Karena Yadnya Yang Paling Utama adalah Pengetahuan (Jnana)

Beneficial Ownership, Lesson Learned from Tax Court Verdict

Posted by I Wayan Agus Eka on June 3, 2017


Beneficial owner originally is not a tax concept, it is a common law concept that refer to people who enjoy the economic rights of the ownership that might be different from the legal owner. Hence, beneficial owner is the “indirect owner” and the ownership structure is often called as nominee registration or omnibus holding (Alexakis, 2004).

The concept of beneficial ownership was then adopted in international taxation concept when it was firstly introduced in article 10, 11 and 12 of the 1977 OECD Model Convention in order to exclude intermediaries such as nominees, agent and mandataries from enjoying treaty benefit (Duff, 2013). Since its introduction, OECD and several related institutions have tried to revise the meaning of the concept, however the precise interpretation of the concept is remain uncertain (Yoshimura, 2013).


The ambiguity of the beneficial ownership concept has become a source of dispute between taxpayer and tax authority all over the world. One of the famous case in Indonesia was a tax dispute between Indonesia Taxpayer and Directorate General of Taxes (DGT) involving Indonesia – Netherland Double Tax Treaty (hereinafter refer to as DTT). This case has been resolved in tax court in favor of the taxpayer as stipulated in the tax court verdict number PUT.29050/PP/M.III/13/2011 (hereinafter refer to as the verdict). This short paper will try to analyze the taxpayer’s and DGT’s argument as well as the judge’s position in order to find several possible measures that can be adopted by DGT for the same case in the future.


The Case

On October, 31 2006, an Indonesian Taxpayer signed an 8% annual interest loan agreement with Goederhand Finance BV (a financial institution in Netherland, hereinafter refer to as GFBV) amount to USD25 Million and due date on December, 26 2009. During 2006, The taxpayer paid Rp1.868.840.080,00 of interest to GFBV. The taxpayer did not withhold any tax deduction from the interest payment based on article 11 par. 4 of the DTT. However, DGT’s audit (and objection process) decided that The Taxpayer must withhold 20% tax from the interest payment.


DGT’s Argument

In general, DGT’s argument consist of two main issues i.e. mode of application and beneficial ownership. Article 11 par. 5 DTT said that “The competent authorities of the two States shall by mutual agreement settle the mode of application of paragraphs 2, 3 and 4”. DGT argued that since Indonesia and Netherland have not concluded the mode of application, the treaty benefit as stipulated in article 11 par. 4 could not be applied. DGT also argued that the Director General of Taxes Circular Letter number SE-17/PJ/2015 is the official position of the Indonesia Government regarding the implementation of the article 11 par. 4. The circular letter principally says that, for the implementation of article 11 par. 4, since both government have not concluded the mode of application, the withholding tax rate for the interest payment to Netherland resident is 10%.


In its argument, DGT also argued that GFBV was not beneficial owner of the interest paid by The Taxpayer. To enjoy treaty benefit, the certificate of domicile (COD) is only a formal requirement and those who hold the COD does not necessary means the beneficial owner of the income. DGT used opinion from Klaus Vogel (an International Taxation Expert) that “treaty benefits should not be granted with a view to a formal title to dividends, interest, or royalties, but to the real title. In other words, the dispute of ‘form versus substance’ should be decided in favour of ‘substance’”.


DGT, in the litigation process, tried to prove that GFBV was not beneficial owner of the interest. DGT’s arguments can be summarized as follows:

  1. In period 2004-2005, GFBV was not active and in 2006 GFBV had not started its operation yet. Hence, GFBV had not financial capacity to lend money to the Taxpayer.
  2. GFBV was 100% indirectly owned by Golden Agri Resources (GAR, Mauritius resident) through Golden Agri International Trading (GAIT, Malaysian resident). This ownership structure shows that the credit structure was designed merely to enjoy treaty benefit.
  3. DGT also used three OECD approaches in determining beneficial owner
    1. Look Through Approach

GFBV was 100% owned by GAIT. Hence, GFBV did not pass the look through approach since it was controlled by GAIT who was not the residence of the treaty partner.

  1. Subject to tax Approach

Until 2005, GFBV did not commence its operational activity, hence GFBV’s activity was not subject to tax in Netherland.

  1. Bonafide Transaction Approach

The establishment of a company should be based on business motivation. GFBV did not pass this test since it was newly born at that time and its share was not publicly traded in the stock exchange.

  1. In its last argument, DGT also used Director General of Taxes Regulation number PER-62/PJ./2009 to show that there was a treaty abuse in this transaction. However, the argument based on this new rule was basically the same with the previous arguments.


Taxpayer’s Argument

The Taxpayer argued that based on DGT Circular Letter number SE-03/PJ.101/1996, GFBV’s COD issued by Netherland tax authority was enough to enjoy the treaty benefit. The taxpyaer also argued that DTT was lex specialist and had been ratified by two countries, hence both countries must follow the agreement. The absence of the mode of application does not necessary means that the other article can not be executed. Moreover, the DTT position, from the perspective of law hyrarchy, is higher than domestic law and much more higher that just a circular letter. Therefore, DGT could not override any article in the DTT only by issuing circular letter.


