The concepts of ‘beneficial ownership’ and ‘beneficial holding’ would often lead to a confusion as to their scope and sphere of application. Few questions which immediately arise are:
- Whether the two terms are interchangeable?
- Whether the application of one would result into the automatic application of other and vise-versa?
- What could be the intention behind different wording?
This article tries to explore answer to the above questions in light of the explanations provided under the international model tax conventions, Income-tax Act, 1961 (the ITA) and various judicial interpretations in an international and Indian territory.
Understanding beneficial ownership as per international model tax conventions
The concept of ‘beneficial ownership’ is found under the international tax treaties. The tax treaties are negotiated based on the model tax conventions and these conventions inter alia provide explanations as to the intent and purpose behind terms appearing therein. The phrase ‘beneficial owner’ appears in both the OECD Model Tax Convention and the UN Model Tax Convention in the provisions dealing with the following incomes:
- Royalties; and
- Fee for technical services (FTS) - this income does not appear in the OECD Model Tax Convention.
Upon satisfaction of beneficial ownership condition, the taxpayers can avail beneficial tax rates as available under the tax treaties in respect of the aforesaid incomes.
Very categorically, the OECD commentary explains that the term ‘beneficial owner’ is not to be understood in the narrow technical sense which could have been given to it by the domestic laws of any state. Rather, the term has to be “understood in its context, in particular in relation to the words ‘paid…to a resident’, and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance”.
The OECD commentary considers a ‘beneficial owner’ to be the person ‘who has the right to use and enjoy that income’. The said right is unfettered of any contractual or legal obligation to pass on the income to another person.
Aligned to the object and purposes of the OECD Convention, direct recipient of the incomes who are agents, nominees or conduits are excepted from being considered as the ‘beneficial owner’. The agents, nominees and conduits are not to be allowed tax tax treaty benefits as they are subject to contractual and legal obligations towards their principal or for their restricted powers with respect to the incomes received by them in fiduciary or administrative capacity.
The OECD commentary seems to advocate the use of ‘substance over form’ test to determine beneficial ownership. This understanding of the beneficial ownership test is also borrowed and applied by the UN Model Commentary.
It’s important to note that the concerned articles of the Model conventions talk about the beneficial owner of the incomes (i.e. dividends, interest, royalties, FTS) and not the beneficial owner of the underlying assets (i.e. shares, debt-claims, right or property in relation to which such incomes are being paid).
Thus, while explaining the meaning of ‘beneficial owner’ with respect to such incomes, the commentaries have considered it ‘inappropriate’to consider the meaningwhich has been developed (for beneficial owner) to refer to the individuals who exercise ‘ultimate effective control over a legal person or arrangement’. Meaning thereby, a limited meaning has been provided to the term ‘beneficial owner’ of such incomes which cannot be extended to the beneficial owner of underlying assets. In other context, the states are free to provide a different meaning to the term ‘beneficial owner’ of the underlying assets.
Judicial application of ‘beneficial ownership test’ across the world
While some courts have adopted the OECD definition of ‘beneficial owner’ as it is, some other courts have further clarified the scope of the term, without compromising with the essence of the OECD definition.
One popular ruling on this issue comes from the Tax Court of Canada in Prevost Car Inc. v. Her Majesty the Queen, 2008 TCC 231,which was affirmed by the Federal Court of Appeal. The court herein interpreted the meaning of ‘beneficial owner’ of dividends under the Canada–Netherlands treaty.
As per the court, ‘beneficial owner’ is the true owner who receives the dividends for his/her own use and enjoyment, assumes all attributes of the ownership including the risk and control of the dividend and is not accountable to anyone for how the dividend is used.
Further, if such recipients are companies, the corporate veil is to be pierced only if the company is a conduit for another person and has absolutely no discretion as to the use or application of funds routed through it, or has agreed to act on another person's behalf pursuant to that person's instructions, without any right to do other than what that person instructs it.
