The concept of beneficial ownership has been prominent in double tax agreements (“DTA”) based on the Organisation for Economic Co-operation and Development (“OECD”) model treaties from as far back as 1977. Articles pertaining to dividends (article 10), interest (article 11) and royalties (article 12) all provide for a reduced level of withholding tax provided that such income is remitted to a beneficial owner. Despite its importance there has been, until recently, very little jurisprudence concerning the meaning of beneficial ownership.
The meaning of the term beneficial ownership was comprehensively discussed in the recent Canadian judgment of Velcro Canada v Her Majesty The Queen 2012 TCC 57. In this case the Court was required to rule whether a Dutch resident company which received royalties from a Canadian resident company was the beneficial owner of such royalties.
facts of the case
Velcro Industries BV (Velcro Industries), a company resident in the Netherlands, was the owner of Velcro Brands and Technology. In 1987 Velcro Industries concluded an agreement with Velcro Canada Inc. (Velcro Canada). In terms of the agreement Velcro Canada obtained the right to manufacture, sell, and distribute the licensed products, and the right to use the licensed trademarks to promote, sell, and distribute in relation to the licensed products. Velcro industries received a royalty amount in return which was subject a reduced withholding rate of 10%.
In 1995 a reorganisation of the Velcro Group resulted in Velcro Industries changing its residence from the Netherlands to the Netherlands Antilles a country which does not have a DTA with Canada. Velcro Industries then assigned its rights and obligations in relation to its intellectual property to Velcro Holdings BV (Velcro Holdings), a company resident in the Netherlands. Velcro Holdings was assigned the right to grant licenses in respect of Velcro Industries intellectual property to Velcro Canada. In addition, it was also required to:
- collect royalty payments from Velcro Canada;
- enforce the terms of the licensing agreement; and
- take the necessary steps in case of breach by Velcro Canada.
The ownership of the intellectual property remained with Velcro Industries.
The Appeal Court began by quoting with the approval the dicta from Prevost Car Incorporated v The Queen which stated that the beneficial owner is the person who receives the income (i.e. dividends in that case) for his own use and enjoyment and assumes the risk of control of the income received.
From this the court outlined the four elements that must be considered in determining the whether the recipient is the beneficial owner:
- risk; and
The first step of the enquiry is to ascertain the ordinary meaning of the individual words Once this was done the Court then undertook an in depth analysis of each term and its applicability to the circumstances of the case.
The ordinary meaning of possession is “to have or hold property in one’s power” or “the exercise of dominion over property.” In this regard the Court held that Velcro exercised possession or dominion over the royalty amounts due to the following factors:
- Velcro Holdings had the right to receive the royalties in terms of the licensing agreement;
- the royalty amounts were deposited into an account owned by Velcro Holdings;
- Velcro Holdings had exclusive possession and control over these accounts;
- interest on the royalty amounts were for the benefit of Velcro Holdings; and
- the royalty amounts were not segregated and there was a co-mingling with other amounts.
According to the Court, the term use refers to the application or employment of something or the “long continued possession or employment of a thing for which it is adapted”.
The court held that there was nothing in the assignment agreement or the licensing agreement which prevented Velcro Holdings from using the royalty amounts at its own discretion. Further, it was held that the royalties were co-mingled with a variety of other funds and were used on an operational basis, this included; the paying of bills, repaying of loans; investing in new enterprises etc.
The term risk refers to the chance of injury, damage or loss (i.e. economic loss). The Court found that Velcro Holdings assumed the risk in relation to the royalty payment in two ways:
- Velcro Holdings assumed the risk of currency fluctuations where the royalties were received in Canadian Dollars and then converted into US Dollars or the Dutch currency.
- Velcro Holdings reported the royalty amounts as assets as such, the amounts were subject to creditors’ claims.
There was also no indemnification in any of the agreements to reduce the risks and exposure of Velcro Holdings.
Control refers to the exercise of power or influence. Therefore, the Court needed to ascertain if Velcro Holdings exercised power over the royalty amounts. The considerations listed under possession, use and risk above are equally applicable to the concept of control. In addition, the Court found that the funds did not just flow through Velcro Holdings but rather that the royalties were comingled with other funds at the discretion of Velcro Holdings. Finally, the court also considered and dismissed the Revenue Authority’s contention that Velcro Holdings was a mere agent or conduit for Velcro Investments. The Court held that in order to be an agent one must have the ability to affect the legal position of the principal by entering into contracts with third parties on the principal’s behalf. Since Velcro Holdings did not have the capacity to effect the position of Velcro Investments it could not constitute an agent.
Although the decision in Velcro only holds persuasive value in South Africa, it provides a useful framework for both the taxpayers and the Courts in determining whether or not a recipient of an amount is the beneficial owner. This will be particularly important with the introduction of dividends tax effective from 1 March 2012 and the proposed interest withholding tax.