We bring you a recent judgment of the Regional Court in Brno (no. 29 Af 62/2018), which considered the issue of the beneficial owner of income arising from the royalties paid abroad. Recently, beneficial ownership of income has been a topic that has received considerable attention from tax administrators in tax audits. So, if you pay royalties either to a group or to a third party, you should not miss this judgment.
The case concerned a company which, in connection with the distribution of television programmes, paid royalties to its parent company in Romania and fellow subsidiaries in Hungary and Slovakia (“the foreign entities”). However, as the tax administrator found, those foreign entities were themselves contractually obliged to pay royalties to the producers of the individual television programmes.
Therefore, the tax administrator had doubts as to who was the beneficial owner of the royalties: whether it was the foreign entities or the producers of the television programmes themselves. The assessment of this question is crucial in determining which double taxation treaty and which withholding tax rate apply to the case.
In addition to the Income Taxes Act, the definition of “beneficial owner” is also based on the OECD Model Tax Convention and is understood as an entity that can use the income without restriction and is not obliged by law or contract to pass on the payments to another person.
In its judgment, the Regional Court, in agreement with the tax administrator, assessed the foreign entities as the so-called immediate recipients and not as the beneficial owners of the income, primarily on the basis of the following arguments:
(i) The programme producers contractually granted foreign entities a non-exclusive right to receive, transmit or distribute the programmes for the designated countries, and the foreign entities were not entitled to grant the rights (sublicences) to other persons or to use other means of distribution. It therefore appears from the judgment that the foreign entities entered into contracts for the granting of licensing rights essentially also on behalf of the Czech company, since sublicences could not be granted.
(ii) The amounts of the royalties negotiated between the payer (i.e. the Czech company) and the foreign entity were in the same amount as the subsequent royalties paid by the foreign entity to the programme producers. Thus, the foreign entities did not make any profit margin in this case.
Taking these facts into account, the Regional Court thus upheld the tax administrator’s conclusions and ruled that the foreign entities were not the beneficial owners of the income arising from the royalties but functioned as “flow-through entities” that merely intermediated payments between the payer and the programme producers (the actual owners of the income). Therefore, the Czech company as the payer in this case should have considered the programme producers as the beneficial owners of the income and applied the double taxation treaty concluded between the Czech Republic and the state of residence of this beneficial owner (i.e. the producer of the relevant programme to which the licence related).
Points of interest of the judgment
Although the logic of the conclusions and the reasoning of the Regional Court itself are in line with previous case law on the subject, we would like to highlight some interesting points:
(i) The tax administrator did not apply any double taxation treaty
Although the Regional Court upheld the tax administrator’s conclusions on the issue of the beneficial owner of the income, it ultimately annulled its decision and remanded the case back to it for further proceedings.
This was on the grounds that the tax administrator had applied a 15% withholding tax rate under the Income Taxes Act, as it was not clear which double taxation treaty was to be applied. However, according to the court, on the basis of the evidence submitted on the tax residency of the producers of the individual programmes, the tax administrator should have examined whether the relevant double taxation treaty could be applied to the case and reduced the tax rate accordingly.
(ii) Evidence
On the issue of proving beneficial ownership, the Regional Court reaffirmed that a certificate of tax residency alone, combined with a declaration of beneficial ownership of income, is not sufficient to prove beneficial ownership and that it is always necessary to look at the substance of the transactions themselves.
In the present case, however, the fact that the foreign entities had obtained a decision to grant exemption from licence fee income under Section 38nb of the Income Taxes Act was not taken into account. Nor did the tax administrator consider the foreign tax administrator’s confirmation that the foreign entities were the beneficial owners of the income to be relevant.
The issue of the beneficial owner of income is thus becoming more and more complex and, in view of the recent trend in tax audits, we recommend not to take this issue lightly, as the responsibility for the correct withholding of tax lies with the paying entity or payer.
For the sake of completeness, we would like to add that the plaintiff has a similar case pending before the Regional Court in Ostrava. However, its previous decisions, which have also been subject to review by the Supreme Administrative Court, have dealt more with procedural issues and have not yet dealt with substantive matters (as in the present case).
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