On 22 December 2009 the National Bank of Ukraine (NBU) made publicly available the letter of the State Tax Administration (STA) of 18 November 2009. In this letter, the STA reconfirmed Article 18.2 of the Law of Ukraine "On Taxation of Profit of Enterprises" No. 334/94-VR, dated 28 December 1994 (as amended) which prohibits inclusion of provisions into cross-border contracts whereby a Ukrainian entity undertakes to pay the taxes of a non-resident. Based on this rule, the STA decided that additional payments to a non-resident lender of an amount, which compensates the lender for taxes withheld in Ukraine, is not in line with Ukrainian law.
While we do not assess the correctness of the STA's conclusions, we believe that the NBU may apply the STA's logic and refuse to register cross-border loan agreements containing tax gross-up provisions. In fact, we are aware of circumstance in which the NBU has refused to register a loan agreement on the basis of the logic of the STA's letter.
In addition, although we believe that the tax gross-up provisions should be treated as commonly drafted, i.e., as payments of an extra amount rather than as payments of tax, there is a risk that those provisions may subsequently be interpreted by the respective competent authority as a constructive payment of tax and held invalid on those grounds. Borrowers may thus be prevented from grossing-up any payments to take account of any taxes applicable to such payments.
In these circumstances, the parties to a loan agreement will need to design new, sophisticated mechanisms to ensure that the cross-border loan agreements reflect their commercial agreements and at the same time comply with Ukrainian law.
Letter of the State Tax Administration of Ukraine No. 14086/5/22-5016, dated 18 November 2009 "Clarification on the payment to a non-resident lender of an amount which compensates the non-resident for taxes withheld in Ukraine".
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The original publication date for this article was 20/01/2010.
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