Swedish IFA branch seminar on beneficial ownership and permanent establishments

WebJournal on International Taxation in Sweden, WITS, (no 8/2012 November)

I have recently attended a tax seminar arranged by the Swedish branch of the International Fiscal Association (IFA) regarding the changes considered by the Fiscal Committee of the OECD of the commentaries to their Model Tax Treaty on the application of the rules on

• ”beneficial ownership” in articles 10-12 on dividends, interest and royalties
• and on the definition of ”permanent establishment” in article 5. 

See the homepage of the OECD.

Beneficial ownership

Considering the recent blogs I have written (WebJournal on International Taxation in Sweden, WITS, numbers 1,6 and 7 posted on petersundgren.blogspot.com) on the beneficial ownership issue, involving specifically certain royalty payments made within the IKEA group, my interest at the seminar was of course mainly focused on the development in the OECD of this matter.

Moreover, which is also gearing up the interest in this field is that the Swedish Supreme Administrative Court (Högsta Förvaltningsdomstolen, HFD,) has issued a ruling regarding the  meaning in Swedish tax law of the expression ”the true recipient of income” (faktiskt har rätt till inkomst) which closely resembles the beneficial ownership concept in our tax treaties. David Kleist has recently published an article in Skattenytt 2012 page 619 ff. about this case titled ”HFDs bedömning av vem som ”faktiskt har rätt till inkomsten” - det första svenska avgörandet om beneficial owner?” (The HFD's opinion on who is ”the true recipient of income” - Sweden's first case on beneficial ownership?) Mr Kleist concludes that these issues are now squarely on the table (”uppe på banan”).

In my afore mentioned blogs I have raised the question of who is the beneficial owner of the (very substantial) royalty payments made by all IKEA stores in Sweden – and in fact by all such stores worldwide – to Inter IKEA B.V. in the Netherlands. This question has become highlighted since the revelation in the Swedish television broadcast ”Uppdrag Granskning” (Mission Investigation) in early 2011 that Inter IKEA was owned by a hitherto completely unknown Liechtenstein based trust (Stiftung) called Interogo which was fully controlled by IKEA's founder Ingvar Kamprad and his family and which trust also owned the IKEA trademark(s). Kamprad has further confirmed that Interogo has a capital of - are you ready - about 100 billion SEK, approximately 15 billion USD. (It has subsequently also been anounced that as per 1 January 2012 the trademarks have been transferred by Interogo to Inter IKEA for 75 billion SEK).

OECD's proposals for the update of the commentaries to the model treaty on the beneficial ownership concept were published on 29 April 2011. After considering comments submitted thereto by various interested parties the OECD has recently issued a somewhat revised version published on 19 October 2012.

The main focus of the OECD proposals made in the spring of 2011 and which remain unaltered in the revised version is to determine whether the recipient of the royalty (or the dividend or interest for that matter) has ”the full right to use and enjoy the income received unconstrained by any contractual or legal obligation to pass the payment received to another person.” If so the recipient is considered the beneficial owner of the income. Or, in other words regarding Inter IKEA and Interogo: Does Inter IKEA in the Netherlands have the right to fully use and enjoy its royalty payments received from Sweden unconstrained by any contractual or legal obligation to pass them on to Interogo in Liechtenstein?

According to the information in the Uppdrag Granskning broadcast and various other press reports together with the somewhat contradictory (and paternalizing) information I have received from Inter IKEA's head of information (see WITS no 6-7/2012) it cannot be excluded that Inter IKEA has been obliged to pass on its Swedish sourced royalties (or parts thereof) to Interogo. Particularly indicative hereof is a) as afore mentioned, that Interogo has owned the IKEA trademarks, b) that there has existed a license agreement, i.e. a contractual obligation, for Inter IKEA to pass on, as it seems, its received royalties to Interogo and c) that Interogo, which as it appears, has not conducted any other business, has amassed a 100 billion SEK fortune therefrom. The IKEA group is well-known for its very ingenious and often secretive business structure consisting of companies, trusts etc, around the world. And one has never denied fhat the the purpose hereof has been to shelter the group from tax exposure. As further implied in my earlier blogs it may also be argued that Interogo has engineered an unacceptable tax avoiding treaty shopping set-up which, according to the OECD Model Treaty commentaries, sometimes could deny treaty benefits.

