Clarifying the Meaning of ‘Beneficial Owner’ in Tax Treaties

and general language. Also, the discussion drafts do not clarify the context, object, and purpose to be considered in the interpretation of beneficial owner. Regarding the context, the drafts only explain that ‘‘the term ‘beneficial owner’ was added to address potential difficulties arising from the use of the words ‘paid to . . . a resident’ in paragraph 1,’’19 but they leave unspoken exactly what those potential difficulties are; therefore, this additional explanation was not particularly helpful in defining beneficial owner. In this sense, the business community’s criticisms are reasonable. In practice, contrary to the original intention, this action by the OECD might even have had the effect of increasing the risk of uncertainty in some countries Id. at comment 12 on article 10, comment 9 on article 11, comment 4 on article 12; see also id. at C(10)-30 (discussing history of comment 12 on article 10), C(11)-24 (discussing history of comment 9 on article 11), C(12)-25 (discussing history of comment 4 on article 12). See supra text accompanying note 1. OECD model, supra note 2, comment 12.1 on article 10, comment 10 on article 11, comment 4.1 on article 12. In 2010 the OECD commentary added paragraphs 6.8 through 6.34 to the commentary on article 1 (which relate to the treatment of collective investment vehicles); paragraph 6.14 stipulates about ‘‘beneficial owner,’’ but only in relation to collective investment vehicles. Id. comment 6.8-6.34 on article 1. First discussion draft, supra note 7. See also public comments on the first discussion draft (July 22, 2011), available at http:// www.oecd.org/tax/taxtreaties/publiccommentsreceivedonthe discussiondraftonthemeaningofbeneficialownerintheoecdmodeltax convention.htm. Second discussion draft, supra note 7. See also public comments on the second discussion draft (Feb. 12, 2013), available at http://www.oecd.org/tax/publiccommentsreceivedontherevised proposalsconcerningthemeaningofbeneficialownerinarticles1011 and12oftheoecdmodeltaxconvention.htm. See, e.g., public comment from Japan Foreign Trade Council, Inc. on the second discussion draft, at 1 (Dec. 14, 2012), available at http://www.oecd.org/ctp/treaties/BENOWNJapan_ Foreign_Trade_Council.pdf; Public Comment from BIAC on the Second Discussion Draft, at 1 (Dec. 14, 2012), available at http:// www.oecd.org/ctp/treaties/BENOWNBIAC.pdf. First discussion draft, supra note 7, at 3; second discussion draft, supra note 7, at 2. SPECIAL REPORTS TAX NOTES INTERNATIONAL NOVEMBER 25, 2013 • 763 (C ) T ax A nlysts 213. A ll rhts resrved. T ax A nlysts does ot claim coyright in ny pblic om in or tird prty cotent. where not much attention has been paid to the term ‘‘beneficial owner,’’ and hence it has just been ignored in practice.20 On the other hand, such criticisms often just request clarity and foreseeability for taxpayers and do not give sufficient consideration to the interests of the opposite side, including the necessity to handle tax avoidance. Some say that even if ‘‘beneficial owner’’ is a concept for anti-tax-avoidance purposes, now that many treaties or domestic laws have limitation on benefits clauses or anti-conduit rules, the OECD does not also need to allow tax authorities to make use of ‘‘beneficial owner’’ for that purpose, so the scope of beneficial owner should be defined in a much clearer and narrower way.21 Although this might appear to be a valid argument at first glance, the critics do not provide any specific examination to support this line of argument. In this sense, their arguments sound naïve, and if we take a cynical view, they are trying to push ‘‘beneficial owner’’ back into a world where they can, in practice, just ignore it.22 B. Approach of This Article 1. Object and Purpose of the OECD Model The foregoing is a brief description of the current situation regarding ‘‘beneficial owner,’’ and there is no consensus about where we should go. Even the OECD might be unsure, because it does not specifically articulate the context, object, and purpose to be considered in the interpretation of beneficial owner, and it hesitates to clarify the scope of beneficial owner beyond a certain point.23 Without a precise consensus about both the context and the object and purpose, it is difficult to establish the scope of beneficial owner in a way that is clear and acceptable among differing interests. Conversely, once we have consensus about both the context and the object and purpose, it is likely that we will be able to agree on the scope of beneficial owner, based on that context, object, and