Double taxation of airline leasing threatens to destroy civil aviation in the country

Ukrainian businesses working with foreign counterparties may lose significant funds due to incorrect application of international tax law norms. This particularly applies to companies that use loans, leasing, or rent property abroad. Despite the existence of international conventions on the avoidance of double taxation, in practice, enterprises often face situations where taxes are effectively paid twice, writes UNN.

How the international mechanism for avoiding double taxation works

Conventions on the avoidance of double taxation are one of the key instruments of international tax law. Their essence is that a company registered in one country but earning income in another does not bear an excessive tax burden. In other words, a business should not pay the same tax twice simply because its activities are international in nature.

As Igor Sukholit, audit and taxation partner at Consulting Group "Pareto" LLC, explained in a comment to UNN, the mechanism for avoiding double taxation looks logical in theory, but in practice, it contains many nuances. According to him, businesses often confuse basic concepts of what constitutes income, profit, source of income, and in which country taxes should be paid for a particular operation.

"Suppose your Ukrainian IT company provided software development services to an enterprise that is a resident of Japan. According to the tax legislation of Ukraine, your company must pay tax to the Ukrainian budget from the profit received from providing these services. At the same time, the customer enterprise from Japan, guided by its national legislation, is also obliged to withhold tax from the payment for your services and pay it to the Japanese budget. Such withholding is called 'repatriation tax' and as a phenomenon is present in the tax legislation of most countries," Sukholit gave an example.

At the same time, according to him, the Tax Code of Ukraine stipulates that a resident who pays income to a non-resident with a source of origin from Ukraine is obliged to withhold a tax of 15%, unless otherwise provided by an international treaty.

"A resident, including an individual entrepreneur, an individual engaged in independent professional activity, or a business entity (legal entity or individual entrepreneur) who has chosen a simplified taxation system, or another non-resident who conducts business activities through a permanent establishment in Ukraine, who makes any payment from income with its source of origin from Ukraine received by such non-resident (including to non-resident accounts maintained in national currency) to a non-resident or a person authorized by him, withholds tax from such income, (...) their amounts and at their expense, which is paid to the budget during such payment, unless otherwise provided by the provisions of international treaties of Ukraine with the countries of residence of the persons in whose favor payments are made, which have entered into force. The requirements of this paragraph do not apply to non-resident income received by them through their permanent establishments in Ukraine," the Tax Code of Ukraine states.

This is where international tax conventions come into play. If an agreement on the avoidance of double taxation has been concluded and ratified between Ukraine and another state, it can either completely exempt income from double taxation or significantly reduce the tax rate.

In order to use the provisions of the convention, the company must confirm its tax resident status by obtaining a corresponding certificate from the State Tax Service of Ukraine.

Igor Sukholit specifically emphasizes that international tax treaties do not work the same for all operations. Everything depends on the conditions stipulated in the Convention and on the type of company income. This particular point often becomes critical for Ukrainian businesses operating in international transportation, aviation, maritime logistics, or using financial or operating leasing.

For example, the Convention between Ukraine and Cyprus, ratified in August 2013, stipulates that enterprise profits from international maritime, river, or air transportation are taxed only in the country where such enterprise is registered.

"In particular, Article 8 of such Convention stipulates that the profit of an enterprise engaged in international transportation (sea, river, air transport) is taxed only in the country where such enterprise is registered. At the same time, if such enterprise pays interest to a non-resident for a loan and/or leasing arranged for transport for such international transportation, then Article 11 of the Convention already applies. It obliges, under appropriate conditions, to accrue the 'repatriation tax' we have already mentioned," the tax expert said.

Usually, according to him, loan or leasing agreements contain a defined interest rate (rate) and the company cannot pay a smaller amount, withholding any tax payments. In this case, the Ukrainian company will be forced to pay the "repatriation tax" at its own expense. In addition, the Ukrainian company will pay profit to the budget of Ukraine from international transportation services provided using transport purchased at the expense of a loan or leasing provided by a non-resident.

"Thus, the effect of the Convention on the Avoidance of Double Taxation depends on the type of income/profit paid to a non-resident. Also, the Convention may contain significant differences in taxation conditions, depending on the country with which it is concluded. Nevertheless, it is an effective means of avoiding additional tax costs, which Ukrainian enterprises should be aware of. Thanks to the full application of the terms of such international agreements, Ukrainian business gains competitive advantages and scales operational activities to foreign markets," Igor Sukholit summarized.

Realities of the aviation market

At first glance, the international mechanism for avoiding double taxation seems quite beneficial and understandable. However, the modern realities of Ukrainian airlines' operations introduce their own adjustments to its functioning.