The test as laid down in Prevost (supra) was applied by the Tax Court of Canada again in another subsequent decision in Velcro Canada Inc. v. Her Majesty the Queen, 2012 TCC 57,to determine the beneficial owner of royalty income arising in the context of the Canada–Netherlands treaty.
Another landmark ruling on this issue comes from the Court of Justice of the European Union (CJEU) in a decision involving six cases, popularly known as the CJEU Danish cases (see the ruling dated February 26 2019 in cases C-115/16, C-118/16, C-119/16 and C-299/16, N Luxembourg 1 and Others and Cases C-116/16 and C-117/17, T Danmark and Y Denmark.).
In the facts of the cases, the CJEU, inter alia, interpreted the term ‘beneficial owner’ of interest income in light of the relevant provisions of the Council of European Union’s Directive 2003/49/EC, the applicable tax treaties and also the purpose of the directive and the treaties. It noted Article 1(4) of the Directive which considers the recipient as the beneficial owner if it receives the interest for its own benefit and not as an intermediary (e.g. an agent, trustee or authorised signatory) of another person.
The Court observed that both the Directive and the tax treaties (which were based on the OECD Model Convention) aimed at avoiding international double taxation. It also noted that the Directive drew upon Article 11 (Interest) of the OECD Model Convention. Thus, the court considered the explanation of beneficial ownership test (BOT) as understood in the OECD Model Convention and the other bilateral tax treaties as being relevant in interpreting the beneficial ownership requirement of the Directive.
Heavily relying upon the aforesaid Danish cases, the Italian Supreme Court judgement in Decision No. 14756/2020, given on July 10 2020, looked at the meaning of ‘beneficial ownership’ of interest income as occurring in the aforesaid Directive 2003/49/EC.
The court adopted the OECD commentary definition of ‘beneficial owner’. If this definition is fulfilled, a sub-holding company would be the beneficial owner of the interest income even if its activities are very limited. Further, the court specifically observed that following factors are irrelevant in determining that a recipient sub-holding company is the beneficial owner of such income:
- Such company is controlled (directs/indirectly) an entity of a third country;
- Such company not having any significant/substantial staff, equipment, premise or even material structure; and
- Such company has no assets other than intercorporate loans and shareholdings.
Additionally, from the directive’s standpoint, the court also held that a holding company having sufficient autonomy in management of the underlying asset from which the income is arising, apart from the lack of obligation (legal/contractual) to pass on such income to its controlling company/entity, will qualify the company for the directive benefits.
Another relevant ruling is that of the Korean Supreme Court in its decision 2018Du38376, decided on November 29 2018. The court interpreted the meaning of ‘beneficial owner’ of dividend income, as per Article 10(2)(a) of the Korea–Hungary tax treaty.
The court looked at the judicial precedents and the legislative history and context of this provision to hold that a beneficial owner is one who is entitled to enjoy benefits of the dividend and is not contractually or legally bound to retransfer the dividend to another person. Further, to identify the beneficial owner, one has to also look at “the content and status of business activities related to the income at issue, and the details of usage and operation of said income”.
The courts in India have also supplied the same meaning to the BOT as provided by the model tax conventions. In the case of Golden Bella Holdings Ltd v. Dy. CIT (IT)  109 taxmann.com 83(Mumbai-Trib.),Golden Bella Holdings Ltd (GBH), a Cyprus-resident company is a wholly-owned subsidiary of a Mauritian company (MCo).
MCo had remitted a sum to GBH and a few days later, GBH had invested in the compulsorily convertible debentures (CCDs) of an Indian company called ABPL. MCo also held 99.5% equity in ABPL. GBH received interest from ABPL on these CCDs and sought to use the India–Cyprus treaty to apply the beneficial withholding rate of 10% on this interest income.
The tribunal specifically relied upon the OECD commentary definition of ‘beneficial owner’ and held that GBH was the beneficial owner of the interest. The interest income was earned by GBH as its sole property and for its own exclusive benefit and not on behalf of anyone else.
