"Tax" on Advertising Ordered from a Non-Resident

Quite often, Ukrainian businesses turn to foreign advertising agencies for help in creating high-quality advertising materials or for distributing these materials. However, during tax accounting—and subsequently during tax audits—businesses inevitably face the issue of correctly taxing business transactions involving the commissioning of a non-resident to produce and/or distribute advertising materials.

In accordance with subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine (hereinafter—the Tax Code of Ukraine), residents who make payments to non-residents for the production and/or distribution of advertising shall, at the time of such payment, pay tax at a rate of 20 percent of the amount of such payments at their own expense.

This provision has been in effect under subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine since January 1, 2015. Prior to January 1, 2015, a similar provision was contained in paragraph 160.7 of the Tax Code of Ukraine. Before the adoption of the Tax Code of Ukraine, a similar legislative requirement was contained in paragraph 13.6 of Article 13 of the Law of Ukraine “On Corporate Income Tax,” pursuant to which residents who made payments to non-residents for advertising services provided within the territory of Ukraine paid tax at a rate of 20 percent of the amount of such payments at their own expense.

However, the practice of applying the provision set forth in subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine—which has existed unchanged in the legislation for a long time—is ambiguous, as evidenced by the conflict between the position of the tax authorities and certain decisions of courts of various instances, in particular, the decisions of administrative courts in cases No. 810/243/15 (appeal) and No. 820/5441/13-a (High Administrative Court of Ukraine).

Income originating in Ukraine?

Paragraph 141.4 of Article 141 of the Tax Code of Ukraine sets forth the specifics of taxation for non-residents. Thus, according to this paragraph, income received by a non-resident that is sourced from Ukraine is taxed in accordance with the procedure and at the rates specified in Article 141 of the Tax Code of Ukraine. The same paragraph defines what constitutes income for these purposes, specifically: interest and discount income paid to a non-resident, including interest on loans and debt obligations issued by a resident; dividends paid by a resident; royalties, etc.

Subparagraph 141.4.2 of Paragraph 141.4 of Article 141 of the Tax Code of Ukraine provides that a resident or a permanent establishment of a non-resident that makes, for the benefit of a non-resident or a person authorized by the non-resident (except for a permanent establishment of a non-resident on the territory of Ukraine), any payment of income derived from sources in Ukraine, received by such a non-resident from the conduct of economic activities (including to the non-resident’s accounts maintained in the national currency), shall withhold tax on such income specified in subparagraph 141.4.1 of this paragraph, at a rate of 15 percent (except for income specified in subparagraphs 141.4.3–141.4.6 and 141.4.11 of this paragraph) of such amounts and at their expense, which is paid to the budget at the time of such payment, unless otherwise provided by the provisions of international treaties of Ukraine with the countries of residence of the persons in whose favor the payments are made, which have entered into force.

In other words, paragraph 141.4 of Article 141 of the Tax Code of Ukraine establishes rules for the taxation of non-residents’ income derived exclusively from sources in Ukraine.

In turn, subparagraph 14.1.54 of paragraph 14.1 of Article 14 of the Tax Code of Ukraine defines the concept of “income derived from sources in Ukraine” as any income received by residents or non-residents, including from anykinds of their activities on the territory of Ukraine (including the payment (accrual) of remuneration by foreign employers), its continental shelf, and in its exclusive (maritime) economic zone.

Non-resident taxpayers, in accordance with subparagraph 133.2 of Article 133 of the Tax Code, include: a) legal entities established in any organizational and legal form that receive income sourced from Ukraine, with the exception of institutions and organizations that enjoy diplomatic privileges or immunities under Ukraine’s international treaties; b) permanent establishments of non-residents that receive income sourced from Ukraine or perform agency (representative) and other functions on behalf of such non-residents or their founders.

Thus, it follows from the content of the above provisions that income sourced from Ukraine is understood to mean income from any type of activity on the territory of Ukraine, including income derived from economic activities conducted by a non-resident (or a permanent establishment of that or another non-resident) within the territory of Ukraine, with the exception of income in the form of proceeds or other types of compensation for the cost of goods, work performed, or services provided, transferred/performed/provided to a resident by such a non-resident (permanent establishment), including the cost of international telecommunications or international information services.

