The Chartered Accountant • Journal of ICAI January 2022 • Vol. 70 • No. 7 • pp. 77–83 (Journal pp. 853–859)

Taxation • International Taxation

The Beneficial Ownership Saga

CA. Vijaykumar Puri

The author is a member of the Institute. He can be reached at vkrpuri@gmail.com and eboard@icai.in

“The concept of ‘beneficial ownership’ plays a crucial role in determining whether a recipient of income (e.g. dividends, interest, royalties etc.) qualifies for certain benefits under the DTAA. In the absence of any formal rules around this concept, it is a highly fact specific exercise determined largely by legal dictionaries, commentaries and international as well as domestic judicial precedents. Dividend distributing companies are required to undertake this detailed analysis at the time of distribution of dividend (and their Chartered Accountants at the time of issuing Form 15CB certificate). In this article, the author attempts to shed light on the factors determining beneficial ownership based on various meanings assigned to the concept, domestic and international jurisprudence and the way forward in an Indian context. Read on…”

Background

The concept of “beneficial ownership” (BO) plays a crucial role in determining whether a recipient of income qualifies for certain benefits under the Double Taxation Avoidance Agreement (DTAA). It is quite significant from the perspective of international taxation as a significant number of tax treaties adopt the condition of BO for granting concessional treatment to a resident of another country; in particular, when it comes to articles dealing with dividend, interest, and royalties.
BO under tax treaties is a specific anti-abuse rule incorporated to target specific instances of tax treaty shopping involving the use of agents/nominees/conduits i.e., entities which act as mere administrators or fiduciaries of income and have no substance of their own.
From an Indian perspective, the concept of BO has gained even more relevance with the abolishment of dividend distribution tax (DDT) on companies whereby the dividend is now taxable in the hands of the investors with effect from 1st April 2020. The domestic tax rate for a non-resident prescribed under Section 115A of the Income-tax Act, 1961 (“Act”) is 20% (plus applicable surcharge and health and education cess), while many of India’s bilateral tax treaties typically provide a concessional tax rate of 5% to 15% subject to BO and certain other shareholding related conditions. Thus, foreign investors exploring to avail benefit under the tax treaty are strictly required to fulfil the BO criteria.
To understand the methods for evaluating BO, it is imperative to first discuss the evolution of the concept in the international tax arena.

“BO under tax treaties is a specific anti-abuse rule incorporated to target specific instances of tax treaty shopping involving the use of agents/ nominees/ conduits i.e. entities which act as mere administrators or fiduciaries of income and have no substance of their own.”

Evolution of the Concept of BO in Tax Treaties

The concept of BO was first envisaged in the US-Canada tax treaty of 1942 and has evolved continuously over time.
The expression “beneficial owner” has not been defined under the tax treaties or under the Indian Income-tax Act, 1961, and must therefore be interpreted based on general commercial understanding, international tax commentaries, and judicial precedents in this regard.
The Model Commentaries (MC) to the tax treaties and leading international tax jurists have commented that the term has to be given a purposive interpretation (viz. prevention of tax avoidance), and persons not entitled to treaty protection are to be prevented from obtaining benefits thereunder by interposing entities between the ultimate beneficiary and the payer.
Further, in evaluating the concept of BO, one has to take cognizance of the “substance” of the transaction and not merely its “form”, duly considering all relevant facts and circumstances. In other words, the meaning of the term “BO” should be understood in commercial or general parlance.

Definitions of Beneficial Owner

In the absence of a codifying statutory definition, reliance is placed upon legal lexicons and authoritative international treaties:

Black’s Law Dictionary (6th Edition, 1990)

Defined as “one recognized in equity as the owner of something because use and title belongs to that person, even though the legal title belongs to someone else.”

Law Lexicon

Defines beneficial owner as “one who, though not having apparent legal title, is in equity entitled to enjoy the advantage of ownership.”

