Month: August

Can we not ask one question to ourselves? Where is that soul and where is that awakening? In that dance of death in Uttarakhand many pilgrims have been looted, robbed and corpses have been disfigured to steal a few grams of gold. Is this our tryst with our destiny? Compare this with Japan where atomic power plant was completely damaged by tsunami. It was a huge national disaster. Hundreds were washed away, Entire township collapsed like a pack of cards. But not a single incidence of looting or theft was reported. People formed orderly queues quietly to gather help. Each one of the Japanese was doing his best to be accountable in that disaster. Here some are questioned, few are held accountable, and nobody is punished. There is no accountability-neither to the nation nor to the conscience. During elections politicians woo voters, like the directors during a general meeting of shareholders. Once done, forgotten for a year. Do anything, nothing will happen, if you have same powerful friends at the right places.

What we lack is sensitivity, and national character. Even the so called educated during traffic jams will break traffic laws to rush ahead, causing more traffic jams. There is no discipline, no respect for order. For everything to run in order we require a long danda. Our politicians have not taught us patriotism they demand blind loyalty. Power is their sole aim. We have forgotten that this country is a huge organisation or company and every citizen is its valued member . None think that he is responsible/accountable to the motherland. If you expect your country to give you education, food, clothing, employment and all sort of facilities don’t we owe anything to it? We want our fundamental rights, privileges, legal help but what about our responsibilities? Mere authority without any accountability/ responsibility is the privilege of a harlot. We have degenerated ourselves to this dismal level.

After seeing a large number of relatives, grand sire Bhishma and friends, assembled at kurukshetra, Arjuna’s limbs became languid and body started trembling. The famed Gandiwa started slipping from Arjuna’s powerful hands. Dharmaraja had entered kurukshetra war because of the total commitment of Arjuna & Bheema. Arjuna wavered; Lord Krishna made him aware of his duty, his commitment and accountability. He chastised him with severe words. Don’t be an eunuch Arjuna, be steadfast. You scorcher of foes arise, give an excellent account of your power and forget your petty-heartedness. We require today leader like Lord Krishna and followers like Arjuna totally committed, never compromising on accountability/ responsibility. The last words of Socrates show us how when death was staring at his face – he fulfilled his responsibility. To his close friend, before drinking deadly poison, Socrates said, “Crito, we owe a cock to Asclepius. Do pay it. Don’t forget it” when as a nation we become as accountable as Socrates we shall rise to dizzy heights.

My mind goes back to the great founder of the Maratha Empire Chhatrapati Shivaji and his clear vision. Prataprao Gujar, his brave and loyal general allowed Bahlol Khan, a sworn enemy of Marathas to escape when he had surrendered totally and shown white flags. Prataprao in a moment of generosity exceeded his limits and allowed Bahlol Khan and his thirsty army to quench their extreme thirst and to escape. Shivaji Maharaj was not amused. He won’t have any of such nonsense. When he came to know of Prataprao’s blunder he thundered in his letter “On whose permission did you allow Bahol Khan to go? Didn’t you know that the same Khan had killed our army and devastated our country? You are accountable for this blunder. Go at once and catch Khan or don’t show me yourself’. Prataprao understood his grave mistake and attacked with his handful of brave soldiers and died. When twin towers fell in New York, the Mayor of New-York camped at that site and directed all operations. Here we come by helicopter, survey and retreat. That is the only duty we perform. It is better to be a good, effective and accountable citizen and fulfill one’s obligations than to have hollow name and power.

When we glance at our independence movement we see beacon lights in Dadabhai Naoroji, Gopal Krishna Gokhale, Bal Gangadar Tilak and Mahatma Gandhi etc. when the whole of India was dancing wildly in independence Celebration, Gandhiji went on fast unto death to restore peace in Bengal at Naokhali. He held himself accountable and responsible for brutal communal killing and went in the midst of violent killing mobs and restored order. Where are such leaders today and where are such loyal followers of Gandhiji? There are two types in this world, those who expect politician to produce responsible, alert, selfless and disciplined citizens and others who do practice these virtues themselves. Those who rely upon politicians, government are indulging in pipe-dream. Reform, accountability start with us let us remember.

In the word of Malcome Muggeridge a great thinker, never was any generation of men, more advantageously placed to attain a grand dream fulfilled but we with seeming deliberation took opposite course towards destruction instead of creativity and light. The persistent incompetence and unaccountability of leaders in all fields including Social, Political, and Financial, has brought us to this dismal state. Our finest spiritual heritage has sunk abysmally. Our own Karma is responsible for them.

If we decide on it we can certainly do it. If we punish vices severely and reward virtues generously that will be the first step towards achieving it.

Let us get committed. Let us be patriotic again and not self-centered.

There is a beautiful…………(Shloka) in Sanskrit. Let me quote it here.

With this in mind, it is interesting to note the Bombay High Court’s recent dismissal of the Revenue’s appeal in the case of DIT vs. Universal International Music BV4 on the issue involving beneficial ownership of royalty payment. The question of law raised before the High Court was whether on the facts and circumstances of the case and in law, the Tribunal was correct in holding that the Dutch company (Universal International Music BV) is the ‘beneficial owner’ of the royalty received from the Indian Company (Universal Music India Private Ltd) and therefore entitled to be taxed at a rate of 10 % as per the Tax Treaty?

