TAX STATUS OF A REPRESENTATIVE OFFICE IN UKRAINE
By Chadbourne & Parke LLP
www.chadbourne.com
A permanent establishment (“PE”) risk is one of the main
tax risks that have to be estimated and, if possible, reduced or eliminated for a representative office (a “RO”).
PE Concept in Ukrainian Domestic and International
Tax Law
Law of Ukraine “On Taxation of Profits of Enterprises”
No. 334 dated December 28, 1994 (the “CPT Law”)
provides a rather broad definition of a PE. According
to this definition, any fixed place of activity through
which a non-resident wholly or partly carries out business activities3 in Ukraine, is a non-resident’s PE in
Ukraine. As Ukrainian tax authorities interpret the term
“business activities” in a very broad sense, they may
consider almost any type of activity conducted through
a RO as giving rise to a taxable presence (i.e. a PE) of
a foreign entity in Ukraine.
However, provisions of international agreements for
the avoidance of double taxation (“Treaties”) overrule
provisions of Ukrainian domestic tax law. Accordingly,
a RO may seek protection from a creation of a PE in
Ukraine by the application of the Treaties’ provisions.
Although Ukraine is not an OECD member, many Treaties concluded between Ukraine and other states follow the OECD Income and Capital Model Convention
(the “OECD Model”). A PE concept established by the
OECD Model differs from a PE concept expounded by
Ukrainian domestic tax law.
According to Art. 5 of the OECD Model, the term “PE”
means a fixed place of business (a “FPB”) through
which the business of an enterprise is wholly or partly
carried on. Also, where a dependent agent is acting
on behalf of an enterprise and has, and habitually exercises, [in Ukraine] an authority to conclude contracts
in the name of the enterprise, such enterprise shall be
deemed to have a PE [in Ukraine].
However, the OECD Model provides for protection
from the creation of a PE if the maintenance of a
FPB or the dependent agent’s activities are limited to
activities of a preparatory or auxiliary character. Accordingly, the key question for the RO is whether the
activities the enterprise conducts through it qualify as
of a preparatory or auxiliary character. If they do, an
enterprise will be entitled to protection against Ukrainian corporate profits tax under the Treaty4. Otherwise, income the enterprise derives through its RO (if
any) will be subject to Ukrainian corporate profits tax
at 25% rate.
“Negative List”
Art. 5(4) of the OECD Model lists preparatory and
auxiliary activities that do not create a PE, if they are
carried on through a FPB. These activities are as
follows:
a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise
belonging to the enterprise;
b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
d) the maintenance of a FPB solely for the purpose of
purchasing goods or merchandise or of collecting
information, for the enterprise;
e) the maintenance of a FPB solely for the purpose of
carrying on, for the enterprise, any other activity of
a preparatory or auxiliary character;
According to Art. 1.32 of the CPT Law, business activity is considered to be an entity’s activity of any type aimed at deriving
income if the direct participation of the entity in such activity is regular, permanent and essential. Direct participation is defined
as an entity’s activity through its units (e.g. a RO), or agents, or any other entity acting on its behalf.
3
To benefit from the Treaty protection, the RO must submit to Ukrainian tax authorities its head office’s residence certificate. The
residence certificate is valid only within a calendar year in which it was issued.
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f) the maintenance of a FPB solely for any combination of activities mentioned in subparagraphs a) to
e), provided that the overall activity of the FPB resulting from this combination is of a preparatory or
auxiliary character.
Please note that wording of the “negative list” in the
Treaties may slightly differ from the wording of the
such list in the OECD Model. As a result, the scope
of the “preparatory and auxiliary activities exemption”
may be reduced or extended for a particular Treaty as
compared with the OECD Model.
For example, Art. 5(4) of the Italy-Ukraine Treaty omits
subparagraph f), Art. 5(4) of the Ukraine-Russia Treaty omits subparagraph b) and the word “delivery” in
subparagraph a). This reduces the scope of activities
that do not create a PE contrary to other Treaties that
strictly follow the OECD Model.
On the other hand, subparagraph f) of Art. 5(4) of the
Ukraine-Russia and USA-Ukraine Treaties omits the requirement that the overall activity resulting from a combination of activities must be of a preparatory or auxiliary
character. That is, these Treaties allow any combination
of the activities mentioned in subparagraphs a) to e),
whether or not the criterion of the preparatory or auxiliary character of such a combination is met. Accordingly,
the scope of activities falling under the protection according to these Treaties is extended contrary to Treaties that strictly follow the OECD Model.
There are also other differences in wording of the “negative list” of various Treaties. Such specialties have to
be considered when deciding on the RO’s tax status.
