Expert Tax Advice From Milestone International Tax consultants Ltd - July 2008

Financial expert Binne Vries from Milestone International Tax consultants Ltd gives his personal opinion on the latest tax schemes:

Tax Tip

Treaty Shopping and Beneficial Ownership - The Canadian view

Multinational groups with cross border activities often use intermediary holding companies that own local subsidiaries to conduct local activities. The location of the intermediary holding company may produce a tax advantage through reducing withholding taxes on distributions by the local subsidiary via the intermediary holding company to the ultimate owner or parent company. However, in virtually all double tax treaties, the benefits of the reduced withholding tax rates are only granted if the recipient of the dividend income is the 'Beneficial Owner' of the dividend. In situations where an intermediary holding company is used, tax authorities sometimes claim that the structure is used only to obtain a tax benefit and that it cannot be considered to be the Beneficial Owner.

The term Beneficial Owner is not defined in the tax treaties and, to further complicate matters, States applying tax treaties give different meanings to the term. The Commentary to the OECD Model Conventions provide that a conduit company cannot normally be regarded as the beneficial owner if it has, as a practical matter, very narrow powers that render it a mere fiduciary or administrator acting on account of the interested parties. Some of our readers may remember the UK Indofood case where the Civil Court in the UK decided that a Dutch intermediary company receiving interest from a UK resident could not be regarded as the Beneficial Owner. An important factor in this case was that the Dutch company never received the interest: the debtor of the interest paid the interest due directly to the beneficial owner. As a result of the decision, HMRC was entitled to ignore the reduced withholding tax rate under the relevant tax treaty. Although this decision is considered to be controversial, HMRC announced that they would follow the decision and have since published guidelines on the 'International meaning of the term Beneficial Owner'. 

The issue was more recently tested in a Canadian case (Prévost Car Inc v HM The Queen).  In this case, the Tax Court of Canada was asked to consider the meaning of Beneficial Owner in the Canada-Netherlands tax treaty.  Volvo of Sweden and Henlys of the UK owned, via a Dutch intermediary JV company (Prevost Holding BV), a Canadian subsidiary (Prevost Car Inc).  Revenue Canada argued that the Dutch company was not the beneficial owner but was merely a conduit (effectively agent or nominee) for the shareholders of the Dutch company. Revenue Canada based their arguments on the fact that there was a shareholders’ agreement which provided for required distributions from the company and the fact that there was no real substance in the Dutch company. 

In rejecting Revenue Canada’s assertions, the Tax Court determined that the Dutch company was indeed the beneficial owner of the relevant dividends, since it was the person who received the dividends for its own use and enjoyment. The shareholders’ agreement governed the relationship between the shareholders only, not the relationship between the Dutch company and the shareholders. The Dutch holding company was not party to the shareholders agreement and neither Henlys nor Volvo could take action against the Dutch company for failure to follow the dividend policy described in the shareholders agreement.  Financial statements of the Dutch company show that it owned the relevant assets and had liabilities, and it was a requirement, if dividends were to be declared to the shareholders, that the directors had to declare such dividends and the shareholders subsequently to approve them. Until such time as dividends were declared, the dividends receivable were an asset of the Dutch company and were available to any creditors.

These two apparent contradictory decisions (the UK and the Canadian perspective) will not resolve the different interpretations of the term Beneficial Owner used in double tax treaties. They do, however, provide interesting guidelines and it would seem that it is still possible to use an intermediary conduit company located in a jurisdiction that has the most favourable tax treaty in respect of withholding taxes on dividend, interest or royalty income.  This of course is on the proviso that beneficial ownership will only be satisfied where the intermediary company legally (Prevost) and practically (Indofood) is the owner of the income.  Naturally, one can expect HMRC to adhere to its published guidelines and will continue to challenge conduit situations irrespective of the legal and practical circumstances.  Readers who would like to know what solutions may be available in this regard should contact binne@milestonetax.com.

European Union / Belgium

A recent ECJ ruling on Belgian participation exemption may lead to a change in law

A Belgian court in Belgische Staat v NV Cobelfret (C-138/07) recently held that the distributed profits of a member state subsidiary to its parent in another member state are indirectly taxed because the 95% deduction cannot be fully used in a loss situation.  The Court observed that the offset of the losses from the distributed profits of the subsidiary company reduced the loss carry forward possibilities.  On 27 February 2007, the Court requested a preliminary ruling from the ECJ as to whether this was compatible with the Art 4(2) EU Parent / Subsidiary Directive (the “Directive”). 

The ECJ held that the current Belgian domestic rule that governs the tax treatment of dividends received by a parent company from its subsidiary situated in another member state is incompatible with Art. 4 of the Directive.

The background to the issue is as follows:  Article 4 of the Directive provides that if a parent company has a participation of at least 15% in its subsidiary situated in another member state and receives distributed profits, the parent company member state must not tax those profits or must give a tax credit for the corporation tax paid by the subsidiary on such profits.  However, Article 4(2) of the Directive allows member states to disallow a fixed amount of management expenses related to the distribution of up to 5% of the total amount of profits distributed.