The facts of this case are not fully clear because as noted by the Tribunal in its Order, the taxpayer did not furnish all the information before the tax inspector. 5 However, it is clear that, during the year, the taxpayer-a company incorporated in the Netherlandsreceived a royalty from the Indian company(Universal Music India Private Ltd). The Universal Music Group is known as one of the largest music publishing groups in the world,with global group headquarters in USA. According to its business model, the group companies enter into contracts with singers, performers,etc. Such companies are known as repertoire companies.The repertoire companies license these rights to other group companies outside their home territories for its commercial exploitation.Accordingly, Universal Music India Pvt. Ltd. was granted rights of exploitation in India, with the result that the Indian Company paid royalties to the Dutch company on acquired licences of musical tracks.

As mentioned, the taxpayer did not file before the tax inspector copies of the agreement between the taxpayer and repertoire companies and did not furnish information of the persons from whom the taxpayer had acquired the musical rights.The Assessing Officer therefore held that the taxpayer was not the ‘beneficial owner’ of the royalty but was merely a collecting agent of the repertoire companies.The Assessing Officer deniedthe taxpayerthe benefit of the reduced rate of withholding tax available under Article 12 of the tax treaty and taxed the royalty at the maximum rate (30 %). The CIT(A) and the ITAT decided the appeal in favour of the taxpayer6.

The High Court decided the appeal in favour of the taxpayer on following basis:

1. The CIT(A) and the Tribunal arrived at the finding of fact on the basis of the certificate from revenue authorities in the Netherlands certifying that the taxpayer was a ‘beneficial owner’ of the royalty received in respect of musical tracks given to Universal Music India Pvt. Ltd.

2. CBDT Circular No.789 dated 13-04-20007, which states that the certificate from the revenue authorities is sufficient evidence of beneficial ownership.

3. The Revenue was not able show anything on record to contradict the finding of fact arrived at by the CIT(A) and the Tribunal that the taxpayer is the ‘beneficial owner’ of the royalty received on musical tracks given to Universal Music Private Limited.

Apparently, there was no one to argue the Revenue’s appeal before the High Court. Otherwise, arguments might have been placed that, firstly, in the absence of agreement, it could not be ascertained as to whether the Dutch company acted or did not act as an ‘agent’ or ‘nominee’ of other group companies or was a ‘conduit’ between one of the group companies and the Indian company. Therefore, on the given facts,the Tribunal could not have reached the legal finding which it did reach. Secondly, the certificate of beneficial ownership furnished by the taxpayer is the interpretation arrived at by the Netherlands authorities. Indian Courts may not necessarily agree with the interpretation of the Netherlands authorities. Thirdly, Circular 789 specifically deals with the India-Mauritius tax treaty. It cannot be applied to India-Netherlands tax treaty. Fourthly and most importantly, the Tax Residency Certificate (TRC), which is subject matter of Circular 789 relied upon by the Court, has nothing to do with the beneficial ownership.

The same view on the relationship of the TRC to beneficial ownership was expressed in a different context by the Indian Finance minister Mr. P. Chidambaram. On the proposed insertion of section 90A(5)8 he stated that “all that the Section 90A(4) intends to say is, if you produce a TRC that is a complete answer to your status as a resident. But whether you are the beneficial owner is a separate issue. The TRC certifies that you are a resident. It does not certify you are a beneficial owner.”9 His statement only supports the fact that the reliance placed by the High Court on the TRC to decide the beneficial owner issue is misplaced.

In context, one cannot avoid the feeling that the High Court and the Tribunal lost a valuable opportunity to provide guidance as to the meaning of ‘beneficial owner’. In other words, this judgment highlights the fact that this concept has not received the attention of the experts in India as much as it has received outside India.

This Article proposes to discuss the meaning of theexpression ‘beneficial owner’ in light of the revised draft guidelines on ‘beneficial owner’ released by the OECD last year10 and position of the Indian law on ‘beneficial owner’. However, it might be worthwhile first to discuss other related aspects of this concept.

I. Background

The term ‘beneficial owner’ is found in the Double Taxation Avoidance Agreements (DTAAs) in Articles 10, 11 and 12 on interest, dividend and royalty payments respectively. These tax treaty articles provide for withholding tax at the reduced rate, if the recipient is a ‘beneficial owner’ of the dividends, interest or royalties and is a resident of the state which is a party to the DTAA. It may be mentioned that the concept of ‘beneficial owner’ was introduced in the tax treaties as a countermeasure against treaty shopping11 to confine bargaining only to the contracting states which were intended to benefit from the treaty. 12

J David, B Oliver et al have noted that it was Article III of the 1945 United Kingdom-United States tax convention which referred to beneficial ownership, prior to the usage of the term by the OECD13. The OECD used it for the first time in the Model Convention in 1977. This term is neither defined in the OECD Model Convention nor in any of the Indian tax treaties. The term is not used by civil law countries but is used in many common law countries.14 In fact, Indian income tax law and other laws also use the term ‘beneficial owner’. Therefore, one would be tempted to apply the meaning of ‘beneficial owner’, as explained in the Indian domestic law, to the Indian tax treaties, when it is not defined in the tax treaty. However, it is now widely accepted that this term should be given international fiscal meaning and not domestic law meaning. There are several reasons for coming to this conclusion. These reasons are discussed in the subsequent paragraphs:

II. Meaning of ‘beneficial owner’-what is the context?

The expression ‘beneficial owner’ is not defined in the tax treaties. When a particular term is not defined in a tax treaty, Article 3(2)15 of both the OECD and UN Model treaties requires that the domestic law meaning may be adopted unless the context otherwise requires. Therefore, before applying the domestic law meaning, one has to conclude that the context does not otherwise require adopting a meaning other than the meaning given in the domestic law. The basic question-here is:what is the context for ‘beneficial owner’? The OECD commentary also states that 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.16 This raises a further question, as to what extent OECD commentary is relevant for interpreting tax treaty? Another broader question is, as to how text treaties are to be interpreted?

