Beneficiary ownership of royalty paid for sublicense

Ukrainian tax authorities opined on beneficiary ownership status of royalties originated from Ukraine. As to their opinion, royalty for sublicenses are not deemed to be paid to beneficiary owners, and thus does not enjoy treaty protection and withholding tax relief.

International transactions may require that the person who does not possess exclusive intellectual property rights (but duly obtained a license to use it) have to provide a sublicense to the third party. Ukrainian tax authorities focused on the beneficiary ownership application to this type of transactions (payment of royalty for sublicense in particular).

According to the Tax Code of Ukraine:

"103.3. The factual beneficiary (owner) of income for the purpose of application of a decreased tax rate in accordance with the rules of the international agreement of Ukraine as regards the dividends, interest, royalty, rewards etc. of the non-resident obtained from sources in Ukraine is considered to be the person that bears the right to obtain that income.

The factual beneficiary (owner) of income cannot be a legal entity or individual, even if that person has the right to obtain such income, but is an agent, nominal holder or a mediator as regards such income”.

Payment for sublicense are made to licensee (e.g. not to the owner of exclusive IP rights) that is not considered as intermediary or nominal holder from legal perspective. Moreover, at reasonable conditions payment of royalty for sublicense may be justified as fulfilling business purpose test.

However, tax authorities opined on application of beneficiary ownership to these payments in quite inflexible way simply stating that DTT may be applied only if the beneficiary of payment is the owner of exclusive IP rights.

Such situation creates serious risk for Ukrainian entities that pay royalty for sublicenses abroad. They may suffer from both application of regular 15 per cent withholding tax rate and penalties up to 75 per cent of the amount of unpaid tax.

NB. The abovementioned information is based on the letter of the State Tax Administration of Ukraine of 18 March 2011 No. 7505/7/22-5017 that has not been published yet (unofficial copy in Ukrainian may be downloaded here). At the same time, American Chamber of Commerce in Ukraine (AmCham) received clarification from the State Tax Administration of Ukraine (letter of State Tax Administration of Ukraine dated 30 March 2011 No. 3917/5/12-0216 in Ukrainian) that maintain more liberal approach and confirm that royalty for sublicense may be deemed to correspond BO requirements. However, the clarification provided to AmCham does not eliminate the abovementioned risk but rather confirming doubletalk practice of Ukrainian tax authorities.




Mykola Khomenko ©