The fact that the investment was made using a portion of an interest-free loan extended by its shareholder was considered immaterial, especially because GBH was found to have absolute control over the funds received from MCo. It was also highlighted that GBH had wholly assumed and maintained the foreign exchange risk on the CCDs and the counter party risk on interest arising on the same.
The Pune Tribunal in the case of Imerys Asia Pacific (P.) Ltd v. Dy. DIT(IT)  180 TTJ 544 (Pune - Trib) was considering whether the appellant was the beneficial owner of the royalty, as per the India–Singapore tax treaty. The tribunal held that a recipient of royalty is the beneficial owner of the same if it receives such royalty in its own right.
Therefore, a very limited meaning and understanding has been given to the concept of ‘beneficial ownership’ as used in the tax treaties for certain specific incomes. However, an unrestricted right remains with the domestic tax laws to extend the application of this term to other assets and sources of income, and to provide a different and extensive meaning to the term or its variant terms.
Beneficially held: Section 79 of the Indian Income-Tax Act, 1961
Section 79(1) of the ITA states as under:
“(1) Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place during the previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year, unless on the last day of the previous year, the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred…”
The aforesaid provision was introduced to curb the practice of acquisition of loss-making companies/their shares in order to utilise these losses to reduce the taxable profits of the new owner of the business. The emphasis is on continuity of beneficially holding shares carrying at least 51% of voting power by the same persons. As long as the same set of persons continue to beneficially hold shares carrying at least 51% voting power, this section is not triggered and the company can carry forward and set off the earlier losses.
On a prima facie understanding of Section 79, the term ‘beneficially held’ definitely appears to be an attempt of the legislature to look beyond the mere registered shareholder and instead look at the person holding/controlling the requisite voting power.
Let us now see how the judiciary has interpreted ‘beneficially held’. Firstly, ‘held’ has been noted to be more elastic than ‘owned’, by ITAT Ahmedabad in CLP Power India (P.) Ltd v. Dy. CIT  170 ITD 744 (Ahmedabad-Trib.).
The Supreme Court in CIT v Italindia Cotton Co. P. Ltd.  174 ITR 160, seems to have equated the change in shareholding as envisaged in Section 79 with change in control of the company. Karnataka HC ruling in CIT v. AMCO Power Systems Ltd,  379 ITR 375 (Karnataka) is a landmark ruling on this section and its interpretation. In this case, the Court recognised the difference between shareholding and voting power in a company. It noted that despite the change in immediate/intermediate shareholding the control of the company remained with the ultimate holding company.
Another important case on this provision is that of Wadhwa & Associates Realtors (P.) Ltd v. Asstt. CIT,  92 taxmann.com 37 (Mumbai-Trib.). The Tribunal highlighted that the crucial concept in Section 79 is not shareholding but exercising of the voting power. Further the tribunal noted that the section uses the term ‘held’ instead of ‘owned’ which means that Section 79 does not see whether the same person owns the shares or not. Instead, because of the use of the term ‘beneficially held’, what needs to be seen is whether that same person holds the benefit of voting rights or not.
The Delhi High Court has added yet another dimension to the jurisprudence of this provision by its observations in the case of Yum Restaurants (India) (P.) Ltd. v. ITO  380 ITR 637 (Delhi).
In this case, the assessee’s contended that the change in the intermediate shareholding doesn’t trigger Section 79 as the ultimate shareholding of the US parent company has remained unchanged.
The Delhi High Court rejected this contention and noted that just because the immediate holding companies of the assessee were subsidiaries of the ultimate parent company, it cannot be presumed that the beneficial owner of the shares was the ultimate parent company. The court noted that the registered owners of the shares were the immediate holding companies and that the assessee had not shown that there was any arrangement or agreement in place that the beneficial owner was the ultimate parent company.
The Delhi High Court thus emphasised on the requirement to prove beneficial ownership (by way of agreement or arrangement etc.) and specified that there can be no presumption of beneficial ownership, regardless of the holding-subsidiary relationship between the registered owner of shares and the alleged beneficial owner.
