27 July 2008
The Tax Court of Canada gave its decision on 22 April 2008 in the case of Prévost Car Inc. v. Her Majesty the Queen (2008TCC231). In Prévost, a Canadian company paid dividends to a Netherlands company. The parties argued that the lower treaty rate of 5% should apply pursuant to Art. 10(2) of the Canda-Netherlands tax treaty. The tax authorities argued that the treaty did not apply as the Netherlands holding company was not the beneficial owner of the dividends. Their position was that the dividends were beneficially owned by the two shareholders of the Netherlands company, who were located in the United Kingdom and Sweden. The issue was, therefore, whether the holding company in the Netherlands was a mere conduit (or a mere agent or nominee) for the shareholders or the beneficial owner of the dividends. Put another way, the issue was whether the concept of beneficial ownership can be used to pierce the corporate veil in order to find that shareholders are the beneficial owners of a company's assets.
The taxpayer, Prévost Car Inc. (Prévost), a bus manufacturer, was incorporated under the laws of Quebec and is a resident of Canada. In 1995 its shareholders decided to sell their shares to Volvo Bus Corporation (Volvo) a resident of Sweden and Henlys Group PLC (Henlys), a resident of the United Kingdom. They set up a Netherlands resident company, PHB.V., to which they transferred the Prévost shares. The shares of PHB.V. were owned as to 51% by Volvo and 49% by Henlys. They formed PHB.V. because Volvo and Henlys were both in the business of manufacturing buses and wanted to expand into North America and both manufactured different parts. There were practical reasons, as well as tax reasons, for incorporating the entity in the Netherlands. Henlys did not want a Swedish company and Volvo did not want an English company. Both wanted a company resident in Europe where they have "a set-up" for that type of activity that is not too expensive and where business could be conducted in English. Arthur Anderson & Co. in Rotterdam had recommended that in order to avoid tax claims from the United Kingdom or Sweden, and other international tax issues, the effective management and control of PHB.V. should be located in the Netherlands. They also planned on expanding into Mexico.
The shareholders' agreement provided, among other things, that not less than 80% of the profits of the taxpayer and PHB.V. and their subsidiaries, if any (together called the "Corporate Group"), were to be distributed to the shareholders. The distribution of the profits was subject to the Corporate Group having sufficient financial resources. The dividends in question were paid by the taxpayer to PHB.V. and then distributed by PHB.V. to Volvo and Henlys in accordance with the Shareholders' Agreement.
At all relevant times PHB.V.'s registered office was in the offices of Trent International Management PHB.V. (TIM), originally in Rotterdam and later in Amsterdam. TIM was affiliated with PHB.V.'s banker, Citco Bank. In March 1996 the directors of PHB.V. executed a Power of Attorney in favour of TIM to allow it to transact business on a limited scale on behalf of PHB.V. There was no evidence what this "limited" business included. Later, in December 1996, PHB.V. executed another Power of Attorney in favour of TIM to allow it to arrange for the execution of payment orders in respect of interim dividend payments to be made to PHB.V.'s shareholders. During the years under appeal, PHB.V. had no employees in the Netherlands nor did it have any investments other than the shares in Prévost.
From time to time PHB.V. had to provide "Know Your Client" documentation to its banker. According to this documentation PHB.V. represented that the beneficial owners of the shares of Prévost were Volvo and Henlys, not PHB.V. itself.
Under Art. 10(2) of the Netherlands-Canada tax treaty, the source state can subject the dividends to withholding tax. If the recipient is the beneficial owner the tax shall not exceed 5% (25% under domestic law) if the company has a participating interest. The taxpayer maintained that the lower treaty rate of 5% should apply as PHB.V. was the beneficial owner of the dividends. The tax authorities argued that the treaty did not apply as PHB.V. was not the beneficial owner of the dividends; the two shareholders beneficially owned the dividends.