Belgian domestic law allows for a 95% exemption of profits received provided the parent company holds at least 10% of the capital of its subsidiary and the subsidiary is subject to tax at a minimum rate of 15%.  Dividends received are included in the company’s taxable profits which are then adjusted.  The deduction of the exempt inter-company dividends can only be made after all other deductions, including loss deductions. 

This means that the parent company can only deduct 95% of the qualifying dividends received if there are any remaining taxable profits.  Therefore should the parent company have losses, the 95% deduction cannot be fully used, nor can it be carried forward against future profits.  The deduction is also not available if the parent company’s profits are lower than that of its subsidiary.  Further, the profits received from the subsidiary must be offset against the losses of the parent company before the parent company can carry forward its losses.

The Belgian Revenue authorities have not yet responded to the ECJ decision.

France / Luxembourg

Double CGT exemption

We reported in previous ITNs that the double CGT exemption that was achievable under the old France / Luxembourg 1958 treaty was no longer effective as the treaty is in the process of being renegotiated.

However, the new treaty, which is applicable from 1 January 2008 only abolishes the double CGT exemption on direct ownership (or ownership through a transparent French entity) of French real estate.  The following are possible structures to use for French real estate going forward:

1. Luxembourg company owns a French company owning French real estate:  the gain on sale of the shares of the French company is, not taxable in France, and the gain may be exempt in Luxembourg under the participation exemption, provided the relevant conditions are met; or
    
2. Luxembourg company owns a French SCI owning French real estate:  a French SCI can elect to be a civil or commercial entity.  If the French SCI elects to be subject to corporate tax, any gain on disposal of the SCI shares will be taxable in France.  If, however, the French SCI is subject to corporate tax by virtue of its trading activities, the gain will be taxable in Luxembourg only and may be exempt under the Luxembourg participation exemption.

Other planning opportunities do exist but care must be taken due to the complexity of French tax law.

Liechtenstein

Tax reform planned

The Liechtenstein government has published the outline and draft discussion points for a tax reform.  A draft final report should be published by the end of 2008.  The most notable points of the proposal are:

• Abolition of capital tax;
   
• Abolition of inheritance and gift tax; and
   
• The taxation of asset management structures, such as foundations, establishments and trusts is to be reviewed.

Luxembourg

International tax competitiveness increased

The Luxembourg corporate tax rate is set to be reduced from 29.63% to 25.5% by 2010, with an initial reduction being made on 1 January 2009.

Capital duty, currently levied at 0.5% on capital contributions to companies and partnerships, will be abolished from 1 January 2009.  One less thing to consider in international structuring!

Luxembourg continues to take positive steps to enhance its competitiveness.  However, we would also like to see the abolition of net wealth tax.  This is unattractive to foreign investors and often causes problems in structuring inbound investments.

Moldova / Cyprus

First time treaty

A first-time income tax treaty has been signed between Cyprus and Moldova, although it has not yet been ratified.  The treaty has been concluded in Moldovan, Greek and English and is based on the OECD Model Convention.

Rates of withholding tax may be reduced under the treaty as follows:

Dividends:   10% generally, 5% if the beneficial owner is a company (other than a partnership) holding at least 25% of the capital of the company distributing the dividend.

Interest: 5%

Royalties: 5%

The permanent establishment article deviates from the OECD Model Convention, in that, a construction PE will only exist if a building site, a construction, assembly or installation project or supervisory activities in connection therewith, lasts longer than 9 months (compared to 6 months in the Model Convention). 

This first-time treaty may be interesting for structuring investment into Moldova or possibly for the development of Moldovan real estate.  Cyprus is a good holding company jurisdiction.  It does not tax capital gains and has a corporate income tax rate of 10%, although there are unusual anti-abuse provisions to be aware of such as the ‘special defence contribution’, as discussed in earlier ITNs.  If you would like advice on structuring investments in Moldova or other Eastern European jurisdictions please contact the tax team who have a wealth of experience in this area.

Ukraine / Cyprus

Update on applicability of Cyprus / Old Soviet Union Treaty to Ukraine

We have mentioned in previous ITNs that Cyprus / Ukraine have concluded and signed a new treaty, but not yet ratified it.  It can sometimes take years before a treaty is ratified and will not be applicable until it is in force. 

Currently the Cyprus / Soviet Union treaty is applied as between Ukraine and Cyprus.  The new Cyprus / Ukraine treaty is not as beneficial as the Cyprus / Soviet Union treaty, for this reason it seems as though Cyprus has dragged its heals, first in the signing of the treaty and now in ratifying it.  As such, the Cabinet Ministers of Ukraine have submitted a draft law to Parliament denouncing the old treaty.  How long it will take for the denunciation to be approved is not known, particularly if it is correct that a number of members of the Ukrainian parliament have an interest in keeping the old Soviet treaty applicable! 

Whatever happens we have solutions for exiting Ukrainian investments once the new treaty comes into force so do contact us if you have a query in this regard.

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