A review of Indofood International Finance Ltd v JP Morgan Chase Bank NA London Branch [2006] STC 1195 (“Indofood”) and draft guidelines issued by HM Revenue & Customs (‘HMRC’)

18 October 2006

Mathew Oliver, Ingrid Toth

The Indofood decision concerns the meaning of “beneficial ownership” in double tax conventions (‘DTC’) and is being used by HMRC to restrict the availability of treaty relief in circumstances where a company is artificially inserted into a structure to obtain the benefits of treaty relief. This practice is known as “treaty shopping”.

The facts of the case

Indofoods, an Indonesian resident company, wished to borrow from third parties but would have faced a 20% withholding tax in Indonesia on interest payments if it had borrowed directly. It therefore set up a special purpose vehicle (‘SPV’) subsidiary resident in Mauritius which issued loan notes to the lenders and subsequently lent the proceeds to Indofoods. This allowed access to a reduced withholding tax rate of 10% under the DTC between Mauritius and Indonesia (‘MI DTC’).

Under the terms of the loan issue, the SPV could redeem the notes early if the withholding tax exceeded 10% and this could not be avoided by taking reasonable measures.

As a result of the revocation of the MI DTC, the SPV sought to redeem the notes. However, the holders resisted the redemption arguing that a Netherlands company (‘Dutch Co’) interposed between the parent and the SPV would benefit from a 10% rate of withholding tax under the DTC between Netherlands and Indonesia (‘NI DTC’). This would require the Dutch Co to be the “beneficial owner” of the interest payable within the meaning of the NI DTC.

The Court held that the Dutch Co could not be a beneficial owner and therefore treaty relief would not be available. Therefore, the insertion of the Dutch Co was not a “reasonable measure” available to the borrower.

The Court interpreted the term “beneficial owner” according to an ‘international fiscal meaning’ as distinct from a domestic law meaning. This meaning derives from the commentary to the OECD model convention which states that in interpreting beneficial ownership one should not be bound by a narrow technical meaning but understand the term in the context of the purposes of the DTC, “including avoiding double taxation and prevention of fiscal evasion and avoidance”.

The Court held that the Dutch Co needed ‘the full privilege to directly benefit from the income’ to have the necessary beneficial ownership. Having regard to the proposal, the Dutch Co would be a back to back finance vehicle which was bound to pass the income to the SPV. It would therefore be a mere conduit or “administrator of the income”.

This decision has raised many issues such as to whether the “international fiscal meaning” of ‘beneficial ownership’ applies to all DTCs in which the UK is a party and whether the ordinary domestic meaning of the term has been made redundant for UK treaty analysis.

Although there are a number of arguments why the judgment should be limited to its facts and merely represent the views of the Court of Appeal on how the Indonesian authorities would interpret the wording in the MI DTC, HMRC are adopting a much wider approach and will be applying the case as a means of interpreting UK DTCs.

HMRC’s draft guidelines (see: www.hmrc.gov.uk/)

HMRC’s views on Indofoods are set out in draft guidelines dated 9 October 2006. In a nutshell, HMRC takes the view that the ‘international fiscal meaning’ is applicable in circumstances of treaty abuse or treaty shopping and is applicable to all DTCs.

Where your clients are considering inward investment or lending arrangements to the UK and a conduit arrangement is used, then:


  1. if the intermediary and underlying lenders are all residents of countries in which the UK has similar DTCs, then the Guidelines state that no issue should arise because ‘it is unlikely that the purpose of the arrangement is the avoidance of UK withholding tax, since the level of UK withholding tax would have been the same with or without the intermediate lending‘;

  2. If the underlying lender is resident of a country in which the UK has;



a. no DTC; or

b. a DTC less favourable than the DTC applicable to the intermediary lender,


then the Guidelines state that the ‘international fiscal meaning’ will apply unless there is some other reason why there would have been no withholding tax on a direct loan (eg it is represented by a Quoted Eurobond).


Helpfully, the guidelines set out various scenarios under which HMRC will not apply the international fiscal meaning. These include:


  1. securitisation SPVs where the only lenders to the SPVs would have benefited from zero withholding tax if lending directly to the company under the applicable DTC;

  2. securitisation SPVs funded by Quoted Eurobonds (as there would be no withholding tax on such Eurobonds if issued by the UK company rather than the SPV);

  3. CDO/CLO/Mezzanine funds where there is no reduction of UK withholding tax by the use of the non resident SPV (eg if it is funded by quoted Eurobonds);

  4. Sub participation of a loan made as part of normal banking business (but not where lenders not entitled to treaty relief deliberately initiate a loan through a treaty lender which then syndicates);

  5. SPVs funded by Commercial Paper – as there would be no UK withholding tax on discounts; and

  6. conduit companies where there is no withholding tax advantage from using the company.

The guidelines are useful up to a point, but do not cover many examples which one would encounter in the real world. For example in many securitisation structures, there would be a mix of bond holders some of whom would qualify for treaty relief and some of whom would not. The guidance would appear to suggest that all such vehicles will now have to list their bonds in order to satisfy the Quoted Eurobond exemption.

Additionally, the examples set out in the guidelines only cover interest payments, whereas the decision has a wider impact on royalty flows.

There will therefore still be considerable doubt as to the impact of the Indofood decision in many commercial transactions.

The Guidelines are in draft only and may change as a result of comments from advisers and the investment community. If you wish to discuss the impact of the decision please contact a member of the tax department.