Ukraine ratifies income tax treaty with Luxembourg

General

On 3 April 2017, the President of Ukraine signed the law ratifying the Convention between the Government of Ukraine and the Government of the Grand Duchy of Luxembourg for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains (the “Convention”), including the amending Protocol to the Convention.  

The Convention between two states was signed as long ago as on 6 September 1997, but has not been ratified until now. On 30 September 2016, parties amended several provisions of the Convention by the Protocol, including articles regarding taxation of dividends, interest and royalties. Luxemburg ratified the amended Convention on 23 December 2016.

The Convention will apply to taxes chargeable and income derived on or after 1 January 2018.

Thus, the overall number of effective income tax treaties entered into by Ukraine is going to increase to 73.

Below is summary of key provisions of the Convention.

Capital Gains

A source state may tax only certain types of capital gains, namely:

  • Capital gains from alienation of immovable property situated in the source state;
  • Capital gains from alienation of shares (other than shares quoted on the “approved stock exchange”) deriving their value or greater part of their value directly or indirectly from immovable property situated in the source state;
  • Capital gains from alienation of interests in a partnership the assets of which consist mainly of immovable property situated in the source state;
  • Capital gains from alienation of movable property forming a part of the business property of a permanent establishment of a foreign enterprise in the source state.

Passive income

The Convention provides for reduced tax rates at source for passive income (dividends, interest, royalties) derived by a resident of the contractual state, who is a beneficial owner of such income:

Dividends:

  • 5 per cent if the beneficial owner of dividends directly owns at least 20 per cent of capital of a company distributing dividends;
  • 15 per cent in other cases.

Interest:

  • 5 per cent if the lender is a bank or other financial institution;
  • 10 per cent in other cases.

Royalties:

  • 5 per cent if royalties are paid for the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or know-how;
  • 10 per cent if royalties are paid for the use of, or the right to use, any copyright of literary, artistic or scientific work;
  • 15 per cent in other cases.

However, reduced rates do not apply if a resident of the contractual state has a permanent establishment in the source state.

With respect to interest and royalties there is also a specific anti-avoidance rule prescribing that reduced tax rates apply only to the arm’s length part of amount of the respective payments. The amount of interest/royalties exceeding the arm’s length level is taxable at standard rates (taking into account other provisions of the Convention).

Please note that provisions of the Convention regarding taxation of interest do not prejudice new rules of taxation of LPN Eurobond structures that are in effect from 1 January 2017.

Opportunities

Historically, Luxembourg has been one of the most popular jurisdictions to establish holding companies. However, in the absence of the convention on the avoidance of double taxation between Ukraine and Luxembourg, Ukrainian businesses have used advantages of Luxembourg to a very limited extent.

Establishing a holding company in Luxembourg may have the following advantages:

  • Prestigious jurisdiction for European stock exchanges and foreign investors, which offers Ukrainian company groups easier access to financing via IPOs or private placements;
  • Moderate corporate income tax, provided that the holding company qualifies for the participation exemption regime;
  • Stable and reputable banking system, ease of establishing and doing business; and
  • Simple accounting procedures that do not require to make financial statements publicly available.

For more information, please contact Serhiy Verlanov or Olexander Olshansky.