purpose. The discussion drafts explicitly admit that ‘‘the concept of ‘beneficial owner’ deals with some forms of tax avoidance.’’24 Although this might appear to be just a reiteration of the current OECD commentary, which says the term ‘‘beneficial owner’’ should be interpreted in light of the object and purposes of the OECD model, including ‘‘the prevention of fiscal evasion and avoidance,’’25 this reiteration nonetheless shows that the OECD is obviously focusing on anti-tax-avoidance as a function of beneficial owner.26 Although the current OECD commentary implies that there could be other objects and purposes that are not enumerated,27 given the OECD’s focus on the anti-tax-avoidance See, e.g., public comment from Taxand on the second discussion draft, at 1 (Dec. 15, 2012), available at http:// www.oecd.org/ctp/treaties/BENOWNTaxand.pdf; public comment from Chartered Institute of Taxation on the second discussion draft, at 1 (Dec. 13, 2012), available at http:// www.oecd.org/ctp/treaties/BENOWNChartered_Inst_tax.pdf; Gavin Helmer, ‘‘Beneficial Ownership — A Looming Disaster?’’ available at http://www.pwc.com/sg/en/tax/tax-issue 20120730.jhtml. In Japan, aside from agent or nominee cases, I am of the impression that practitioners started to worry about the beneficial owner requirement only after the first discussion draft was published. For a brief overview of the interpretation of beneficial owner in Japan, see Eiichiro Nakatani and Akira Tanaka, ‘‘Host Country JAPAN,’’ Tax Mgm’t Int’l Forum, Dec. 2012. See, e.g., Helmer, supra note 20; public comment from Capital Markets Tax Committee of Asia on the first discussion draft, at 8 (July 13, 2011), available at http://www.oecd.org/tax/ treaties/48413629.pdf; public comment from Association for Financial Markets in Europe on the first discussion draft, at 4 (July 15, 2011), available at http://www.oecd.org/tax/treaties/ 48413772.pdf; public comment from Ernst & Young International Tax Services on the second discussion draft, at 2-3 (Dec. 14, 2012), available at http://www.oecd.org/ctp/treaties/ BENOWNErnst&Young_LLP.pdf; public comment from New Zealand Institute of Chartered Accountants on the second discussion draft, at 4 (Dec. 15, 2012), available at http://www.oecd. org/ctp/treaties/BENOWNNew_Zealand_Institute_Chartered_ Accountants.pdf. See, e.g., Public Comment from Taxand on the Second Discussion Draft, supra note 20, at 1; Public Comment from PricewaterhouseCoopers LLP on the second discussion draft, at 1, available at http://www.oecd.org/ctp/treaties/BENOWNPwC. pdf. See infra note 88. First discussion draft, supra note 7, at 4; second discussion draft, supra note 7, at 10. OECD model, supra note 2 at comment 12 on article 10, comment 9 on article 11, comment 4 on article 12; see also id. at C(10)-30 (discussing history of comment 12 on article 10), C(11)-24 (discussing history of comment 9 on article 11), C(12)-25 (discussing history of comment 4 on article 12). John Avery Jones, Richard Vann, and Joanna Wheeler object to the OECD’s focus on anti-tax-avoidance as a function of the beneficial owner by introducing the history of the concept of beneficial owner in the OECD model. Public Comment from John Avery Jones, Richard Vann, and Joanna Wheeler on the First Discussion Draft (July 15, 2011), available at http:// www.oecd.org/tax/treaties/48420432.pdf. However, their argument is, at the same time, based on their view that ‘‘other antiavoidance principles are available to deal with treaty shopping situations,’’ and that to interpret ‘‘beneficial owner’’ more broadly than originally intended brings ‘‘confusion and disputation.’’ Id. at 5. It is not clear what ‘‘other anti-avoidance principles’’ they have in mind, but as far as an LOB clause is concerned, I question their views. Although the history of legal concepts or measures is not something that we can just ignore, I believe that if there is a need to deal with a problem (here, tax avoidance), we should have the option to take advantage of preexisting legal concepts or measures (here, the concept of beneficial owner) rather than introduce new legal concepts or measures, even if that option might not be compatible with history. The OECD commentary stipulates that the principal purpose of income tax treaties ‘‘is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion.’’ OECD model, supra note 2, at comment 7 on article 1. However, it is SPECIAL REPORTS (Footnote continued on next page.) 764 • NOVEMBER 25, 2013 TAX NOTES INTERNATIONAL (C ) T ax A nlysts 213. A ll rhts resrved. T ax A nlysts does ot claim coyright in ny pblic om in or tird prty cotent. function of beneficial owner, and no explicit mention about such other potential objects and purposes in the OECD commentary or the discussion drafts, it does not seem unreasonable to ignore such other potential objects and purposes, and I will do so for the purpose of the analysis of this article. That said, the current OECD commentary explicitly includes, in addition to ‘‘the prevention of fiscal evasion and avoidance,’’ ‘‘avoiding double taxation’’ as another object and purpose. Since this is explicit, it would not be appropriate simply to ignore this language in the interpretation of beneficial owner. However, as we have seen from the beginning, ‘‘beneficial owner’’ is a concept to limit the application of treaty provisions that eliminate double taxation. Therefore, given the OECD’s emphasis on anti-tax-avoidance, it would be appropriate to understand this other object and purpose as just intending that ‘‘beneficial owner’’ should not be interpreted more widely than necessary to prevent tax avoidance so that elimination of double taxation would not be impaired.28 Hence, I will explore the scope of beneficial owner only to the extent necessary to prevent tax avoidance. 2. Context of Beneficial Owner Having determined to focus on anti-tax-avoidance as an object and purpose of the OECD model to be considered in the interpretation of beneficial owner, this can also provide the answer to the next question: What is the context of beneficial owner? As shown above, I could not determine the term’s context because the object and purpose to be considered is uncertain. The method of tax avoidance being considered in the tax treaty context, especially regarding ‘‘beneficial owner,’’ is, as shown in Section I.A of this article, ‘‘conduit’’ transactions. As another piece of evidence, the OECD commentary, when discussing the term ‘‘beneficial owner,’’ specifically cites29 the report from the Committee on Fiscal Affairs entitled ‘‘Double Taxation Conventions and the Use of Conduit Companies’’ (the conduit report).30 In contrast, there is no clue that would suggest what other methods of tax avoidance will be handled by way of using the term ‘‘beneficial owner.’’ Therefore, I assume that the context to be considered in the interpretation of beneficial owner is the conduit transactions as discussed in the OECD commentary and the conduit report. Here, I briefly overview how such conduit transactions work and why they are considered to be tax avoidance. A state enters bilateral tax treaties on the condition that the other contracting state will give it the same treaty benefits as it gives to the other contracting state. In other words, a state is not willing to give up its revenues to other states that do not provide the same treaty benefits in return. However, sophisticated taxpayers are motivated to achieve tax benefits under tax treaties, regardless of their connection to the contracting states of such tax treaties. The conduit report describes the mechanism of how a third-state resident tries to take advantage of a tax treaty between other states, using typical methods of tax avoidance, such as direct conduits and steppingstone conduits.31 a. Direct Conduits. Figure 1 is an illustration of the following description of direct conduits. State A and State B correspond to the residence state and the source state, respectively: A company resident of State A receives dividends, interest or royalties from State B. Under the tax treaty between States A and B, the company claims that it is fully or partially exempted from the withholding taxes of State B. The company is wholly owned by a resident of a third state not entitled to the benefit of the treaty between States A and B. It unclear how such promotion of ‘‘exchanges of goods and services, and the movement of capital and persons’’ can possibly relate to the meaning of ‘‘beneficial owner.’’ But see public comment from Avellum Partners on the second discussion draft, at 3 (Jan. 30, 2013), available at http://www.oecd.org/ctp/treaties/ BENOWNAvellum_Partners.pdf (arguing that, since ‘‘promotion of international trade and movement of capital’’ is one of the ‘‘object[s] and purpose[s]’’ of the tax treaty, special purpose vehicles for financial transactions should be entitled to beneficial owner status). Regarding agent and nominee, the OECD commentary states: it would be inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resident of the other Contracting State. The immediate recipient of the income in this situation qualifies as a resident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. It would be equally inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. [Emphasis added.] OECD model, supra note 2 at comment 12.1 on article 10. This might suggest that a recipient will not be regarded as a beneficial owner when there is no potential double tax, and that another object and purpose — that of avoiding double taxation — will be considered in such a manner. However, although the OECD commentary states ‘‘equally inconsistent with the object and purpose of the Convention,’’ there is a stretch here between (a) an agent or nominee, and (b) a conduit. Unlike an agent or nominee, a ‘‘conduit’’ would be treated as the owner of the income for tax purposes in the residence state, and hence, at least theoretically, potential double taxation arises there. Therefore, this purpose would not be ‘‘equally’’ applicable to a conduit. Id. at comment 12.1 on article 10, comment 10 on article 11, comment 4.1 on article 12. Id. at R(6)-1. Id. at R(6)-2 to -3. SPECIAL REPORTS TAX NOTES INTERNATIONAL NOVEMBER 25, 2013 • 765 (C ) T ax A nlysts 213. A ll rhts resrved. T ax A nlysts does ot claim coyright in ny pblic om in or tird prty cotent. has been created with a view to taking advantage of this treaty’s benefits and for this purpose the assets and rights giving rise to the dividends, interest or royalties were transferred to it. The income is taxexempt in State A, e.g. in the case of dividends, by virtue of a parent-subsidiary regime provided for under the domestic laws of State A, or in the convention between States A and B.32 b. Steppingstone Conduits. Figure 2 is an illustration of the following description of steppingstone conduits. State A and State D correspond to the residence state and the third state, respectively: The situation is the same as in [the above example of direct conduits]. However, the company resident of State A is fully subject to tax in that country. It pays high interest, commissions, service fees and similar expenses to a second related ‘‘conduit company’’ set up in State D. These payments are deductible in State A and tax-exempt in State D where the company enjoys a special tax regime.33 If such attempt can be successfully made by a thirdstate resident, it would result in revenue loss of the source state without receiving anything in exchange, impair the principle of reciprocity that underlies tax treaties, and reduce incentives to conclude tax treaties.34 Therefore, it is necessary for the contracting states of tax treaties to limit who can enjoy treaty benefits to those whose connection with the contracting states can be considered sufficient to entitle them to treaty benefits. 3. Assuming the Existence of an LOB Clause In sections I.B.1 and I.B.2 of this article, I have assumed that beneficial owner is a concept to handle tax avoidance, especially regarding conduit transactions. However, as a measure to handle conduit transactions specifically, the OECD commentary proposes an LOB clause.35 So, one question arises: How should we understand the relationship between beneficial owner and an LOB clause? If there are some similarities in the functions to be performed by beneficial owner and an LOB clause, respectively, to understand the difference in such functions would help to understand and clarify the scope of ‘‘beneficial owner’’ by assigning to it specific functions that it can and should appropriately handle. This approach also promises better acceptability among differing interests. The current approach of the discussion drafts is too focused on how to establish a general definition of beneficial owner without providing enough explanation about the rationale behind the definition, and this seems to be one of the biggest criticisms against it. If a sufficient rationale is provided, and that rationale is acceptable among differing interests since it is based on a functional analysis rather than a dogmatic definitional approach, it will be more easily accepted.36 Id. at R(6)-2. Id. at R(6)-3. Id. at R(6)-4 to -5. See, e.g., Simone M. Haug, ‘‘The United States Policy of Stringent Anti-Treaty-Shopping Provisions: A Comparative Analysis,’’ 29 Vand. J. Transnat’l L. 191, 195-220 (1996). OECD model, supra note 2, at comment 13-20 on article 1. The assumption and approach of this article are different from those of previous discussions regarding the concept of beneficial owner, including judgments rendered in several jurisdictions; hence, I do not examine those discussions in this article. See, e.g., Christiana HJI Panayi, in Peter HJ Essers et al., eds., Double Taxation, Tax Treaties, Treaty-Shopping and the European Community 44-50 (2007), for previous discussions. [Residence State]