“Article 4 Fiscal Domicile 1. For the purposes of this Agreement, the term “resident of one of the two States” means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or other criterion of a similar nature. [2. 3.] 4. Where by reason of the provisions of paragraph 1 a person other than an individual ........is a resident of both States, then it shall be deemed to be a resident of the State in which its place of effective management is situated. If the competent authorities of the two States consider that a place of effective management is present in both States, they shall settle the question by mutual agreement.” ..... “Article 11 Interest 1. Interest arising in one of the two States and paid to a resident of the other State may be taxed in that other State. 2. However, such interest may also be taxed in the State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest. [3....] 4. Notwithstanding the provision of paragraph 2, interest arising in one of the two States shall be taxable only in the other State if the beneficial owner of the interest is a resident of the other State and if the interest is paid on a loan made for a period of more than 2 years or..... 5. The competent authorities of the two States shall by mutual agreement settle the mode of application of paragraphs 2, 3 and 4. [6... 7... 8...] 9. Where, owing to a special relationship between the payer and the recipient or between both of them and some other person, the amount of the interest paid, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the recipient in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each State, due regard being had to the other provisions of this Agreement.”
“3. Based on the facts, circumstances and regulations described above, the following are some guidance and confirmation on the matters in question: a. In accordance with its original title of the tax treaty that is “Agreement (Convention) between the Government of the Republic of Indonesia and the Government of ... for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income”, and the OECD and UN Commentary on Model Tax Convention, one of the underlying objectives of the establishment of the tax treaty is for the avoidance of double taxation and for the prevention of tax avoidance and evasion in respect to taxes on income. b. Treaty Shopping is an abuse/improper use of the tax treaty as they are contrary to the objectives of the establishment of the treaty itself. Treaty shopping may occur where taxpayers who are not residents of Contracting States seek to obtain the benefits of a tax treaty by organizing a corporation or other legal entity in one of the Contracting States to serve as a conduit for income earned in the other Contracting State. c. Therefore, any types of financing structures which will be adopted by [the Parent Guarantor] and [the Issuer] that is contrary to the objectives of the tax treaty will not be eligible under the Indonesian tax laws. On the facts and circumstances as stated in your letter, as the main purpose of the new financing structure to be adopted by [the Parent Guarantor] and [the Issuer] is clearly to avoid the increased withholding tax as a result of the termination of the Indonesia-Mauritius Tax Treaty and to take advantage of the provisions of the tax treaty of another country, accession to treaty benefits will be denied. d. In accordance with the principle of Indonesian Income Tax Law which is “substance over form”, and also in accordance with OECD and UN Commentary on Model Tax Convention, the term beneficial owner which has been set as one eligibility requirements for the application of withholding tax rate on interest specified in the treaty is an anti abusive rule intended to limit the accession to the benefits provided by the treaty to only those who have the actual rights for such entitlement. Therefore, the term “beneficial owner” means the actual owner of the interest income who truly has the full right to enjoy directly the benefits of that interest income. Consequently, conduit company and nominee such as the NewCo will not be regarded as the actual owner of the income. Thus, the rate that shall be applied is in accordance with the Indonesian Income Tax Law which is 20%..... [e f] g. The NewCo will be regarded as a resident of Indonesia if the composition of the board of directors and management; of the NewCo meets the criteria set by the provision of Article 4 of the Tax Treaty between Indonesia and the Netherlands.... h. If “interposition” scheme is to be adopted and established in the Netherlands, the provision of paragraph 4 of Article 11 of the Tax Treaty between Indonesia and the Netherlands cannot be applied since the mode of application between competent authority of Indonesia and the Netherlands has not been settled by mutual agreement. [i]” [i]”
“If interposition were to be used, the Issuer would assign its receivable under the loan to DutchCo against a receivable on DutchCo (i.e. the issuer would assign its rights under the loan with the Indonesian guarantor to DutchCo in return for DutchCo entering into a separate loan agreement with the issuer)”
