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HMRC internal manual

International Manual

Double taxation treaties: Beneficial ownership: What beneficial ownership means

Meaning of beneficial ownership

The concept of beneficial ownership first featured in the OECD Model in 1977. It was introduced to clarify what was meant by the term “paid to a resident” and provides that to qualify for the benefits of the DTA it is not enough that the immediate recipient of interest is a resident of the other state; the resident must also be the beneficial owner of the interest. Without this condition, a resident of a state with which the UK did not have a treaty could obtain treaty benefits by simply interposing an intermediary in a treaty partner state to receive income on its behalf.

The purpose of its inclusion was to prevent this abuse, but it is important to note that the concept is permissive as well as restrictive. While the benefits of the DTA will be denied if a claimant is not the beneficial owner of the income, relief will be allowed if the claimant resident in the other state is beneficial owner of the income, albeit that he may have derived the income through an intermediary. This will be the case whether the intermediary is resident in same state as the claimant or a third country.

Paragraph 9 of the Commentary to Article 11 of the OECD Model explains that the term

“beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in the light of the object and purpose of the treaty, including avoiding double taxation and the prevention of fiscal evasion and avoidance.

So its meaning is not limited to the meaning that it might have under the domestic law of a state (such as in the context of UK trust law), rather in the context of treaties it should be given an “international fiscal meaning”.

The Commentary gives three examples of persons who should not be considered the beneficial owners of income:

  • Agents;
  • Nominees; and
  • Conduit companies which have, as a practical matter, very narrow powers which render them, in relation to the income concerned, mere fiduciaries or administrators acting on account of the interested parties.

In the Indofood case (see INTM332040) the Court of Appeal commented favourably on guidance issued by the Indonesian tax authority which described the beneficial owner of income as a person ‘that has the full privilege to directly benefit from the income’ (see paragraph 42 of the judgement). The examples in the Commentary are not the beneficial owners of income because they do not have this ‘full privilege’.

It follows that if a person does not have the full privilege to directly benefit from the income they must be under an obligation to pass that income on to another person. This obligation might be found in legal documents, but the Court of Appeal was also clear that such an obligation might also be found by looking at the commercial and practical substance of an arrangement (see paragraph 44 of the judgement). It is, therefore, relevant to examine all aspects of a transaction and not just its legal form when enquiring into beneficial ownership. Further guidance on what to look for can be found in INTM504050.

Where an obligation to pass income on exists, it may not always be the case that the obligation is to pass the income on in the same form as it was received. For example, if an arrangement exists whereby a person is obliged to pass on an interest receipt in the form of dividends to a shareholder, the fact that the income has changed character is not in itself an indicator that the immediate recipient is the beneficial owner of the income. Similarly, the fact that income is not passed on immediately is not necessarily an indicator of beneficial ownership. For example, a investment advisor may be authorised to hold a client’s investment income on their behalf with a view to reinvestment by the client rather than paying it over immediately, but this would not make them the beneficial owner of the client’s income.

In considering whether an obligation to pass on an item of income exists, it should be noted that the obligation must be specific to the payment received. For example, a bank operating in the ordinary course of its business may borrow money (or accept deposits) in order to advance loans to borrowers. The interest income from borrowers in general will be used to pay interest on deposits and interest-bearing funding. However, as there is no obligation to pass on a specific item of income to another person, the bank is clearly the beneficial owner of the income it receives. Likewise, collective investment schemes or pension funds who pass investment income on to investors or scheme members in the form of distributions or pensions will still be the beneficial owners of that income.

So, while the test of beneficial ownership is important in preventing improper use of the UK’s tax treaties, its scope is limited to a particular set of circumstances: where a person does not have the full right to directly benefit from income because of an obligation to pass it on to another person. As a result it will not be applicable in all cases of treaty shopping and regard should also be had to other provisions in the relevant DTA if treaty abuse is suspected.