In pursuit of the beneficial owner – 2021 guidelines from the French judges

The concept of the beneficial owner - one of the fundamental principles of international taxation – is in the spotlight again and is the focus of renewed interest by tax practitioners, local tax authorities and tax courts since the so-called “Danish cases” dated 29 February 2019 concerning the application of EU parent-subsidiary and interest-royalty directives.

Since appearing for the first time in the 1977 OECD Model tax convention as an anti-abuse rule tackling treaty shopping and the use of conduit companies, the beneficial ownership requirement has become an integral part of the French double tax treaty network and a precondition to the granting of treaty benefits for French-source passive income (dividends, interest, royalties) as well as “other income” in some of the treaties. The French legislator had the foresight in 1991 to include the beneficial ownership condition in the Article 119 ter of the French tax code, transposing the parent-subsidiary directive into French law, although the directive itself does not include any such reference.

However, neither the treaties, the EU directives nor the French tax code give any clear definition of the beneficial owner.

It is therefore the task of the French courts to define this concept and propose an analysis grid, based on a series of markers, to support or reject beneficial ownership status for the payee of French-source passive income. The “Danish cases” have relaunched this praetorian dynamic.

In pursuit of the beneficial owner, three French court cases provide their share of guidelines for 2021.

First of all, at the beginning of the year, in the “Performing Rights Society” case dated February 2021[1], the French Supreme Court considered whether the British Performing Rights Society (“PRS”), responsible for collecting royalties on behalf of songwriters and music publishers, could be viewed as beneficial owner of royalties collected on its behalf in France by its French counterpart, SACEM. PRS claimed from the French tax authorities the refund of the French withholding tax levied by SACEM on the royalties collected on behalf of PRS in France. The French tax authorities allowed a refund only on the portion of royalties repaid by PRS to its members resident in the UK for tax purposes. Although the lower court judges have decided in favour of PRS and allowed the refund of a residual portion of the withholding tax, the French Supreme Court considered, against all expectations and contrary to the findings of the public reporting judge, that PRS was not the beneficial owner of the said royalties. The French Supreme Court stressed in its decision that the purpose of PRS was to collect and manage royalties on behalf of its members and although the articles of association provide that the board of directors shall determine the allocation of the revenue collected by PRS, the corresponding royalty income should in principle be repaid by PRS to its members net of reasonable corporate expenses. Thus, as the major share of collected income is repaid by PRS to its members every year, it is therefore not eligible for treaty benefits.

Then, in May 2021, the Court of Appeal of Versailles considered the case of the French company, Alphatrad, which was paying dividends to its Swiss parent Optilingua Holding, itself held by Mr. B, sole shareholder and resident in Portugal for tax purposes. Alphatrad had not levied French withholding tax on dividends paid to its Swiss parent, relying on the dividend withholding tax exemption in the France-Switzerland double tax treaty. The French tax authorities challenged the withholding tax exemption on the grounds that Optilingua Holding was not the beneficial owner of the dividends and claimed withholding tax at the 15% standard treaty rate (instead of applying either the domestic withholding tax rate or the rate as per the treaty with Portugal as State of tax residency of the ultimate shareholder and beneficial owner of the dividend). The Administrative Court of Montreuil confirmed the reassessment.

In a decision dated 27 May 2021, the Administrative Court of Versailles confirmed the lower court decision and ruled that the Swiss parent could not be viewed as the beneficial owner of the dividends paid by Alphatrad, as despite its apparent ownership of the income, it had in practice only the limited powers of a mere intermediary acting on behalf of Mr. B. In particular, Alphatrad had not demonstrated that the Swiss parent company was indeed a managing holding company allegedly participating in the management of its subsidiaries and the development of its group, in the absence of any element demonstrating such activity and any tangible, intangible and human means to exercise such activity. The Court also pointed out that the fact that the dividends received had not been repaid by the Swiss parent to Mr. B but placed in a reserve or accumulated profit account, and that Mr. B was the only director of the company, were not sufficient per se to support that the Swiss parent was the beneficial owner of the dividend income as long as it was not demonstrated that the Swiss parent company had indeed the power to dispose of the income, instead of merely acting on behalf of its sole shareholder Mr. B. In this respect, the French tax authorities argued that the absence of repayment of dividends to Mr. B. was a deliberate decision of the latter given the increase in the amount of upstream loans granted by the Swiss company to Mr. B., showing that company’s assets were actually at the disposal of its sole shareholder.