Tax treaties are to be interpreted according to the Article 3117 and Article 3218 of the Vienna Convention of Tax Treaties, 1969. Article 31(1)requires that atreaty shall be interpreted in ‘good faith’ (pacta sunt servanda) in its context and in light of its object and purpose.The obvious object and purpose of the tax treaty is to avoid double taxation and to counter treaty shopping. To achieve these objectives, it is necessary that a meaning accepted by all, that is, international autonomous meaning, should be given. Further, the meaning derived from the OECD material, including OECD documents considered at the time of writing commentary, is the special meaning referred in the Ar-ticle 31(4)19. This meaning is also articulated in the OECD commentaries, which call for adoption of international meaningof this term. It may be appreciated that OECD material can also be used as supplementary means of interpretation of tax treaty.20 Thus, it can be concluded by following above approaches that an international fiscal meaning is to be used for interpreting the term ‘beneficial owner’. This position is affirmed again by the OECD in the revised discussion draft on ‘beneficial owner’, in which references to the domestic law mean-ing of beneficial owner, which were appearing in the first draft were deleted.21 It may be interesting to note that the Court of Appeal in the Indofood decision has also stated that, “the term ‘beneficial owner’ is to be given international fiscal meaning not derived from the domestic laws of the contracting states.”22

Further, on examination of the object and purpose of the tax treaty, it can be seen that the treaty does not use the general term ‘owner’ but uses the specific term ‘beneficial owner’. Therefore, the treaty intends to give the benefit of withholding tax at the reduced rate only to the person who can be loosely described as a ‘final’ owner of income. The concept of ‘final owner of income’ can be elaborated with the help of attributes of ownership of income. Income ownership has several attributes, such as the right to possess, use or manage income, the power to alienate and ability to consume waste or destroy, the risk of depreciation and hope of appreciation.23 It is possible to split these attributes among different persons by entering into a legal or contractual arrangement to avail benefit of the favourable treaty without losing ownership of income. Therefore, the ‘beneficial owner’ is the one which has more attributes of ownership of income than others. This explanation is described by Charl Du Toit as ‘beneficial owner is the person whose ownership attributes outweigh those of any other person’.24 Considering these aspects,the domestic law meaning of the ‘beneficial owner’ is not relevant in interpretation of this concept; instead, autonomous fiscal meaning is to be given.

As mentioned, the OECD revised draft implicitly accepts this position by deleting references to resorting to domestic law for its interpretation. However, it needs to clearly mention the adoption of international fiscal meaning in the Commentary.

III.    Meaning of ‘beneficial owner’

As mentioned, the term ‘beneficial owner’ historically under common law had the objective of distinguishing the concept of ‘legal ownership’ for trust law purposes, which referred to the formal attributes of trustee ownership, from beneficial ownership, which was held by the ‘true’ beneficiaries, who could enforce their rights against third parties.25

The OECD Commentary of 1977 defined ‘beneficial owner’ in a negative manner by denying treaty benefits to ‘agents’ and ‘nominees’. It stated in 2003 that normally a ‘conduit company’ will not be regarded as a ‘beneficial owner’. The Commentary did not decline tax treaty benefits to ‘conduit companies’ in all the cases. Because as Baker has pointed out, it is perfectly possible in certain cases that intermediary holding company can be regarded as a ‘beneficial owner’.

26    However, ‘beneficial owner’ was not defined in a positive manner and its meaning continued to remain uncertain.

Several Court decisions deciding this issue one way or the other only added to the uncertainty and did not conclusively resolve the issue. For example, in one of the most quoted decisions, Indofood,27 the issue before the Court was not related to tax28 . The tax issue was hypothetical and incidental29. The case was argued by lawyers and heard by judges, who both were not expert in tax matters30. The Court of Appeal in Indofood held that, as shown by the commentaries and observations, the concept of beneficial ownership is incompatible with that of the formal owner who does not have the full privilege to directly benefit from the income.31 This meaning is based on the Indonesian domestic Circular on Beneficial Owner.32 Although the decision states that international fiscal meaning should be adopted, it has decided the appeal based on elements of Indonesian domestic law.33

The Canadian Prevost34 decision is criticised as a narrow legalistic interpretation of beneficial ownership35. It did not consider substance of the arrangement. Whereas, in the case of Bank of Scotland36, the Court applied anti-abuse doctrine and found that the arrangement was entered into for the sole purpose of obtaining treaty benefits37. Strictly speaking, this decision does not consider the attributes of ‘beneficial owner’ for deciding the case. The more recent decision of Velcro38 follows the approach adopted by the Court in Prevost. There are several other decisions on ‘beneficial owner’; however, it is difficult to arrive at a common meaning of the term after considering all the judgments.