Prof. Klaus Vogel on Control and Beneficial Ownership:

As per Prof. Klaus Vogel, among other factors, the issue of control is the most important factor in deciding the BO. Beneficial owner is the person who is free to decide:

Whether or not the capital or other assets should be used or made available for use by others; or
On how the yield therefrom should be used; or
Both.

Further, Klaus Vogel in his authoritative commentary (Klaus Vogel on Double Taxation Conventions, Third Edition, Kluwer Law International, 1977, p. 561) specifically notes:

“….even a one hundred per cent interest in a subsidiary does not preclude the latter’s ‘beneficial ownership’ in the assets held by it. There would have to be other indications of the fact that the subsidiary’s management is not in a position to make decisions differing from the will of the controlling shareholders. If it were so, the subsidiary’s power would be no more than formal and the subsidiary would, therefore, not qualify as a ‘beneficial owner’ within the meaning of Arts. 10 to 12.”

Reference from Treaty Commentaries (OECD Model Commentary)

The OECD Model Commentary (2014 edition), in relation to the “BO” was substantially amended. The key highlights of the commentary in relation to BO are as under:

Autonomous Treaty Interpretation: The meaning of “beneficial owner” should be interpreted as not to refer to any technical meaning that it could have had under the domestic law of a specific country, but it must be understood in the light of the context and purpose of the tax treaty.
Exclusion of Conduit Companies: In addition to agents and nominees, conduit companies do not satisfy the status of BO.
Contractual or Legal Constraints on Enjoyment: A direct recipient of income may not qualify as a “beneficial owner”, if from the very inception of his status, that recipient’s right to use and enjoy the income is constrained by a contractual or legal obligation to pass on the payment received to another person.
Related vs. Unrelated Obligations: Reference has been made to the “related” and “unrelated” obligations. In case where the recipient has a specific obligation to pass on the income received, such factor is directly relevant to the BO test.
Inference from Documents and Facts: The obligation may be inferred from legal documents or facts and circumstances of the case.
Simultaneous Application of Anti-Avoidance Rules: The concept of BO and other forms of anti-avoidance principles are applicable simultaneously since BO addresses specific forms of tax avoidance.

Reference from Domestic and International Judiciary

A robust body of domestic and global case law provides foundational principles for assessing beneficial ownership:

Key Indian Judicial Precedents and Circulars

1. CBDT Circular No. 789 (13 April 2000) & Azadi Bachao Andolan (Supreme Court)

Circular No. 789 dated 13 April 2000 issued by the Central Board of Direct Taxes (CBDT) in the context of the India-Mauritius Treaty provides that a Tax Residency Certificate (TRC) issued by the tax authorities of a country would be regarded as conclusive evidence regarding residential status and BO of the income earned by Mauritian entities. The constitutional validity of Circular No. 789 has been affirmed by the Supreme Court of India in its landmark decision in Union of India v. Azadi Bachao Andolan [(2003) 263 ITR 706 (SC)].

2. Bharti Airtel Limited [TS-141-ITAT-2014(DEL)]

The issue before the Income Tax Appellate Tribunal (ITAT) was whether the benefit of Article 11 of the India-Sweden tax treaty would be available when interest was paid to an “arranger” of a loan (ABN Amro Bank, Sweden) instead of the actual lender. The ITAT held that the provisions of Article 11 shall not be applicable since the arranger is a mere conduit for onward payment to the actual lenders. Even though the arranger produced a TRC to establish their residency in Sweden, the interest received by the arranger was not in its own right but merely as a facilitator and thus the arranger is not the beneficial owner of the interest income.

3. HSBC Bank (Mauritius) Ltd. [ITA No. 1078/Mum/2016]

In the context of BO of interest income, the ITAT Mumbai Bench adjudicated the following comprehensive standard:

“Considering the above, we infer that the ‘beneficial owner’ can be the one with the full right and the privilege to benefit directly from the interest income earned by the FII-Bank (Indofood International Finance Ltd vs. J.P. Morgan Chase Bank NA London Branch [2006] EWCA case 158). The income must be attributable to the assessee for tax purposes and the same should not be aimed at transmitting to the third parties under any contractual agreement / understanding. The bank should not act as a conduit for any person, who in fact receives the benefits of the interest income concerned. The recipient of the interest income should be deemed as the ‘beneficial owner’ unless there is any evidence to suggest that the said interest income is for the benefit of third persons.”

