OECD Proposes clarifications on the meaning of 'Beneficial Owner' in the OECD Model Tax Convention
By Marc Schmitz and John Hames, Ernst & Young, Luxembourg
On April 29, 2011, the OECD's Centre for Tax Policy and Administration released a public discussion draft of proposed changes to the Commentary on Articles 10, 11, and 12 of the OECD Model Tax Convention, focusing on the clarification of the meaning of "beneficial owner" (the "Discussion Draft"). The OECD Model Tax Convention and its Commentary influence how many countries interpret their income tax treaties, so any such clarification may have broad effect.
The concept of "beneficial owner" found in Articles 10, 11, and 12 of the OECD Model Tax Convention is used to determine whether the recipient of a payment is entitled to treaty benefits with respect to the payment (as opposed to being a mere agent, nominee, etc.), and has given rise to different interpretations by courts and tax administrations. Given the risks of double taxation and non-taxation arising from these different interpretations, the OECD Committee on Fiscal Affairs, through its Working Party 1 on Tax Conventions and Related Questions, has worked on proposals aimed at clarifying the interpretation that should be given to that concept in the context of the OECD Model Tax Convention.
All interested parties may provide comments on the proposed changes by e-mail before July 15, 2011. All comments received will be reviewed and examined at the September 2011 meeting of the Working Party.
The requirement of "beneficial ownership" was introduced in the OECD Model Tax Convention on Income and on Capital (the "Model Treaty")in 1977 and is a concept applied in Articles 10, 11, and 12. These articles address the taxation of dividends, interest, and royalties, respectively. The introduction of the term, "beneficial owner," in the Model Treaty was primarily to counter treaty shopping.
The Model Treaty's current commentary states, among other things, that the term, "beneficial owner," was introduced to "clarify the meaning of the words 'paid … to a resident' as they are used in" Articles 10, 11, and 12 and that such "term is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purpose of the Convention."(1) However, the current commentary does not clarify whether the term, "beneficial owner," should be interpreted in accordance with domestic law or whether the term has an international tax treaty meaning.
Contents of the Public Discussion Draft
The Discussion Draft seeks to expand the Model Treaty's commentary to provide further guidance regarding the meaning of the term "beneficial owner" in the treaty context. The OECD believes such guidance is necessary due to the confusion that has arisen over the term because the rules of treaty interpretation allow source countries to use domestic law in defining terms not otherwise defined in a treaty.
In particular, the Discussion Draft proposes to clarify the concept of a "beneficial owner" in the context of the Model Treaty by adding identical language to the Model Treaty's commentary on Articles 10, 11, and 12. Under the proposed clarification, it is explicit that the term, "beneficial owner," as used in the Model Treaty is not intended to be interpreted or to refer to any technical meaning that it could have under the domestic law of a specific country; rather, it should be understood in its treaty context (namely, avoiding double taxation and prevention of fiscal evasion and avoidance) and in relation to the words "paid … to a resident." The proposed clarification acknowledges, however, that the domestic law meaning of "beneficial owner" is not automatically irrelevant for the interpretation of that term in the context of the Article and that the domestic law meaning applies to the extent it is consistent with the general guidance included in the Model Treaty's commentary.
The Discussion Draft's clarification further provides that the recipient of a dividend, interest, or royalty payment is the "beneficial owner" of the subject payment where he has the full right to use and enjoy the dividend, interest, or royalty unconstrained by a contractual or legal obligation to pass the payment received to another person. The proposed commentary notes that such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the full right to use and enjoy the payment. Additionally, the clarification notes that in determining the "beneficial owner" the use and enjoyment of a payment must be distinguished from the legal ownership, as well as the use and enjoyment, of the property which generated the payment.
The Discussion Draft also clarifies that the mere fact that the recipient of a payment is considered to be the beneficial owner of that payment does not mean that the recipient is entitled to treaty benefits with respect to the payment. Rather, the proposed language explicitly states that treaty benefits should not be granted in cases of abuse and refers to other methods of combating treaty-shopping situations, including specific treaty anti-abuse provisions, general anti-abuse rules and substance-over-form or economic substance approaches. Under the clarification, the concept of "beneficial owner" must not be considered as restricting in any way the application of other approaches to addressing treaty-shopping cases.
Finally, the Discussion Draft proposes a provision to explicitly state that the above explanations concerning the meaning of "beneficial owner" make it clear that the meaning given to this term in the context of the subject Article must be distinguished from the different meaning that has been given to that term in the context of other instruments that concern the determination of the persons that exercise ultimate control over entities or assets. As noted in the proposed commentary, in the context of Articles 10, 11, and 12, the term, "beneficial owner," is intended to address difficulties arising from the use of the word "paid" in relation to dividend, interest, and royalty payments; it, therefore, would be inappropriate to consider a meaning developed in order to refer to the individuals who exercise "ultimate effective control over a legal person or arrangement."
The Draft Discussion's proposed clarification represents a step towards achieving an international consensus on the scope and meaning of the term, "beneficial owner." This step appears to be in tacit agreement with the UK Court of Appeal's decision in Indofood International Finance Ltd. v. JP Morgan Chase Bank NA ("Indofood") that the term should be interpreted as a global concept and "be given an international fiscal meaning not derived from the domestic laws of contracting States." If the proposed clarification is adopted, the confusion that has arisen, in particular due to different interpretations given by some common-law jurisdictions where the term "beneficial owner" has traditionally been narrowly interpreted, should be greatly diminished.
Given the effect these changes could have on treaty interpretations by member countries of the OECD, taxpayers should closely review the discussion draft and consider whether it would be appropriate to provide comments on the proposed additions.
(1)The Model Treaty's current commentary also explicitly states that an agent, nominee, or conduit company would normally not qualify as a beneficial owner.
By Marc Schmitz, Tax Partner, National Director of Tax Ernst & Young Luxembourg
and John Hames, Tax Partner, Ernst & Young Luxembourg