Experts and scholars are also not unanimous in their views on beneficial ownership. According to Vogel, a ‘beneficial owner’ is one who is free to decide (1) whether or not the capital or other assets should be used or made available for use of others or (2) on how the yields therefrom should be used or (3) both39. Danon is of the view that for deciding beneficial ownership, legal, economic and factual control over use of income should be decisive over the element of enjoyment of income and ownership attributes. He also believes thatthis issue should be examined on the basis of the substance-over-form approach40. For Charl du Toit, the beneficial owner is the person, whose ownership attributes outweighs those of any other person.41

Jurisdictions such as China have attempted to provide guidance on this vexed concept.42 A Chinese Circular43 essentially defines ‘beneficial owner’ as one who meets all the following four conditions:(1) a person has the right to own or dispose of the income and rights or property in the income; (2) a person who is usually engaged in a substantial business operation; (3) a person who is not an agent; and(4) a person who is not a conduit company.44

However, despite the opinions of experts and several court decisions, the meaning of beneficial owner has remained elusive.

IV. OECD meaning-revised discussion draft

The OECD released a revised discussion draft on October 19 2012. The OECD, after making additions and deletions to the first draft, arrived at the revised draft para 12.4 on meaning of ‘beneficial owner’ as below:

12.4 In these various examples (agent, nominee, conduit company acting as a fiduciary or administrator), the recipient of the dividend is not the “beneficial owner” because that recipient’s right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass on the payment received to another person. Such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person. This type of obligation must be related to the payment received; it would therefore not include contractual or legal obligations unrelated to the payment received even if those obligations could effectively result in the recipient using the payment received to satisfy those obligations. Examples of such unrelated obligations are those unrelated obligations that the recipient may have as a debtor or as a party to financial transactions or typical distribution obligations of pension schemes and of collective investment vehicles entitled to treaty benefits under the principles of paragraphs 6.8 to 6.34 of the Commentary on Article 1. Where the recipient of a dividend does have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the “beneficial owner” of that dividend. It should also be noted that Article 10 refers to the beneficial owner of a dividend as opposed to the owner of the shares, which may be different in some cases.

The OECD in the revised draft has again given a negative definition of ‘beneficial owner’. However despite doing so, it has furnished an almost acceptable work. The revised draft states that the recipient of the dividend is not the “beneficial owner”, when the recipient’s right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass on the received payment to another person. It has further clarified that the obligation can normally be ascertained from the legal documents and facts and circumstances, which show in substance that recipient does not have right to enjoy or use income unconstrained by obligation to pass on the payment.

Secondly, the obligation must relate to the payment received. Therefore, it would not include contractual or legal obligations unrelated to the payment received even if those obligations could effectively result in the recipient using the received payment to satisfy those obligations.

The OECD has placed the comments received on the discussion draft on its website. It might be interesting to peruse some of these comments. Avellum partners in their comments have stated that a fiduciary or administrator of income may be considered as a beneficial owner of such income, provided there is sound commercial reason for establishment of such entity. For example, entities established for public issuance of securities traded on recognised stock exchanges could be beneficial owners of income provided that operation of their establishment was required for access to the stock exchange for legal or regulatory considerations and not merely for tax economy purposes.46

Van Bladel has argued that to be a beneficial owner, the owner of an asset should also be its legal owner. Besides being a legal owner, it also should have sufficient degree of economic ownership. According to which,a legal owner will not be able to fully recover the value of its asset. In his opinion, this can be measured by the solvency rules of Basel II and Basel III, whereby, no beneficial ownership can be assumed if there is no solvency requirement. According to him, beneficial ownership can be assumed if there is a solvency requirement of 1.6 %, 8 % or 100 %. However, beneficial ownership will be debatable in the case of 0 % solvency.47

Regarding ‘facts and circumstances’ to be considered for ascertaining as to whether there is any contractual obligation or not, it is suggested that factors such as close dates of receipt and payments, similar amounts of receipt and payment, similar subject matter or same reference asset or currency,48 same counterparty of transactions, same or similar interest or rate of return, same duration of transactions, same amount or quantum of contracts etc should be considered.49 It is suggested further that the contractual obligation must exist before the receipt of payment and must be triggered only on receipt.50 Moreover, conduct and statements of the parties also should be taken in to account while considering ‘facts and circumstances’.51 As far as use of the word ‘substance’ is concerned, it is suggested that, it should be seen as ‘economic substance’ used in the anti-avoidance doctrine.52 It should also be examined as to whether recipient has gained risk and control over the payment.53

Maximum numbers of the comments are received on the use of word ‘related’ and ‘unrelated’. The commentators have found these words to be unclear and thus giving uncertainty to the proposed explanation of the concept. However, Vaan Raad in his comments has aptly explained these words by giving examples. He has stated that, normally a person (individual or company) receiving income also will have an obligation to make payments. For example, a salaried person may have contractual obligation to pay house rent. A bank receiving interest income on money lent by it is under contractual obligation to pay interest on money deposited with it. However, these obligations are independent of any particular receipt. This would be different if any particular receipt is earmarked by an obligation based on law or contract to be forwarded to another person.54

This can also be explained with the help of the concept of ‘diversion of income by overriding title’. The Indian Supreme Court explained this concept by holding that, Where by the obligation income is diverted before it reaches the assessee, it is deductible (being income diverted by overriding title) ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law does not follow.55 (Words in the bracket are added). If this concept is applied to the ‘beneficial owner’, then it can be said that the recipient is not a ‘beneficial owner’ whose income is diverted because of the overriding (either legal or contractual) title. The payment made in consequence to such overriding title would be considered as a ‘related’ payment, whereas the payments of application of income would be considered as ‘unrelated’ payment.