Deciding on the RO’s Tax Status
As follows from the OECD Commentary on Art. 5(4) of
the OECD Model5, in deciding whether or not a FPB of
a non-resident enterprise is used solely for activities of
a preparatory or auxiliary character, it is necessary to
consider the following factors:
a) The character of activity: If a general purpose of
a FPB is identical to the general purpose of a whole
enterprise, then the activities of such FPB are not
of a preparatory or auxiliary character.
For example, a RO collecting market research information in Ukraine for its head office engaged in
FMCG trade will not create a PE. However, if the
foreign enterprise’s main trade is connected with
market research, then such activities of the RO in
Ukraine will not be preparatory or auxiliary, and
there will be a PE in Ukraine.
b) The object of activity: A FPB must carry on the
activities for its enterprise. A FPB rendering services not only to its enterprise but also directly to other
enterprises is not within the scope of “preparatory
and auxiliary activities exemption”.
For example, if a RO collects market research information in Ukraine not only for its head office, but
also for other companies of a group, then such activities of a FPB are not subject to exemption and
create a PE. If the RO receives financing from entities other than its head office or the RO’s employees
have direct working relations with other companies,
it can be regarded as the RO effectively conducting
activities for entities other than the head office and,
accordingly, constituting a taxable presence.
In practice, it is often difficult to distinguish between
activities which have a preparatory or auxiliary character and those which do not. Each individual case
will have to be examined according to its specific
substance.
Ukrainian Tax Authorities’ Review of a RO’s Tax
Status
Due to the above, when reviewing the tax status of
a RO, the tax authorities aim to clarify the activity
of the RO in relation to the main activity of the head
office.
In view of Ukrainian tax authorities, the main activity
of a non-resident is defined as the activity which is
(a) stipulated in the non-resident’s statutory documents, and (b) is regular and permanent during a
calendar year to which a reporting period is attributed6. To clarify the non-resident’s main activity, the
tax authorities may require a RO to provide the following documents for their review: (a) the statutory
In Ukraine, the OECD Commentaries are not legally binding. Unofficially, the tax authorities may refer to the OECD Commentaries in their practice, but we are not aware of any cases when the tax authorities or a court referred to them in their official explanatory letters/decisions. Letter of the State Tax Administration of Ukraine No. 5601/6/12/0116 dated June 3, 2008 expresses the
opinion that the OECD Commentaries may be taken into account when applying Treaties.
6
Art. 4.6.2 of the Procedure for Completing a Calculation of Corporate Profits Tax for a Non-resident that Conducts its Activity on
the Territory of Ukraine through a PE, approved by the Order of the State Tax Administration of Ukraine No. 274 dated July 31,
1997 and registered with the Ministry of Justice of Ukraine on August 28, 1997, No. 274.
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registration documents of the non-resident, (b) extract from the register of Chamber of Commerce and
Industry, (c) a statement issued by a bank in which
the non-resident has a bank account, or (d) other
documents issued according to the foreign country’s
legislation7.
In addition, to clarify the RO’s activities in Ukraine,
the tax authorities usually consider the sources of
financing of the RO, functions performed by it, the
lines of reporting of its employees, personnel seconded to Ukraine, etc. For this purpose, they review the RO’s registration documents, job description of employees, concluded contracts (if any),
type of the RO’s bank account8, other documents.
However, often Ukrainian tax authorities follow a
formalistic approach. If no evidence of trade activities conducted by the RO in Ukraine9 is found and
a residence certificate of a non-resident is filed by
the RO, they do not investigate actual RO’s ac-
tivities in-depth and accept the treaty protection
against tax in Ukraine.
Accordingly, the risk that the tax authorities may challenge a tax-exempt status of a RO is not high at the
moment. In addition, there is no sufficient court practice
on the deciding on the tax status of a RO in Ukraine.
However, the risk of challenging a tax-exempt status
of a RO grows in line with development of statutory
tax audit methodologies relating to international tax issues. Potentially, the RO’s failure to comply with the
Treaty’s requirements in respect of preparatory and
auxiliary activities may result in unexpected consequences for a RO in terms of additional tax liabilities
and penalties.
To eliminate or, at least, to reduce a PE risk for a RO,
careful structuring of the operations of the head office
and the RO, as well as the documents trail properly
supporting this structure is required.
Letter of the State Tax Administration of Ukraine No. 6793/6/15-1316 dated August 6, 2003.
7
In Ukraine, a RO may open one of two types of bank accounts: (i) “P” bank account - if a RO declares itself as a commercial RO,
and (ii) “N” bank account - if a RO declares itself as a non-commercial RO. Ukrainian banks do not require any confirmation of
a non-commercial status of a RO when they open an “N”-type bank account. The scope of banking operations for “N”-type bank
account is limited.
8
E.g., local trade contracts, local commercial payments, invoices, etc.
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