Tax Alert Ratification of New Double Tax Treaty Between Ukraine and Cyprus On 4 July 2013, the Verkhovna Rada of Ukraine accepted the Law of Ukraine On Ratification of a Convention between the Government of Ukraine and the Government of Cyprus for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and Protocol thereto (hereinafter the Convention is referred to as the Double Tax Treaty or DTT ). The respective Double Tax Treaty and Protocol were signed on 8 November 2012 in Nicosia, during the visit of the President of Ukraine Viktor Yanukovych to the Republic of Cyprus. The Law will enter into force upon its signing by the President of Ukraine and publication in official mass media. The Double Tax Treaty and Protocol shall enter into force on the date of receipt of the last written notification of completion of all domestic procedures, which are required for documents to enter into effect, by the Contracting States. In fact, provision of the new DTT and Protocol will have effect from the 1 January of a year following the year when the DTT is ratified by the parties, i.e. not earlier than 1 January 2014, provided that all the aforementioned procedures are completed. The new DTT will replace the old treaty, which was signed between USSR and Cyprus on 29 October 1982. Please find below a brief overview of principal provisions of the new DTT and new provisions of the Protocol thereto:
Permanent Establishment Definition of a Permanent Establishment (hereinafter referred to as the PE ) is brought into compliance with the definition of the Model Tax Convention of the Organization for Economic Cooperation and Development (hereinafter, the OECD ). Please note that the old treaty had some non-standard provisions. For example, it stipulated that the risk of permanent establishment for a non-resident should not arise: Even if activities of a related agent (conclusion of contracts on behalf of a non-resident on the basis of the power of attorney) did not constitute such agent s ordinary professional activities, or If goods were stored in a warehouse, including warehousing transactions and supply of goods Such non-standard provisions are aligned with the OECD Model Tax Convention. For now, availability of a warehouse or any other storage structure used for sale of goods leads to the risk of the permanent establishment, and the PE risk does not arise in respect to any activity of a preparatory or auxiliary character when a warehouse is used solely for the purposes of storage, display, or delivery of goods. Moreover, such alignment with the OECD Model Tax Convention provides for more grounds to use the Commentary to the OECD Model Tax Convention to support the position of taxpayers in respect of the PE risk. Please note that Ukraine is not a member of the OECD, thus, the Commentary to the Model Tax Convention is not binding. However, Ukrainian tax authorities in their letters refer to the Commentary, and mainly while interpreting a provision regarding the PE risk. In addition, this year Ukraine has announced its intent to become a member of the OECD in the foreseeable future. Dividends Dividends will be taxed at source (the withholding tax will be charged in a contracting state in which the dividends arise, i.e. from dividends paid, for example, by a Ukrainian company to a resident of Cyprus) at the following rates: 5% if the beneficial owner holds at least 20 per cent of the capital of the company or has invested in the corporate rights of the company equivalent of at least 100 000 EURO, and 15% in all other case Considering that for the purposes of application of the reduced withholding tax rate the above conditions are interchangeable ( or ), this factor will definitely be advantageous for holders of more than 20 per cent of shares. At that, for minority shareholders the situation is more complicated, especially with respect to joint stock companies. In such a case, a share capital of the Ukrainian company, most probably, will have to be increased by a significant amount. Furthermore, a ruling from Ukrainian tax authorities will have to be obtained if shares/stock in the Ukrainian company were purchased by a Cypriot company (not invested by the company directly in the process of set-up or by way of capital increase). Interest 2
According to the DTT, interest is also taxed at source (in a contracting state in which it arises) at the rate of 2%. However, the Article stipulates that the rate may be applied only if it is mutually agreed between the competent authorities of the Contracting States. This provision has not been commented by Ukraine so far, and such approach might formally impede payment of interest at reduced rates. In practice, such provisions exist in other DTTs, to which Ukraine is a party, and no difficulties have been observed with respect to application of the reduced tax rate. Royalties These payments will also be subject to withholding tax in a contracting state in which they arise. The following tax rates will apply: 5% if royalties are paid under license agreements in respect of any copyright of scientific work, any patent, trade mark, secret formula, process or information concerning industrial, commercial or scientific experience 10% in all other cases In case of paying royalties, there is also a reservation that the reduced rate (5%) may be applied only if it is mutually agreed by the competent authorities (please see our comments in Section Interest above). Please also note that royalties in respect of use of intellectual property rights to software do not fall within the reduced withholding tax rate. Capital gain Unlike the Model Tax Convention, both the old and new Double Tax Treaties with Cyprus provide