30 November 2011
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Our people in the press
This article originally appeared
in the 14 October 2011
issue of Tax Management
International Journal, Volume
40, No. 10 on page 613.
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Beneficial Ownership: A
Common Term In Search
Of A Common Definition
By James J. Tobin, Esq.1
You have to give the Organization for Economic Cooperation and
Development (OECD) a lot of credit for trying to bring some semblance
of symmetry to the hodgepodge of international tax rules around the
globe. One of their current forays to bring order to the system is the
ongoing project aimed at clarifying the meaning and interpretation of
the term “beneficial owner” for tax treaty purposes in light of the risks of
double or non-taxation that arise from differing interpretations in various
countries. The OECD issued a discussion draft, with proposed changes to
the Commentary on the OECD Model Tax Convention, on this subject in
April of this year. As with all OECD discussion drafts, interested parties
were invited to submit comments. I’m very interested, so consider this my
comment.
For the record, I completely agree that guidance in this area would be
beneficial indeed (sorry -- pun intended). The term “beneficial owner”
is being inconsistently defined and interpreted around the world. This
creates burdensome and unnecessary uncertainty. Particularly troubling
are the attempts to use the beneficial ownership language in a treaty
as an all-purpose tool to address any perceived “abuse.” The beneficial
ownership concept is not a substitute for other anti-abuse concepts
that can be incorporated in a bilateral treaty, like anti-treaty-shopping
provisions or GAAR-type rules. Where those kinds of provisions have not
been negotiated in the treaty agreement, they should not be read into the
treaty unilaterally by one of the countries simply by creatively interpreting
the beneficial ownership phrase to deny treaty benefits that are due.
However, this kind of creative interpretation is clearly a growing trend and
1 The views expressed herein are those of the author and do not necessarily reflect those
of Ernst & Young LLP.
consequently a growing problem.
Moreover, it has never been
more important for multinational
businesses to have clarity in
understanding the parameters for
entitlement to treaty benefits.
The complexity of international
business means that simple
economic relationships -- an
ultimate parent company with
a direct line to each operating
subsidiary in a foreign jurisdiction
-- are generally the exception rather
than the rule. Global economic
relationships today can best
be described as Gordian knots
without the quick solution: there
are regional holding company
structures, regional operating
business models, merger and
acquisition activity involving
international groups that have
their own global operations, joint
venture operations, cost-sharing
arrangements, etc. All these
common cross-border business
dealings create a transactional
web of substantive business
relationships from country to
country under the umbrella of an
ultimate parent company. Yes,
the parent company -- or perhaps
the shareholders of the parent
company -- is the ultimate owner
of the entire global group. But that
doesn’t mean that an intermediate
entity in the global group cannot
be the economic owner of a crossborder payment from an affiliate
or a third party. That intermediate
entity should be entitled to treaty
benefits in its own right as long as
it is the beneficial owner of such
income and satisfies any other
requirements specified in the treaty.
2
Another added complexity for
multinational groups is the
wide disparity in the breadth of
countries’ treaty networks. The
United States has only 59 treaties
in force, while the United Kingdom
has more than double that number.
And then you have an important
regional location like Hong Kong
with less than 20 tax agreements.
Given this uneven patchwork of
treaty coverage coupled with the
complex global groups described
above, multinationals need to
know what the true criteria are
for eligibility for benefits under a
treaty. Unexpected denial of treaty
benefits can result in real economic
double taxation. Add to this picture
the typical multi-tiered structures
of most global companies and the
result can be a lot worse than mere
double taxation!
Today’s complex global operating
groups arise for a myriad of
business reasons. But I am
concerned that many countries’ tax
authorities approach these groups
not with a recognition of global
business realities but rather with an
innate suspicion, or even a negative
presumption, with respect to any
intermediate entity that is claiming
treaty benefits. To be fair, countries
have a right to be concerned about
who benefits from their carefully
crafted bilateral tax treaties. After
all, inappropriate use of tax treaties
by third-country residents nullifies
the whole point of having a bilateral
accord. So I get why countries
include anti-treaty-shopping
provisions in their treaties. What I
worry about is the tax authority of
one treaty partner trying to stretch
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the beneficial ownership concept
beyond recognition to address what
it perceives as a potential treaty
shopping situation.
As the OECD’s work on the
beneficial ownership project
continues, I am hopeful that there
will be a dual focus: first, on much
needed clarifications of what the
beneficial ownership concept
means; and second, on equally
important clarifications of what the
beneficial ownership concept does
not mean. Based on the discussion
draft, I am cautiously optimistic on
both fronts.