The Taxpayer also tried to prove that GFBV is beneficial owner in substance. The relation between taxpayer and GFBV does not necessary mean that GFBV is not beneficial owner since taxpayer had no right to interfere GFBV asset and the interest was directly sent to GFBV’s bank account. GFBV was a Netherland’s resident and of course it paid tax in Netherland even though the GFBV had not commenced its operation. The PER-62/PJ./2009 also can not be used since the rule had not existed when the transaction took placed.


Judge’s Position

Judge divided their argument in formal and material aspect. In formal aspect, the judge’s explanation was based on both international and national law. In international law aspect, they used article 26 and article 27 of the Vienna Convention on The Law of Treaties 1969. Article 26 stated the “Pacta Sunt Servanda” principle meaning that the treaty binds the parties and should be performed in good faith. Moreover, article 27 explain that the failure to perform a treaty due to domestic law can not be accepted in international justice process. In domestic law aspect, the judge claimed that the notion that the SE-17/PJ/2005 was the official statement of the Indonesian government was exaggerated since circular letter, by definition, was only a guidance for internal officer. The judge also explained that the termination of the article 11 par. 5 only by a circular letter was not approriate and violating “Pacta sunt Servanda” principle.


In the discussion of the substance aspect of the beneficial owner, the judge had several opinions. The judge claimed that DGT’s arguments that BFBV was not beneficial owner was merely based on analysis not a valid evidence. DGT’s argument was only based on ownership structure and the fact that GFBV was newly born company. Moreover, DGT’s argument about the relation between The Taxpayer and GFBV should be used to prove whether the interest amount had followed the arm length principle (article 9 of DTT) instead of determining the beneficial owner of the income. Based on those arguments, the judge decide to accept all The Taxpayer’s request.



To analyze the case, I divide into two aspects, formal and material aspect. In formal aspect, DGT’s argument was always based on SE-17/PJ/2015. Using circular letter as a legal basis has several weaknesses. First, Indonesia does not recognize a circular letter in our formal legal hierarchy[1]. Second, circular letter is basically a directive for internal DGT, hence it was too ‘low’ to be regarded as a formal position of the Indonesia Government regarding the implementation of the article 11 DTT.


In material aspect, the failure to convince the judge about the “substance over form” principle becomes the biggest reason why DGT loss the case. Both DGT and the judge initially agreed that the determination of beneficial owner should be put in material aspect instead of formal aspect. Hence, the judge required DGT to prove two hypotheses, i.e. that GFBV was not the beneficial owner and who is/are the beneficial owner of the interest income[2]. In judge views, DGT’s argument basically was only an analysis without a clear evidence. DGT’s only used argument about ownership, newly-born company and non-active company as a reason that GFBV was not beneficial owner. Those arguments, based on judge’s view, were not enough to prove that GFBV was not the beneficial owner.


Too see how the implementation of the ‘substance over form’ principle, we can see how the litigation process in other beneficial owner cases. In Indofood case, the judge said that Mauritian company (and therefore the Newco, a Netherland’s residence) was not a beneficial owner because it was bound to pay the interest to the trustee from the interest it received from Indofood (McGowan, 2006). Comparing to our case, in the litigation process, DGT has never explained (with an evidence of course) whether there was an obligation (by document or by fact) that the interest income received by GFBV was then transferred to third party. The importance of this ‘predetermined or automatic flow of fund’ principle was also become one of the judge’s main argument in Prevost case (Arnold, 2013). Similarly, the ‘no automatic flow of fund’ principle as stated in Prevost case was also applied in Velcro case even though there was a contractual obligation that 90% royalties received by VHBV must be transferred to VIBV. In Velcro case, the judge concluded that VHBV was the beneficial owner based on two factors, i.e. first, the royalties received by VHBV were commingled with other funds in one bank account, and second the amount paid by VHBV to VIBV was different from the amount received by VHBV from Velcro Canada (Arnold, 2013). From this three different cases we can see that beneficial owner determination process involving a deep examination in income recipient side (in our case is GFBV) on how and to what extent the income received by that company flow to other party (both in contractual agreement and by fact). Due to the its limitation, DGT could not provide this analysis in the litigation process and, to some extent, contribute to judge’s decision in favor of The Taxpayer.


What’s next?

In the last section of the verdict, the judge explained their point of view regarding beneficial ownership in two law perspectives, international and domestic law. This explanation implicitly becomes a guidance for DGT in preparing a solid argument when facing the same case in the future. In international perspective, DGT should prepare in building an argument regarding beneficial ownership based on international fiscal meaning including literature from OECD rather than domestic law (McGowan, 2006). The example of the international fiscal meaning implementation could be found in Velcro case where the judge analyzed the four attributes of beneficial owner: possession, use, control and risk (Arnold, 2013).


