• Tax Administrative Cooperation
    The European Strabismus About Beneficial Owners Concept

    By Lorenzo Savastano


    EU Directive on Administrative Cooperation n. 2016/2258 (so called DAC 5) amends Dir. (EU) n. 2011/16 and enables Member States’ Tax Authorities to access to anti-money-laundering (AML) information in order to detect the beneficial owner of a transaction in a multi-layer structure. However, DAC 5 seemingly suffers from strabismus about the definition of “beneficial ownership”, since that notion differs significantly between fiscal and AML sector, as remarked recently by Financial Action Task Force (FATF) and new OECD Model Convention.

    1. Introduction

    The recent entry into force in Italy of DAC 5 (i.e. European Union Directive on Administrative Cooperation, n. 2016/2258), which allows to Tax Authorities to collect anti-money laundering data and information for tax purposes, gives rise to a deep reflection about the reach and the effectiveness of the EU strategy against economic and financial crimes.

    Given that an overarching and multi-pronged approach is needed, it is pivotal distinguish the inner nature of the investigation methods carried out in two highly related taxonomy of crimes: fiscal avoidance and ML/TF (Money Laundering/Terrorism Financing) conducts. Keeping this in mind, we have to pay special attention to terminology used in both these fields, that it is equivalent only in appearance, as the (mis)use of the term “beneficial owner” (BO) in EU directive at issue makes dramatically clear. Nonetheless, the fact that the wording of EU DAC 5 overlooks this dissenting meaning, might cause serious pitfalls in the right interpretation of the economic reality for fiscal law enforcement purposes.

    2. The “cross-eyed” rationale of DAC 5

    First off, it is crucial to note that the rationale behind the further enlargement of data collection for Tax Authorities is twin-track. Indeed, as cleared by the Directive in question, this further provision of data stems from the emerging need of identification of actual beneficial owners (BO) behind intermediary entities key in the fight against tax fraud and evasion and – at the same time – of granting full access to beneficial ownership information within the EU.

    These targets are affirmed in the preamble of the Dir. 2016/2258, where apertis verbis is contended that: “Directive 2011/16/EU stipulates that, where the Account Holder is an intermediary structure, Financial Institutions are to look through that structure, and identify and report on its beneficial owners. That important element in the application of that Directive relies on anti-money-laundering (‘AML’) information obtained pursuant to Directive (EU) 2015/849 of the European Parliament and of the Council for the identification of the beneficial owner” (second preamble). On that basis, the Directive at issue states that “To ensure effective monitoring of the application by Financial Institutions of the due diligence procedures set out in Directive 2011/16/EU, the tax authorities need access to AML information. In the absence of such access, those authorities would not be able to monitor, confirm and audit that the Financial Institutions are applying Directive 2011/16/EU properly by correctly identifying and reporting on the beneficial owners of intermediary structures” (third preamble).

    That said, as indicated by the wording of DAC5, the aim of the widening of the data at disposal of EU Tax Authorities consists in the possibility of using a “look through approach” in the analysis of the beneficial owner in a transaction, typical of the AML’s philosophy. However, what EU institutions forgets is that there is a substantial difference between the notion (and the definition) of beneficial owner used in tax and AML/TF sectors.

    3. Beneficial ownership in anti-ML/TF field

    A recent definition of BO in AML environment is provided by a FATF (Financial Action Task Force - OECD) report, titled “Concealment of Beneficial Ownership” (issued in July 2018), where BO is defined as “natural person(s) who ultimately own(s) or control(s) a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement”. As outlined by the aforementioned FATF report, the concept of BO differs from the definitions of “beneficiary” and “beneficiaries”, which can include both:

    • natural and legal persons and arrangements (often relate to the recipients of charitable, humanitarian, or other types of assistance through the services of an non-profit organisations);
    • person(s) entitled to the benefit of a trust arrangement or insurance policy.

    Similarly, an analogous definition of BO is provided by a dated report of the OECD Steering Group on Corporate Governance, named “Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes (OECD, Paris, 2001), where beneficial ownership is encompassed as follows (page 14): “beneficial ownership refers to ultimate beneficial ownership or interest by a natural person. In some situations, uncovering the beneficial owner may involve piercing through various intermediary entities and/or individuals until the true owner who is a natural person is found. With respect to corporations, ownership is held by shareholders or members. In partnerships, interests are held by general and limited partners. In trusts and foundations, beneficial ownership refers to beneficiaries, which may also include the settlor or founder”.

