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PKF Cyprus

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The principles of economic substance and beneficial owner in international business

There have been significant discussions around the world on taxpayers’ methods of minimizing taxes. Expressions like

  • beneficial owner,
  • economic substance
  • management and control,
  • place of effective management,
  • resident,

have been triggering discussions throughout the world as they are closely related to people’s tax minimization.

How did tax minimization use to be effected?
Intermediary company?
Residents of non–treaty countries have been able to obtain the benefits of the conventions between two treaty countries usually by forming an intermediary company (flow-through company), in a treaty country in order to obtain treaty benefits.

Court cases
Multinational companies like:

  • Vodaphone
  • Google
  • Starbacks
  • Prevost (Volvo)
  • Other

have been scrutinised and defamed of using tax ‘efficient’ structures
Prevost (Volvo) was scrutinised as owning a holding company registered in the Netherlands with no employees in order to get the benefits of the Netherlands’ low withholding tax rates.

When a company may be considered a “paper” intermediary company?
If a third party i.e. fiduciary provider or administrator seems to act on behalf of a beneficial owner?
Be taxed in the source country, thus lifting the veil of incorporation of the intermediary company.
On the contrary,
An intermediary company is an entity itself and is distinct from its shareholders. Some of the intermediary company’s powers may be exercised by its directors without the interference of its shareholdersDirectors may also be advised by other experts and in many cases, they have sufficient powers to make decisions.
What might then be a definition of beneficial ownership?
A person that, either directly or indirectly, has the power to influence decisions?
Organisation for Economic Co-operation and Development (OECD) attempt was to describe the term of the beneficial owner which relates to the receipts and payments of dividends, interest, and royalties mainly by intermediary companies.
Organization for Economic Co-operation and Development (OECD) attempt
An intermediary company is not a beneficial owner if:

  • The right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass the payment on,
  • In substance, the recipient does not have the right to use and enjoy the dividend unconstrained and,
  • If the obligation relates to the payment received,
  • Each case will be treated on the interpretation of legal documents, facts, and circumstances.

Economic substance (OECD)
Sufficient economic substance should be present at the level of intermediary Company and therefore allocation of risks should be consistent with the economic substance (i.e. of that intermediary company)

Important considerations/examples

  • The entity owning the most valuable intangibles and performing the most important functions within a corporate structure will typically be entitled to the largest share of the profits or losses;
  • The income should arise to the intermediary Company itself and be reported in its bank account and financial statements. The intermediary company should freely deal with the inflow of funds representing the dividend received at its full discretion;
  • Appointing qualified directors residing in the country of the intermediary company which will have the ability to make decisions and really understand the nature of business;
  • Maintaining group head offices in the intermediary country, having fully-fledged offices with business telephone lines, telephone answering and call forwarding machines, own website and employ employees;

Our conclusion

  1. There is no standard approach on the above terms
  2. Each case will be treated on:
    • The interpretation of legal documents, facts and circumstances
    • The size and numbers

Contact details

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The authors expressly disclaim all and any liability and responsibility to any person, entity or corporation who acts or fails to act as a consequence of any reliance upon the whole or any part of the contents of this document. Accordingly no person, entity or corporation should act or rely upon any matter or information as contained or implied within this publication without first obtaining advice from an appropriately qualified professional person or firm of advisors

PKF / ATCO Limited is a member firm of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms. This publication is for information purposes only and should not be considered as professional advice.