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HMRC internal manual

International Manual

Double Taxation applications and claims: Indofood: The Judgement

  1. The judgement can be found at www. The brief facts are that an Indonesian trading group (Indofood) wished to raise finance using the issue of internationally marketed loan notes. It did so using a Mauritian special purpose vehicle (SPV) Indofood International Finance Ltd because, under the Indonesia-Mauritius Double Taxation Convention (DTC), the rate of Indonesian withholding tax (WHT) on interest was reduced from 20% to 10%. The terms of the loan note issue included a clause that if the Indonesian WHT went above 10% and no “reasonable measure” could be found to avoid the increase, then the Mauritian SPV could redeem the bonds.
  2. Because the Indonesian government decided to terminate its DTC with Mauritius, the WHT rate consequently increased to 20% (for which Indofood was liable) and Indofood sought to initiate the get-out clause. JP Morgan, as Trustee/Paying Agent for the bondholders, refused to accept this, on the basis that Indofood could set up a Dutch SPV to perform the same function but utilising the Indonesia/Netherlands DTC.
  3. The Court of Appeal had four issues to consider;
* whether the Dutch SPV would be the beneficial owner of the interest payable by Indofood for the purposes of the relevant DTC;
* whether the Dutch SPV would be a resident of the Netherlands for the purpose of the relevant DTC;
* whether the obligation of Indofood to pay interest would, after the assignment to the Dutch SPV, be that originally owed to the Mauritian company, or a new obligation following novation, and
* assuming that the answer to the first two questions was "yes" then whether it would be reasonable for the Dutch SPV to be interposed in the way suggested.

It is the first of these questions on which this guidance focuses.

Beneficial ownership

  1. Like many other countries (including the UK), Indonesia reduces its withholding taxes on interest and royalties paid to non-residents where the recipient is entitled to claim that benefit under the terms of the relevant DTC. One of the most important conditions for relief is that the recipient must be the “beneficial owner” of the interest or royalty. The Court of Appeal quotes from OECD published reports and from the 1986 and 2003 Commentaries on the OECD Model Convention on Income and on Capital to explain how “beneficial ownership” is to be interpreted in the context of DTCs. These explanations were explicitly relied on by the Court of Appeal in its judgement in Indofood. For example, Paragraph 35 of the judgement quotes from the 1986 OECD report entitled “Double Tax Convention and the Use of Conduit Companies”, where at paragraph 14(b) it states that:

“Articles 10 to 12 of the OECD Model deny the limitation of tax in the State of source on dividends, interest and royalties if the conduit company is not its “beneficial owner”. Thus the limitation is not available when, economically it would benefit a person not entitled to it who interposed the conduit company as an intermediary between himself and the payer of the income…The Commentaries mention the case of a nominee or agent. The provisions would, however, apply also to other cases where a person enters into contracts or takes over obligations under which he has a similar function to those of a nominee or an agent. Thus a conduit company can normally not be regarded as the beneficial owner if, though the formal owner of certain assets, it has very narrow powers which render it a mere fiduciary of an administrator acting on account of the interest parties…”

It also quotes (at Paragraph 36) from the 2003 Commentary on Article 11, which states at Paragraph 8.1 that:

“Where an item of income is received by a resident of a Contracting State acting in the capacity of agent of nominee 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. …no potential double taxation arises … since the recipient is not treated as the owner of the income… 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 that through and agency of nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons … a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator …”

These explanations of the meaning have been encapsulated in the 2005 Commentary on paragraph 2 of the Interest Article (Article 11) which says:

“The requirement of beneficial ownership was introduced in paragraph 2 of Article 11 to clarify the meaning of the words “paid to a resident” as they are used in paragraph 1 of the Article. It makes plain that the State of source is not obliged to give up taxing rights over interest income merely because that income was immediately received by a resident of a State with which the State of source had concluded a convention. The term “beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.”

  1. At paragraph 42 of the judgement the Court stated:

“The fact that neither the Issuer nor Newco [the intermediary companies in the case] was or would be a trustee, agent or nominee for the noteholders or anyone else in relation to the interest receivable from the Parent Guarantor is by no means conclusive. Nor is the absence of any entitlement of a noteholder to security over or right to call for the interest receivable from the Parent Guarantor. The passages from the OECD commentary and Professor Baker’s observations thereon show that the term “beneficial owner” is to be given an international fiscal meaning not derived from the domestic laws of contracting states.”

This shows that the Court effectively adopted an “international fiscal meaning” of beneficial ownership in contrast to what it calls a ‘narrow technical’ domestic law meaning.

  1. The Court supported the view that, under an “international fiscal meaning”, beneficial ownership is to be determined by reference to a test which requires that the recipient ‘enjoy the full privilege to directly benefit from the income’. It added that where recipients, as in the circumstances of this case, are bound in legal, commercial or practical terms to pass on the income, they will not be the beneficial owner of the income.
  2. The Chancellor examined the legal form of the loan notes issued and concluded at Paragraph 44 that, on the facts of the case, this legal form prevented Indofood from directly befitting from the income. However, he also looked wider than this “technical and legal approach” to consider the substance of the scheme in commercial and practical terms and found that it was “impossible to conceive of any circumstances in which [the intermediary] could derive any ‘direct benefit’ from the interest payable by the Parent Guarantor except by funding its liability to the Principal Paying Agent or Issuer respectively. Such an exception can hardly be described as the ‘full privilege’ needed to qualify as the beneficial owner…”. All these tests were applied to determine whether the intermediary was the beneficial owner of the income.
  3. Applying all these test, the Chancellor came to the conclusion that neither the Issuer nor Newco could be described as the beneficial owner of the income and, therefore, were not entitled to access the benefit of the relevant DTA.
  4. Finally, the Chancellor tested this conclusion against the purpose and object of the respective DTAs. He stated (at Paragraph 45) that this conclusion appeared “consistent with the evident purpose and object of the Mauritian DTA and the Dutch DTA. Their primary purpose is apparent from their respective titles.” The title of the Dutch DTA had already been stated (at Paragraph 14) as being “For the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.” The Chancellor continued, in Paragraph 45, to state “Accepting that the Dutch DTA also had as its object the encouragement of long term foreign loans, hence the inclusion of Article 11.4, none of such purposes is furthered by affording tax relief to the Parent Guarantor because it has a Mauritian or Dutch Subsidiary when such relief would not have been afforded to the Parent Guarantor had the loan been made direct to it.”