Supreme Court of France upholds a novel view on beneficial ownership of income from Royalties
Beneficial ownership has been one of the most debated topics in international taxation. Most of the Double Taxation Avoidance Agreements have incorporated the concept of ‘beneficial owner’ condition for availing the advantageous provisions of the tax treaties. We have seen tax authorities and Courts denying treaty benefits since the recipient of certain income is not a beneficial owner. Due to this tax as per domestic provisions of respective jurisdictions needs to be discharged. But, in a recent case of Planet Fitness, the judicial authorities of France have applied the tax treaty provisions of the true beneficial owner of such income.
Introduction
The situs of taxation resulting from the ‘beneficial ownership’ of income has been a vexed issue under the Income tax laws. Beneficial ownership is significant from an international tax perspective since it is one of the conditions to claim relief under the double taxation avoidance agreements (‘tax treaties’ or ‘DTAA’). What complicates things is the absence of a definition of the term beneficial owner in the tax treaties.
As a result, beneficial ownership has been construed in a general sense along with certain International judicial precedents and tax commentaries like Organisation for Economic Co-operation and Development (OECD):
- In a general sense1: A ‘beneficial owner’ is a person who enjoys the benefits of ownership even though the title to some form of property is in another name.
- As per OECD2: Beneficial owners are always natural persons who ultimately own or control a legal entity or arrangement, such as a company, a trust, a foundation, etc.
This provision is primarily used in various tax treaties to prevent treaty abuse i.e. claiming unintended benefits under tax treaties by resorting to tax avoidance strategies or routing transactions through intermediaries or conduits.
Indian Jurisprudence Benchmark: The Bharti Airtel Ruling3
In the ruling of Bharti Airtel, Bharti Airtel availed foreign credit from a Swedish Bank for the purchase of equipment. The Bank later novated the terms of the loan and transferred the liabilities to 5 different parties, thereby acting as an arranger/intermediary of this loan.
Bharati Airtel had obtained a declaration and a certificate of residence from the Swedish bank that their income is not taxable in India. Accordingly, Bharati Airtel paid interest to the Swedish bank, believing that they are not liable to tax in India as per the India-Sweden tax treaty.
The Revenue held that to avail the treaty benefits on interest, Swedish Bank needs to be a beneficial owner of such interest. An arranger of the loan was not considered a beneficial owner of interest but a mere conduit or facilitator since the Swedish bank had transferred the liability to 5 other parties. Accordingly, the beneficial provisions of the tax treaty were denied. Taxes were required to be withheld by Bharati Airtel on interest paid to the Swedish Bank as per Indian domestic income tax rules.
As it can be observed from the example above, favourable provisions under the tax treaty were denied since beneficial ownership of the underlying interest income was not established. Ordinarily, when tax authorities encounter such a case where the recipient of income is not the beneficial owner, treaty benefits are sought to be denied and taxes as per domestic laws are required to be discharged.
But, the French tax authorities went a step ahead in a similar case which has led to an interesting judgment of the Supreme Court of France - the Conseil d’État, on the concept of ‘beneficial owner’.
In the case of Planet Fitness Group (20th May 2022, # 444451, Société Planet; concl. C. Guibé)4, the Supreme Court of France recently passed a ruling on beneficial ownership of royalty income earned by the French company Planet Fitness Group (Planet). The Supreme Court of France has ruled that where a treaty benefit is denied on account of the conditions of beneficial ownership not being satisfied, the tax authorities may apply the tax treaty provisions of the jurisdiction which is the true beneficial owner of such income. So, this is going further than the usual course of action of applying for beneficial ownership only as an anti-abuse tool.
Brief facts of the case5
Planet is a French company involved in the fitness and wellness sector. Planet entered into an agency agreement with a New Zealand-based company (NZ Company) and acquired distribution rights to fitness programs initially owned and developed by the NZ Company. Planet paid a royalty to the NZ Company as a consideration. Further, Planet distributed this program to local fitness groups in France against a license fee.
Original Contractual Structure:
- NZ Company: Owned and developed fitness programs.
- Planet (France): Acquired distribution rights directly from NZ Company and paid Royalty.
- Local French Entities: Planet distributed program to fitness groups in France against License Fees.
Revised Triangular Sub-Distribution Scheme:
- Two group companies under common control of Planet in Belgium and Malta entered into distribution agreement with NZ Company.
- Belgium Co & Malta Co entered into sub-distribution agreement with Planet (France).
- Planet paid Royalty to Belgium Co and Malta Co.
- Planet sub-licensed to local French entities against License Fees.
View of the French tax authorities
The French tax authorities held that Belgium and Malta are mere conduits, and the ultimate beneficial owner of this royalty is the NZ Company. The authorities stated that since Belgium and Malta are not the beneficial owners, the rates of tax on royalty as per these Double Tax Avoidance Agreements cannot be applied while withholding taxes on the royalty by Planet to their group entities under the sub-distribution agreement.
But the French tax authorities contended that in the present case, since the jurisdiction of the beneficial owner is known, the tax rate as per France - New Zealand Treaty might as well be used for withholding of taxes. Accordingly, for the royalty paid to Belgium and Malta, the tax rates as per France - New Zealand Treaty was applied by the French tax authorities.
Issues under consideration before the French Court:
- Will the treaty benefit on royalty under France - Belgium DTAA and France - Malta DTAA be denied based on beneficial ownership test not being satisfied? Further, is the France - New Zealand Treaty application for the payments made to Belgium and Malta valid?
- Whether NZ Company qualified as the beneficial owner of the royalty?
The Ruling of the French Court
On the first question: It was held that the provisions of the France - New Zealand DTAA were applicable to the royalty, the beneficial owner of which is a resident of New Zealand, even though these royalties have been paid to an intermediary established in a third State.
