August 12, 2020 · 5 min read
And we continue to answer our clients' questions, this time the question was as follows:
Our enterprise acquired from a resident of Latvia the rights to use ten computer programs (ten users) for accounting for the daily number of visitors in our retail outlets. In addition, we also purchase hosting services from the same non-resident.
During a comprehensive audit, tax authorities additionally assessed us with a "repatriation tax" for these operations, citing the provisions of the Convention for the Avoidance of Double Taxation (for payments for the use of computer programs), as well as the provisions of sub-paragraph "g" of sub-clause 141.4.1 of the Tax Code of Ukraine (for payment for hosting services).
Is the tax authorities' point of view justified?
Answer:
Use of Licenses
Payments made by your company as remuneration to a resident of Latvia for the use of computer programs indeed fall under the definition of "royalties" as set forth in paragraph 3 of Article 12 of the Convention for the Avoidance of Double Taxation between Ukraine and the Republic of Latvia (hereinafter – the Convention). Furthermore, as stated in paragraph 2 of Article 12 of the Convention, such income may be taxed in Ukraine. Therefore, at first glance, the tax authorities' claims in this situation appear entirely justified.
However, if one reads paragraph 2 more closely, it can be seen that payments of such income by a Ukrainian taxpayer to a resident of Latvia are subject to taxation "in accordance with the legislation of that Country" (i.e., Ukraine). Therefore, when paying such income to a non-resident, we must be guided by the norms of national tax legislation (in this case – the norms of the Tax Code of Ukraine).
According to sub-paragraph "c" of sub-clause 141.4.1 of the Tax Code of Ukraine, royalties are indeed one type of income for which, when paid to a non-resident, a 15% tax must be withheld and transferred to the budget.
At the same time, sub-paragraph 2) of sub-clause 14.1.225 of the Tax Code of Ukraine states that "payments received are not royalties if they are: remuneration for the use of a computer program, if the terms of use are limited to the functional purpose of such program and its reproduction is limited to the number of copies necessary for such use (use by an "end user"); for the acquisition of samples (copies, instances) of intellectual property objects embodied in electronic form, for use according to their functional purpose for final consumption". Based on the information provided in the description regarding the essence of the matter, it can be assumed that the situation fully fits into the exception provided in sub-paragraph 2) of sub-clause 14.1.225 of the Tax Code of Ukraine (i.e., payments for such operations are not royalties). Therefore, in our opinion, the company has every chance to challenge the tax authorities' point of view (it is not excluded that this may involve litigation).
Hosting Services
The definition of "hosting" is absent in Ukrainian legislation. At the same time, information about hosting available on the Internet indicates approximately the following:
"Hosting is a dedicated space on a server or a separate physical server where your website is located. To draw a clear analogy, it is a rented plot of land on which you build a house, i.e., a website. Hosting cannot be owned: you can only rent space on a server and renew the agreement for placement and support annually." (https://konstruktorysajtov.com/hosting/chto-takoe-hosting-i-domen).
Thus, in our opinion, the acquisition of hosting services inherently bears similarities to the acquisition of rental services. Therefore, the company's payment for such services to a non-resident supplier may fall under the definition of "leasing/rental payments made by residents or permanent establishments of non-residents in favor of a non-resident – lessor/landlord under operating lease/rental agreements" (sub-paragraph "g" of sub-clause 141.4.1 of the Tax Code of Ukraine). A similar point of view is also indirectly confirmed by recent clarification letters from regulatory bodies on similar issues – see, for example, DFSU Letter No. 6312/6 / 99-99-15-02-02-15 dated 28.03.2017, which addresses the issue of "rental of a portion of disk space on an Internet server". Additionally, we recommend paying attention to sub-clause 14.1.97 of the Tax Code of Ukraine, according to which a rental operation means "an economic operation... that involves the transfer of fixed assets for use by other... persons... for a fee and for a certain period" (and a hosting agreement likely also provides for such a period). It should be noted that the norms of the Tax Code of Ukraine do not impose any additional conditions for the formalization of such operations to be considered rental – for example, the execution/signing of an act of acceptance and transfer of leased property, etc.
In view of all the above, we are forced to state that in this situation, the tax authorities still have certain grounds to assert that for operations involving your company's payment to non-residents for hosting services, there is a need to withhold from such payments and transfer to the budget a 15% "repatriation tax" in accordance with sub-clause 141.4.2 of the Tax Code of Ukraine. However, it should be noted that these grounds are clearly not flawless and unambiguous, so the company also has chances to defend the opposite position (especially with the involvement of an experienced external tax consultant).
Director of Audit Services
Certified Auditor
Safinsky Viktor
