Aircraft Leasing and Withholding Tax Exposure in Ukraine: Emerging Treaty Interpretation Issues

Contents

• I. Withholding Tax Risks in Ukrainian Aircraft Leasing: Executive Overview
• II. Tax Treatment of Aircraft Leasing under Domestic Law and Treaties
• III. Judicial Practice: Contractual Lessor and Article 8 Treatment
• IV. Double Tax Treaty Framework: Article 8 vs Article 12
• V. Treaty and Structuring Risks in Cross-Border Aircraft Leasing

~ 12 min read

Developments in March 2024 in Ukrainian tax practice have raised questions around the withholding tax (WHT) treatment of cross-border aircraft leasing payments. These questions primarily concern the application of double tax treaties, particularly the interaction between Article 8 (international traffic) and Article 12 (royalties).

Historically, payments made by Ukrainian airlines to non-resident lessors have generally been treated as part of the operation of aircraft in international traffic and, therefore, exempt from withholding tax under Article 8 of applicable double tax treaties. This approach has been broadly consistent with international practice and aligned with the structure of the global aviation leasing market.

Administrative guidance from the Ukrainian tax authorities published on 24 May 2024 suggests that, in certain cases, leasing payments may be recharacterized as royalties under Article 12 of the relevant tax treaties with the necessity to pay WHT in Ukraine at an appropriate rate fixed in the treaty (for example, 10% for Cyprus, Turkey, Portugal, Estonia, Poland etc). This interpretation is linked to the inclusion, in some treaties, of payments for the use of industrial, commercial, or scientific equipment within the definition of royalties.

Importantly, the jurisdictions identified by the tax authorities in this context (Estonia, Poland, Lithuania, Latvia, Bulgaria, Brazil, Czech Republic, Cyprus, Azerbaijan, Algeria, Vietnam, Egypt, Jordan, Iceland, Kazakhstan, Saudi Arabia, Libya, Morocco, Mexico, Mongolia, Pakistan, Singapore, Slovenia, Thailand, Turkey, Turkmenistan, Uzbekistan) are not typically associated with major aircraft leasing platforms. Rather, the focus appears to be on specific treaty configurations where such “equipment royalty” provisions are present. This indicates that the current scrutiny is directed at particular structuring approaches rather than at the aviation leasing sector as a whole.

In practice, this has already led to a limited number of disputes involving Ukrainian airlines, primarily concerning the classification of leasing payments and the availability of treaty protection.

For aircraft lessors and their advisors, these developments should not be viewed as a fundamental shift in the tax treatment of aviation leasing in Ukraine. Instead, they highlight the need to carefully assess the structure of leasing arrangements, the applicable treaty framework, and the potential for differing interpretations in specific cases.

At this stage, the issue remains manageable and largely dependent on the specific facts and structure of each transaction.

1. Domestic Law and Treaty Override

Under Ukrainian tax law, lease payments made by a Ukrainian resident to a non-resident are generally treated as non-resident income derived from a Ukrainian source and are subject to withholding tax at a rate of 15%, unless reduced or exempted under an applicable double tax treaty. The relevant analysis, therefore, focuses on the taxation of the non-resident lessor’s income, rather than that of the Ukrainian airline.

Double tax treaties concluded by Ukraine typically include provisions in Article 8 governing the taxation of profits derived from the operation of aircraft in international traffic. These provisions are commonly drafted broadly and may include income derived by the lessor from leasing aircraft without crew.

Where Article 8 applies, taxing rights are allocated exclusively to the state of residence of the lessor. As a result, Ukraine does not exercise its domestic withholding tax right, notwithstanding that the income is classified as Ukrainian-source under domestic law.

The application of this treaty protection depends on the lessor properly documenting its entitlement to treaty benefits, including its tax residency.

2. Market Practice and Structural Context

The global aircraft leasing market is highly structured, with Ireland serving as the primary jurisdiction for leasing platforms.

In a standard leasing structure:

• the contractual lessor that is an owner of the aircraft is typically a special-purpose vehicle created for certain aircraft within an established leasing platform;
• such ownership structure and financing are integrated within a recognized aviation finance framework in Western countries;
• lease payments reflect the structure and terms of financing the aircraft;
• aircraft are operated across multiple jurisdictions as part of international traffic.

In practice, aircraft leasing transactions in Ukraine do not operate in isolation. Their effectiveness depends on the interaction between transaction structuring, regulatory requirements, and financing models, particularly in cross-border contexts. The ability of a leasing structure to achieve its intended tax outcome, therefore, depends not only on treaty interpretation but also on whether these elements function coherently within the Ukrainian legal and administrative framework.

Ukrainian court practice in this area remains limited, which is unsurprising given the size of the domestic aviation market. However, the available judgments point in a consistent direction.

In disputes involving Ukrainian airlines and UK aircraft lessors, courts have generally focused not on the mere ownership of the aircraft, but on whether the contractual lessor acted in its own name and interest, and whether the tax authority proved that it was merely an agent, nominee, or conduit.

This approach was confirmed by the Supreme Court in the middle of 2021 in a withholding tax dispute No. 826/13255/18 initiated by the Ukrainian tax authorities against a Ukrainian airline Windrose in connection with aircraft lease payments to a UK lessor. The Court held that the concept of beneficial ownership should not be automatically extended beyond dividends, interest, and royalties, and that the tax authority must prove that the non-resident lessor acted only as an agent or nominee. Where the contractual lessor receives lease payments in its own name and is not shown to be a mere intermediary, the Article 8 treaty position remains supportable.

A similar approach can also be seen in another aircraft leasing dispute No. 640/20024/18 considered in February 2019 involving a Ukrainian airline UIA, where the court treated the contractual lessor as the relevant recipient of leasing income and rejected the tax authority’s attempt to deny treaty protection based solely on the broader ownership and financing structure.