Finally, in October 2021, the Administrative Court of Appeal of Bordeaux considered the case of Meltex, a French distributor of textile products under the Hartford trademark. The right to use this trademark was granted to Meltex by the Dutch company Wonga BV under a sub-license agreement, Wonga BV itself benefiting from this right under a “master license” agreement entered into with Impala World Inc., owner of the trademark and parent of Wonga BV, established originally in the British Virgin Islands and subsequently transferred to Panama. Relying on the provisions of the France-Netherlands double tax treaty, Meltex did not levy withholding tax on royalties paid to Wonga BV. The French tax authorities challenged this withholding tax exemption on the grounds that Wonga BV was not the beneficial owner of the royalties but an intermediary acting on behalf of Impala World Inc. and subsequently reassessed Meltex. The French tax authorities grounded the reassessment on (i) the provisions of the “master license” agreement stating that in the case of a sub-license, the licensee should repay to the owner of the trademark 93% of royalties received from the sub-licensee, (ii) the fact that the capital of Wonga BV was held for 99.6% by Impala World Inc., (iii) the financial statements of Wonga BV showing that the activity of the company was limited to the passive collection of royalties from Meltex and (iv) the bi-annual frequency of payments and the short period of time (four to eight days) between receipt of the income and its repayment by Wonga BV.

The Administrative Court of Appeal of Bordeaux has ruled in favour of the French tax authorities and confirmed the lower court decision on the grounds that Wonga BV’s right to use and dispose of the income received from Meltex was particularly limited given that it was under contractual obligation to repay the income as per the provisions of the “master license” agreement.

Based on these three 2021 French court cases, and subject to adjustments and additions arising from further case law developments, the following should be taken into account when considering whether the recipient of French-source passive income may be viewed as beneficial owner of the income:

1. When the recipient of French source passive income is a collective management organization whose purpose/aim is to collect and manage revenues on behalf of its members and which repays annually the major portion of the collected income, such collective management organization should not be viewed as beneficial owner;
2. When the recipient of French source passive income is a holding company, the existence of material and human means in its State of incorporation, its involvement in the management of its subsidiaries and/or exercise of activities other than the mere passive receipt of French source income are part of the elements taken into account to appreciate the beneficial ownership status of a holding company;
   
3. When the recipient of French-source passive income is under contractual obligation to repay the income received, it is deemed not to be the beneficial owner of the income to which the contractual obligation applies, especially if it complies with this contractual obligation and systematically repays the major part of the income received;
   
4. When there is no contractual obligation of repayment incumbent on the recipient of the income, the non-repayment of the income and its booking in a reserve or profit carryforward account are not per se sufficient to establish the status of beneficial owner, in the absence of elements demonstrating that the recipient of the income (i) enjoys the power to freely dispose of the income and (ii) does not act as a mere interposed agent.
   

In the PRS and Alphatrad cases, the beneficial ownership concept was used to deny double tax treaty benefits to the recipient of French-source passive income outside of any abusive situation or artificial arrangement. The Meltex case looks more artificial given the “exotic” location of the beneficial owner and the fact that the role of the Dutch BV interposed in the chain of ownership was limited to collection and repayment of royalties received from its sole sub-licensee Meltex. Yet, it was not necessary for the French tax authorities to apply the abuse of law procedure, as denying treaty benefits on the ground of beneficial ownership leads to immediate effects without any procedural constraints.

The PRS and Alphatrad cases bring nevertheless a share of consolation to French paying institutions, which might have imprudently refrained from levying withholding tax on payments to a recipient resident in a treaty state and would have been subsequently reassessed by the French tax authorities on the grounds that the recipient was not the beneficial owner of the income. Indeed, although the French tax authorities refuse beneficial owner status to the recipient of income in the PRS and Alphatrad cases, they nonetheless accept to “look through” the recipient when the beneficial owner is located in a treaty state and apply (i) in the PRS case, the withholding tax exemption provided for by the France-UK double tax treaty on the portion of royalties repaid to UK tax residents and (ii) in the Alphatrad case, the reduced dividend withholding tax rate provided for by the France-Switzerland double tax treaty (or, if there is a material error in the court decision, the treaty between France and Portugal, which should normally be applicable to payments benefiting an individual shareholder resident in Portugal for tax purposes).

This approach, which consists in applying to French-source passive income the double tax treaty entered into with the State of tax residency of the beneficial owner, when an intermediary is interposed in the chain of payment, is not entirely new and refers to the commentaries on the OECD Model Tax Convention and the position of the French tax authorities expressed in their official guidelines regarding France-Uzbekistan double tax treaty.

It has still to be confirmed (i) concerning dividends in particular, whether this “look-through” approach would be acceptable if several intermediaries are interposed in the chain of ownership outside of any abusive situation or artificial arrangement, and (ii) for any kind of French-source passive income (excluding interest, which is not subject to withholding tax, except in the case of payment to a non-cooperative jurisdiction) whether this approach would be acceptable (with the underlying withholding tax exemption) in the case where the recipient of the payment is located outside France but is held by one or several beneficial owners resident in France for tax purposes – a situation which could occur, notably, in the case of a joint-venture set up by a French group/company with non-resident partners.

[1] French Supreme Court, 10e-9e ch. 5 February 2021, n°430594 and 432845, min. c/Sté Performing Rights Society Ltd.