On the second question: The Supreme Court of France remanded the matter back to the subordinate authority to consider afresh whether the NZ Company can be considered a beneficial owner of the royalty.
Analysis: Affirmative Interpretation of a Negative Provision
For the first time, the Supreme Court has upheld such a treatment that where the treaty with the recipient country does not apply for lack of beneficial ownership, the tax treaty of the actual beneficial owner is to be considered for withholding taxes. This indicates an affirmative interpretation of a negative provision.
In the revised arrangement of sub-distribution, Planet’s rights of distribution of the fitness program were indirectly acquired by back-to-back arrangements. It was contended that the primary purpose behind this arrangement was to carry out some tax arbitrage on the royalty tax rates by establishing a triangular structure with the group entities.
Comparative analysis of royalty tax rates across DTAAs in question
| Jurisdiction / Treaty | Royalty Withholding Rate | Article 12 Treaty Provision |
|---|---|---|
| French Domestic Law | 26.5% | Standard statutory domestic withholding required on royalties paid to non-residents. |
| France - Belgium DTAA6 | 0% (Exempt) | Taxable only in the state of residence of recipient. Exemption on withholding of taxes on royalties paid/attributed. |
| France - New Zealand DTAA7 | 10% | May be taxed in source state, but if recipient is beneficial owner, tax shall not exceed 10%. |
| France - Malta DTAA | 10% | Provisions mirror the New Zealand treaty (concessional 10% rate). |
From the above treaty analysis, it is evident that routing royalties through Belgium where there is no withholding requirement is more beneficial to Planet than the first arrangement from a tax perspective. Where Belgium is not considered a beneficial owner, Planet would have had to withhold taxes on such royalty paid at 26.5% on denial of treaty benefits. Even with Malta, the tax is at a concessional rate of 10%, hence Planet is better off in this case.
But, the French tax authorities extended the benefit of the alleged beneficial owner of the royalty and reduced the incentive in this strategy to some extent. A purposive interpretation of the term beneficial owner in line with OECD guidelines is said to have been made by the Supreme Court of France while upholding this treatment.
OECD Commentary on Beneficial Ownership (Article 12, Paragraph 1)8:
“The requirement of beneficial ownership was introduced in paragraph 1 of Article 12 to clarify how the Article applies in relation to payments made to intermediaries. It makes plain that the State of source is not obliged to give up taxing rights over royalty income merely because that income was immediately received by paid direct to a resident of a State with which the State of source had concluded a convention. The term “beneficial owner” is therefore not used in a narrow technical sense (such as the meaning that it has under the trust law of many common law countries), 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.
Subject to other conditions imposed by the Article, the limitation of tax in the State of source remains available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, in those cases where the beneficial owner is a resident of the other Contracting State (the text of the Model was amended in 1995 to clarify this point, which has been the consistent position of all member countries). States which wish to make this more explicit are free to do so during bilateral negotiations.”
Reference was drawn to the part where the Commentary refers to an intermediary, such as an agent or nominee, interposed between the beneficiary and the payer. Since it is stated that limitation of tax in the State of source (i.e., France in the present case) is available even when an intermediary (Belgium and Malta) is interposed, the Supreme Court went ahead with the provisions of France - New Zealand DTAA to the payments made to Belgium and Malta.
The other interesting aspect is the words “paid to a resident” in the France - New Zealand tax treaty. If interpreted strictly, the said treaty will not apply since the royalty is not paid to a resident of New Zealand. But, the expression “paid to a resident” is interpreted liberally, to provide a benefit to the assessee.
The PURC Matrix: 4 Factors to Determine Beneficial Ownership
The second question, i.e., whether in the scheme of arrangement of sub-distribution, New Zealand can be regarded as the beneficial owner of Royalty, has been remanded back to the French tax authorities to carry out a detailed factual analysis. For this determination, available facts are analysed based on 4 factors—Possession, Use, Risk and Control (PURC Matrix)9, derived from international and domestic court decisions:
1. Possession10
Ownership, control, or occupancy of any object or asset. Possession of income is established by receipt of income or exercise of dominion in one’s own right.
Precedent: Pune ITAT in Imerys Asia Pacific (P.) Ltd Vs DDIT [2016] 69 taxmann.com 454 held: recipient must receive interest and royalty in its own right and not act as a mere conduit.
2. Use
The recipient must have the right to benefit directly from the income and be free to decide its utilization (e.g., expansion, dividend distribution, saving) without any contractual or legal obligation to pass on such income.
3. Risk
Apart from enjoying returns, the recipient must bear economic and business risks. Any contractual agreement passing on risk or loss indicates an absence of risk borne by the intermediary.
4. Control
Refers to who has the ultimate authority to influence decisions and actions. The true beneficial owner must retain full, unhindered control over the income.
PURC Matrix Applied to Belgium & Malta Intermediaries:
Whether Belgium and Malta companies are receiving royalty in their own right (possession) must be deliberated. One view is that they are merely sub-distributing rights to French counterpart Planet without outside commercial engagement, acting as mere intermediaries rather than direct possessors.
Regarding Use and Control, because contractual back-to-back obligations existed to pay royalty to NZ Company against distribution rights, Belgium and Malta companies cannot be said to directly benefit from or retain full control over the income.
Conclusion
To sum up, determining the beneficial ownership is heavily a fact-specific exercise. Factors like the ultimate control and use and risks being borne determine the beneficial ownership of any income stream. For the lack of a proper definition, beneficial ownership remains a significant aspect of tax controversy.
It will be interesting to see how the French tax authorities interpret this arrangement from the lens of beneficial ownership. Nevertheless, the Supreme Court ruling should be considered a welcome step in the beneficial ownership jurisprudence. This will also impact other income streams like interest and fees for technical services (FTS) and royalty.