In other words, income derived from economic activities originating in Ukraine is recognized as income of a non-resident when such activities are carried out through a permanent establishment in Ukraine. The State Fiscal Service of Ukraine shares this view, as stated, in particular, in its letter No. 12298/6/99-99-15-02-02-15 dated June 3, 2016. Therefore, a non-resident who does not have a representative office in Ukraine and provides services related to the production and/or distribution of advertising to a resident of Ukraine does not carry out business activities on the territory of Ukraine; accordingly, a payment made to such a non-resident does not constitute income sourced from Ukraine.

Is this provided for by international agreements?

The provisions of subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine do not apply in this case, taking into account the conventions for the avoidance of double taxation (hereinafter referred to as the “Conventions”), concluded by the Government of Ukraine with the governments of other countries to avoid double taxation.

Thus, Article 9 of the Constitution of Ukraine stipulates that international treaties in force, the binding nature of which has been approved by the Verkhovna Rada of Ukraine, form part of Ukraine’s national legislation.

Non-residents of Ukraine conduct their business activities and pay taxes in countries that have concluded Conventions with the Government of Ukraine and confirm these facts with the relevant certificates of residence issued by the competent authorities of the contracting states.

In accordance with the non-discrimination provisions in the treaties concluded by the Government of Ukraine with other countries (Germany, Israel, the United States, Poland, etc.), payments made by a resident of one contracting state to a resident of the other contracting state shall, for the purpose of determining the taxable income of the former resident, be taken into account under the same conditions as if they had been paid to a resident of the first-mentioned contracting state.

In other words, payments made by residents of Ukraine to residents of other contracting states are subject to inclusion for the purposes of taxing residents of Ukraine under the same conditions that apply to payments made to non-residents of Ukraine. The Tax Code of Ukraine does not provide for such a condition for the inclusion of payments (for the production of advertising) made to a resident of Ukraine, namely the payment of an additional 20% of the cost of services from the customer’s own funds. Accordingly, the same identical conditions must apply under the Conventions when payments are made to a resident of a contracting state. If applied otherwise, such a tax constitutes an additional condition (burden) compared to similar payments made to residents of Ukraine for the proper recognition of such payments for tax purposes.

Pursuant to Part 5 of Article 7 of the Code of Administrative Procedure of Ukraine, if an international treaty, the binding nature of which has been approved by the Verkhovna Rada of Ukraine, establishes rules other than those established by law, the rules of the international treaty shall apply.

Therefore, the non-discrimination provision contained in the Convention precludes the application of subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine regarding the payment of a 20% tax on payments made to a resident of a Contracting State.

Tax?

Furthermore, the tax provided for in subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine does not meet the criteria for a tax and is not subject to payment based on the provisions of the Tax Code of Ukraine when applied systematically.

Thus, pursuant to paragraph 4.2 of Article 14 of the Tax Code of Ukraine, taxes not provided for in the Tax Code of Ukraine are not subject to payment.

Pursuant to Article 7 of the Tax Code of Ukraine, a tax is defined by a set of mandatory elements. The list of national taxes is set forth in Article 9 of the Tax Code of Ukraine.

As for the tax provided for in subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine, it is not specifically defined in Article 9 of the Tax Code of Ukraine, and it does not fall under the concept of corporate income tax due to the absence of mandatory elements. In particular, subparagraph 141.4.6 of paragraph 141.4 of Article 141 of the Tax Code of Ukraine and the tax provided for therein cannot be considered a tax on the income of a non-resident, since it provides for the payment of a 20% tax not by withholding it from the non-resident’s income, but rather from the own funds of the Ukrainian resident making the relevant payments.

Nor can such a tax be considered a tax on the income of a resident of Ukraine, given the absence in this case of a taxable base for corporate income tax, which, according to subparagraph 134.1.1 of paragraph 134.1 of Article 134 of the Tax Code of Ukraine, is determined by adjusting (increasing or decreasing) the pre-tax financial result (profit or loss) determined in the enterprise’s financial statements in accordance with national accounting regulations (standards) or international financial reporting standards, by the differences arising in accordance with the provisions of the Tax Code of Ukraine.

Can tax authorities independently determine monetary obligations during an audit?

