Beneficial Ownership,
New Tax Code of Ukraine, and
Risks for Corporate Structures
November 2011
Contents
1. Beneficial Ownership Concept – History
2. Ukraine: Beneficial Ownership Concept before the Tax Code
3. Recent Trends and New Approach by OECD
4. New Tax Code of Ukraine and Beneficial Ownership
5. Draft New DTT between Ukraine and Cyprus
6. What To Do – Best Practices
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
• The “first line of defence” against treaty shopping
• Used in Arts. 10, 11 & 12
• Not defined in most treaties
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
OECD :
• 1986: 2 reports:
– “Double taxation conventions and the use of base companies”
– “Double taxation conventions and the use of conduit companies”
• OECD Commentary: amended in 2003:
– Commentary on Art. 1: “Improper use of the Convention”
– Commentaries on Arts. 10, 11 & 12: Expansion of comments on “beneficial owner”
test
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
• Report adopted by OECD Council November 1986
• Report identifies two types of conduit companies
1. Direct conduits
Beneficial owner
100%
Conduit company
Dividends, interest,
royalties, etc.
Third State
(State of beneficiary)
State A
(State of conduit)
State B
(State of source)
Payer of dividends,
interest, royalties,
etc.
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Beneficial Ownership Concept - History
2. “Stepping stone” conduits
Beneficial owner
Third State
(State of beneficiary)
Secondary
conduit company
(“sink”)
Conduit company
Interest, commissions, service
fees and similar expenses
State D
(State of
secondary
conduit
company)
State A
(State of conduit)
Dividends, interest, royalties, etc.
Payer of dividends,
interest, royalties,
etc.
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State B
(State of source)
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
• OECD model:
- Art. 10(2): “the beneficial owner”
- Art. 11(2): “the beneficial owner”
- Art. 12(1): “beneficially owned”
• Question: Who is “the beneficial owner”?
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
• Under English law, the term, “beneficial owner”, would exclude a legal owner who
is trustee for another
• OECD Commentary: “The term ‘beneficial ownership’ is not used in a narrow
technical sense…”
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Beneficial Ownership Concept - History
• Art. 3(2):
• “As regards the application of the Convention at any time by a Contracting State,
any term not defined therein shall, unless the context otherwise requires, have
the meaning that it has at that time under the law of the State for the purposes of the
taxes to which the Convention applies, any meaning under the applicable tax laws of
that State prevailing over a meaning given to the term under other laws of that
State.”
What is “the context” for the purposes of Art. 3(2)? Would “the context” include the
OECD Commentary?
Is it permissible to consult the OECD Commentary to determine the meaning
of “beneficial owner”?
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
Vienna Convention on the Law of Treaties:
“Article 31 : General rule of interpretation
1. A treaty shall be interpreted in good faith in accordance with the ordinary
meaning to be given to the terms of the treaty in their context and in the light
of its object and purpose.
2.The context for the purpose of the interpretation of a treaty shall comprise, in
addition to the text, including its preamble and annexes:
a. any agreement relating to the treaty which was made between all the
parties in connexion with the conclusion of the treaty;
b. any instrument which was made by one or more parties in connexion with
the conclusion of the treaty and accepted by the other parties as an
instrument related to the treaty.
Note: Bolding added
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Beneficial Ownership Concept - History
3. There shall be taken into account, together with the context:
a. subsequent agreement between the parties regarding the interpretation of the treaty or
the application of its provisions;
b. any subsequent practice in the application of the treaty which establishes the agreement
of the parties regarding its interpretation;
c. any relevant rules of international law applicable in the relations between the parties.
4. A special meaning shall be given to a term if it is established that the parties so
intended.
Article 32 : Supplementary means of interpretation
Recourse may be had to supplementary means of interpretation, including the
preparatory work of the treaty and the circumstances of its conclusion, in order to
confirm the meaning resulting from the application of article 31, or to determine the
meaning when the interpretation according to article 31:
a. leaves the meaning ambiguous or obscure; or
b. leads to a result which is manifestly absurd or unreasonable.”
