The principle of beneficial ownership is nothing new (first appearing in the 1977 OECD Model Tax Convention)1 but, 40 years later, it is still relevant. The principle is an anti-abuse provision; its primary role is to curb treaty shopping and prevent a loophole whereby conduit companies are incorporated whose sole purpose is to benefit from certain double tax treaty (DTT) benefits.

According to the OECD,2a recipient of income cannot be considered the beneficial owner if he/she does not have the full right to the income due to obligations, contractually or otherwise, to pass on that payment to another person or entity.

Tax authorities often consider pure holding companies not to have beneficial ownership of their income due to insufficient substance. In that regard, the Italian Supreme Court has recently issued important guidance,3 stating that assessments of beneficial owner statuses should take the specific nature of the pure holding company's activities into account, since these activities help determine whether the substance level is adequate. Notably, there is a distinction between what is adequate for pure holding companies versus for operating or mixed holding companies: pure holding companies must have an appropriate level of organisation, i.e. maintain coordination of and control over the subsidiary, assume the relevant entrepreneurial risk, host shareholder meetings, and collect dividends.

I believe that the decision of the Italian Supreme Court is a good starting point for assessing a pure holding company's beneficial ownership status, especially as differentiating between pure and operating/mixed holding companies is important. Indeed, the decision clarifies that beneficial ownership conditions for a pure holding company don't hinge completely on its having a significant organisational structure or a non-treaty country in its chain of control, but rather on the effectiveness of its management and where its main management and administrative decisions are taken.

Even if an entity is considered the beneficial owner under a DTT, the benefit of the DTT may still be denied.4 Action 6 of the OECD's Base Erosion and Profit Shifting (BEPS) report introduces a "principal purpose test" (PPT) which aims to prevent the application of the benefit granted by a DTT in cases where "one of the principal purposes of transactions or arrangements is to obtain treaty benefits [...] unless it is established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty." The OECD's draft from 6 January 2017,5 examples from which were also included in the 2017 OECD Model Tax Convention draft, provides guidance on the application of the PPT rule.

A subsidiary that is located in one jurisdiction, is wholly owned by a fund located in another jurisdiction, and acts as the regional platform of the fund, should pass the PPT test and accordingly benefit from treaty access in cases where the decision to establish the subsidiary in that jurisdiction was driven by:

  • the availability of directors with knowledge of regional business practices and regulation
  • the existence of a skilled multilingual workforce
  • the State's membership of a regional grouping
  • the existence of an extensive network of tax conventions
  • the company's employing an experienced local management team to review investment recommendations

According to the above, I would think it possible that a Luxembourg limited liability company (a "LuxCo") that is owned by a foreign or domestic fund, that has appropriate substance, and whose main management and administrative decisions are taken in Luxembourg by a board of directors with strong industry knowledge, should:

  • be considered the beneficial owner of the income received from its investment; and
  • benefit from the DTTs signed by Luxembourg for income derived from subsidiaries located other jurisdictions.

Footnotes

1OECD Model Tax Convention on Income and Capital (11 April 1977)
2OECD, Clarification of the Meaning of "Beneficial Owner" in the OECD Model Tax Convention Discussion Draft (2011)
3Italian Supreme Court 28 December 2016 Decision n° 27113
4OECD Model Tax Convention on Income and Capital (26 July 2014) Models IBFD
5BEPS Action 6 Discussion Draft on non-CIV example 6 January – 3 February 2017

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