The concerns of all would be adequately addressed if the OECD incorporated an explanation on ‘related’ and ‘unrelated’ payments on the above lines in its final version.

If we were to revisit the case law discussed here in light of the proposed clarification in the revised discussion draft, it may be seen that the decision of Indofood will hold good. However, the decision in the case of Bank of Scotland could generate discussion. This is because, the UK company RBS had already made upfront payment to a US company on acquisition of usufruct of shares of French subsidiary. Therefore, there was no legal or contractual obligation on RBS to make payment to the US company from receipt of dividend. Secondly, as mentioned earlier, this decision is rendered by following the doctrine of anti-avoidance and not considering attributes of beneficial ownership. In this case, beneficial-ownership test was not applied independently of the ‘abuse of law’ concept, but rather as a consequence of ‘abuse of law’ analysis.56 Further, RBS cannot be considered as an ‘agent ‘or ‘nominee’ or ‘conduit company’ of the US parent company. Yet, it is clear from the facts that, RBS cannot be considered ‘beneficial owner’ of the dividend.

Similarly, in Prevost shareholders had decided by agreement to distribute 80 % of profit. Other important facts of Prevost are that, the holding company in the Netherlands had minimum substance, and the directors in holding company and in the Canadian company were the same. Secondly, the intermediary company had only two shareholders; namely, Henleys and Volvo. Therefore, in substance, there is no difference between the company and shareholders, when shareholders had agreed to act in a particular way. Although the company is a different legal entity, it acts only according to the wishes of the shareholders. In these circumstances, the company is bound to follow the shareholder’s agreement. However, the Canadian court has not seen the facts this way. Probably because according to it, as expressed in the decision of Velcro, piercing of the corporate veil should be done as a the last resort.57

In Velcro 90 % of royalties were to be paid to the parent company within 30 days. The Canadian Court decided after elaborately discussing as to how the intermediary company was in ‘possession’, ‘use’ ‘risk’ and ‘control’of the payments and how it cannot be regarded as ‘agent’ or‘nominee’ or ‘conduit company’. Legally speaking, it is difficult to disagree with both the decisions. These decisions are also compatible with the revised draft as recipients’ right to use or enjoy is not constrained by obligation related to receipt. Most of the scholars and experts across the world find these decisions acceptable by following the legal approach. However, the ‘substance’ of the matter is quite different in both the cases.

This discussion highlights the apparent shortcoming of the revised draft as it does not explicitly address substance-over-form aspect, which is necessary to address the situation involving some of the tax–avoidance arrangements involving ‘beneficial owner’. The OECD addresses this aspect in para 12.4by stating that “Such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person”.

Draft para 12.5 permits application of other approaches to counter anti-avoidance by stating that, “whilst the concept of “beneficial owner” deals with some forms of tax avoidance (i.e. those involving the interposition of a recipient who is obliged to pass on the dividend to someone else), it does not deal with other cases of treaty shopping and must not, therefore, be considered as restricting in any way the application of other approaches to addressing such cases.” However, it might be good if the OECD elaborates on such aspect for clarity and certainty.

V. India’s Law

Beneficial ownership is not a new concept in Indian law. It is used in the Income tax Act, 196158 and is also used in several non-tax laws such as the Companies Act 1956, Depositories Act 1996, Indian Trusts Act 1982 and Transfer of Property Act 1882.59

It may be noted thatthe concept of ‘beneficial owner’ in treaties is used with reference to the ownership of income and not with respect to the ownership of the underlying asset.60 Ownership of the underlying asset is not relevant for determining whether a person is a beneficial owner of income or not. However, Indian income tax law uses this concept with relation to the beneficial ownership of asset. Therefore, the majority of the disputes relate to issues in which formal legal ownership was not vested with the person because legal title was not yet registered in the official records in its name. In these circumstances, Court had to decide the dispute as to whether such person could be held as a beneficial owner or not for attributing income u/s. 2(22)(e) or granting depreciation or for taxing capital gain u/s. 2(45A).

The factors on which a person can be considered as ‘beneficial owner’ of the asset are different than whether a person can be considered as‘beneficial owner’ of income. Therefore, Indian domestic law is of no help in understanding the domestic law meaning of ‘beneficial owner’ of income. This is notwithstanding the position that the domestic law is not relevant for ascertaining the treaty meaning of ‘beneficial owner’.

A striking consequence emerges that a ‘beneficial owner’ may not be taxable under Indian tax treaties. This is because, presently, Indian income tax law u/s. 9 attributes income (interest and royalty for the purpose of beneficial ownership) to the non-resident recipient. However, the ‘beneficial owner’ remains out of the legal purview for its taxability. This can be explained with an example. Let us assume that entity X, resident of country ‘A’, advances a loan to an Indian entity through a conduit company, which is a resident of Country ‘B’, to access the more favourable India-Country B tax treaty. However, domestic law taxes interest payable by Indian residents to a conduit company but does not tax interest payable by conduit company to entity X in country A. As domestic law does not tax the beneficial owner, Indian tax authorities may not be in a position to invoke the India-Country ‘A’ tax treaty,with the result that India may have to tax only a conduit company and not the ‘beneficial owner’ because it is not taxable under domestic law. However, this position would work favourably for the taxpayer till the Income-tax Act is amended.