Under the current OECD
Commentary, a resident of a
Contracting State would not be
considered the beneficial owner
of dividends, interest, or royalties
received if the resident merely acts
as agent or nominee in respect
of the income, or if such resident
otherwise acts as a conduit with
respect to such income.
In the introduction to the discussion
draft, the OECD recognizes
that the concept of “beneficial
owner” contained in Articles 10,
11, and 12 of the OECD Model
Tax Convention has given rise to
different interpretations by courts
and tax administrations globally.
The stated purpose of the proposed
changes is to clarify the meaning
and interpretation of the term to
prevent double taxation or nontaxation arising from these different
interpretations. A single, accepted
meaning of the term is a laudable
goal and the OECD is in a unique
position to advance this cause.
So what has Jeffrey Owens, et
al, come up with for purposes of
clarification?
One proposed change (among
others) would add the following to
the Commentary:
12.4 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; also,
the use and enjoyment of a dividend
must be distinguished from the
legal ownership, as well as the use
and enjoyment, of the shares on
which the dividend is paid.
So far, so good. I take from this that
the beneficial owner must have
the full right to use and enjoy the
dividend (or interest or royalty).
Any legal (or other) obligation
to pass the payment received to
another person would disqualify the
recipient as the beneficial owner
and as a result would jeopardize
that person’s access to treaty
benefits.
Put another way, the OECD is
clearly favoring a dominion and
control test that focuses on the
particular treaty-protected income
rather than a test that looks to the
ultimate ownership or source of
funding for the entity in question.
Indeed, the OECD underscores this
in proposed paragraph 12.6 of the
Commentary:
[T]he meaning given to this
term [beneficial owner] in
the context of the Article
must be distinguished
from the different meaning
that has been given to
that term in the context
of other instruments that
concern the determination
of the persons (typically
the individuals) that
exercise ultimate control
over entities or assets.
That different meaning of
“beneficial owner” cannot
be applied in the context of
this Article.
For those paranoid advisors among
us, there could be a worry about
how full the right to use and enjoy
the treaty-protected payment
must be. For instance, persons
that are receiving dividends and
other treaty-protected payments
naturally will incur operating
expenses and funding costs in
deriving such payments. It seems
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clear to me that the use of cash
generated from a treaty-protected
payment to fund such costs would
not impact the beneficial ownership
determination.2 After all, that is
what owners of income ordinarily
do -- use their receipts to fund
their costs and hopefully have
some profit left over. The new
Commentary considers there to be
a conduit situation if the recipient
has an obligation to pass the
payment on to another person. The
use of some cash proceeds from the
payment to fund costs doesn’t seem
to me to involve an obligation to
“pass the payment” on to another.
That said, I understand paranoid
tendencies and fall prey to them
myself, so while the OECD has got
the Commentary on the beneficial
owner concept open and their
pencils sharpened, why not make
this point more explicitly.
With these clarifications of what
beneficial ownership means, the
OECD next turns to the issue of
what it doesn’t mean and what
purposes it doesn’t serve. Proposed
paragraph 12.5 of the Commentary
discusses the potential for antiabuse rules to be incorporated
in a treaty, including provisions
to address treaty shopping
considerations. The paragraph
notes that “[w]hilst the concept
of ‘beneficial owner’ deals with
2 If an obligation specifically tracks to the
payment in question, such as a loan that
is payable only with regard to a dividend
received, for example, that would call
beneficial ownership into question.
Take, for instance, an extreme case like
Indofoods where there was a virtual
100% back-to-back loan with no other
activity in the intermediate entity.
3
some forms of tax avoidance (i.e.,
those involving the interposition
of a recipient who is obliged to
pass the dividend to someone
else), it does not deal with other
cases of treaty shopping . . .” In
this regard, the OECD cites several
approaches that could be used to
address abuse of treaty benefits,
including specific or general antiabuse rules and substance-focused
approaches. The inclusion of the
beneficial ownership concept in a
treaty does not restrict the ability
to include one or more of these
anti-abuse provisions; at the same
time, the beneficial ownership
concept cannot be made to serve
the purpose of one or more of such
anti-abuse provisions. Here again,
I would find the OECD’s proposed
changes to the Commentary
more beneficial to the system if it
were made explicit that the other
approaches referenced are intended
to involve specific language
included in a bilaterally negotiated
agreement.
The potential for confusion in this
regard is real and such confusion
is occurring in jurisdictions around
the world. Moving on from the
beneficial ownership concept to
other approaches for addressing
treaty abuse (which, as mentioned
earlier, often get confused with
the subject at hand), I would put
them into two broad categories:
(1) general anti-avoidance rules
or sham-entity-type attacks; and
(2) U.S.-style treaty limitation on
benefits approaches.