Note : Bolding added
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Beneficial Ownership Concept - History
First
disqualifying
condition
Second
disqualifying
condition
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OECD Commentary
“12.1 Where an item of income is received by a resident of a Contracting State acting in the
capacity of agent or nominee it would be inconsistent with the object and purpose of the
Convention for the State of source to grant relief or exemption merely on account of the
status of the immediate recipient of the income as a resident of the other Contracting State.
The immediate recipient of the income in this situation qualifies as a resident but no potential
double taxation arises as a consequence of that status since the recipient is not treated as
the owner of the income for tax purposes in the State of residence. It would be equally
inconsistent with the object and purpose of the Convention for the State of source to grant
relief or exemption where a resident of a Contracting State, otherwise than through an
agency or nominee relationship, simply acts as a conduit for another person who in fact
receives the benefit of the income concerned. For these reasons, the report from the
Committee on Fiscal Affairs entitled ‘Double Taxation Conventions and the Use of Conduit
Companies’ concludes that a conduit company cannot normally be regarded as the
beneficial owner if, though the formal owner, it has, as a practical matter, very narrow
powers which render it, in relation to the income concerned, a mere fiduciary or
administrator acting on account of the interested parties.
“12.2 Subject to other conditions imposed by the Article, the limitation of tax in the State of
source remains available when an intermediary, such as an agent or nominee located in a
Contracting State or in a third State, is interposed between the beneficiary and the payer
but the beneficial owner is a resident of the other Contracting State…”: OECD Commentary
(paragraphs 12 to 12.2 to the Commentary on Art. 10) [substantially identical comments are
contained in the Commentaries on Art. 11 and Art. 12].
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© 2011 PJSC "Deloitte & Touche USC
Beneficial Ownership Concept - History
Indofood case – Leading Judgement:
“But the meaning to be given to the phrase ‘beneficial owner’ is plainly not
to be limited by [a technical and legal approach which focuses on the
contractual arrangements]. Regard is to be had to the substance of
the matter. In both commercial and practical terms [Indofood Mauritius]
is, and [Indofood Netherlands] would be, bound to pay on to the Principal
Paying Agent that which it receives from [Indofood Indonesia]…. In
practical terms it is impossible to conceive of any circumstances in which
either [Indofood Mauritius] or [Indofood Netherlands] could derive any
‘direct benefit’ from the interest payable by [Indofood Indonesia] except by
funding its liability to the Principal Paying Agent or [Indofood Mauritius]
respectively. Such an exception can hardly be described as the ‘full
privilege’ needed to qualify as the beneficial owner, rather the position of
[Indofood Mauritius] and [Indofood Netherlands] equates to that of an
‘administrator of the income’.”
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© 2011 PJSC "Deloitte & Touche USC
Ukraine: Beneficial Ownership Before Tax Code
• No formal rules
• For banks – NBU introduced the concept back in 2007
• Applied in practice without legal grounds: fiscal approach
• Tax authorities referred to OECD approach
• Protocols to effective double taxation treaties
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© 2011 PJSC "Deloitte & Touche USC
Recent Trends and New Approach by OECD
• 29 April 2011 – public discussion draft “CLARIFICATION OF THE
MEANING OF “BENEFICIAL OWNER” IN THE OECD MODEL TAX
CONVENTION”
• “The concept of “beneficial owner” found in Articles 10, 11 and 12 of the
OECD Model Tax Convention has given rise to different interpretations
by courts and tax administrations”
• NEW: “Since the term “beneficial owner” was added to address
potential difficulties arising from the use of the words “paid to …a
resident” in paragraph 1, it was intended to be interpreted in this context
and not to refer to any technical meaning that it could have had under
the domestic law of a specific country (in fact, when it was added to the
paragraph, the term did not have a precise meaning in the law of many
countries)… This does not mean, however, that the domestic law
meaning of “beneficial owner” is automatically irrelevant for the
interpretation of that term in the context of the Article: that domestic law
meaning is applicable to the extent that it is consistent with the
general guidance included in this Commentary.”
