IFA - Mauritius, 11 May 2012

Recent case law developments on the beneficial ownership concept

Ridha Hamzaoui

IBFD

The Netherlands

IBFD - www.ibfd.org

Agenda

- A reminder about the Prévost Case

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- The Velcro Case decided on 24 February 2012

- The East Division of the Danish High Court decided on 21 December 2011

- Some comments on the OECD 2011 discussion draft

- Practical elements to consider to secure beneficial ownership

Prevost Case - Canada

Prévost Car Inc. v. The Queen,

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- The Canadian Revenue Authority (CRA) argued that a shareholder (NL Holding Co.) was not entitled to treaty benefits under the Canada-NL tax treaty in respect of dividends paid by the taxpayer to the shareholder because this shareholder was not the beneficial owner of the dividends.

- The CRA was unsuccessful at the Tax Court and, on February 26, 2009, the Federal Court of Appeal affirmed the Tax Court’s decision.

Prevost Case - (Canada)

HenlysUKCo

VolvoSweden Co

Holding Company(Net HoldCo)

Prevost(CanCo)

UK Sweden

100%

49% 51%

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WHT 5%

WHT 0%

WHT 15%WHT 10%

Canada

Netherlands

After Prevost case... Velcro Case

- Although the Prévost decision is very helpful for non-residents investing in Canada through a third jurisdiction that has a beneficial tax treaty with Canada, it does not deal with "back-to-back" arrangements.

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- A decision on a new case has been issued (Velcro Canada Inc. v. The Queen) concerning beneficial ownership for the purposes of the Canadian- NL tax treaty in the context of a back-to-back arrangement, which may clarify this issue.

- The hearing by the Tax Court was held in May 2011.

- Decision pronounced on 24 February 2012.

Velcro Case - Canada

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V- Canada V- BV NL

IPRoyalties

Licence

Royalties WHTCanada

25% domestic law0% under CA-NL treaty

Canada NL

- on 27 October 1995, V-BV had assigned the V licence to Velcro Holdings BV (V- Hold BV), a Dutch company that acted as the exclusive sublicensor of V-BV’s intellectual property in several jurisdictions.

Velcro Case - facts

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- On 29 December 1995, V-BV changed its residence to the Netherlands Antilles to become V-NA BV

- From 1995 to 2004 tax years, the taxpayer, Velcro Canada Inc. (V Ca), an operating Canadian company, paid royalties for intellectual property licensed from Velcro Industries BV (V-BV) a Dutch resident company.

Velcro Case – V-BV sublicense to V-Hold

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V- Canada

V- Hold NL

V- BV NL

IP

Sub-license

Royalties

Canada NL

- on 27 October 1995, V-BV had assigned the V licence to Velcro Holdings BV (V- Hold BV), a Dutch corporation that acted as the exclusive sublicensor of V-BV’s intellectual property rights in several jurisdictions.

Velcro Case – Migration of V-BV from NL to NL Antilles

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V- Canada

V- Hold NL

V- BV NA

V- BV NL

IP

Sub-licence

Royalties

Canada NL AntillesNL

0% or 25%?

- On 29 December 1995, V-BV changed its residence to the Netherlands Antilles.

Royalties

Velcro Case - facts

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- In 1999 and subsequent years, V Ca did not withhold any Canadian tax on the royalty payments made to V Hold BV.

- From 1996 to 1998, V Ca withheld 10% withholding tax on royalties paid to V Hold BV on the basis of the Canada-Netherlands tax treaty.

- The Ca – NL tax treaty was later amended to exempt certain types of royalties (including the type of royalties involved in this case) from Canadian withholding tax.

The CRA reassessed V Ca on the basis that V Hold BV was not the beneficial owner of the royalties from V Ca and that V Hold BV was a mere conduit for V NA-BV, a resident of a NL Antilles.

The Court applied the four criteria of beneficial ownership set out in the Prévost Case:

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Velcro Case – beneficial owner analysis

1- possession,

2- use,

3- risk, and

4- control.

1 -The possession criterion

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The Court considered that V Hold BV “possessed” the royalties received from V Ca because:

- V Hold BV deposited the royalties in its own bank account ;

- The funds were mixed with other funds available to V Hold BV;

- Interest earned on the funds was for the own account of V Hold BV; and

- V Hold BV used the funds to pay for expenses other than the royalties paid back to V NA BV.

