Ukraine: Withholding tax rates under tax treaty and “principal purpose test” (court decision)

District Administrative Court of Kyiv judgment addressing withholding tax rate for interest paid on loan from non-resident counterparty

District Administrative Court of Kyiv judgment

The District Administrative Court of Kyiv issued a judgment (1 March 2021) addressing the withholding tax rate for interest paid on a loan from a non-resident counterparty and specifically whether the “principal purpose” of the loan transaction was only to qualify for the reduced withholding tax rate under the income tax treaty between Ukraine and the United Kingdom.

The Ukraine tax authority applied the “principal purpose test” with regard to passive income paid from Ukraine and whether the reduced withholding tax rate under the treaty could apply if application of that lower rate was the principal purpose of the transaction with the non-resident.

In other words, the tax authority’s position was that if it did not agree with the economic reasonableness of the transaction with a non-resident and that the transaction’s principal purpose was to obtain the reduced withholding rate benefits under the treaty, the taxpayer may be subject to a rate of withholding tax at 15% (plus penalties). Furthermore, the tax authority asserted that it could raise the test with regard to transfer pricing and compliance with the arm's length principle.

The court in Kyiv concluded that the non-resident counterparty provided the loan under its own business activities and in connection with the economic and commercial needs of the taxpayer. Therefore, the court rejected the position of the tax authority that the transactions between the taxpayer and the counterparty were part of the of tax planning model, and concluded that there was no evidence of “artificially” obtaining the tax benefits under the income tax treaty with the United Kingdom.

KPMG observation

Similar conclusions were also reached in a 2020 decision of the Poltava District Administrative Court (№ 440/2010/20), as affirmed in February 2021 by the Second Administrative Court of Appeal. In that case, it was concluded that the tax authority's assumptions about entering into the loan arrangement to benefit from the income tax treaty with the United Kingdom were unfounded.

Accordingly, the tax authority’s reliance on the principal purpose test indicates there has been a deep analysis of the disputed transactions, of the features of commercial activities of counterparties, of the economic substance of a nonresident in the country of registration, and the legal and factual ability to dispose of income. Therefore, businesses need to be prepared to prove that the application of a reduced rate of withholding tax was not the main purpose of the transaction, and they need to be prepared to justify the commercial reasons for its implementation.

For more information, contact KPMG’s Global Head of International Tax:

Rodney Lawrence | +1 (312) 665 5137 |



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