Posted by Constantine M on August 29, 2004 at 07:01:01:
Victoria V. Chornovol,
Olga V. Loboda
Upon enactment of the new Personal Income Tax Act (hereinafter — the Act) there was a significant change in the definition of personal income of Ukrainian origin. Before 1 January 2004, the term “income of Ukrainian origin” meant income paid by a Ukrainian entity. Now, any income of an individual received from any activities on the territory of Ukraine, which is paid either by a Ukrainian or by a foreign entity, shall be taxable in Ukraine. This provision led to the situation that foreign citizens temporarily working in Ukraine have to pay tax in Ukraine on income received from their activities in Ukraine both from Ukrainian and foreign entities. In some cases, this procedure contradicts the provisions of international conventions on avoidance of double taxation (hereinafter — the International Convention).
In view of the changes adopted, we will discuss in this article the new procedure for taxation of income received by foreign citizens (both residents and non-residents) as a result of work performed in Ukraine.
According to the general rule, residents pay taxes to the Ukrainian budget on income received from world-wide sources in the whole world, while non-residents pay taxes on income of Ukrainian origin. To determine the taxation base in Ukraine, it is necessary to determine the residency status of a foreign citizen as the first step. The procedure for determining the tax residency in accordance with the Act is shown in the table below:
Despite the fact that according to the Act, a person can independently identify him/herself as a resident of Ukraine, the procedure for implementing this provision is not spelt out in the legislation. This gap is addressed by the Explanation by the State Tax Administration of Ukraine on the application of some provisions of the Personal Income Tax Act with regard to taxation of foreigners and non-residents (hereinafter — the STAU Explanation). For example, the supreme tax authority specifies that a foreigner may independently determine his/her residency status by submitting a written application to the tax authority at the place of residence in Ukraine with a request to be considered as a resident of Ukraine for the purposes of taxation in the current year.
Different status — different rate?
The foreigner’s residency status is essential for establishing the tax rate applicable to him/her. Despite the fact that the Act establishes the rate of the personal income tax as 13 % before 31 December 2006 and 15 % starting in 2007 (except for some income when the rate is directly established by legislation), this provision is not applied to all taxpayers.
According to the provisions of the Act, some incomes imputed for the non-resident individual are to be taxed at the double rate (i.e. 26 %). Legislation, however, does not provide any clear list of such incomes. In this connection, foreign citizens doing work in Ukraine often face the problem of determining what income is to be taxed at the double rate. Having analyzed the chain of the Act’s blanket provisions dedicated to the procedure of taxation of non-residents’ income we conclude that the Act does not contain a list of non-residents’ incomes to be taxed at the 26 % rate.
According to Clause 9.11.1 of the Act, income of Ukrainian origin paid for the non-resident’s benefit shall be taxable in accordance with rules established for residents taking into consideration the specifics determined by this Act.
This provision implies that the income received by a non-resident in the form of wages shall be taxable according to the rules established for residents, that is, at the rate of 13 %. Meanwhile, the legislator talks about the specifics envisaged by the provisions of the Act. One can only guess what specifics were meant. It is possible that they include the procedure for payment of the tax on the non-resident’s income by a resident tax agent, or in the event of payment of wages by a non-resident to a non-resident by a resident bank.
The conclusion that the rate of tax on income of Ukrainian origin is the same for a resident and a non-resident corresponds with the view of the tax authorities. For example, according to the STAU Explanation, “wages irrespective of origin that are paid to a non-resident by a resident employer shall be taxed at the rate of 13 %”. In order to receive a tax credit in a country where a foreigner is resident for the amount of tax paid in Ukraine, the foreigner has to apply to the tax authority in Ukraine for a certificate confirming the payment of tax.
Taxation of a foreigner’s wages
Having determined the foreigner’s residency status and the tax rate, it is necessary to find out in which country his/her wages received for the work performed in Ukraine are to be taxed.
As pointed out above, the Act defines income of Ukrainian origin, in particular, wages paid by employers (either Ukrainian or foreign) as a result of the work performed by a foreign citizen in the territory of Ukraine. In this situation, however, in addition to the provisions of national legislation one should comply with the provisions of International Conventions. In Ukraine, there are currently conventions with 53 countries. In most cases, the texts of these conventions conform with the Model Tax Convention on Income and on Capital of the Organization for Economic Cooperation and Development (OECD) (hereinafter — the OECD Convention).
According to Article 15 of the OECD Convention, income received as wages shall be taxed only in a state where the recipient is a resident, except for cases when the individual is engaged in work in a different state. Work is considered to be performed in the state where the individual stayed when the labor obligations were fulfilled. Thus, if a Belgian resident, for example, concluded a labor contract with a Belgian company and works temporarily under that contract in Ukraine, the remuneration received from a Ukrainian company shall be taxed in Ukraine, after which the Belgian resident has the right to a tax credit in his/her country of residence, Belgium. If a person receives wages from a Belgian company, his/her income will be released from taxation in Ukraine. This conclusion was made on the basis of following analysis.
Every rule has exceptions
According to Part 2 of Article 15 of the OECD Convention, irrespective of the state where employment is carried out, remuneration shall be taxed only in the state where the foreigner is a resident if:
— the recipient is present in the other State for a period or periods not exceeding a total of 183 days in any 12 month period commencing or ending in the fiscal year concerned, and
— the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
— the remuneration is not borne by a permanent establishment, which the employer has in the other State.
Thus, the Convention envisages the direct release of non-residents from taxation in Ukraine of income received from foreign employers in Ukraine. If such income is paid to a non-resident by a Ukrainian employer, the Ukrainian tax shall be deducted as income tax paid. Later, the non-resident will be able to pay the tax in his/her country of residence minus the amount of the Ukrainian tax in accordance with the so-called tax credit rule.
It should be noted that the provisions canceling taxation of wages received by persons temporarily employed in a foreign state were a reaction to particular violations and appearance of the “international employment” phenomenon, when a local employer is released from taxation on income paid as wages to a foreigner hired for a period not exceeding 183 days. Let us use the example of Ukraine and Germany. In order to avoid deducting tax on wages paid to a foreign employee, a Ukrainian employer finds an intermediary — a German company that hires the employee and is formally considered to be its employer. In reality, however, this German company is actually “providing” the employee to the Ukrainian firm. As a result, the German company complies with the terms releasing income from taxation in the state where he is temporarily employed, that is, Ukraine.
Such schemes are sometimes used by employers in order to make use of tax advantages envisaged by the OECD Convention. The comments on the OECD Convention, however, envisage that the term “employer’ in this case should be understood as a person having the right to the fruit of the employee’s labor. As a rule, in the event of employment through an intermediary the employer functions are exercised by a local company where the foreigner works despite the fact that the formal legal employer is a foreign intermediary company. It should be noted that the comments on the OECD Convention contain recommendations to the tax authorities to check whether the non-residents declared as employers are actual consumers of the works conducted.
Thus, to determine the state where a foreigner’s wages are to be taxed, it is necessary to refer to the provisions of conventions on avoiding double taxation concluded between the relevant states. Even if the income received as wages is not released from taxation, a foreigner is not losing anything: first he pays the 13 % tax and then receives a tax credit in his country of residency. ¢
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