ESBU's attempt to classify aircraft leasing as "royalties" could hit Ukraine's defense
Kyiv • UNN
The Economic Security Bureau of Ukraine (ESBU) interprets aircraft leasing as royalties, introducing a 15% tax. This threatens airlines with bankruptcy and risks halting the repair of AFU military equipment.
The continuation of the practice by tax authorities and the Bureau of Economic Security (BES) of interpreting leasing payments for aircraft rentals abroad as royalties threatens not only double taxation for airlines but could also jeopardize part of the strategic repair infrastructure currently operating in the interests of the Armed Forces of Ukraine. UNN looked into how the attempt at a new approach to interpreting transport leasing as the use of intellectual property will affect the civil aviation industry.
This refers to attempts to apply a 15% tax as "royalties" to the leasing of aircraft abroad by Ukrainian airlines.
Pressure on the aviation business through loose interpretation of legislation
The Bureau of Economic Security has already opened a number of criminal proceedings involving almost all Ukrainian companies that lease aircraft abroad from non-resident companies of Ukraine. Investigators are convinced that airlines should have paid royalties in Ukraine, i.e., a fee charged for the use of intellectual property. At the same time, the fact that transport is not intellectual property is completely ignored, and Conventions on the Avoidance of Double Taxation are in force between Ukraine and a number of countries. According to these agreements, Ukrainian companies pay taxes in the countries where the lessor companies are residents. At least 5 airlines have already suffered from BES pressure: UIA, "Constanta Airline", "Urga", "H3OPERATIONS", and "Skyline". Furthermore, court materials indicate similar approaches in other sectors, with attempts to impose an additional fee on leased railway transport and even agricultural machinery.
It is important to note that for over 30 years, the legislation regarding the taxation of leasing in Ukraine has not changed, and previously it did not raise questions or remarks from either tax or law enforcement authorities. Therefore, there are obviously no justified grounds for the investigators of the Bureau of Economic Security to change the interpretation of the legislation, and the situation looks exclusively like pressure on business that harms the state.
The situation changed after the State Tax Service of Ukraine published an article on May 24, 2024, with clarifications regarding the taxation of leasing operations by airlines. In these "reflections on the topic," tax officials point out that the leasing of aircraft from non-resident companies must be taxed as royalties. At the same time, fiscal authorities juggle articles of international conventions on the avoidance of double taxation, claiming that for aircraft rentals, airlines must pay fees as if for the use of intellectual property.
Such an approach is not just an erroneous interpretation of tax law norms, both Ukrainian and international, but a "tax on the Ukrainian flag," which makes Ukrainian air carriers uncompetitive in the global market.
"Accordingly, this (the change in the interpretation of legislation – ed.) creates a situation where a Ukrainian airline becomes less attractive a priori. And this is not a question of management efficiency; it is a question of the rules of the game, which in this case are dictated by the state itself in the person of tax and regulatory authorities. I would say that our airlines are effectively forced to pay a markup for operating under the flag of Ukraine,"
Not only airlines may disappear: consequences for defense
Another key thesis of the market is that after the start of the full-scale war, Ukrainian airlines operate entirely abroad. This means that the planes do not enter Ukrainian airspace, crews are based abroad, contracts are executed outside Ukraine, and revenues are generated outside Ukrainian jurisdiction.
In other words, currently, airlines do not receive income in Ukraine, the asset is physically located abroad, and the BES is trying to tax the expense as if it were a Ukrainian source of income. Obviously, this is an attempt to tax economic activity that has no proper connection to Ukrainian jurisdiction.
Market participants warn that the consequences could be much broader than just the bankruptcy of individual operators or their complete withdrawal from Ukraine. Civil aviation is the foundation for the existence of an entire repair ecosystem, which remains in Ukraine today despite the war and also services Ukraine's military aviation. For security reasons, we will not list the names of these enterprises to avoid giving hints to the enemy, as Russia has long been hunting for aircraft repair bases that continue to operate in Ukraine.
As experts in the field of military aviation explain, in no country in the world do air forces have a completely autonomous repair base. Military equipment is repaired by civilian enterprises. According to them, if civil aviation dies, the repair base dies next, and then problems arise with the repair of military equipment.
Today, it is civilian contracts that allow for the maintenance of repair facilities, engineers, and production teams, enabling the enterprises to function.
Thus, it can be concluded that the issue of interpreting aircraft leasing as royalties and the attempt to obtain short-term dividends is already moving into the realm of national security. Can the Ukrainian state today, in the conditions of war, afford to lose the capabilities for repairing military aviation that protects the skies over Ukraine during mass shelling? The answer to this question is obvious.
Not a tax on a non-resident, but an additional fee from the Ukrainian operator
In aircraft leasing operations abroad, the Ukrainian lessee company formally acts as the tax agent. In order for a business generating profits abroad not to pay them twice – in the foreign state and in Ukraine – conventions on the avoidance of double taxation were ratified between our state and a number of countries.
However, the BES is currently trying to change this practice and impose an additional 15% fee on the lessor company, which is a non-resident of Ukraine. In reality, the non-resident does not suffer losses; they simply include these 15% in the contract price and collect them from the airlines.
That is, the foreign lessor continues to receive their "net" amount, and the difference is paid by the Ukrainian airline. Thus, from a "tax for a foreigner," it turns into an additional 15% surcharge on the cost of leasing specifically for Ukrainian operators.
As a result, Ukrainian companies receive worse conditions than any other foreign air carriers: the same aircraft, the same lessor, the same market conditions, but for Ukraine, they are 15% more expensive.
In aviation, where margins are traditionally very low, such changes can become critical.
Business with a profitability of 3-5%
Aviation industry representatives explain that before the full-scale war, the average profitability of Ukrainian airlines was approximately 3-5%. After the closure of Ukrainian skies, the situation became even more difficult, as operators have to work in survival mode, having completely relocated abroad. At the same time, aircraft rental costs account for about 40-70% of all airline expenses.
In other words, the mechanics look like this: if leasing accounts for an average of 50% of the cost price, and an additional 15% is imposed on it, the total cost of operations increases by at least 7.5%. For an airline that previously had a profitability of 3-5%, this means an automatic move into loss.
Thus, the BES approach to interpreting leasing as royalties kills the ability of airlines to operate profitably. According to UNN's interlocutors working in the aviation business, this is effectively a "turnover tax" that does not take into account the real economics of the industry and the attempts to survive in wartime conditions.
World practice does not provide for interpreting aircraft leasing as royalties
Aircraft leasing is a global practice by which the entire world air transport market operates. Airlines in most countries do not buy planes outright because it is expensive. Renting an aircraft is significantly cheaper and faster. Aircraft are purchased by specialized leasing companies, which then transfer them to operators for use. This is how aviation markets in Europe, the USA, Canada, Turkey, Asian countries, and the Middle East operate.
Representatives of the Ukrainian aviation market note in conversations that in Poland, Germany, Canada, or Turkey, it doesn't even occur to anyone to tax aircraft rental payments as royalties. Foreign tax authorities take into account the effect of international conventions on the avoidance of double taxation, and for them, such an approach would be nonsense.
According to them, international conventions on the avoidance of double taxation are practically unified between countries. However, it is in Ukraine that BES investigators and former tax officials have begun to interpret leasing as "royalties."