4. Golden Bella Holdings Ltd. [TS-523-ITAT-2019(Mum)]

The ITAT held that the mere fact that an investment was funded using a portion of an interest-free shareholder loan shall not deprive the Cyprus entity from enjoying the concessional rate of 10% withholding taxes as per Article 11 of the India-Cyprus tax treaty. It was held that the Cyprus entity is not a conduit to be subject to tax at 42% but is indeed the beneficial owner of the interest income.

Key International Judicial Precedents

i. Canadian Federal Court of Appeal: Prévost Car Inc. v The Queen [2009 DTC 5053 (FCA)] & Velcro Canada v The Queen [2012 TCC 57]

The Canadian Court concluded that the beneficial owner is the person who receives dividends for his own use and assumes the risk and control of the dividend and is not accountable to anyone for how he deals with it. However, where the person receiving the dividend is obligated to pass on such dividends to a third party, such a person would not be considered as a beneficial owner of the dividends.

This decision reaffirms the principle that while examining the BO rule, the corporate veil of the entity earning income should be respected unless the corporation is a conduit and has no discretion to deal on its own with the property put through it as a conduit or is acting as an agent, trustee or nominee of its shareholders. A similar view was taken in Velcro Canada v The Queen.

ii. UK Court of Appeal: Indofood International Finance Ltd. v JP Morgan Chase Bank NA, London Branch [(2006) EWCA Civ 158]

The UK Court of Appeal held that an interposed entity between the beneficiary and the ultimate payer with a back-to-back debt obligation would not qualify as the beneficial owner of such interest income. The UK Court of Appeal arrived at its conclusion on the application of the “substance over form” approach.

iii. Swiss Federal Administrative Court & Federal Supreme Court (FSC): The Total Return Swaps Dispute

The Federal Administrative Court of Switzerland (Case no. A - 1246/2011 and A-6537/2010), while determining the BO of dividend under the DTAA between Switzerland and Denmark, held that the concept of BO as stated in double tax conventions has to be interpreted based on “substance over form”. The beneficial owner was defined as a person who has broad discretion to decide how dividend shall be utilized. The Court observed that although the taxpayer had a duty to compensate the counterparty of a total return swap for the appreciation of underlying shares including dividends distributed during derivative maturity, the swap did not contractually obligate the taxpayer to hedge its position by acquiring the underlying assets. There was no factual obligation to transfer dividend income to the counterparty (taxpayer was merely obliged to pay an equivalent amount irrespective of actual dividend receipt). The holding period of shares was held to have no impact.

Reversal by Federal Supreme Court (FSC) [2C_364/2012, 2C_377/2012, and 2C_895/2012 dated 5 May 2015]: On appeal by the Swiss Federal Tax Authority (SFTA), the FSC reversed the Federal Administrative Court. The FSC held that:

There is an implicit BO requirement in treaties even where not explicitly articulated in the text.
BO requires that at the time of receiving dividend, the recipient has an unconstrained right to use, enjoy, and dispose of the dividend received. If constrained by legal or factual obligation to pass on under derivatives, BO is denied.
The beneficial owner must bear the economic risk of whether dividend is distributed. Where risk is passed to counterparty under derivatives, BO is denied. The Danish banks matched investments accurately in volume and timing, acquired when shares were purchased and terminated when sold; thus risks and rewards were substantially with third parties, Danish banks making only small profit.

“The recipient must have full right to directly benefit from the income and must be free to decide the manner of using the income so earned i.e. there should not be any contractual/ legal obligation to pass the income so earned.”

Factors for Determining BO – The PURC Matrix

Based on the meanings and judicial decisions discussed above, the PURC (Possession, Use, Risk, Control) matrix is a widely regarded test of BO. The elements of the PURC matrix need to be cumulatively fulfilled in order to satisfy the BO condition.