“20. It is proposed that Newco will be incorporated in Holland, will keep all its records, whether of trading, incorporation, shareholding, or otherwise, in Holland. It will be accounted for, including for all tax purposes, in Holland by Netherlands auditors. It will comply in all respects with Netherlands registration requirements. It will have no fixed place of business in Indonesia. All of its directors will be resident in Holland even if their nationality is Indonesian. 21. It was explained to me that, for a finance company of this kind to be accepted by the Netherlands Revenue Authorities as being resident for tax purposes in the Netherlands, it was necessary to comply with those Authorities’ “substance and risk” requirements. These requirements prescribed that the relevant company must be fully capitalised up to a defined level and that, where the purpose of the company was the provision of loan facilities that those facilities must be made available on the basis of a transaction yielding a profit to the lending company and thus to be lent at a rate of interest greater than that at which the proceeds of the interest payments are accounted for to the providers of the finance from which the loan is made, here the Noteholders via the Issuer. The minimum resulting “spread” is fixed by the Netherlands Revenue Authorities. Newco would comply in all respects with these requirements. 22. Having incorporated Newco in the Netherlands in this way it is proposed that the benefit of the loan agreement between the Issuer as lender and the Parent Guarantor as borrower would be assigned by the Issuer to Newco and so the Parent Guarantor would be paying interest on that loan to Newco a company resident in the Netherlands which would then pay to the Issuer an amount sufficient to ensure that the Issuer would be enabled to pay the Noteholders’ interest at the rate due under the Notes. I will hereafter refer to the proposals set out in the previous four paragraphs as “the Proposed Restructuring”.”
“it seems to me that this court should apply a “reasonable certainty” test in coming to any conclusion as to the likely reaction of the Indonesian Tax Authorities to the putting into effect of the Proposed Restructuring.”
“The requirement that the recipient of the dividends be the “beneficial owner” (the French version of the Model uses: bénéficiaire effectif - both language versions of the Model are equally authoritative) was added when the text of the Model was revised in 1977, and was added to prevent abuse in the form of treaty-shopping. Unfortunately, the meaning of the phrase still remains less than fully clear.”
“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”
“Where an item of income is received by a resident of a Contracting State acting in the capacity of agent or 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. The immediate recipient of the income in this situation qualifies as a resident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. 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 than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the [Conduit Companies Report] concludes 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.”
“The essence of this Commentary is to explain that the “beneficial ownership” limitation is intended to exclude: (a) mere nominees or agents, who are not treated as owners of the income in their country of residence; (b) any other conduit who though the formal owner of the income, has very narrow powers over the income which render the conduit a mere fiduciary or administrator of the income on behalf of the beneficial owner. It is worth making the point that, as seems clear from this amended Commentary, the mere fact that the recipient may be viewed as a conduit does not mean that it is not the beneficial owner.”
“The practical question remains whether, for example, a company under the control of another - and therefore likely (though not legally obliged) to pay to its ultimate owner any sums received - could be regarded as beneficial owner of the dividends it receives. Or, to take another example, suppose that a member of a multinational group borrows money and then lends the money on to another group company: the two loans are not tied together, and the lending company is not obliged to use the interest it receives to pay interest on the loan it received - in practice, however, it is likely to do so. Adopting the approach of the OECD Commentary (paragraph 12, as amended in 2003), the issue is whether the recipient company is an agent, or a nominee, or a conduit which has, as a practical matter, very narrow powers over the income which render it a mere fiduciary or administrator. As a practical approach, one can ask whose income the dividends (interest/royalties) are in reality. One way to test this is to ask: what would happen if the recipient went bankrupt before paying over the income to the intended, ultimate recipient? If the ultimate recipient could claim the funds as its own, then the funds are properly regarded as already belonging to the ultimate recipient. If, however, the ultimate recipient would simply be one of the creditors of the actual recipient (if even that), then the funds properly belong to the actual recipient. It is worth remembering that there are many forms of treaty shopping, and not all states have a uniform view on what constitutes abuse of a tax treaty relationship. The beneficial ownership limitation is intended to counter one particularly abusive form of treaty shopping: by the use of agents, nominees or conduits who are mere fiduciaries. If Contracting states wish to provide more extensive anti-abuse provisions, they are at liberty to agree to put these in their treaties (and many do so, which is strong proof that the beneficial ownership limitation is of only limited scope).”
