainian borrower shall be increased (grossed-up) for the amount of any withholding tax or other deductions made from the amounts payable to the nonresident lender. Effectively, the non-resident lender shall receive interest and other amounts payable net of any Ukrainian withholding taxes or other deductions.
The issue here is that Article 18.2 of the Law of Ukraine "On Taxation of Profits of Enterprises" ("CIT Law") prohibits contractual tax clauses, pursuant to which resident entities undertake to "pay" corporate income tax on income for non-residents. Although under gross-up clauses resident borrowers do not legally "pay" Ukrainian withholding tax for non-resident lenders, resident borrowers effectively incur the burden of such tax.
In the opinion of the STA, gross-up clauses are prohibited under Article 18.2 of the CIT Law and, as a result, are null and void.
It is hard to predict at this moment how this position of the STA may potentially affect cross-border financing agreements with resident borrowers paying grossed-up interest to non-resident lenders and, in particular, rights of non-resident lenders to receive grossed-up interest.
Non-resident lenders should carefully consider risks of the following negative consequences. Read the full newsletter from Taxand Ukraine to identify the full nature of these consequences
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