Element	Factors & Evaluation Criteria
Possession	This refers to possession of income which is substantiated by factors like receipt of income, exercise of dominion over income and property and valid economic, commercial purpose for the transaction. Further, the recipient should not be acting as a mere conduit, nominee or agent. Legal ownership, ultimate control and holding period of shares are irrelevant factors for fulfilling this element.
Use	The recipient must have full right to directly benefit from the income and must be free to decide the manner of using the income so earned i.e. there should not be any contractual/ legal obligation to pass the income so earned. An adverse factor denoting lack of use by the recipient is that the right to use and enjoy is constrained by interdependency between obtaining an income and an obligation to pass it on.
Risk	The recipient must bear the business risk of the income in order to satisfy this element of the matrix. The recipient must be the economic owner i.e. he must bear the consequences of loss as well as enjoy the fruits of income. Further, his liability towards creditors must not be affected by lack of receipt of the income. Any contractual agreement to pass on the risk of bad debt, loss, exchange fluctuation is indicative of lack of risk of the recipient.
Control	The recipient must retain full control over the income. Even in absence of explicit contractual agreements, the Revenue Authorities have regarded common Board of Directors (between the recipient and the alleged beneficial owner) as a sufficient factor for determining that the recipient does not have control over the income. However, merely because of a holding-subsidiary relationship, it should not be assumed that the subsidiary company does not retain control of the income.

“The evaluation of BO is a highly fact specific exercise and there is no one-size-fits-all approach for the evaluation.”

Based on the above, it can be concluded that the evaluation of BO is a highly fact-specific exercise and there is no one-size-fits-all approach for the evaluation.

Way Forward – Is Evaluating BO a Challenge?

Fact-Specific and Evolving Jurisprudence: The evaluation of BO requires a careful study of the facts of the case and is an evolving matter in the courts of law. For instance, in some cases Revenue Authorities have held that merely having a common director leads to non-fulfilment of the “Control” element; however, having common directors across group entities is a normal business practice and driven by commercial considerations – all of which are seldom considered by the Revenue Authorities.
Increased Treaty Litigation Post-Abolition of DDT: Given the recent amendment on taxation of dividends in the hands of the investors with effect from 1st April 2020, the BO test would be required to be fulfilled by foreign investors seeking to avail tax treaty benefits for such dividend income. Thus, litigation around the overall concept of BO may increase substantially.
Administrative Complexity and Need for GAAR-Like Guidance: The determination of BO will be a time-consuming activity, both for the Assessing Officer (in terms of understanding complex multinational group structures and applying the concept of BO) and the taxpayer (in terms of collating documentation). Similar to the approach adopted under GAAR, the Indian Revenue Authorities should release comprehensive administrative guidance on the BO to provide certainty on the matter.
Role and Responsibility of Chartered Accountants in Form 15CB: Chartered Accountants are also required to issue certificates in Form 15CB certifying applicability of beneficial rates under DTAA, which will necessarily include satisfying the BO test. CAs must ensure that there is adequate documentation on record to substantiate that the foreign investor is indeed fulfilling the BO test. Where BO has not been evaluated, it would be a worthwhile exercise to undertake the same before certifying applicability of beneficial rates under DTAA.
Conclusion & Hope for Business Certainty: That being said, just like Pandora’s box, there does remain “hope” – that the tax authorities are able to provide clarity around the issue to promote Ease of Doing Business in India instead of resorting to frivolous litigation.

“Given the recent amendment on taxation of dividends in the hands of the investors, the BO test would be required to be fulfilled by foreign investors seeking to avail tax treaty benefits for such dividend income. Thus, litigation around the overall concept of BO may increase.”

“CAs must ensure that there is adequate documentation on record to substantiate that the foreign investor is indeed fulfilling the BO test. Where BO has not been evaluated, it would be a worthwhile exercise to undertake the same before certifying applicability of beneficial rate under DTAA.”