My own conclusions of the application of the beneficial ownership rules in our tax treaty with the Netherlands as far as IKEA is concerned, as mentioned above, is based only on official sources and without exact knowledge of ownership relations, business agreements or timing issues etc. and a final decision of the implications hereof for the beneficial ownership determination must of course await a thorough investigation of all relevant facts and circumstances in the particular case.

It would be surprising if none of the tax administrations in countries that have tax treaties with the Netherlands including beneficial ownership clauses and tax information exchange agreements with Liechtenstein would not test those treaties.

A further tricky question, which Mr Kleist has brought to my attention, is how to determine the royalty income if Interogo would be considered the beneficial owner of the royalty payments or parts thereof made from Sweden to the Netherlands and subsequently passed on to Liechtenstein. According to Swedish tax law royalty income derived by foreign residents is taxed as regular business income (from a permanent establishment in Sweden) subject to ordinary income tax rates. (It has been suggested several times that Sweden should switch to a withholding tax regime on gross income but this idea has been rejected). Inter IKEA in the Netherlands should thus report its gross Swedish royalties as taxable income but also deduct all royalties passed on to Interogo (and other business costs).

Example: Inter IKEA receives 100 million SEK in royalties from its Swedish IKEA stores and passes on (directly or indirectly) 70 million thereof to Interogo in Liechtenstein. The remaining 30 million SEK is subjected to regular Swedish corporate tax (which qualifies for tax credit purposes in the Netherlands). What then happens to the 70 million passed on to Liechtenstein? It remains an open question but it is a fair guess that the Swedish fisc will consider this to be permanent establishment income in Sweden of Interogo. What an irony it would otherwise be in these situations if Sweden should lose its taxing rights on outgoing royalties to foreign licensors because it taxes them as net (business) income instead of a final source gross income by withholding!

Permanent establishments

The second issue, as mentioned above, discussed at the IFA seminar was the OECD's new commentaries in the model treaty of the definition of permanent establishments. These problems, however, are too comprehensive to discuss in this report. See again OECD's home page.

However, my main reaction to what was said is the desperation one feels from the level of complexity and detail to which this problem has now risen! From the original 15 pages of commentaries these have now grown to 37! And considering further that this material shall apply to constantly varying facts and circumstances in each and every case, one can easily imagine the misery of the tax payer and the fiscal authorities of dealing with these problems.

But to solve these problems - like Alexander's slicing of the Gordian knot - I propose, which I did in an article already in 1996 in Skattenytt, that Sweden should unilaterally abolish taxation alltogether of ”small” permanent establishments during (say) the first five years of their presence in our country. This, actually, was something that was suggested in some long-forgotten EU report. And the idea as such was indeed adopted by Sweden and Denmark (in our tax treaty) during the construction of the Öresund bridge. It could be worth while introducing this idea again to a new generation of policy makers.

The taxation of permanent establishments is something particularly complicated (and expensive) for small and mid-sized businesses. Moreover, in many cases, there is nothing or very little to tax as the start up period of a business is often burdened by high costs. Cost which to a large extent represent wages paid to employees who are subject to tax in Sweden. Or, in other words, we are considering a system that creates new jobs! Also, of course, the business will allways generate employers fees, value added taxes etc. And - which I especially thought of during the seminar presentation - think of all the costs and head-ache spared for employers, taxpayers and their experts, the fiscs and our tax courts by doing away with permanent establishment taxation of this kind.

First of all in a tax regime of this kind one must of course determine what is meant by a ”small” permanent establishment. In my 1996 article I referred to an explanation hereof by the EU. Personally I suggested a business employing up to 25 people and/or with a turnover of not more than 7 million ECUs. In order to prevent an undue competitive situation (= double non-taxation) only enterprises that are subject to business taxation in their home countries (and which countries do not have a tax treaty with Sweden that prevent double taxation of business income by exemption) should be eligible for the proposed tax system. Maybe, too, financial institutions, which do not generate so many jobs, and tax haven companies which may engage in improper tax avoidance operations should be excluded. Losses made during the five year start up phase should of course not be deductible in the sixth and following years of operation. A good idea would also be to persuade our treaty partners, especially our Scandinavian neighbors, to introduce this system on a reciprocal basis in our multilateral tax treaty.

Finally and most importantly, just imagine the psychological effect of being able to present Sweden as a country where foreign entrepreneurs can settle and operate tax free! (And, by the way, where also – see my earlier blogs hereon – there are a number of very generous tax breaks for foreigners assigned to work in Sweden.)

Stockholm in November 2012

peter@sundgren.net