This case law does not eliminate the risk of recharacterization. But it confirms an important point: Ukrainian courts tended to examine the actual contractual and functional role of the lessor, rather than treating aircraft ownership by another group entity as sufficient to deny treaty benefits.

1. The Treaty Split Within Article 12

While Article 8 provides the principal basis for exemption from Ukrainian withholding tax, the position of the lessor may also depend on the wording of Article 12 of the applicable treaty, particularly when viewed within the broader context of Ukraine’s treaty network and cross-border structuring of aviation transactions.

Under the first model, reflected in a group of 27 tax treaties, royalties include payments for the use of industrial, commercial, or scientific equipment. This is the group of treaties referenced in an administrative analysis by the Ukrainian tax authorities in 2024.

Under the second model, characteristic of treaties with key aviation and capital-exporting jurisdictions such as Ireland, the United States, the United Kingdom, France, and Germany, royalties are limited to payments for intellectual property and know-how and do not extend to equipment leasing.

2. Contextual Role of the “Equipment” Clause

Even where treaties include equipment within the definition of royalties, such provisions typically appear alongside payments for intellectual property, industrial processes, and know-how.

This suggests that the concept of “equipment” is embedded within a broader framework for technologically complex or specialized assets, rather than intended to capture ordinary commercial leasing.

3. Competing Characterizations

Where an “equipment royalty” clause is present in a treaty, aircraft leasing payments may be subject to competing interpretations.

• Under Article 8, such income may be treated as part of profits from the operation of aircraft in international traffic.
• Under Article 12, the same payments may be viewed as consideration for the use of equipment.

The classification is determinative: Article 8 allocates taxing rights to the lessor’s jurisdiction, while Article 12 allows Ukraine to assert withholding tax.

4. Treaty-Specific Nature of the Issue

The treaties identified in Ukrainian administrative materials do not include the principal jurisdictions associated with mainstream aircraft leasing.

This indicates that the issue is treaty-specific rather than industry-wide, and that it arises primarily where both the treaty wording and the transaction structure support an alternative classification of leasing payments — from Article 8 (international traffic) to Article 12 (royalties).

1. Administrative Focus and Treaty Selection

Recent materials from the Ukrainian tax authority indicate a focus on a defined set of treaties that include the “equipment royalty” formulation rather than a general reassessment of aircraft leasing payments in international aircraft leasing.

2. Role of Transaction Structure

In practice, aircraft leasing arrangements may involve multiple jurisdictions, including cases where:

• the contractual lessor differs from the ultimate economic owner;
• intermediary entities are used for financing or structuring purposes;
• the applicable treaty differs from that of the primary leasing platform.

In such cases, the tax analysis depends not only on the nature of the asset (aircraft or equipment) but also on how the leasing structure is legally arranged and whether the lessor’s rights under the lease can be effectively enforced in Ukraine — including in default scenarios. In this context, the relevant question is not limited to classifying lease payments under a tax treaty. It also extends to whether the overall transaction structure — including title allocation, enforceability of lease rights, and interaction with regulatory authorities — remains workable in Ukraine in both operational and default scenarios, including enforcement and repossession, which is critical for aircraft leasing, acquisition, and repossession in practice.

3. Structural Sensitivity to Treaty Model

Where the contractual lessor is located in a jurisdiction within the “equipment royalty” treaty group:

• the treaty wording may allow leasing payments to fall within the scope of Article 12;
• the tax authority may scrutinize the characterization of such payments;
• and, in this context, may seek to reclassify the income from Article 8 (international traffic) to Article 12 (royalties).

Where the lessor is located in a jurisdiction which treaty following the narrower royalty definition, the likelihood of such recharacterization is significantly reduced.

4. Functional Perspective

The classification also depends on the lessor’s functional role.

• Where the lease arrangement is aligned with an integrated aviation leasing business, the connection to Article 8 of a treaty is stronger.
• Where the lease structure presents the lessor primarily as a provider of equipment, the relevance of Article 12 of a treaty may increase.

This assessment depends on substance, contractual arrangements, and the overall context of the lease transaction.

5. Practical Risk Indicators

Potential recharacterization risk is more likely where several factors are present:

• use of a treaty including an “equipment royalty” clause;
• presence of intermediary entities;
• limited economic substance at the level of the contractual lessor;
• misalignment between contractual structure and operational reality (in particular, where the contractual allocation of rights and obligations does not reflect the actual functions performed, decision-making authority, or economic risk assumed by the parties).

These factors do not determine the outcome but may increase the likelihood of scrutiny, including potential recharacterization of payments, additional tax assessments, and penalties.

6. Controlled Nature of the Risk

These developments — primarily reflected in the Ukrainian tax authorities’ interpretative approach to treaty provisions and in a number of enforcement actions involving Ukrainian operators — do not indicate a structural change in the taxation of aircraft leasing.

7. Coordination with Local Advisors

Because the application of tax treaties in Ukraine depends heavily on the specific structure of each transaction, local legal and tax input is often necessary — particularly where the arrangement is not entirely standard.

This is especially relevant in cases involving:

• non-standard leasing structures;
• so-called “intermediary” jurisdictions;
• complex ownership or financing arrangements.

In practice, this means that even widely used structures in the aviation industry may require a local review to confirm how they will be treated by the Ukrainian tax authorities.

Such a review is important to ensure that the legal structure, tax position, and regulatory framework are aligned not only in theory but also in their practical application.

Ultimately, addressing these issues requires a coordinated approach that goes beyond tax analysis alone. It involves structuring the transaction to work across tax, contractual, and regulatory dimensions simultaneously.

For transaction-specific analysis of withholding tax exposure and treaty application in aircraft leasing, contact the author below.