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© 2011 PJSC "Deloitte & Touche USC
Recent Trends and New Approach by OECD
• “Where an item of income is received by paid to a resident of a Contracting
State…”
• “In these various examples (agent, nominee, conduit company acting as a
fiduciary or administrator), the recipient of the dividend is not the “beneficial
owner” because that recipient does not have the full right to use and enjoy the
dividend that it receives and this dividend is not its own; the powers of that
recipient over that dividend are indeed constrained in that the recipient is obliged
(because of a contractual, fiduciary or other duty) to pass the payment received to
another person. The recipient of a dividend is the “beneficial owner” of that
dividend where he has the full right to use and enjoy the dividend unconstrained
by a contractual or legal obligation to pass the payment received to another
person. Such an obligation will normally derive from relevant legal documents but
may also be found to exist on the basis of facts and circumstances showing that,
in substance, the recipient clearly does not have the full right to use and enjoy the
dividend…”
• Similar approach to dividends, interest and royalties
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© 2011 PJSC "Deloitte & Touche USC
New Tax Code of Ukraine and Beneficial Ownership
• The Tax Code introduced the concept of a beneficial owner of Ukrainiansourced income
• For a non-resident to qualify as the beneficial (actual) owner (recipient) of
Ukrainian-sourced income (dividends, interest, royalties, etc.), they should be
entitled to receive the income in question
• A legal entity or individual who acts in the capacity of an agent or nominee /
fiduciary, or who is recognized as an intermediary, may not be regarded as the
beneficial owner of income, even if they are entitled to receive the income in
question
• Ukraine specific issue: the beneficial owner rules affect not only taxation treaty
benefits but tax deductibility of expenses for domestic taxpayers
• Lack of rulings / court practice
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© 2011 PJSC "Deloitte & Touche USC
New Tax Code of Ukraine and Beneficial Ownership
• Tax authorities: lack of consistent approach
• Letter 7505/7/22-5017 of 18 March 2011: to claim treaty benefit in respect of
royalties one must be a register owner of the respective rights. Intermediaries
do not qualify; but
• Letter 3917/5/12-0216 of 30 March 2011 says any proof of the right to income
can be accepted, OECD and UN Model Treaty Commentaries can be taken
into account
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© 2011 PJSC "Deloitte & Touche USC
Draft New DTT between Ukraine and Cyprus
• OECD Model-based Treaty
• Refers to a beneficial owner in respect of dividends, interest and royalties
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© 2011 PJSC "Deloitte & Touche USC
What To Do – Best Practices
• Qualify as tax resident
• “To claim treaty benefits, you need to have substance in the residence
country”
– What is the source of this “requirement” ?
– No reference to “substance” in OECD / UN model treaties
• Two possible sources:
1. Domestic tax law or “substance over form” doctrine
2. Anti-avoidance rule is “read into” treaty, perhaps based on the
Vienna Convention on the Law of Treaties
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What To Do – Best Practices
Substance (the basics)
• Local office
• Local knowledgeable directors
• Board meeting held in country
• Sufficient capitalization
• Local bank account
• Company accounting, secretarial and other compliance activities
carried on in country
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What To Do – Best Practices
Substance (additional)
• Additional economic activities carried on or risks assumed
• More than a special purpose holding company
• Financial substance: The financial capacity to bear the relevant risks
• Managerial substance: Employees or directors who make the key decision
about assets and risks:
Assets: Whether to spend money (and how much) to acquire the asset,
how much to spend to maintain the asset, how to best exploit or deploy
the asset, etc.
Risks: Whether to take on the risk, how to best manage the risk, etc.
• Operational substance: Employees or directors who are performing various
functions – e.g. procurement, finance, accounting, HR, etc. Place as many
activities as possible in the company
Financing/licensing structures:
• Avoid blatant “back-to-back”
• Increase size of rate spread
• Pay attention to payment dates
• Use equity / mixer structures
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