International double taxation treaties (“DTTs”) often provide that income of non-residents from Ukraine in the form of dividends, interest or royalties, can be subject to preferential tax rates. However, these benefits are not automatically applicable – certain requirements must be complied with to activate them.

Application of the preferential tax rate usually requires, inter alia, confirmation the status of beneficial (actual) recipient (owner) of income (“BO”). Though it may appear simple, the practical application of the BO status often leads to considerable difficulties for taxpayers.

1. The definition of BO

In accordance with the provisions of the Tax Code of Ukraine (“Tax Code”), the BO is a person (legal or individual) who is entitled to receive such income and is its beneficiary, i.e., has the right to actually dispose of this income.

However, a legal entity or individual is not a BO, even if it is entitled to receive it, but acts as an agent, nominee (nominal owner) or performs only intermediary functions. This may be indicated if such a subject:

Additionally, the interpretation of the concept of BO is contained in the Commentaries of the OECD on the Article 11 “Interest” of the Model Tax Convention on Income and on Capital.

The Commentaries state, inter alia, that “a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties”.

2. Approaches of Ukrainian courts to qualifying the BO

Judicial practice in Ukraine has been actively developing regarding the clarification of the BO status and the criteria for a non-resident to be recognized as a BO. In their decisions, the courts, inter alia, pay attention to the following aspects:

It is necessary to consider these aspects when applying for tax benefits, as in the case of a court dispute, the court will also take into account the case law.

3. The application of the “look through approach”

In accordance with the provisions of the Tax Code, if a non-resident – a direct recipient of income originating from Ukraine – is not the BO of such income, the DTT provisions with the country of residence of the actual BO can be applied.

This approach, known in the doctrine as the “look through approach”, allows to “skip” the intermediary straight to the actual BO.

To confirm the status of BO in this case, the following documents must be provided to the tax agent paying income:

In summary, to take advantage of this approach, the correct determination of the BO within the chain of intermediaries, is also the key point.

The issue of determining the status of the BO is one of the main factors in the possibility of applying the tax benefits provided by DTTs. Failure to clearly understand and comply with the special criteria may result in significant tax risks for taxpayers.

Ukrainian judicial cases demonstrate that courts analyse the essence of transactions and the real role of the non-resident owner of income in depth. Formal compliance usually is not sufficient if there is no real economic function and control over the income.

Taxpayers are advised to be particularly careful when structuring cross-border transactions with passive income. It is important to document the economic substance of such transactions and be prepared to prove the status of the BO.

Authors:

Vadym Zhukov, Paralegal at Tax, Restructuring, Claims and Recoveries practice at GOLA