There have been several cases in Europe and beyond over the past few years concerning the concept of beneficial ownership under double tax agreements (“DTAs”). In the UK, the case of Indofood1 from 2006 has received much attention, and has been the subject of previous published commentary from HM Revenue & Customs (“HMRC”).
HMRC has recently issued further guidance on this topic, which is helpful in seeking to determine whether a non-UK owner of an income stream (typically interest) which attracts UK withholding tax under domestic law beneficially owns that income, and is therefore entitled to the benefits of the relevant DTA, subject to any other anti-abuse provisions that may be in the specific DTA.
As well as some general discussion of the concept of beneficial ownership in DTAs and the inerpretation given by the commentary on the OECD model treaty, HMRC has included some helpful practical considerations to assist in determining whether a non-UK company has beneficial ownership if it is arguable that the company in question is a “conduit.” A conduit, in HMRC’s words, is “an entity through which income, etc., is channelled between other entities, without itself generally having much active input or use of the income.” Examples given of possible conduits are special purpose vehicles placed between investors and the objects of their investment for administrative simplicity, a group finance company providing third party lending to the group without itself bearing risk in relation to the debt, or a securitisation vehicle where contractual debts (such as mortgages) are pooled and sold on in another form (bonds, securities, etc).
The considerations listed by HMRC are set out below. The “claimant” refers to the non-UK resident seeking to claim under a DTA with the UK for relief from UK withholding tax.
- In a corporate group context, what is the wider picture of the funding structure? Where is the true source of the funding? Who carries the risk for third party borrowing? Does it appear that the overseas parent (or other group company) has raised funds to lend to the UK, but routed the funds through an intermediary which appears to serve little commercial purpose?
- Is there evidence that the claimant is acting as agent or nominee for another person, and has no real stake in the income, but is handling it for another party?
- Is the claimant under a contractual or fiduciary obligation to pay on the specific income it receives to a third party? If so, it is unlikely to be beneficial owner. If there is no legal obligation, but the commercial or practical terms of the arrangements mean it is probable that the claimant will pay the income on, the circumstances would require closer examination before reaching a conclusion.
What discretion does the claimant have as to the use of the funds which pass through its hands? What control does the claimant have over what it does with the money which comes to it, whether
- that be the principal of the loan or the interest on it? Is the use of either genuinely discussed and decided by the board of the claimant company or does this seem predetermined? How far was the claimant actively involved in the sourcing and application of the funding (i.e. Did it create the investment opportunity and devise how it would be funded at the time the structure was set up or at the time of later payments)?
- Where there is doubt over beneficial ownership, it is useful to consider the substance of the claimant. Does it have employees, offices or domestic activities within the country of residence? What expertise do its employees have? Are its responsibilities in practice discharged by other group companies or outsourced to third parties? Even if the claimant company has substance, complex operations, etc, is the income which is subject to the claim part of those activities, or is it still recognisable as part of a conduit function? However, a company with few or no employees in its territory of residence is not precluded from being recognised as beneficial owner. Special purpose companies and holding companies established for commercial purposes may be recognised as such, despite limited function.
- Have the funds actually passed through the claimant’s hands, and if so, in what manner? If not, was the claimant clearly entitled to the payment, and have they chosen to direct payment to another party?
- How closely dependent is the claimant on the relevant income source to meet the relevant liabilities? Could the claimant fund interest payments from another source of income, and if so, for how long?
- What do the the loan agreements say (any side agreements and less formal items, such as correspondence and emails)? Do these show that the loans (UK-to-conduit and conduit-source) have common or interlinking features? It is important to consider whether the claimant independently considered the merits of entering into the arrangements, rather than simply being directed to do so.
- There may be claims that the conduit has been set up for a wider ranging purpose, that it is “looking for investment opportunities,” or that it may be a future European hub of some sort. This might be the case, but what is relevant is the state of affairs at the time the income is paid.
- Do the local tax rules applying to the claimant make it impossible or unlikely that it would be beneficial owner?
- Is information about other parts of the same group helpful? Follow the money. Can it be traced through the intermediary to a tax haven source, where direct lending to the UK would entail suffering withholding tax on the interest, with no treaty to relieve any double taxation?
- Has the interposition of the intermediate recipient reduced the rate of withholding tax paid by the UK borrower? If the UK borrower could have paid without withholding to the ultimate recipient of the interest paid, HMRC may not challenge beneficial ownership, even if the recipient has very little legal or practical discretion over the use of the interest received.
Whilst these practical tests are helpful to enable groups and non-resident investors into the UK to determine with more certainty their DTA position, each case will turn very much on its facts, with one of the critical points being the ability of the overseas investor to control what it does with the income received.