Beneficial owner principle not applicable if not expressly allowed by tax treaty

In a judgment rendered on September 23, 2020 (cassation appeal 1996/2019), the court analyzed the ability to apply the withholding rate provided in the Spain-Switzerland tax treaty to royalties paid to a Swiss entity, when it was confirmed in an audit that this Swiss entity was not the beneficial owner of those royalties.

The National Appellate Court had concluded (supporting the tax auditors’ view) that the withholding rate could not be applied, even though it acknowledged that the tax treaty did not refer to the beneficial owner in the tax treaty article on royalties. According to the National Appellate Court, tax treaties must be interpreted, as far as possible, according to the spirit of the commentaries on the OECD model tax convention, or in other words, under a dynamic interpretation of tax treaties; and that model tax convention currently contains that concept.

As it had found in a judgment rendered on March 3, 2020 in cassation appeal 5448/2018 (see our newsletter dated June 5, 2020 and our earlier alert dated June 2, 2020), the Supreme Court noted that this view, adopted by the tax authorities and later supported by the National Appellate Court, is not consistent with the described principle of dynamic interpretation. The court underlined that this principle cannot be taken as a reason for sidestepping the contents of the tax treaty agreed between the parties that signed it. The OECD model tax conventions and their commentaries are not, the court said, sources of law.

In relation to the case under examination, the court also drew attention to the fact that the Spain-Switzerland tax treaty had been modified to include the concept of beneficial owner, although only for dividends and interest, not for royalties, which indicates that it could have been the signatories’ intention for this concept not to affect the taxation of royalties. As the court said, the beneficial owner clause or principle is not a metalegal rule or principle of natural law that always has to be imposed whenever interpreting a tax treaty, leaving aside its specific provisions and therefore the sovereign intention of the countries that signed it.

It had also happened in this particular case that the auditors had not allowed application of the Spain-United States treaty either (the US is where the parent company and beneficial owner of the rights that gave rise to the payment of the royalties was based), and applied the higher rates required in domestic law to the royalties.

The court criticized this conclusion, because its only aim appears to be to obtain the highest possible amount of tax from the taxpayer.