Taxes – a landmark court ruling in Ukrainian interpretation of BO concept

13 June 2016
Iryna Kalnytska
GOLAW Law Firm Senior Associate
One of the tools for preventing  multinational corporations  (MNCs) from such form of tax avoidance as treaty shopping was the introduction by OECD into the Model Tax Convention  of the beneficial owner concept  (BO).

In this respect, the construction by the courts of the BO concept varies from country to country. However, the common feature in such interpretation is that the BO of the income should have the right to use and enjoy the passive income, bears certain risks in its respect and  control the income.

In Ukraine the most popular tax disputes related to the application of the BO concept are related to royalty and interests payment in favor of non residents. There was, however, very controversial tax dispute regarding payment of dividends that may become a landmark case in the tax field.

In the said case the company decided to make payment of the dividends distributed in 2006 - 2007   to its parent company located in Cyprus. According to DTA between Ukraine and Cyprus (that was in force at the date of dividends’ payment) the withholding tax (WHT) on dividends paid from Ukraine to Cyprus was 0% subject that the recipient of the income is the beneficial owner of the dividends. Since the payment of dividends was made in 2013 Ukrainian Co applied the said DTA and 0% WHT on dividends respectively.

In its turn tax authorities denied the application of the 0% WHT on dividends based on the fact that in 2006 -  2007 (the period for which the dividends were distributed) the Cyprus Сo was not the shareholder of Ukrainian Co, thus, Cyprus Co is not the beneficial owner of the received dividends. Surprisingly, that the Cyprus Co acquired the corporate rights of the Ukrainian Co in May 2012 just several months before the payment of the dividends. Another interesting fact is that the seller of the corporate rights of Ukrainian Co was the Ukrainian individual. Hence, if the dividends were distributed directly to him, the tax rate at the level of the recipient would be 5%.

The court of first instance and Appellate court ruled in favor of tax authorities stating that  Cyprus Co can not be the BO of the dividend because in 2006 – 2007 the company was not the owner of the corporate rights of Ukrainian Co. Such interpretation of the case is rather questionable, since  from legal point of view for application of reduced WHT on dividends it does not matter who was the owner of the corporate rights of the company in the past.  The company that is the  holder of the corporate rights at the moment of dividends’ payment matters. The same position was reflected in the decision on the case ruled by Highest Administrative Court of Ukraine. The court reversed the previous courts’ decisions and sent the case for a new hearing. The grounding for such ruling was very simple, since in 2013 the Cyprus Co was the legal and real owner of the Ukrainian Co (that was proved by the minutes of the general members meeting of Ukrainian Co and information from the public Company’s register) Cyprus Co is the BO of the received dividends. Ukrainian legislation does not provide for any other extra requirements or restrictions in this respect.

However, this is not the end of the story. The Highest Administrative Court of Ukraine only sent the case for the new trial to the court  of first instance where the case will be reviewed  from the very beginning.  Considering the strengthening of the anti tax avoidance measures on the international level and the intention of Ukraine to implement BEPS plan into national legislation legal counsels of  Ukrainian Co should tried their best to prove that the mere purpose of  alienation of the corporate rights of Ukrainian Co to Cyprus Co was not the abuse of DTT between Ukraine and Cyprus. It may be also presumed that during the new hearing the court will examine the activity or substance  of Cyprus Co in more details and apply the broad economic interpretation of the BO concept.