that capital gain is taxed in the country of residence (including income from sale of corporate rights and securities even if the company s assets consist of immovable property for more than 50 per cent). Considering that capital gain from sale of securities is exempt from tax in Cyprus, shares in Ukrainian companies can be sold without any tax consequences. Beneficial owner The concept of the beneficial (actual) owner is used almost in all articles the new DTT and corresponds to international tax approaches as well as to Ukrainian tax legislation requirements. In this respect, we recommend paying special attention in future to the so-called substance of foreign companies and ensuring availability of a real office abroad, effective management of the company in the country of its tax residence, availability of appropriate personnel, etc. Entry into force As mentioned before, the Double Tax Treaty shall enter into force on the date of receipt of the last written notification (in the case concerned notification of documents ratified by Parliaments) and shall have effect in respect of tax withheld from amounts paid on or after the first day of January in a year following the year when the DTT enters into force (i.e., the year of ratification). 3
An old treaty usually ceases to have effect once a new DTT comes into effect. However, please note that the Ukrainian text of the draft treaty (according to the Draft Law No. 0024 dated 17.05.2013) has a provision that the old treaty ceases to have effect from the moment the new DTT enters into force (not from the date when it comes into effect). This contradicts the draft treaty in English (where the date of coming into effect is used) as well as the world practice of interpretation of the date of entry into force. Should the Ukrainian text of the new DTT remain unchanged, there is a theoretical risk that on the basis of the Ukrainian version any transactions between Ukraine and Cyprus performed in the period between the date when the new DTT enters into force and the date when its provisions come into effect (1 January of a year following the year of the treaty ratification) will be regulated (from a Ukrainian point of view) by neither of the double tax treaties. However, we believe that this reservation should be treated broader, based on English text (it should be used in case of any contradictions between Ukrainian and Greek versions of the treaty), and the old double Tax Treaty will actually be valid until the new DTT comes into effect. Protocol to the Double Tax Treaty: Exchange of information In addition to standard provisions of Article 24 of the DTT, which regulate the procedure for exchange of information between the competent authorities of the Contracting States, Ukraine and Cyprus have set special rules with respect to the exchange of information. If there is any request for information, the requesting Contracting State shall demonstrate the expected correspondence between the requested information and the submitted request. In particular, the Contracting State shall provide: Information on a person, which is being checked or under examination Application describing the essence of the required information and form, in which the information should be provided Tax purpose of the request Grounds to believe that the requested information is available to the Contracting State or is owned or controlled by a person, which is located in the jurisdiction of the Contracting State Name and address of any person (as far as it is known) that is believed to be the owner of the required information Confirmation that (i) the request is in line with laws and administrative practice of the requesting Contracting State; (ii) if the requested information is under the jurisdiction of the requesting Contracting State, the competent authorities will be able to obtain the information in accordance with laws or in the course of ordinary administrative practice, and (if applicable) in accordance with this Double Tax Treaty Confirmation that the requesting Contracting State has used all available means to obtain information within its own territory, save for those that are connected with incommensurate difficulties At that, the requested information will not be provided if the Contracting State, from which information is requested, has no mutual provisions and/or does not apply the respective administrative practice to provide the information requested. Please note that our analysis and conclusions are preliminary. They are based on the Ukrainian text of the new Double Tax Treaty (in accordance with the Draft Law No. 0024 dated 17.05.2013) and on the English version of the DTT available to us (which is slightly different from the Draft Law No. 0024 dated 17.05.2013). In accordance with the Double 4
Tax Treaty and Protocol thereto, in case of any discrepancies between Greek, English and Ukrainian versions of the DTT, the English text prevails. In general, the new DTT requires additional approval procedures to be implemented and explanations (official commentaries) to be provided by Ukrainian and Cypriot competent authorities. Contacts If you have any questions or comments with respect to the tax alert, please do not hesitate to contact our Tax & Legal professionals. Andriy Servetnyk Partner Tax & Legal Services aservetnyk@deloitte.ua Our address in Kyiv: 48, 50A Zhylyanska St., Prime Business Center, Kyiv, 01033, Ukraine Tel.: +38 (044) 490 90 00 Fax: +38 (044) 490 90 01 Please visit our web-site: www.deloitte.ua Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/ru/about for a detailed description of the legal structure of Deloitte CIS. 2013 PrJSC Deloitte & Touche USC. All rights reserved. 5