“49. It is clear to me that in the absence of any trust or fiduciary relationship between Newco and the Issuer, in an insolvency of Newco undistributed interest received from the Parent Guarantor would be an asset of Newco for distribution amongst its creditors generally, including the Issuer, pari passu. 50. It seems to me that there can be no ambiguity in the application of the concept of beneficial ownership to the loan transaction as proposed to be restructured. The beneficial owner of interest received under a loan transaction must be the lender. As a result of the proposed assignment of the benefit of the loan agreement between the Issuer and the Parent Guarantor, by the Issuer to Newco, Newco will be the lender. In no sense will Newco be acting as nominee or administrator for the Issuer or the Noteholders. It will merely be contractually bound to indemnify the Issuer against its obligations to those Noteholders. The Noteholders will have no claim to be the beneficial owners of the interest. They would be in no position to claim the interest from the Parent Guarantor and for that reason or otherwise to suggest that Newco will hold the interest when received on trust for them. After restructuring there will have to be some entity that qualifies as beneficial owner of the interest. It seems to me there will be only one candidate for that, namely, Newco. In fact if one is considering the “substance” of Newco as beneficial owner of the interest, its position is stronger than that of the Issuer, because, by contrast with the Issuer, it will be receiving interest from the Parent Guarantor at a greater rate than that for which it will be indemnifying the Issuer in making payments to the Noteholders. It follows that if the Indonesian Tax Authorities were prepared to tolerate the current arrangements and confer the benefit of double taxation relief pursuant to the Indonesia/Mauritius DTA while it was in force, a fortiori they should be prepared to give that relief after the Proposed Restructuring has been put into force.”
“I have come to the clear conclusion that in those circumstances Newco would indeed be treated as resident in the Netherlands for tax purposes both in the view of the Netherlands Tax Authorities and of the Indonesian Tax Authorities.”
“The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. The place of effective management will ordinarily be the place where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined; however no definitive rule can be given and all relevant facts and circumstances must be examined to determine the place of effective management.”
“59. I accept [counsel]’s submission that the appropriate comparator with which the likely cost of setting up the Proposed Restructuring and thereafter its running costs (which would take account of any resulting reduction in Indonesian withholding tax but also tax incurred in Holland by Newco), is to be compared, is the amount of the additional 10% withholding tax now being incurred as a result of the Indonesian Tax Authorities imposing on the Parent Guarantor a 20% rate, an additional 10%, for the remaining period of the loan. This has been calculated at$1.8M . 60. If my conclusion on the application of article 11.4 is correct Indonesia will allow a nil rate of withholding tax or, if my conclusion on article 11.4 is rejected it will allow a rate limited to 10% which the Netherlands Tax Authorities would deduct from any Netherlands liability to tax of Newco. It is the Issuer’s case that the cost of setting up the Proposed Restructuring, spread over the unexpired portion of the loan together with the running costs, will amount to approximately US$300,000 . I accept that there should be added to those costs, the costs incurred by the Issuer in investigating the availability of alternative countries DTAs with Indonesia but only up to November 2004 the date when the Trustee rejected the Issuer’s proposed notice to redeem. Because of the Issuers obligation to indemnify the Trustee against all costs that figure must include the investigation costs of both parties. The Issuer has estimated those costs at$490,000 . 61. On the basis that my conclusion as to the applicability of article 11.4 is correct there would be a saving of$1.8M in Indonesian withholding tax but a consequent increase in Netherlands tax on Newco reflecting the fact that Newco would not be able to set-off against its liability to Netherlands tax any Indonesian withholding tax. As I understand Mr Elias’ evidence these will at worst simply cancel each other out. In my judgment even taking the Issuer’s estimate of the costs at their face value, and they are not accepted by the Trustee, the costs do not exceed the standard of reasonableness contained in the Proviso.”