2 -The use criterion

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V Hold BV “used” the royalties received from V Ca because:

- It used the money for various purposes other than paying back the royalties to V NA BV;

- Even though V Hold BV contractually owed royalties to V NA BV, there were no restrictions on the use of the funds;

- There was no distinction of the cash received from V Ca in a “lock-box” or other similar arrangement.

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V Hold BV incurred “risk” with respect to the royalties received from V Ca because: .

- It was exposed to the currency risk associated with the royalties;

- The cash was available to creditors of V Hold BV, with no priority or subordination given to V NA BV as a creditor comparing to other creditors.

3- The risk criterion

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V Hold BV did “control” the royalties received from V Ca because:

- V Hold BV was able to mix the royalties with its other funds;

- The royalties were available to V Hold BV creditors;

4- The control criterion 4- The control criterion

- V Hold BV was subject to interest and currency risk with respect to the royalties.

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- The Court decided that Velcro was the beneficial owner

- It is interesting to know that the CRA did not appeal

Velcro Case – beneficial owner analysis

- This is a confirmation to the Prévost decision in another context which is a back to back arrangement

- It will also be interesting to see whether the CRA will adopt a new strategy and shifts its focus in the future towards greater reliance on codified anti-treaty shopping provisions negotiated on a treaty-by-treaty basis, instead of continuing to pursue yet more treaty shopping cases in the Tax Court.

Velcro Case – practical elements to consider

With intermediate financing, licensing or holding companies, the intermediate company should:

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- Undertake activities other than receiving and making the relevant payments.

- Have its own bank account and Canadian-source payments should be deposited into that account.

- Cash remitted from Canada should not be separate from outbound-payment, but rather should be mixed with other funds.

- There should be a reasonable timing between the payments from Canada to the intermediate company and any outbound-payments.

- There should be no restrictions on the use of the funds by the holding company which should be able to use the funds received from Canadian sources for other purposes, such as to fund its other activities or to pay its general expenses, at the intermediate company’s discretion.

- There should be a spread between the amounts paid from Canada and the amount of any outbound-payments.

- The intermediate company should be entitled to retain for its own use any interest earned on the funds received from the Canadian payor.

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Velcro Case – practical elements to consider

- The funds received from Canada should form part of the general assets of the intermediate company that, in theory, would be available to the intermediate company’s creditors in an insolvency, and the ultimate recipient should not have any priority over other creditors.

- While the immediate recipient of funds from Canada may have a contractual obligation to make payments to the ultimate recipient, the ultimate recipient should have no legal right to or control over specific funds received by the intermediate company and there should be no segregation of those funds.

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Denmark

Luxembourg

Target

DK Hold co

FS Invest (Sarl)

PE Fund

DividendsLoans

Danish Tax authority: 28% WHT under domestic law

0% WHT if FS Invest is the beneficial owner

East Division of the Danish High Court

East Division of the Danish High Court

- Structure established to acquire a Danish target company;

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- Danish Tax authorities considered that the non-resident company is not the beneficial owner;

- The reason is that income was passed by the Luxembourg company to another company resident in a different country;

- In April 2010, the National Tax Tribunal decided that FS invest was the beneficial owner;

- The tax authority appealed to the High Court.

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East Division of the Danish High Court

- Case decided on 21 December 2011

- The High Court considered that since FS Invest Sarl did not redistribute the dividends but provided a loan with an equal amount to the Danish subsidiary DK Hold Co, it could not be regarded as a conduit company with respect to the dividends. Accordingly, FS invest Sarl was the beneficial owner of the dividends under the Denmark-Luxembourg tax treaty

-The High Court confirmed also that the fact that a company possesses narrow powers to act is not sufficient to disregard the company as a beneficial owner.

-The Danish tax authority did not appeal the case to the Supreme Court.

Some comments on the OECD 2011 discussion draft

• The “beneficial owner” test under the discussion draft (section 12.4) seems to be more difficult to satisfy than that applied in the Velcro case as it requires the recipient of the passive income to have “the full right to use and enjoy the [dividend, interest or royalties] unconstrained by a contractual or legal obligation to pass the payment received to another person”.

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• Pass the payment received …:Does it mean that an obligation to pass the payment in another form of income is a constraint?

• To pass: Is there a clear time frame? What about the amount?

• No guidance provided by the discussion draft

Thank you for your attention

R.Hamzaoui@ibfd.org

23 © 2012 IBFD