In the verdict, the judge also explained that based on article 3 par. 2 of DTT, the term not defined in DTT should be defined using domestic law. Regardless the controversy behind this argument, strengthening domestic law in defining beneficial owner becomes an important point for DGT. DGT had issued Director General of Taxes Ruling Number PER-25/PJ/2010 as an amendment for PER-62/PJ./2009 concerning Prevention of Tax Treaty Abuse. Article 3 and 4 of this ruling describes criteria for an entity to be regarded as beneficial owner. This regulation, to some extent, becomes an answer for the judge argumentation in the verdict concerning about the absence of the beneficial owner definition in domestic law. However, DGT should also considering the possibility that taxpayer or judge will questioning the legal position of the Director General of Taxes Ruling in the future, the same reason when the judge questioning the legal position of circular letter in the case. Director General Ruling is not recognized in Law Number 12 year 2011. One way to solve this problem is upgrading the legal status of the ruling to become Finance Minister Ruling so that it is legally known in the domestic legal hierarchy based on Law Number 12 year 2011[3].


In the future, DGT should consider to include limitation on benefit (LoB) provision in treaty negotiation since it is important to restrict the definition of beneficial owner in the article 10, 11 and 12 of double tax treaty (Borrego, 2006). OECD Commentary of Article 1 (par 13-20) has also described several measures to handle conduit company issues and proposing LoB (OECD, 2010). Including LoB provision is regarded as one of the long term measure since negotiating treaty is not a simple task and need a quite long time to be mutually agreed.


Closing Remarks

From the verdict, several lessons can be withdrawn. The substance over form principle required DGT to do a deep analysis on the income recipient side, hence gathering data become a very crucial task to defend DGT’s argument. DGT should consider to upgrade the current regulation about treaty abuse prevention so that it will align with the Law Number 12 year 2011. Moreover, building an argument about beneficial owner in the perspective of international fiscal meaning is also important to anticipate taxpayer’s or judge’s challenge in the future. Lastly, including LoB provision in the process of treaty re-negotiation is important to prevent treaty abuse in the future.





Agreement between The Government of The Republic of Indonesia and The Government of The Kingdom of The Netherlands for The Avoidance Of Double Taxation And The Prevention of Fiscal Evasion With Respect To Taxes On Income. Jakarta, 29 January 2002.

Alexakis, P. (2014). How to Identify Beneficial Owner. Retrieved September 8, 2016 from https://www.oecd.org/daf/ca/corporategovernanceprinciples/32387308.ppt

Arnold, B.J. (2013). The Concept of Beneficial Ownership under Canadian Tax Treaties. Beneficial Ownership: Recent Trends. IBFD: Amsterdam

Borrego, F.A.V. (2006). Limitation on Benefits Clauses in Double Taxation Conventions. Kluwer Law International: The Netherland.

Duff, D.G. (2013). Beneficial Ownership: Recent Trends. IBFD: Amsterdam

Law of The Republic of Indonesia Number 12 Year 2011 Concerning The Establishment of the Law (in Indonesian). Retrieved September 13, 2016 from http://www.unm.ac.id/files/surat/UU12-2011Lengkap.pdf

McGowan, M. (2006). Indofood Court Expands Interpretation of Beneficial Ownership. Tax Notes International, June 26 2006. p. 1091. Retrieved September 13, 2016 from http://www.shearman.com/~/media/Files/NewsInsights/News/2006/06/Indofood-Court-Expands-Interpretation-of-Benefic__/Files/View-Full-Text/FileAttachment/mcgown_062606.pdf

Organization for Economic Cooperation and Development [OECD]. (2010). Model Tax Convention on Income and on Capital. OECD Publishing: France.

Tax Court Verdict number PUT.29050/PP/M.III/13/2011. Retrieved September 8, 2016 from https://www.google.co.id/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0ahUKEwjPk8f3gYDPAhXBo48KHdCOD30QFggcMAA&url=http%3A%2F%2Fwww.setpp.depkeu.go.id%2FDataFile%2FRisalah%2F29050S.doc&usg=AFQjCNFAw9JxURLCGvi6J6Yjnw2YqfYp0A&sig2=82e4OGvw5iQlcr6XtPP_CA

Yoshimura, K. (2013). Clarifying the Meaning of Beneficial Owner in Tax Treaties. Tax Analysts, 761-782. Retrieved September 8, 2016 from http://taxprof.typepad.com/files/72ti0761.pdf


[1] The lowest legal hierarchy based on article 7 Law Number 12 Year 2011 is Regency/City Ruling

[2] The judge also explicitly stated that the burden of proof is on DGT side.

[3] Please refer to article 8 the Law Number 12 year 2011. However, there is no guarantee that there will be no debate about the legal status of ruling even though the Director General of Taxes Ruling is then replaced by Finance Minister Ruling. Article 8 par. 2 of the Law Number 12 year 2011 explicitly said that Finance Minister Ruling will be recognized and lawful only if it is ordered by the higher law or it is enacted based on Finance Minister’s authority. The Income Tax Law, however, does not have any provision that explicitly mandating Finance Minister to regulate about treaty abuse prevention. Therefore, in the next amendment of the Income Tax Law, DGT should propose a provision regarding treaty abuse prevention to be explicitly stipulated in the Income Tax Law.


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