Although Ukrainian tax legislation is constantly undergoing the reform, which usually means improvement, certain foreign transactions taxation issues still baffle non-residents and their professional advisors from time to time. Here we consider the case when a non-resident company disposes of real estate in Ukraine as an asset to another non-resident.
A sore spot
The Tax Code of Ukraine ("Tax Code") imposes the tax ("Sale Tax") on non-resident's income from the sale of a real estate located within the territory of Ukraine. This rule has existed for a long time, although it was slightly changed during the tax reform.
Most double tax treaties ("DTT") support such approach. For instance, the DDTs between Ukraine and Cyprus, Ukraine and the USA, Ukraine and the Great Britain, Ukraine and the Netherlands etc. provide similar provisions and allow collecting the Sale Tax in the country of real estate location.
Recently amended Tax Code provides how to collect taxes under the indirect sale of real estate between non-residents, namely when it comes to alienation of a share in a company holding real estate, but does not provide the same for the direct disposal of real estate as an asset.
Specifically, the Tax Code sets out the tax rate which is 15% and the taxation procedure only for the situation when a buyer of a real estate is a Ukrainian resident or a permanent establishment of a non-resident. The Tax Code also defines that the buyer of immovable property is responsible for withholding the Sale Tax form the seller's income.
Hence, the transactions between non-residents are formally outside the scope of the Tax Code since the Sale Tax rate and the procedure is absent for the situation when a non-resident buyer ("Buyer") acquires a real estate from a non-resident seller ("Seller").
The Tax Code does not define how non-resident Buyer shall pay the Sale Tax yet, however it does determine that the tax on non-resident Seller's income from sale of real estate shall be paid in Ukraine.
Certainly, the rule "all doubts in favour of the taxpayer" ("Rule") declared by the Tax Code should protect non-resident taxpayers, however some Buyers are still concerned with theoretical chance the tax authorities may bring their claims in case of the Sale Tax non-payment.
The Buyers' fears are mainly associated with newly introduced tax provisions which impose the fine on non-resident failing to pay the tax defined by the Tax Code. The level of fines may be quite high, from 10% to 75% of the amount of payable tax, depending on the circumstances and a non-resident's guilt.
Since mentioned provisions are quite new, there are still no representative cases and the tax authority's position on the matter remains unsettled.
The Buyer's concerns are exacerbated by the fact that the tax authorities may easily reach and address all claims to the Buyer through the Buyer's representative in Ukraine appointed during newly introduced mandatory tax registration of the Buyer.
We do not really see any material tax risks for a representative in case of non-resident's violations since a representative acting under a power of attorney is not an officer of the non-resident in understanding of Ukrainian legislation, but rather an independent agent, thus, may not be liable in the same way as non-resident's formally employed official.
However, there is no uniform application practice on this matter either, and the practical exposure of registered representatives of non-residents in Ukraine to taxes and other responsibility might be clarified with time only.
Considering the above, a non-resident company contemplating to buy an immovable property in Ukraine from a non-resident may either (1) not pay the Sale Tax with the hope that the Rule would work and the Buyer and its representative would not face any sanctions from the Ukrainian tax authorities; or (2) pay the Sale Tax under the tax rate and the rules provided for Ukrainian resident buyers if the Buyer's concerns of potential fines overwhelm; or (3) seek an official written tax clarification from Ukrainian tax authorities before property acquisition and act in accordance with their vision of the case.
We are not aware of any cases when the Buyer was brought to responsibility for failure to pay the Sale Tax from the Seller's income generated from sale of Ukrainian real estate, despite the long period of existence of the respective tax provision.
In fact, there is even no mechanism to bring a non-resident to responsibility for such violation. However, it might change with the time since the tax authorities now take a broader view of many matters.
For instance, the tax legislation was only recently supplemented with a procedure for tax inspection of non-residents in case they conduct business within the territory of Ukraine even without official registration. Considering this trend, the tax authorities might look at inspections of non-residents which alienate real estate with the time differently and might come up how to reach non-residents.
In case the Buyer is willing to pay the Sale Tax voluntary, the parties need to decide, who would fund such payment. By default, the Sale Tax shall be paid from the Seller's money. The Seller may disagree, reasoning by the absence of explicit formal requirements to pay the Sale Tax and considering it may be more feasible for the Seller to pay the Sale Tax in the jurisdiction of its registration, especially when the sale tax rate is lower there or setting-off the Sale Tax paid in Ukraine is restricted or complicated.
Suppose the Buyer and the Seller achieved a consensus and decided to pay the Sale Tax in Ukraine, we do not see major obstacles to implement that under the tax rate and the procedure provided for Ukrainian resident buyers by the Tax Code.
The Buyer shall open a bank account in Ukraine to be able to pay the Sale Tax to the treasury account which shall not be troublesome, a separate tax registration is not required, provided the Buyer has already registered with the tax authorities as a non-resident buyer of real estate. The Buyer may then continue to use this bank account, including for further quarterly payments of the property tax as a real estate owner or other settlements in Ukraine.
If non-resident has a permanent establishment in Ukraine, it shall pay the Sale Tax.
The Tax Code binds the payment of the Sale Tax to the moment of paying the price to the Seller by the Buyer; both payments shall be simultaneous. So, it is important to clarify before the settlements whether the Buyer has a permanent establishment in Ukraine or not and thus whether it is obliged to pay the Sale Tax.
Some of the Buyer's business activities in Ukraine may trigger its permanent establishment by operation of law, even without its official registration. For instance, the provision of services within the territory of Ukraine by the Buyer or presence of the Buyer's representatives in Ukraine authorised to enter into agreements aimed at generating an income for the Buyer may cause Buyer's permanent establishment.
The mere owning a property by the Buyer does not automatically create a permanent establishment though, while gaining some profit of it, rents for example, triggers permanent establishment.
A possible development is when a real estate sale and purchase agreement provides for payment in instalments and the Buyer starts letting out the premises or otherwise establishes a permanent establishment in Ukraine before final settlement. The Tax Code does not provide any solutions for such situation. Most probably in this case the Buyer should pay the Sale Tax from all payments remained after gaining the permanent establishment status.
Thus, we recommend analysing the Buyer's business activities in Ukraine thoroughly before the settlements with the Seller to define any permanent establishment risks and not to run into fines associated with non-payment of the Sale Tax.
Despite the Ukrainian tax legislation still contains many gaps, foreign businesses remain interested in holding a real estate in Ukraine and require a legal support at all stages, starting with checking the presence of a permanent establishment, the tax registration, bank account opening, support with appeal to the tax authorities for clarifications of legislation, and ending with asset due diligence, transaction's structuring, drafting agreements and other necessary paperwork to ensure the successful closing of transaction and compliance with the tax and other legal requirements.
Authors: Alexander Borodkin, Ivanna Rodionova