In order to qualify for the benefits of a Double Tax Agreement (DTA), certain anti-abuse provisions such as Treaty Shopping or Anti-Conduit clauses need to be considered.

For example, the U.K.-U.S.A. DTA reduces the withholding tax on royalties to 0% provided the relevant conditions are met. Article 12(1) of this DTA states that ‘Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.’, e.g., so long as the beneficial owner is resident in the U.K. then the royalty is only taxable in that country.

Defining beneficial ownership is not straight forward. For example, it is important to distinguish between legislation which depends on the beneficial ownership of the asset and that which depends on the beneficial ownership of the income which flows from the asset.

However, its meaning is not limited to the meaning that it might have under the domestic law of a State. In the context of Treaties, the international fiscal meaning should be considered.

Three different cases are considered in this article in interpreting the definition of beneficial ownership.

The IndoFood Case (UK)

The UK Court of Appeal had to decide whether a Dutch SPV would be the beneficial owner of the interest payable by Indofood for the purposes of the relevant DTA. The Court quotes from OECD published reports and from the 1986 and 2003 Commentaries on the OECD Model Convention on Income and on Capital to explain how “beneficial ownership” is to be interpreted in the context of DTCs. For example, Paragraph 35 of the judgement quotes from the 1986 OECD report entitled “Double Tax Convention and the Use of Conduit Companies”, where at paragraph 14(b) it states that:

‘Articles 10 to 12 of the OECD Model deny the limitation of tax in the State of source on dividends, interest and royalties if the conduit company is not its “beneficial owner”. Thus, the limitation is not available when, economically it would benefit a person not entitled to it who interposed the conduit company as an intermediary between himself and the payer of the income… .

This applies to cases involving a nominee or agent. The provisions would, however, apply also to other cases where a person enters into contracts or takes over obligations under which they has a similar function to those of a nominee or an agent. ‘Thus, a conduit company can normally not be regarded as the beneficial owner if, though the formal owner of certain assets, it has very narrow powers which render it a mere fiduciary of an administrator acting on account of the interested parties.’

The Apter Case (Italy)

A US Corporation owned a holding company in France which owned an Italian operating daughter company. The daughter distributed dividends to the French mother company and withheld 5% WHT. The French company applied for reimbursement of the WHT to the Italian tax authorities who refused.

There was no definition of beneficial ownership in the tax treaty or domestic law, so the Italian tax authority relied on the OECD guidelines and existing international case law and gave attention to the to the lack of operational substance in the French Holdco. It did not have business substance: no premises, staff, equipment and no trading activity beyond its investment in the Italian daughter company in its financial statements so did not have effective management in France. It was a subsidiary of a US company which did not have a DTA in force providing similar tax benefits as the Italy-France DTA.

The Italian tax authority decided the French Holdco was established as a conduit company. The Italian Supreme Court rejected this decision since it did not take into consideration the nature of the French company. They did not take into account that there would be limited activities because it was a holding company. They held that beneficial ownership should be verified taking into account the specific characteristics and nature of the parent company, looking at the decision-making powers, reason for its establishment and use of dividends. As such, the French company was compliant with the relevant DTA.

The Epium Case (France)

The French tax authority refused to grant exemption from withholding tax on dividends distributed by a resident subsidiary to its parent company located in the EU which was controlled by shareholders in a third State. The refusal was on the basis of a French domestic tax principal that in order to avoid directive shopping, the taxpayer parent had to prove that the principal or one of the principal purpose behind the structure was not to take advantage of the exemption from applying withholding tax.

Although this was focused on the EU Directive, the CJEU held that in order for domestic legislation to be justified by the need to avoid tax evasion and abuse, its specific objective must be to prevent conduct consisting of the creation of wholly artificial arrangements. Therefore, a presumption of fraud or abuse cannot justify a tax rule that conflicts with the Directive. Ther French domestic provisions were too wide and should have focused on the narrower point.

If you need details from this article you can contact:

Viraj Mehta,

Tax Partner                                                                                               

Viraj.Mehta@bournerbullock.co.uk

Bourner Bullock Chartered Accountants

114 St Martin’s Lane, London WC2N 4BE

+44 (0) 207 240 5821