There is no definition of "beneficial owner" in the treaty. The Commentary on Art. 10 of the OECD Model Convention (1977) states that under Para. 2, the limitation of tax in the state of source is not available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, unless the beneficial owner is a resident of the other contracting state. The 2003 Commentaries state that "beneficial owner" is not used in a narrow technical sense, rather, it would be understood in its context and in light of the object and purposes of the treaty, including avoiding double taxation and the prevention of fiscal evasion and avoidance. With respect to conduit companies, a report from the Committee on Fiscal Affairs concluded "that 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 acting on account of the interested parties".
According to Art. 3(2) of the treaty, any term not defined in the treaty shall, unless the context otherwise requires, have the meaning which it has under the law of that state concerning the taxes to which the treaty applies. Under Canadian legislation, where a term is not defined in the treaty, one is to look to the meaning in the Canadian Income Tax Act, in its amended form, rather than the meaning at the time the treaty was entered into.
According to Canadian case law (Gladden Estate v. The Queen), tax treaties are to be given a liberal interpretation with a view of complementing the true intentions of the contracting states. The paramount goal is to find the meaning of the words in question (Crown Forest Industries v. The Queen).
A number of expert witnesses were called. Daniel Lüthi gave evidence on the factual background of the use of the term "beneficial owner" in treaties. He stated that the term "beneficial owner" was introduced into Art. 10(1) of the OECD Model Convention (1977), so as to explicitly exclude intermediaries in third states, such as agents and nominees, from treaty benefits. There was no expectation that a holding company was a mere agent or nominee for its shareholders, that is, that its shareholders were the beneficial owners of the holding company's income. Indeed, a holding company is the beneficial owner of dividend paid to it unless there is strong evidence of tax avoidance or treaty abuse. With respect to conduit companies, he referred to the CFA Report of 1987, Double Taxation Conventions and the Use of Conduit Companies, which provides, inter alia, that the OECD does not deny every conduit company the ability to be the beneficial owner by stating "...[t]he fact that the conduit company's main function is to hold assets or rights is not itself sufficient to categorise it as a mere agent or nominee, although this may indicate that further examination is necessary ...". On the other hand, a conduit company cannot normally be considered to be the beneficial owner of the income received if it has very narrow powers, performs mere fiduciary or administrative functions and acts on account of the beneficiary (most likely the shareholder). In the view of the OECD, such a company has only title to property, but no other economic, legal or practical attributes of ownership. In such a case, the company, based on a contract or by way of obligations taken over, will have similar functions to those of an agent or a nominee. According to Art. 4 of the OECD Model Convention (2005), a conduit company, in order to be entitled to claim treaty benefits, must be liable to tax in its residence country on the basis of its domicile, place of management etc. In addition, the assets and rights giving rise to the income must have effectively been transferred to the conduit company. If this is the case, the conduit company cannot be considered to act as a mere agent or nominee with respect to the income received.
Under Canadian law, the term "beneficial" owner is not defined in the Income Tax Act. In Jodrey Estate the Supreme Court found that the plain ordinary meaning of the expression "beneficial owner" is the real or true owner of the property. The property may be registered in another name or held in trust for the real owner, but the "beneficial owner" is the one who can ultimately exercise the rights of ownership in the property.
The taxpayer called an expert in Netherlands law, Professor van Weeghel. He explained that the Netherlands version of the treaty uses the term uiteindelijk gerechtigde for "beneficial owner". This term, translated back to English, means "he who is ultimately entitled". He said that following the Hoge Raad decision in the Royal Dutch case, a person is the beneficial owner of a dividend if (i) he is the owner of the dividend coupon, (ii) he can freely avail of the coupon, and (iii) he can freely avail of the monies distributed. Van Weeghel stated that under Netherlands law, PHB.V. would be regarded as the beneficial owner of the dividends. However, if PHB.V. were legally obligated to pass on the dividends to its shareholders, Netherlands law would consider PHB.V. not to be the beneficial owner of the dividends. Professor Raas was also called on to give expert evidence. He opined that the dividends received by PHB.V. were within the taxing authority of the Netherlands government and that, but for the participation exemption granted by the Netherlands to PHB.V., PHB.V. would have been subject to Netherlands tax in respect of the dividends. Despite the existence of a Shareholders' Agreement between Volvo and Henlys and the Powers of Attorney granted to TIM, PHB.V. itself was not contractually or otherwise required to pass on the dividends it received from the taxpayer. In all cases, dividend payments had to be authorized by PHB.V.'s directors in accordance with Netherlands law and practice. The Shareholders' Agreement and Powers of Attorney did not have any effect on the ownership of the dividends by PHB.V. The tax authorities disagreed, however, on the basis that Professor Raas assumed incorrectly that PHB.V. had a dividend policy independent of that of the Corporate Group set out in the Shareholders' Agreement and referred to in PHB.V.'s Articles of Association. Instead, crown counsel argued, the discretion of the directors of PHB.V. to determine the adequacy of working capital of PHB.V. was inextricably tied to the same determination being made by the directors of Prévost.