VI. India’s Tax Treaties

Most Indian tax treaties use the concept of beneficial owner to grant the benefit of reduced withholding taxes.61 Only the India-Australia tax treaty uses the expression ‘beneficial entitlement’. It is clear from the term ‘beneficial entitlement’ that it is a somewhat different concept than ‘beneficial owner’. The term ‘beneficial entitlement’ is concerned with the‘right to use and enjoy’ income and not concerned with its ownership.

Indian judicial decisions on beneficial ownership under domestic Income Tax law mainly pertain to beneficial ownership of shares and pertain to the ownership of an asset for eligibility of depreciation.In International taxation, the decisions are with respect to beneficial ownership of shares for taxing capital gains.62 In fact, Brian Arnold has questioned the application of the ‘beneficial ownership’ concept in the Indian cases on international taxation, when such a provision does not exist in the Article 13 of the tax treaty on Capital Gains.63

With regard to the nature of the Indian judicial decisions on beneficial ownership, Universal international Music BV was probably the first case in India, in which the issue of beneficial ownership was involved as provided in the tax treaty. The Courts had an opportunity to provide guidance on this difficult issue. However, that was not to be.

This article first appeared in the June, 2013 issue of Tax Planning International Review, published by Bloomberg BNA.

63Brian Arnold, Tax Treaty News, Bulletin for International Taxation, Vol 65(2011) no 2 PP 650-654. He has stated that “the taxpayer would likely argue that the absence of any express beneficial owner requirement in article 13 was intentional and it would, therefore, be inappropriate for a court to read such a requirement into article 13. It might be possible for a court to deny the benefit of article 13 of the tax treaty in these circumstances by applying a domestic anti-avoidance rule or by interpreting article 13 in accordance with paragraphs 7 to 12 of the OECD Commentary on Article 1 of the OECD Model (2010) to prevent abuse of the tax treaty. Both approaches are, however, problematic”.

However, when we speak of control in the
field of corporate law in India, there are numerous meanings and there
is no uniformity. Often, this causes regulatory uncertainty and
ambiguity and leads to interpretation issues. More often than not, the
interpretation of the term ‘control’ has been the subject matter of
widespread debate. Recently, it has been in the limelight on account of
certain sensitive sectors in India, such as, telecom, aviation, defence,
etc. Let us examine the diverse meanings of this term under various
Regulations and the issues ensuing from the same.

Companies Act, 1956
The
Companies Act, 1956, (the “Act”) which currently is the mother statute
for corporate law in India, interestingly does not define this very
important term. However, section 4 of the Act which defines a holding
company and a subsidiary, states that the composition of a company’s
(i.e., a subsidiary) board of directors shall be deemed to be controlled
by another company (i.e., a holding company) if the holding company can
exercise power at its discretion, without the consent of any other
person, to appoint/remove all or a majority of the directors of the
subsidiary. If such a control exists then holding-subsidiary
relationship is deemed to exist. Thus, the ability to control the
composition of the board or the power to appoint or remove the majority
of the board renders one company as a subsidiary of another. The Delhi
High Court in Oriental insurance Investment Corp. Ltd, 51 Comp.
Cases 487 (Del) has held that this power may be enjoyed by virtue of
being a majority shareholder or from certain special rights which are
conferred by the Articles of Association of a company. The judgment in
the case of Velayudhan (M) vs. ROC, 50 Comp Cases 33 (Ker) is on similar
lines. It is the control of the second variety, i.e., control because
of special rights, which is often a matter of debate.

While the
Act is silent on a general definition of the term, the Rules issued
under the Act are one step better. The Unlisted Public Companies
(Preferential Allotment) Rules, 2003 issued u/s. 81(1A) of the Act
define the term to include the right to appoint majority of the
directors or to control the management or policy decisions exercisable
by a person or persons acting individually or in concert, directly or
indirectly, including by virtue of their shareholding or management
rights or shareholders agreements or voting agreements or in any other
manner. Thus, it is a very wide definition on the lines of the Takeover
Code (explained below). The definition is relevant under the Rules for
ascertaining who is a Promoter.

SEBI Takeover Regulations
This
is one Statute which has witnessed the maximum debate over “what
constitutes control”? The SEBI Takeover Regulations of 1997 as well as
those of 2011 both define this very important term. The definition of
the term in the 2011 Regulations includes:

(a) the right to appoint majority of the directors; or

(b)
to control the management or policy decisions exercisable by a person
or persons acting individually or in concert, directly or indirectly,
including by virtue of their shareholding/management rights/
shareholders’ agreements or voting agreements or in any other manner:

However,
a director or officer of a company shall not be considered to be in
control over such company, merely by virtue of holding such position.
Here the decision of the SAT in the case of Ashwin K. Doshi vs. SEBI, 40
SCL 545 (SCL) is relevant. The SAT held that just because a company is
professionally managed does not mean that nobody has control over the
company. Even competent professional managers are given policy decisions
by those in control. Hence, it is a question of fact.

The right to appoint directors must be one which empowers a person to appoint a majority of the board of directors. In Ram Prasad Somani vs. SEBI,
69 SCL 168 (SAT), it was held that appointment of 5 out of 14 directors
could not tantamount to gaining of control over a company since they
were in minority.

R. 4 goes on to state that irrespective of
shares/voting rights in a target company, an acquirer who acquires,
directly or indirectly, control over such target company, must make a
public announcement for an open offer for the shares of such target
company. This applies even if there is no acquisition of shares –
Swedish Match AB vs. SEBI, 42 SCL 627 (SAT).

