Article 10 of the OECD Model Tax Convention provides for the
requirement of beneficial ownership to clarify the meaning of
the words "paid to a resident" and was especially introduced to
deal with a specific form of abuse affecting the source state,
i.e. the transfer of treaty-favoured income to residents of a
third state.
To date, the Swiss Federal Court has had the occasion to
rule on three separate cases dealing with beneficial ownership,
which involved the use of derivatives in the context of
financial transactions, namely the use of total return swaps
(TRS) in an international framework and the use of stock index
futures both in a treaty context and in a domestic situation.
These cases have attracted significant attention being the
first court cases dealing with the concept of beneficial
ownership with regard to derivatives transactions in a double
tax treaty context.
This article presents the concept of beneficial ownership in
the context of financial transactions and examines the OECD's
Multilateral Instrument, as well as the principal purpose test
that will be briefly exposed, in order to illustrate new
developments in connection with tax treaty abuses.
In general
According to the Vienna Convention on the Law of Treaties of
May 23 1969 (VC), a treaty must 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 light of the object and
purpose of the treaty (Article 31, para 1, or the VC). Since
the OECD Commentary constitutes relevant context for the
interpretation of bilateral tax treaties, the Vienna Convention
suggests that its statements on the meaning of beneficial
ownership should be given considerable weight in the
interpretation of this term.
Interpretation of an international treaty in accordance with
domestic law is a last resort, the rule being an autonomous
interpretation.
VOGEL defines the beneficial owner as the person who is free
to decide "(i) whether or not the capital or other assets
should be used or made available for use by others or (ii) on
how the yields therefrom should be used or (iii) both".
Subjectively, this definition thus focuses on the power of the
beneficial owner to control the use and the subsequent
attribution of the capital or the yields, which is coherent
with the goal of this provision, i.e. to prevent the abusive
use of the double tax treaty (DTA), in particular for companies
having the sole purpose of channelling the income via a state
benefiting from a DTA. Objectively, the beneficial ownership
test only concentrates on the attributes of ownership. Thus,
the status of beneficial owner could not be denied to a person
for the reason that it benefits from a tax exemption or due to
the intensity of its link with the resident state (existence of
a commercial activity, local substance, etc.).
OECD Commentary 2010 and the 2014 revision
With regard to the OECD Commentary, which plays an important
role for the interpretation of DTA, this Commentary explicitly
states that an entity which, "has, as a practical matter, very
narrow powers which renders it, in relation to the income
concerned, a mere fiduciary or administrator acting on account
of the interested parties", cannot normally be regarded as the
beneficial owner even though it is the formal owner.
Furthermore, in accordance with the above-mentioned provision
of the Vienna Convention regarding interpretation of treaties,
the OECD Commentary expressly states that "the term 'beneficial
owner' is not used in a narrow technical sense, rather, it
should be understood in its context and in light of the object
and purposes of the Convention, including avoiding double
taxation and the prevention of fiscal evasion and avoidance".
In this context, the OECD Commentary provides two examples of
situations where the immediate recipient of interests, in
particular, cannot be considered as being the beneficial owners
of these interests, i.e. persons acting in the capacity of
agent of nominee and conduit companies, which cannot be
regarded as beneficial owners of the interests, due to their
very narrow powers which render them a fiduciary or mere
administrator acting on account of the interested parties.
The OECD Commentary was revised in 2014 and provides for the
following in relation with the notion of beneficial ownership:
"In these various examples (agent, nominee, conduit company
acting as a fiduciary or administrator), the direct recipient
of the interest is not the 'beneficial owner' because that
recipient's right to use and enjoy the interest is constrained
by a contractual or legal obligation to pass on 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 right to use
and enjoy the interest unconstrained by a contractual or legal
obligation to pass on the payment received to another person.
This type of obligation would not include contractual or legal
obligations that are not dependent on the receipt of the
payment by the direct recipient such as an obligation that is
not dependent on the receipt of the payment and which the
direct recipient has as a debtor or as a party to financial
transactions, or typical distribution obligations of pension
schemes and of collective investment vehicles entitled to
treaty benefits […]".
The OECD Commentary 2014 basically requires two elements
that are relevant to deny the right to use an interest
recipient:
- The existence of a legal obligation
(contractual or legal obligation) to transfer the proceeds;
and
- A relation of interdependence between the
receipt of the original payment and the transfer (a
contrario: "would not include contractual or legal
obligations that are not dependent on the receipt of the
payment by the direct recipient").
It follows from this new version of the OECD Commentary
that, in certain cases, a mere factual duty to transfer is not
sufficient to deny the right to use of the income recipient.
Indeed, with respect to financial transaction, the OECD
Commentary 2014 explicitly states that the right to use of the
income recipient cannot be denied on the sole grounds of a
de facto transfer of income. Moreover, it appears
clearly that the OECD considers as harmful only a commitment
that is related to a received payment (in the sense of
interdependence). The situation where the recipient of income
satisfies other obligations without the existence of a link
between the income and the expense is not considered as
harmful.
Regarding the lack of possibility to deny the right to use
in case a transfer of income is only supported by facts. It is
interesting to note, however, that this was addressed in a
consultation procedure which took place in 2011. Some
commentators were of the opinion that the proposed definition
of beneficial owner at the time, as the one with the "full
right to use and enjoy the dividend" was "excessively broad"
and would prevent withholding tax refund in legitimate cases.
