Article 10. DIVIDENDS

This Article provides rules for limiting the taxation at source of dividends paid by a company that is a resident of one Contracting State to a shareholder who is a resident of the other Contracting State. It also provides rules for the imposition of a tax at source on branch profits, analogous to the tax on dividends paid by a subsidiary company.

Paragraph 1 preserves the residence State's general right to tax its residents on dividends paid by a company that is a resident of the other Contracting State. The same result is achieved by the saving clause of paragraph 3 of Article 1 (General Scope).

Except as otherwise provided in paragraph 4, and in paragraph 3 of the Protocol (discussed below), paragraph 2 limits to 5 percent the tax imposed by the source State on direct investment dividends. A non-reciprocal definition of direct investment dividends has been adopted. In general, source state tax is limited to 5 percent if the beneficial owner of the dividend is a company resident in the other State that owns at least 10 percent of the voting stock of the paying corporation (or 10 percent of the authorized capital if the company does not have voting stock). However, in the case of dividends paid by a Ukrainian company, nonresidents of Ukraine must in total own at least 20 percent of the voting stock of the paying company (or 20 percent of the authorized capital if the company does not have voting stock) in order for the 5 percent limitation to apply. The 20 percent foreign ownership requirement may be satisfied by

any non-Ukrainian shareholder (not only U.S. shareholders). This requirement of 20 percent foreign ownership corresponds to provisions in Ukrainian law relating to foreign-owned joint ventures and eligibility for tax holidays. The United States did not insist that this requirement apply also to dividends paid by United States corporations because it is inconsistent with general U.S. treaty policy of withholding 5 percent of dividends paid to beneficial owners of 10 percent or more of the stock of the paying corporation, and it would be inconsistent with U.S. policy relating to limitation on benefits to confer an additional benefit on a 10 percent Ukrainian shareholder in a U.S. corporation only if an additional investor (potentially from a third state that is not a U.S. treaty partner) also invested in the paying corporation.

In other cases, the source State tax is limited to 15 percent of dividends beneficially owned by residents of the other State.

Paragraph 3 defines the term "dividends" as used in this Article. The term encompasses income from any shares or rights that are not debt claims and that participate in profits, plus income from other corporate rights treated for domestic law tax purposes as dividends in the country of residence of the distributing company, and income from other arrangements, even if debt claims, if such arrangements carry the right to participate in profits and the income is characterized as a dividend under the domestic law of the country of residence of the distributing company. The last case takes into account domestic law distinctions between debt and equity. The definition also confirms that distributions by a Ukrainian joint venture to the foreign participants are dividends for purposes of this Article. Thus, such distributions are eligible for the reduced tax rates specified in paragraph 2.

Paragraph 4 explains that, where dividends are attributable to a permanent establishment or fixed base that the beneficial owner maintains in the other State, they are not subject to the provisions of paragraphs 1 and 2 of this Article, but are covered by Article 7 (Business Profits) or Article 14 (Independent Personal Services), as appropriate. This is also the case if the permanent establishment or fixed base has ceased to exist when the dividends are received as long as the dividends were attributable to the permanent establishment or fixed base in the earlier year.

Paragraph 5 permits a Contracting State to impose a branch profits tax on a corporation that is a resident of the other State. The tax is in addition to the ordinary tax on business profits. The additional tax is imposed on the "dividend equivalent amount" of such profits at the 5 percent rate that would apply to dividends paid by a wholly-owned subsidiary

corporation to its parent. At present Ukraine does not impose such a tax. The U.S. tax will be imposed in accordance with section 884 of the Internal Revenue Code, or a successor statute, subject to the reduced rate provided for in this Article.

Paragraph 3 of the Protocol relaxes the limitations on source country taxation for dividends paid by a U.S. Regulated Investment Company (RIC) and a Real Estate Investment Trust (REIT). A dividend paid by a RIC is subject to the 15-percent portfolio dividend rate regardless of the percentage of voting shares of the RIC held by the recipient of the dividend. The 5percent rate is intended to relieve multiple levels of corporate taxation. Since RICs do not pay corporate tax with respect to amounts distributed, the only tax imposed on their distributions is the shareholder-level tax. Moreover, a foreign shareholder could own a 10 percent interest in a RIC without owning a 10 percent interest in any company whose shares are held by the RIC. In the case of a dividend paid by a REIT, the domestic law rate applies, i.e., 30 percent.