    In this context (and only in this contest), the “look through approach” arises. Indeed, such a method of financial investigation is tailored to detect techniques used to obscure beneficial ownership by means of (see cited FATF report, 2018, p. 25):

    1. generating complex ownership and control structures, both by using shell and shelf companies (i.e. “companies that are incorporated but which have no significant operations or related assets”, see FATF, 2014), and front companies (which, conversely, is a fully functioning company, with assets, income and expenses). Moreover, a further layer of complexity it may be reached by splitting company incorporation and asset administration over different countries, as well as trusts and other legal arrangements;
    2. using individuals and financial instruments to obscure the relationship between the beneficial owner and the asset, for instance by using bearer shares and bearer share warrants, formal or informal nominee shareholders and directors, or declaring numerous beneficiaries of the same transaction;
    3. falsifying activities, that refers to the use of false loans and invoices or the manipulation of a company´s prospectus, annual report etc.

    Consequently, in the AML approach the ultimate purpose of the investigation is always determine the natural person who possesses the ill-gotten profits concealed, irrespective of the legal (or illegal) barriers beneath which he is concealed. In other words, the term “ultimate control” implies only the beneficial ownership and not the legal ownership of the scrutinized profit. In fact, a legal owner is essentially the ‘official’ or ‘formal’ owner of a property whereas a beneficial owner is the person with the right to enjoy or benefit from the property, that can include the right to occupy or enjoy any income from the property (including royalties or interest, as shown below).

    4. Beneficial ownership in international tax field

    The notion and the function of BO in tax context significantly differs from the AML perspective, since it is used in order to identify the beneficiary of a cash flow in an international transaction: typically, it matters when it comes with the fiscal treatment of passive income (i.e. dividends, interests and royalties). In such cases, in fact, a high risk of treaty shopping arrangement could occur, as remarked by the Action 6 of BEPS project (concerning “Preventing the Granting of Treaty Benefits in Inappropriate Circumstances”).

    In this regard, the new par. 12.1 of the Commentary on art. 10 of the OECD Model Convention plainly affirms that: “Since the term ‘beneficial owner’ was added to address potential difficulties arising from the use of the words ‘paid to…a resident’ in paragraph 1 […]. The term “beneficial owner” is therefore not used in a narrow technical sense […], rather, it should be understood in its context, in particular in relation to the words “paid … to a resident”, and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance”.

    On the same note, par. 12.6 of the same Commentary affirms that: “[…] the meaning of “beneficial owner” make it clear that the meaning given to this term in the context of the Article must be distinguished from the different meaning that has been given to that term in the context of other instruments that concern the determination of the persons (typically the individuals) that exercise ultimate control over entities or assets”.

    Therefore that meaning of BO, which refers to natural persons (i.e. individuals), cannot be consistent with the situation where a company is the beneficial owner of a dividend (or interests or a royalties). For these reasons, “[…] That different meaning of “beneficial owner” cannot be applied in the context of the Article” (OECD Model Convention Commentary, 2017).

    The most prominent outcome is that the ultimate recipient of a passive income is not regarded – on a tax field – as the beneficial owner of the dividend if there is a form of treaties abuse. As a result, the company at issue cannot benefit of the fiscal advantages provided for by articles 10, 11, and 12 of the OECD model Convention.

    5. Concluding remarks

    There are no shadows upon the importance of allowing Tax Authorities to harvest as much information and inputs as possible, for the sake of fighting properly challenging and changing tax crimes phenomena. However, it is equally crucial to comprehend that a wrong understanding of the complex notion of beneficial owner, which could vary the perimeter, the purpose and the direction of a financial investigation, could lead to an ineffective use of these new and powerful tools.

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Lorenzo Savastano

Lorenzo Savastano is an Italian police officer belonging to Guardia di Finanza, a highly specialised military Corps committed in fighting economic and financial crimes, both on national and international level. He obtained two master’s degrees with honors, respectively in Law and in Economic and Financial Security. In addition, he attended several courses of advanced studies in International and Corporate Tax Law as well as in Tax crimes investigations. As aggressive tax planning and financial law enforcement specialist, he currently deals with corporate illicit activities and white collar crimes investigation.

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