The Canadian and the Netherlands tax authorities disagreed who was the "beneficial owner" of the dividends received from Prévost. The Netherlands was of the view PHB.V. was the "beneficial owner". The taxpayer requested competent authority assistance. There was some communication between the tax authorities of Canada and the Netherlands, but when the Netherlands and Canadian views differed as to whether the beneficial ownership requirement in Art. 2 of the Canada-Netherlands tax treaty affected situations similar to those in the appeals at bar, the Canadian authorities terminated the competent authority review.
The court determined that the "beneficial owner" of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. The person who is beneficial owner of the dividend is the person who enjoys and assumes all the attributes of ownership. In short, the dividend is for the owner's own benefit and this person is not accountable to anyone for how he or she deals with the dividend income. When the Supreme Court in Jodrey stated that the "beneficial owner" is one who can "ultimately" exercise the rights of ownership in the property, the Court did not mean, in using the word "ultimately", to strip away the corporate veil so that the shareholders of a corporation are the beneficial owners of its assets, including income earned by the corporation. The word "ultimately" refers to the recipient of the dividend who is the true owner of the dividend, a person who could do with the dividend what he or she desires. It is the true owner of property who is the beneficial owner of the property. Where an agency or mandate exists or the property is in the name of a nominee, one looks to find on whose behalf the agent or mandatary is acting or for whom the nominee has lent his or her name. When corporate entities are concerned, one does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds put through it as conduit, or has agreed to act on someone else's behalf pursuant to that person's instructions without any right to do other than what that person instructs it, for example, a stockbroker who is the registered owner of the shares it holds for clients. This is not the relationship between PHB.V. and its shareholders.
The situation was that Prévost, a Canadian corporation, was paying dividends to its sole shareholder, PHB.V., a Netherlands corporation. The court found there was no evidence that PHB.V. was a conduit for Volvo and Henlys. It is true that PHB.V. had no physical office or employees in the Netherlands or elsewhere. It also mandated to TIM the transaction of its business as well for TIM to pay interim dividends on its behalf to Volvo and Henlys. However, there is no evidence that the dividends from Prévost were ab initio destined for Volvo and Henlys with PHB.V. as a funnel of flowing dividends from Prévost. The financial statements of PHB.V. reflect that PHB.V. owned assets and had liabilities. For Volvo and Henlys to obtain dividends, the directors of PHB.V. had to declare interim dividends and subsequently shareholders had to approve the dividend. The court could not find any obligation in law requiring PHB.V. to pay dividends to its shareholders on a basis determined by the Shareholders' Agreement. When PHB.V. decides to pay dividends it must pay the dividends in accordance with Netherlands law. PHB.V. was the registered owner of Prévost shares. It paid for the shares. It owned the shares for itself. When dividends are received by PHB.V. in respect of shares it owns, the dividends are the property of PHB.V. Until such time as the management board declares an interim dividend and the dividend is approved by the shareholders, the monies represented by the dividend continue to be property of, and is owned solely by, PHB.V. The dividends are an asset of PHB.V. and are available to its creditors, if any. No other person other than PHB.V. has an interest in the dividends received from Prévost. PHB.V. can use the dividends as it wishes and is not accountable to its shareholders except by virtue of the laws of the Netherlands. Volvo and Henlys only obtain a right to dividends that are properly declared and paid by PHB.V. itself, notwithstanding that the payment of the dividend has been mandated to TIM. Therefore PHB.V. was the beneficial owner of the dividends.
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