This year while presenting the Budget, the Indian Finance Minister observed that the Tax Residency Certificate (TRC) certifies that an entity is a resident but it does not certify that it is a beneficial owner. Beneficial ownership is a question of fact, he mentioned.
This remark has, lead to speculation that the Indian tax authorities could now examine beneficial ownership aspect in greater details, when Tax Treaty (Treaty) relief is sought in case of passive incomes. It is pertinent to note that in case of incomes such as interest, royalty, fees for technical services and dividend, requirement of beneficial ownership is an important inbuilt criterion, which has to be fulfilled to avail Treaty benefit.
So far, this has not been a focus area of examination by the Indian tax authorities.
No clear definition
Problem arises as, currently neither the Indian Income-tax Act nor the Treaties contain a definition of beneficial ownership. Even OECD is seeking to give it a more precise form.
One may also note, that in the recent past there has been significant rise in controversy around the world centered on beneficial ownership test due lack of clear understanding on what it denotes. It has been debated as to what extent this concept can be used as a general anti avoidance tool, whether it is right to apply any country's domestic law meaning to this term or would a general Treaty based meaning suffice.
In this backdrop it is likely that seekers of Treaty benefit in India may face several problems.
As per the existing guidance by OECD, beneficial ownership should not be used in narrow technical sense but rather should be understood in context of object and purpose of the Convention. Further, agent, nominee, conduit company acting in fiduciary capacity or administrator, are not to be considered beneficial owners. Rationale being, that they are obliged because of contractual, fiduciary or other duty to pass the payment to another person.
OECD has also, in the recent past released two discussion drafts for public comments on this issue. It has proposed that the recipient of the dividend, interest or royalty should be taken to be the beneficial owner of the subject payment where he has theright to use and enjoy such income. This right should be unconstrained by a contractual or legal obligation to pass on the payment received to another person. Further, such an obligation must relate to the payment received.
Structures at risk
In the Indian context, it is anticipated that the following structures could come under scrutiny:
- Back to back loan arrangements
- Interposing an IPR licensing company in a Treaty country which has lower withholding tax rate
- Pooling of service charges at the regional headquarter level, which then passes on the costs to the countries of that region
- Setting up a SPV in a Treaty country with no substance, for making investments in a host country
The recent changes in the Income-tax law provide that details and documents that the non-resident would be required to furnish while seeking Treaty benefit would be prescribed. As far as Mauritius goes, the government has acknowledged that where TRC is issued by Mauritius Government, such TRC would constitute sufficient evidence for accepting the residence as well as beneficial ownership. But there is need for guidance in other cases.
One hopes that well thought out parameters and guidance will be made available to the field officers and the taxpayers within a reasonable time. In specific terms, following aspects need to be looked into while laying down guidelines:
- What are the key factors that would impact beneficial ownership at the intermediary level, China, for example has prescribed factors such as no or minimal business activity, no risk bearing, scale of operations not commensurating with income, non-residents income either being non-taxable or taxable at low effective tax rate. Other factors which could be relevant may be composition of board, number of meetings, nature of decisions in the meetings etc.
- Would a single factor or a few factors collectively impact the verdict of the tax authorities, or all the factors would be assigned some weightage.
- What would be the point of time to test beneficial ownership. Would it be examined when arrangement is entered into or when income is received or accrues.
- Would it be examined as regards a particular transaction or as regards the entity.
- Any safe harbors.
- Time gap between receipt of income and distribution of income and impact of any margin retained by the intermediary. China for instance considers distribution of more than 60% to a resident of another country within 12 months from the date of receipt as one of the factors.
- Type of evidence required, together with range of alternatives that could be furnished.
- Time frame in which the decision would be communicated to the taxpayer. In case of dispute or delays would an interim clearance be given or would taxes be collected in full.
- Modalities for recurring payments during a year and payments made from different locations in the country. Would the tax authorities internally collaborate in such cases.
One can see from the above discussion that there are several factors one needs to address before laying down the beneficial ownership test rule. It is critical, that quality guidance is given to field officers and the taxpayers to ensure that the intended policy objectives are achieved without increasing litigation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.