On 8 November, the Cabinet of Ministers of Ukraine and the Government of Cyprus signed the Convention for the  Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income ("the New Convention").

The New Convention shall replace the Double Taxation Treaty between the Governments of Cyprus and USSR of 29 October 1982 applicable to Ukraine ("Current Convention").

DATE OF ENTRY INTO FORCE

The New Convention will come into effect on 1 January of the year following the year of its ratification by the parliaments of both states. If the parliaments of Cyprus and Ukraine ratify the New Convention in 2013 it will come into effect on 1 January 2014. Upon entry of the New Convention into effect, Current Convention will cease to be in force.

KEY TERMS OF THE NEW CONVENTION

§  Increase of withholding tax rates for dividends, interest, royalty (under Current Convention, the tax rate for these payments is 0%);

§  Introduction of "beneficial owner" for the purposes of application of benefits under the New Convention with regard to dividends, interest, royalty;

§  Introduction of the provision on exchange of information and the procedure for sending tax inquiries;

§  No clause on limitation of benefits envisaged under the New Convention (existing in some other treaties to which Ukraine is a party).

FURTHER USE OF CYPRIOT HOLDINGS

1. Cypriot Holding: a tool for sale of Ukrainian assets

Similarly to the Current Convention, the New Convention allows Cyprus holdings not to pay the tax on profit from sale of shares and corporate rights of Ukrainian companies (irrespective of the assets possessed by such Ukrainian companies).

Accordingly, if a Cyprus holding is used primarily as a tool to support tax-efficient sale of Ukrainian assets there is no direct necessity to restructure ownership of Ukrainian companies and transfer them under the holding in a different jurisdiction.

2. Cypriot Holding: payment of dividends

Tax on dividends payable to a Cypriot holding may be decreased to 5% under the New Convention but not to 0% as before. If income within the group is repatriated mainly through dividends such 5% tax may become a considerable additional tax burden for the group.

Accordingly, to achieve tax saving on dividends, it is possible to consider transferring ownership of Ukrainian companies from the Cypriot holding to holdings in another jurisdiction allowing 0% withholding tax (for instance, in the Netherlands).

Such decisions should be thoroughly considered. In particular, it is necessary to compare the costs of maintenance of the new structure with a new holding and the costs for restructuring, on one hand, and the costs for payment of taxes on dividends under the Cypriot holding, on the other. Also, use of holdings in other EU jurisdictions requires a more complex holding structure on top compared with Cyprus in order to achieve maximum tax saving. There are other non-tax considerations to be taken into account.

3. Cypriot Holding: interest on loans

It will be possible to credit the 2% tax paid in Ukraine against the 10% tax in Cyprus. Given that funding through Cypriot holdings is usually back-to-back, efficient tax rate may be maximally optimized.

Decisions on further use of Cyprus for location of financing companies both for group funding and for borrowing funds from external markets should be made taking into consideration the specific circumstances and require analysis in each particular case. In addition to the withholding tax rate, there are other factors to be considered.

4. Cypriot Holding: Royalty

To a certain extent, the increase of the withholding tax rate to 5% or 10% is balanced by a recently introduced special tax regime for intellectual property in Cyprus. Under this tax treatment, profits from such property are taxed at the rate of 2%.

Decisions on further use of Cyprus for ownership of intellectual property should be made taking into consideration the specific circumstances and require analysis in each particular case.

5. Transit structures (back-to-back arrangements) vs. beneficial owner

The New Convention conditions the application of preferential rates for dividends, interest and royalty by  the status of beneficial owner of the Cypriot  recipient. Similar provisions are introduced by the Tax Code. In the Current Convention, however, such provisions do not exist. Ukrainian tax authorities may disallow the application of reduced withholding tax rates if they can prove that the Cypriot holding receiving profits in the form of dividends, interest or royalty is not a beneficial owner.

Thus, defense files should be prepared for all back-to-back structures using Cypriot holdings to support the status of beneficial owner and obtain the right to benefits under the New Convention.

This is a burning issue and there are court precedents proving the attention of tax authorities to transit structures with the use of Cypriot holdings.

CONCLUSION

·         It is necessary to continue monitoring the ratification process and entry of the New Convention into force;

·         We recommend analysing your situation and taking an informed and weighted decision on the need of restructuring of holding, financial or licensing companies registered in Cyprus. 

We will be happy to assist you in further use of Cypriot holdings in the existing holding structures and for the purposes of the planned transactions.

Svitlana Musienko

Partner and Head of Tax

T +380 44 490 9564

svitlana.musienko@dlapiper.com

Illya Sverdlov

Legal Director, Tax

T +380 44 490 9575

illya.sverdlov@dlapiper.com 

Donets Donets

Senior Associate, Tax

T +380 44 490 9575

dmytro.donets@dlapiper.com  

DLA Piper ukraine llc is part of DLA Piper, a global law firm.

The matters covered in this newsletter are intended as a general overview. This newsletter is not intended, and should not be used, as a substitute for taking legal advice in any specific situation. DLA Piper ukraine llc will accept no responsibility for any actions taken or not taken on the basis of this newsletter. If you would like further advice, please contact our Kyiv Tem at +380 44 490 9575.