The ITAT Mumbai also followed a similar reasoning in Aramex India (P.) Ltd v. Dy. CIT,  112 taxmann.com 172 (Mumbai - Trib.) that there could be not presumption of beneficial ownership, in the favour of assessee unless the assessee is able to show that the beneficial owner of the shares was the ultimate parent company and not the immediate-holding company in whose name the shares were registered.
At this point, a detour can also be made to look at an old Australian case law which deal with a provision similar to Section 79, appearing in the Australian tax legislation, as it stood at that point of time. In the case of Dalgety Downs Pastoral Co. Pty. Ltd v. Federal Commissioner of Taxation  86 CLR 335, the High Court of Australia interpreted the term ‘beneficially held’ as appearing in a provision which disallowed deduction of earlier losses to a company unless the same persons beneficially held shares carrying at least 25% of voting power, both on the last day of year of income and on the last day of the year in which loss was incurred.
The court held that the person whose name appears in the register of members as against those shares and who holds such shares for his/her own exclusive benefit, beneficially holds such shares. Thus, the registered/legal ownership of shares was emphasised as an important factor to understand the term ‘beneficially held’ as appearing in this provision.
Therefore, while the Australian Court kept it fairly easy to understand that the shares are beneficial held by the persons who are registered shareholders, the Indian courts on the contrary are willing to allow benefit of even other than registered shareholders provided it is backed by evidence.
Assess each case on own merits
To answer the questions where we started from, the two terms, i.e. ‘beneficial ownership’ as used in tax treaties and ‘beneficially held’ as used in Section 79 of the ITA operate in two different spheres. The application of one may not per se result in automatic application of other. However, they both are inclined towards finding the true or real owner of the income or assets. Though the two expressions have a common intent of avoiding tax abuse in a transaction or structure by identifying the substance over the form, the two terms need not be interchangeable in all situations.
The courts across the world have applied the concept of beneficial ownership in the context of royalty, FTS, dividend and interest based on the understanding provided under the OECD commentary. In certain cases, some additional tests have also been applied, as may have been required and found necessary to identify the real owner of the income to ascertain the availability of beneficial taxation rates under the respective tax- treaties.
As regards the identification of real owner of assets, the OECD does not provide any guidance but has left it open for the respective countries to frame their own rules in this regard. The Indian tax laws feature a lot of instances where the ‘beneficial owner’ concept or its derivatives have been used to prevent abuse of domestic tax legislation in multiple contexts. An important instance of this is Section 79 of the ITA. Section 79 of the ITA uses a derivative of the beneficial ownership concept, i.e. the ‘beneficially held’ test. This test has been used and applied in relation to the ‘shares’ carrying certain minimum ‘voting rights’ in a company. Thus, the intent of two separate terms is to deal with separate set of income and situations.
A question can further arise as to the simultaneous application of these two concepts in a case and any possible overlap that may arise by such application. The answer to this would lie in the facts or situation in hand. For instance, while there may be cases where beneficial owner of the dividend income is different from the beneficial holder of the voting rights of the underlying shares from which such dividends are generated, there may also be cases where both such beneficial owner and beneficial holder are the same entity. Thus, being mindful of the different spheres in which these two concepts operate, one must assess each case on its own merits and apply either or both of these concepts, as may be necessary.
Jyoti Arora is a joint partner at Lakshmikumaran & Sridharan.
Jyoti specialises in corporate and International taxation. Her practice focuses on companies from industry verticals such as pharmaceutical, engineering consultancy, defense, education, IT & ITeS and automobiles.
Jyoti is a chartered accountant with vast professional experience in the matters relating to advisory, compliance and litigation. Prior to joining Lakshmikumaran & Sridharan, she worked with the Big 4 accounting firms for over 10 years.
Pragya Kaushik is an associate in the direct tax practice at Lakshmikumaran & Sridharan.
Pragya has previously worked as a judicial law clerk-cum-research assistant to the Hon’ble Justice (Retd.) Rohinton F Nariman at the Supreme Court of India.
Pragya holds a bachelor’s degree in law from the National Law School of India University, Bengaluru.
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