Thus, the Takeover
Code imbibes the definition under the Companies Act, i.e., power to
appoint majority of the directors but also goes forth to include various
other facets. The right to control the management or policy decisions
of a company renders a person as being in control of that company. These
rights typically arise by virtue of Shareholders or Share Subscription
or Voting Agreements. Hence, under the Takeover Regulations it is not
necessary for a person to be a majority shareholder. He could even be a
minority shareholder but by virtue of certain Agreements he could be in
control. Such an issue typically arises in the case of private equity
investors or venture capitalists. Any PE/FDI Investment may carry a veto
right or an affirmative vote or special rights for the Investor. Thus,
without the consent of the investor, the company cannot carry out
certain substantial decisions, e.g., corporate reorganisation, starting a
new line of business, borrowing in excess of a limit, etc. The PE has
power to stall a decision of the company. However, in most cases, he
does not have power to carry out a decision on his own behest. Thus, if
he refuses the company cannot go ahead but if he proposes and the
company refuses then he cannot proceed on his own. A question often
asked is that, does the grant of such special rights make the investor a
person in control of the company? This is a question of fact. For
instance, the Securities Appellate Tribunal in the case of SEBI vs
Sandip Save, 41 SCL 47 (SAT) after examining various powers given to
IDBI under a lending agreement held that IDBI was not in control over
the company. This was also the question in the case of Subhkam Ventures (I) (P.) Ltd. vs. SEBI, 99 SCL 159 (SAT). Here, the SAT explained the situation with the help of very interesting metaphors as follows:

“The test really is whether the acquirer is in the driving seat. To extend the metaphor further, the question would be whether he controls the steering, accelerator, the gears and the brakes. If the answer to these questions is in the affirmative, then alone would he be in control of the company. In other words, the question to be asked in each case would be whether the acquirer is the driving force behind the company and whether he is the one providing motion to the organisation. If yes, he is in control but not otherwise. In short, control means effective control.”

On this basis and on an examination of the facts, the SAT held that the investor did not have control over the target company. SEBI contested it before the Supreme Court. There an interesting mutual consent agreement was arrived at between the parties. The Supreme Court’s Order in SEBI vs. Subhkam Ventures, Civil Appeal No. 3371 /2010 states that certain facts changed after the SAT Order. Accordingly, the Court, by consent, disposed of the appeal filed by SEBI by keeping the question of law open and it is also clarified that the order passed by the SAT will not be treated as a precedent. This leaves the all-important question yet open for interpretation. Some of the recent high-profile foreign takeovers/joint ventures have reportedly run into a roadblock with the SEBI on similar grounds. SEBI has questioned whether the grant of special investor protection rights to the foreign investor results into a sharing of management control with the Indian promoters?

SEBI has once again indicated its aversion to special rights, veto powers and other preemptive rights in favour of Private Equity Investors in listed companies. In Kamat Hotels Ltd, Clearwater Capital Partners (Cyprus) was given certain affirmative voting rights. SEBI has taken a stand that this tantamount to control under the Takeover Code. Clearwater has filed an appeal against SEBI’s decision to SAT.

The Takeover Code, 1997 contained R. 12 which provided for a change of control not triggering an open offer. Thus, in cases where a special resolution was passed for change of a control by way of a postal ballot resolution of the shareholders, then the same did not attract an open offer by the acquirer of the control. It applied to an offer triggered only by change of control and not one which was accompanied by acquisition of substantial shares. These were known as the White-wash Provisions. These provisions were resorted to when control was sought to be transferred without increasing shareholding above the threshold limits.

The 2011 Regulations have deleted these provisions. SEBI’s Takeover Regulations Advisory Committee (TRAC) in its Report stated that although whitewash provisions are in principle not undesirable, the time is not yet ripe to introduce them in India. Hence, it suggested that the same not be retained under the 2011 version of the Code. Accordingly, they were dropped. Further, earlier cessation of joint to sole control did not amount to a change of control. However, now the same would be treated as a change of control.

The Takeover Code also contains an express provision for an indirect acquisition of control. For instance, acquiring control over an unlisted company which in turn controls a listed company, thereby acquiring indirect control over the listed company.

FDI Policy

The Consolidated FDI Policy (CFDIP) states that an investment by an Indian company ultimately owned and controlled by resident Indian citizens would be treated as a domestic investment and in other cases as a downstream/indirect foreign investment. Hence, it becomes to understand what constitutes control under this Policy. A company is considered as controlled by resident Indian citizens, if ultimately the resident Indian citizens have the power to appoint a majority of its directors in that company. Thus, the FDI policy defines control in a very narrow manner and does not factor in the power to control policy decisions or management decisions by virtue of an shareholders’ agreement. However, the CFDIP provides that in the case of those sectors which require FIPB approval for any FDI, any shareholders’ agreement which has an effect on appointment of Directors, veto rights, affirmative votes, etc., would have to be filed with the FIPB at the time of seeking approval. It will then consider all such clauses and would decide whether the investor has ownership and control due to them. Thus, if any courier company (where FIPB approval is required) wants to get PE funding, it would also have to get the Shareholders’ Agreement approved by the FIPB. Such a provision does not apply in sectors under the Automatic Route.

The FIPB has asked for control provisions to be re-worked in the case of shareholders’ agreements in sensitive sectors, such as, defence. For instance, in the proposals of M/s EADS Deutschland GmbH, Germany & Larsen & Toubro Limited, Mumbai, M/s Telecom Investments India Private Limited, etc., certain control provisions in favour of the foreign investors were asked to be diluted.

