July 15, 2014 marks the most recent update of the Organisation for Economic Co-operation and Development (OECD) model treaty. One significant component of this amendment is a further clarification of the meaning of the term “beneficial owner.” In itself, this clarification gives rise to potential tax risks. The term “beneficial owner” is commonly used under a tax treaty to determine who receives dividends, royalties, and/or interest. As a result, it has a direct impact on whether that person is entitled to lower withholding tax rates on these payments under the application of a particular tax treaty or whether full local withholding taxes are due. The impact of this amendment will predominantly be felt by intermediate or conduit companies (such as holding companies and back-to-back licensing/leasing/lending companies).
What does the change entail?
When dividends, interests, or royalties originating from one country are received by an intermediate company in another country, the recipient should be entitled to a reduction or exemption from withholding taxes if that intermediate recipient is considered the beneficial owner of the payment. In the past, a beneficial owner would generally only be absent in certain agent or nominee scenarios. Thus, a recipient could be assured of the classification “beneficial owner” if, legally, the recipient was entitled to the dividends, interest, or royalties. The revised OECD commentary states that beneficial ownership also will not be granted when the recipient “simply acts as a conduit for another person.” This conduit status can be evaluated based on:
- A contractual or legal obligation to pass the dividends/interest/royalties/lease payments received on to another party,
- But also on the fact and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the dividends/interest/royalties/lease payments received unconstructed by an obligation to pass them on to another person.
As a result of this amendment, determining whether a recipient of a payment qualifies as its beneficial owner—or merely acts as a conduit for another person—may be more challenging and is more open to interpretation.
When will be the effect of the change?
The effect of this amendment is immediate. In the past, a number of tax authorities and courts have taken the OECD commentaries as a guideline for the interpretation of the term “beneficial owner” under a particular tax treaty. Since the new amendment regards the interpretation of that term, it may have an immediate impact under any tax treaty that uses this term.
How does it affect my structure?
Any structure where dividends/interest/royalties/lease payments are received by an intermediate company may be impacted by this OECD amendment. It may impact your structure in three different ways:
- It can be beneficial. We have seen various courts denying beneficial ownership status using a very wide range of anti-abuse arguments (the most common culprits: Spain, Indonesia, Germany, Sweden, and Denmark). The OECD’s newest explanation may reign in those courts to apply the more narrow interpretation by the OECD (or these authorities may disregard that and continue on their current path);
- It can be negative. Local tax authorities may look closer to intermediate companies and can question and audit your structure or even assess withholding taxes using the new explanations that include certain back-to-back scenarios (regardless of whether the conduit status is contractually arranged or based on facts and circumstances);
- This uncertainty can be a trigger for accountancy purposes. Even if the local tax authorities do not undertake any action, your accountant may force you to book a provision to cover the possible withholding tax liability arising from this revision. Such provision would provide a financial statement detriment, and it also increases the chance of audit/taxation since the local tax authority may view the provision as an invitation to investigate because the taxpayer does not seem to be sure about its beneficial owner status.
What can I do?
Fortunately, there is a lot you can do to minimize the above risks.
- Ryan can help you review your current fact pattern and help you identify your exposures.
- Ryan can subsequently help you in drafting protocols to minimize exposures in your current structure.
- Ryan has also designed structures that, with a minimal restructuring, can give you a much better technical anchor to defend your beneficial ownership position in front of the auditor and against the local tax authorities.
- Key point is not only to help you get the best technical position, it is also to disqualify you from being low hanging fruit to the auditors or local tax authorities, if they feel that these new interpretations warrant additional scrutiny to your international structure.
Since the application of the new interpretation is immediate, non-activity is not recommended. It may well be that your structure or operations are more open to the risk of an inquiry, an audit, or even a challenge. Ryan’s International Tax professionals would be glad to offer you a commitment-free high-level review of your company’s position in light of these changes to the beneficial owner concept. And where needed, we can discuss our solutions to the 2014 OECD amendment.