The main point is that due to Russia's full-scale aggression, the sky in Ukraine is closed to civil aviation. In this regard, Ukrainian airlines are now completely reoriented to work abroad. There they carry out all air transportation, service aircraft, and generate all their income. In Ukraine, they pay income tax. That is, they ensure a continuous inflow of foreign currency into the Ukrainian budget.

At the same time, despite the Conventions on the avoidance of double taxation, the state, represented by the Bureau of Economic Security, is attempting to re-tax airlines that use leased aircraft, for which they have already paid abroad. This effectively turns into an additional levy that not only creates an additional fiscal burden on businesses but also destroys the competitiveness of Ukrainian aviation businesses.

"This 'tax' effectively eats up all potential profit. That is, companies either work 'at zero' or at a loss. And in conditions of war, closed skies, high competition in the international aviation market, and limited access to financing, this directly leads to the risk of bankruptcies, loss of fleet, and players leaving the market. In this situation, it is regrettable, and it is important to understand, that this is precisely caused by the tax authority's position. That is, it turns out that the tax authorities are now jeopardizing the further existence of civil aviation in Ukraine. It must be said that the tax authority introduced this approach in 2024. Before that, airlines did not perform such a function of a tax agent regarding lease payments, annually submitted reports, moreover, audited by international auditing firms, and no one had any complaints," said Mykola Shcherbyna, executive director of the Public Union "Ukrainian Air Transport Association," in an interview with UNN.

According to him, at least 5 Ukrainian airlines have faced such a problem and persecution from investigators of the Bureau of Economic Security. Among them, according to UNN, was PJSC "Ukraine International Airlines".

Despite a court decision that thoroughly explained the application of international law, including Conventions on the avoidance of double taxation for Ukrainian companies, the Bureau of Economic Security decided to prosecute UIA officials for using leasing.

According to the investigation, operating lease agreements for Boeing 737 and Embraer aircraft were concluded between a Cypriot company (the aircraft owner) and a Ukrainian airline.

In fulfillment of these agreements, in 2017-2022, UIA paid income in the form of lease payments for the use of aircraft to the Cypriot company totaling over UAH 3.4 billion.

Using the Convention between the Government of Ukraine and the Government of the Republic of Cyprus on the Elimination of Double Taxation, which has been in force since 2013, the former management of the Ukrainian company applied a preferential 0% repatriation tax rate for payment in Ukraine when making the payment.

The BEB is convinced that the application of the preferential rate by the former management of the Ukrainian airline did not comply with the terms of the concluded agreements and the actual needs of aircraft operation. Investigators believe that the airline should have paid a 10% tax rate to the budget, despite the fact that the company had already paid these taxes in Cyprus.

According to Oleg Ishchenko, lawyer for former UIA president Yevhen Dykhne, the investigation is artificially trying to substitute the very nature of lease payments.

"What is the BEB doing? The BEB takes and interprets these aircraft as intellectual property. That is, not as a vehicle, but as intellectual property," the defender noted.

The lawyer specifically emphasizes that even the international approaches referred to by the investigation in this case are interpreted selectively and are taken out of context. According to him, in certain cases, an aircraft can indeed be considered specialized equipment. But this is only possible when it is not used for its direct purpose, but, for example, as a laboratory or a technical platform for testing. In the case of civil aviation, the situation is fundamentally different.

Oleg Ishchenko separately emphasized that UIA received an official tax consultation, in which the tax authority directly recognized that such leasing operations are not subject to taxation in the manner that the Bureau of Economic Security is now trying to impose.

In addition, UIA, like other Ukrainian airlines, acted as a tax agent in relations with the lessor when paying income to a non-resident. That is, in essence, it only withheld or did not withhold tax from the other party and was not a taxpayer "for itself."

According to the Tax Code of Ukraine, if the recipient company is a resident of a state with which Ukraine has a valid Convention on the Avoidance of Double Taxation, then the Ukrainian tax agent has the right not to withhold tax or to apply a preferential rate, depending on what is provided for by the international document.

Thus, the situation with the taxation of leasing payments by Ukrainian airlines demonstrates a much deeper problem than just a tax dispute. In fact, it is an attempt by state bodies to revise the practice of applying international conventions, which has remained unchanged for years. Such an approach creates a dangerous precedent where any foreign economic activity of Ukrainian companies can at any moment become the subject of a new interpretation, beneficial to the investigators of the Bureau of Economic Security.

For the aviation industry, this has particularly critical consequences. In conditions of closed skies, when Ukrainian airlines survive only by working abroad, an additional tax burden can become not just a financial problem, but a matter of the physical survival of the business and the industry as a whole. If the state continues to try to exert fiscal pressure, this could lead to the loss of the fleet, the curtailment of airline operations, and the actual destruction of civil aviation in Ukraine.