Although this definition of control has been a part of the FDI Policy since 2009, the RBI has only recently notified this under the FEMA Regulations. Recently, the Department of Industrial Policy and Promotion, which drafts the CFDIP, is reported to have moved an amendment to widen the definition of control and to bring it in sync with the definition under the Takeover Regulations. The idea is to focus on de facto rather than de jure control.

Companies Bill, 2012

What the Companies Act omits, the Bill seeks to rectify. The current position of the Act being silent on the definition of control is sought to be corrected by cl. 2(27) of the Bill. It states that control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner. The proposed definition is almost in sync with the Takeover Code except for one small difference – while the Code starts with the word “includes”, the Bill starts with the words “shall include”. Although it may be argued that the difference is only semantic, it is submitted that the Code is wider in scope than the Bill because of the absence of “shall”.

Competition Act, 2002

The Explanation to s.5 of the Competition Act, 2002 defines the term control for the purposes of determining whether an acquisition or a merger would be a combination under the Act. Control is defined to include controlling the affairs or management by—

(a)    one or more enterprises, either jointly or singly, over another enterprise or group;

(b)    one or more groups, either jointly or singly, over another group or enterprise;

The Competition Commission of India (Procedure in regard to the Transaction of Business relating to Combinations) Regulations, 2011 provide that transfer of joint to sole control would not be an exempt trans-action and would require a prior clearance from the Competition Commission of India (CCI). The CCI has been quite explicit in its orders of what constitutes a control. By its Order dated 04-10-2012 in response to a Notice for clearance filed by Tata Capital Ltd and Century Tokyo Leasing Corporation, the CCI has held granting of special rights such as affirmative vote, right to appoint key managerial personnel, approval of business plans, etc., tantamount to transfer of sole to joint control and hence, trigger the Competition Act.

Again by its Order dated 9th August 2012 in response to a Notice for clearance filed by SPE Mauritius Holdings Ltd, the CCI has held that each of the persons in joint control have a right to veto / block the strategic commercial decisions of a company. Careful scrutiny of Agreements is required to distinguish mere investor protection rights from rights resulting in joint control. It held that positive consent for opening new offices or hiring / termination of key management personnel, employees drawing a salary > $30,000, etc., cannot be considered as mere minority investor protection rights. It is a case of joint control by two persons.

Accounting Standards

Control is also relevant under the Accounting Standards issued by the ICAI and notified by the NACAS under the Companies Act. Here there is a very absorbing angle to the tell. 4 different Accounting Standards define the term ‘control’ in 3 different ways. Let us briefly look at these:

How can any discussion be complete without the Income-tax Act having its say? Section 6 of the Act states that if any company is wholly controlled and managed from India then it would be treated as a resident of India. As would be excepted, such a crucial term has not been defined. Hence, one has to examine the facts of each case to arrive at a decision.

Principles laid down by some judicial decisions would help in this respect. To enumerate all would require an Article by itself. However, it is determined by the place where the Head and Seat and the Directing Powers of the Company are located, i.e., the place from where the Board functions– Narottam and Periera Ltd., 23 ITR 454 (Bom). What is relevant is the location of those affairs which produce income – V.Vr. Subbayya Chet-tiar, 19 ITR 168 (SC). It means de facto control and management – Nandlal Gandalal, 40 ITR 1 (SC). The fact that the entire shareholding of a foreign company is from India or that some of the Directors are from India would not be material as long as other facts prove it is not wholly controlled and managed from India – Radha Rani Holdings, 110 TTJ 920 (Del ITAT).

The decision in the case of Vodafone International Holdings B.V., 341 ITR 1 (SC) has also laid down a detailed exposition on what constitutes control. The Apex Court has held that a controlling interest is an incident of ownership of shares in a company and flows out of the shareholding. The control of a company resides in the voting power of its shareholders and shares represent an interest of a shareholder which is made up of various rights contained in the contract embedded in the Articles of Association. Thus, control and management is a facet of the holding of shares.

Section 92A(1) of the Act which deals with the Transfer Pricing provisions defines the term associated enterprise to mean an enterprise which participates in the control of another enterprise. Again, the crucial term has not been defined. Clauses (a), (b), (e), (f), (i), (j), (k) and (l) of section 92A(2) provide specific instances of control. In the context of the definition of control appearing in section 92A(2)(j), the “Guidance Note on Report under section 92E of the Income Tax Act, 1961” issued by the ICAI states that the word ‘control’ can be interpreted to mean that the individual along with his relatives has the power to make crucial decisions regarding the management and running of the two enterprises.

The decision of the AAR in the case of Z, In re., 345 ITR 11 (AAR) has analysed the difference between de facto versus de jure control based on the facts of the case.

Conclusion

To sum up – should we say Conclusion or Confusion? The multitude of Laws and Regulators taking different stands on the meaning of what constitutes control has created a very puzzled and perplexed scenario. Investors, both domestic and foreign, are wary as to whether they would be caught having triggered a change of control. One yearns for a stable and a clear policy on the definition of control. Moreover this policy should apply equally across laws. Different laws interpreting the same term in a different manner is not a healthy situation. Let us hope that our Law makers and Regulators realise this and strive to create a clear environment conducive to business decisions. They could probably take a cue from Michael J. Gelb, the noted personal development trainer:

“Confusion is the Welcome Mat at the Door of Creativity.”