It should be noted that the tax authority does not have the right to independently determine the amounts of monetary obligations for such a tax, since, in accordance with subparagraph 54.3.2 of paragraph 54.3 of Article 54 of the Tax Code of Ukraine, the tax authority independently determines monetary obligations only if the results of audits of the taxpayer’s activities—excluding electronic audits—indicate an understatement or overstatement of the amount of the taxpayer’s tax obligations, the amounts of budgetary refunds and/or a negative taxable income base for income tax or a negative value-added tax liability of the taxpayer, as declared in tax (customs) returns and adjusted calculations.

At the same time, the tax liability under subparagraph 141.4.6 of paragraph 141 of Article 141 of the Tax Code of Ukraine is not a resident’s income tax and, accordingly, is not reported in tax returns as the taxpayer’s own tax liability.

Pursuant to paragraph 103.9 of Article 103 of the Tax Code of Ukraine, a person who pays income to a non-resident is required, if during the reporting period (quarter) payments were made to non-residents of income originating in Ukraine, to submit to the tax authority at its place of business (place of residence) a report on the income paid, as well as the taxes withheld and remitted to the budget on non-resident income, within the timeframes and in the form established by the central executive authority responsible for formulating and implementing state tax and customs policy.

Thus, the report regarding income payments to non-residents, which is submitted by a resident as part of the corporate income tax return, pertains to income sourced from Ukraine and serves as an informative notification regarding the amount of income paid to a non-resident and the non-resident income tax that has already been withheld and paid.

Therefore, based on the foregoing, we believe that any conclusions by the tax authorities regarding the understatement of tax liabilities by residents making payments to non-residents  (provided that they do not conduct business activities in Ukraine through their representative offices) for the production and/or distribution of advertising and have not reported the amounts of such payments in the report accompanying the corporate income tax return, which could have been identified during an audit, and therefore, the use of subparagraph 54.3.2 of paragraph 54.3 of Article 54 of the Tax Code of Ukraine as a basis for the tax authorities to determine tax liabilities is unlawful in such a case.

Pursuant to subparagraph 54.3.5 of paragraph 54.3 of Article 54 of the Tax Code of Ukraine, the tax authority independently determines monetary obligations if the audit findings regarding the withholding of taxes at the source of payment, including those of a tax agent, indicate violations of the rules for calculating, withholding, and paying taxes and fees to the relevant budgets as provided for by the Tax Code of Ukraine, including personal income tax by such a tax agent.

However, subparagraph 141.4.6 of paragraph 141 of Article 141 of the Tax Code of Ukraine does not provide at all for a resident to withhold 20% tax on income paid to a non-resident, since a resident of Ukraine must pay such tax exclusively at their own expense.

Multiple Interpretations?

It follows from the wording of subparagraph 4.1.4 of paragraph 4.1 of Article 4 of the Tax Code of Ukraine that if a provision of a law or other regulatory act issued on the basis of a law, or if provisions of different laws or different regulatory acts allow for an ambiguous (multiple) interpretations of the rights and obligations of taxpayers or tax authorities, and as a result, a decision could be made in favor of either the taxpayer or the tax authority, the decision shall be made in favor of the taxpayer.

Furthermore, paragraph 56.21 of Article 56 of the Tax Code of Ukraine provides that if a provision of this Code or another regulatory act issued on the basis of this Code, or if provisions of different laws or regulatorylegal acts, or when the provisions of the same regulatory legal act contradict one another and allow for an ambiguous (multiple) interpretation of the rights and obligations of taxpayers or tax authorities, as a result of which a decision could be made in favor of either the taxpayer or the tax authority, the decision shall be made in favor of the taxpayer.

Thus, in this case, there is an ambiguous interpretation of the provisions of subparagraph 141.4.6 of Article 141 of the Tax Code of Ukraine. Consequently, in accordance with paragraph 56.21 of Article 56 and subparagraph 4.1.4 of paragraph 4.1 of Article 4 of the Tax Code of Ukraine, tax authorities must rule in favor of the non-resident as the taxpayer and must not issue tax assessment noticesin which they have independently determined monetary obligations for non-resident income tax, nor should they hold residents liable under Article 163-1 of the Code of Administrative Offenses of Ukraine.

In conclusion, it should be noted that the legal nature of the “special tax” on non-residents’ income from the production and/or distribution of advertising commissioned by residents is controversial and requires detailed analysis by the legislature and tax authorities;  Meanwhile, businesses have no choice but to defend the position described in this article in court in order to avoid paying unreasonably assessed excessive tax liabilities on non-resident income.