Examples of these types of treaty
challenges abound. The ATO in
Australia recently took the position
4
in relation to the Texas Pacific
Group/Myer case that the general
anti-avoidance rule of Part IVA had
application to deny the benefits of
the Netherlands-Australia Income
Tax Treaty where a Dutch holding
company was purportedly set up to
obtain tax treaty benefits.
Indian tax authorities traditionally
have been very aggressive in
ignoring intermediate holding
companies, both in a treaty context
as well as under domestic law, to
assert nexus for taxing gains. The
well-known Vodafone case is an
example of the latter approach.
In the treaty shopping context,
however, there has been some good
news in the form of a favorable
ruling by the Indian authority for
advanced rulings with respect to the
availability of the India-Mauritius
Income Tax Treaty in E*Trade
Mauritius Ltd. However, a more
recent decision by the high court
in Bombay (Aditya Birla) upheld a
challenge to that treaty based on
beneficial ownership grounds where
certain voting and management
rights were retained by the
Mauritius company shareholders.
Both the ruling and the case are
appealable to the Indian Supreme
Court. So the jury is still out so to
speak on India and Mauritius.
Another very-high-profile example
of a treaty challenge is in China
where so-called Circular 601
provides a list of seven active
business-type factors to be
evaluated for any entity claiming to
be the beneficial owner for treaty
purposes. One of the factors is
whether the treaty resident has
an obligation to distribute a major
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portion of its income -- that one
certainly sounds like something that
would be relevant to a beneficial
ownership determination. The
other six factors, however, go way
beyond anything that do not involve
areas of inquiry that typically have
been viewed as relevant to such a
determination.
In my view, all of these examples go
considerably beyond the concept
of beneficial ownership discussed
in the OECD Commentary. Clearly,
none is premised on a nominee or
strict economic or legal conduit
relationship. Moreover, none of
them involves the interpretation
of any other anti-abuse measure
contained in the particular treaty
at issue. To my mind, the place
for discussing these types of
treaty limitations is in the bilateral
negotiation of the tax treaties
themselves. So newly advancing
such restrictions is not something
that can be done unilaterally but
rather requires a visit to the treaty
negotiating table. To negotiate a
bilateral treaty in good faith with
no specific provision limiting treaty
benefits in the case of third-country
investors and then unilaterally add
such restrictions under the guise of
international beneficial ownership
standards is neither fair play nor
good tax policy.
Admittedly, the United States has
earned a reputation for treaty
overrides -- going back at least to
our introduction of FIRPTA in 1980.
But for the most part, although I
find a lot to complain about with
respect to our U.S. international tax
system, I think the U.S. approach
to treaty enforcement is pretty
reasonable. The U.S. conduit
financing rules are aimed at straight
back-to-back arrangements and,
while a bit broader than I would
think is intended by the proposed
OECD Commentary on beneficial
ownership, should not have an
impact on equity-funded holding,
finance, or licensing companies
or active financing companies.
Moreover, U.S. treaty limitation
on benefits rules are bilaterally
negotiated (and, as indicated in
my prior commentary on “Tricky
Derivatives,” are perhaps too
bespoke a matter). The approach
of U.S. treaty limitation on benefits
rules in assessing the overall
business connection of the affiliated
corporate group to the treaty
country location of the recipient
company and in looking to potential
entitlement to equivalent derivative
benefits is reasonable by contrast
to the approaches followed by
some countries. In this regard, the
approach of Circular 601 in China,
for example, is to look to separate
entity business activities and to
either ignore or leave unclear the
status of derivative benefits.
Overall, I would encourage
countries to take a two-prong
approach to treaty entitlement:
first, to follow the OECD
guidelines (hopefully after a bit
more clarification) on beneficial
ownership; and second, to consider
how they want to develop an
explicit and reasonable policy on
limitation on benefits. Hopefully,
any future anti-treaty-shopping
policy will clearly recognize the
business realities referred to at
the outset of this commentary.
Countries then could use these new
policy standards for negotiating
and renegotiating their bilateral tax
treaties.
To the OECD, I’d say good start!
Once the current beneficial
ownership project is completed
(with the few points of clarification
I have noted, of course), perhaps
the OECD would consider turning
its attention to encouraging a more
consistent approach to anti-treatyshopping provisions.
For additional information with respect to this ITS in the News, please contact the following:
Ernst & Young LLP, International Tax Services, New York
• James J. Tobin
+1 212 773 6400
[email protected]
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