As examples of cases in which legitimate refund requests could
be affected, the activities of bank or other financial
institutions were mentioned in particular, as well as hedging
risks in the financial sector. Concerns have been expressed
regarding to the effect that an excessively broad wording could
have for financial institutions for which refund requests could
be denied in cases where they take risks and hedge those risks
in the course of their normal business.
In this context, it can be read in the OECD revised
proposals that "[i]n light of all these comments, the Working
Party recognised that the drafting of paragraph 12.4 could give
rise to significant uncertainty and that the paragraph needed
to better identify the kind of obligations that would mean that
the recipient of a dividend would not be considered to be the
beneficial owner of that dividend. After extensive discussions,
it agreed on the proposed redraft included in the box at the
beginning of this section". In the current version of the OECD
Commentary 2014, the word "full" has thus been deleted.
Therefore, this tends to the conclusion that a transfer of
income taking place in the normal business activity of a
financial actor should not justify a denial of right to use and
to a refusal of withholding tax refund.
Decisions of the Swiss Federal Court in relation to
beneficial ownership or the right to use in the context of
financial transactions
All these decisions (2C-364/2012,
2C-895/2012, 2C-383/2013) deal with the
rejection of Swiss withholding tax refunds in cases where
derivatives are used in the relevant financial transactions and
lead to a transfer of income to third parties. The Federal
Court denied the possibility for the taxpayer to recover Swiss
withholding tax, because it considered it was not the
beneficial owner of the underlying asset, respectively it
lacked the right to use on the income. With regard to the
interpretation of beneficial ownership, the Federal Court
unfortunately did not take into consideration the
above-mentioned OECD Commentary 2014.
Regarding the notion of interdependence, the Federal Court
first considered that there is a relation of interdependence if
the obtaining of the income is linked to a direct obligation to
transfer this income. Hence, if the income had not existed,
there would have been no obligation to transfer such income.
The Federal Court retained the possibility to have a legal or a
factual obligation. In all these cases, the Federal Court held
that the bank would not have concluded the underlying
transaction without the conclusion of the derivative contract,
and it did not have a free power of disposal on such income
that it committed to transfer to its counterparty to the
derivative contract. For these reasons, the bank did not bear
the risks inherent in the holding of the underlying asset, the
latter being transferred to the counterparty to the derivative
contract.
The consequences from these Federal Court decisions are that
a financial institution issuing derivatives could not be
considered as a beneficial owner of the underlying asset, if
some of the following conditions are met:
- Derivative and underlying assets are
transacted in a simultaneous way and in the short term;
- Temporal proximity to the time of dividend
payment;
- Underlying performance related to a prior
agreement of transfer to a third party;
- Obligation (legal, economic or factual) to
transfer the performance of the underlying asset to a third
party; and
- Almost no risk borne by the issuer.
The OECD's Multilateral Instrument
In the context of base erosion and profit shifting (BEPS),
referring to tax planning strategies that exploit gaps and
mismatches in tax laws to artificially shift profits to low or
no-tax jurisdictions where there is little or no economic
activity, the OECD developed the Multilateral Instrument (MLI)
in order to implement the BEPS measures in tax treaties.
Switzerland signed the MLI implementing the treaty-related
BEPS provisions. It has announced that it only included 14
double tax treaties at time of signature. Switzerland's focus
is primarily on the minimum standards, in particular the
transparent and dual resident entities (Articles 3 and 4 of the
MLI) and the anti-abuse provisions for permanent establishments
located in third states. With regard to the alternative rules
available to satisfy the minimum standards, Switzerland has
opted for the principal purpose test (PPT) (Article 7 of the
MLI) to counter abuses and tax avoidance.
The PPT in double tax treaties
The PPT is intended to catch situations that meet the
following conditions and can be read as follows:
"Notwithstanding any provisions of a Covered Tax Agreement, a
benefit under the Covered Tax Agreement shall not be granted in
respect of an item or income or capital if it is reasonable to
conclude, having regard to all relevant facts and
circumstances, that obtaining that benefit was one of the
principal purposes of any arrangement or transaction that
resulted directly or indirectly in that benefit, unless it is
established that granting that benefit in the circumstances
would be in accordance with the object and purpose of the
relevant provisions of the Covered Tax Agreement."
While being difficult to implement in practice, the PPT
arguably lowers the abuse threshold by stating that obtaining
the benefit must be one of the principal considerations that
justified entering into the arrangement or transaction. In this
context, the burden of proof is reversed to the detriment of
the taxpayer.
Final thoughts
In connection with tax abuses, in particular the transfer of
treaty-favoured income to residents of a third state, given the
legal nature of the PPT, it will be interesting to observe the
new developments that will arise in relation to the
interpretation and application of the PPT test.
In particular, it might not be as flexible as pre-MLI
policies and as the above-mentioned administrative practice and
jurisprudence applicable in Switzerland. Indeed, the
interpretation of the PPT will obviously depend on serious
coordination at international level in order to implement the
changes on a large and global scale. As for the concept of
beneficial ownership, the interpretation and application of the
PPT will hence depend on guidance of international nature
(international law rules), such as the OECD Commentary,
domestic law and foreign jurisprudence. In any case, the value
and relevance of these sources of interpretation will have to
be analysed on a state-by-state basis, which will lead to
various questions and to a risk of increased tax treaty
disputes. In case of disputes, one can only hope that the
courts will apply the PPT with a view to improving legal
certainty with respect to the allocation of income in a tax
treaty context.
Jean-Blaise Eckert and Charlotte Rossat
Lenz & Staehelin