In a landmark decision recently published in the Gottex case, it was determined that a holding company with no employees may be considered the “beneficial owner” entitled to benefit from the tax treaty reliefs provided to distribution of dividends. The discussion of the principles of the “beneficial owner” doctrine – rooted in the world of international taxation (and not previously addressed in Israeli case law) – and particularly, the ruling regarding holding companies, represents significant news for companies investing in Israel.
Gottex Swimwear Brands, an Israeli resident company representing Inditex in Israel (owner of the brands ZARA, PULL&BEAR, Massimo Dutti and more) (“Gottex”), was held by a Dutch company, which in turn was held by a Canadian company, with two individuals at the top of the ownership chain (the “Ultimate Beneficial Owners” and/or the “UBOs”). Among various tax disputes in the case, the Israeli Tax Authority (the “ITA”) argued that since the individuals “control the company’s business, decide to whom, when, and from where to transfer the money, and what to do with it” they should be regarded as the “beneficial owners”. Therefore, the dividends distributed by the Israeli company should be treated as if distributed to the two individuals, subjecting them to the maximum withholding tax rate of 30%, and making them ineligible for the reduced 5% withholding tax rate provided under the Israeli-Netherlands tax treaty for intercompany dividends.
However, the court accepted Gottex’s position – represented by our firm – and ruled that the dividends in question are entitled to benefit from the provisions of the Israel-Netherlands tax treaty, and are subject to a withholding tax rate of only 5%.
In its decision – the first of its kind in Israel to address this issue – the court extensively analyzed the term “beneficial owner” in double tax treaties, describing it as a “fundamental principle of international tax law, intended to prevent the abuse of tax treaties.” The court explained that benefits of the treaty relief should be granted only to the beneficial owner and denied to intermediary entities (such as agents or nominee) “that serve merely as ‘conduits’ for transferring funds to another country with the purpose of exploiting treaty benefits”.
The court clarified that it is necessary to examine the nature of the dividend recipient – whether it is an independent company with its own existence, not obliged to pass the funds it receives (even if it does at some point), or an entity that serves only as a “conduit” for transferring funds, lacking any independent status or real control over the funds, and typically passing them on automatically under various agreements as part of a chain of transfers. If the legal ownership and control over the assets or income have not been materially diminished, then the formal owner is also the beneficial owner. The “beneficial owner” is not the person who may ultimately receive the assets or income – even if this is highly likely – but rather the party with the substantive legal right and ability to freely determine the use of dividends, without any restriction.
The court ruled accordingly that the “beneficial owner” is not the “ultimate owner”, and that the focus should be on the entity receiving the dividends, not the individual who ultimately receives the final dividend payment. Therefore, even if the shareholders higher up in the chain are the ultimate economic beneficiaries, the Dutch company cannot be disregarded and it is=- entitled to the treaty relief under the Israeli-Netherlands treaty-.
The court further clarified that a distinction must be made between a ‘conduit company’ and a ‘holding company”, while the first serves only as a link for transferring funds along the corporate chain, the latter (such as the Dutch company in this case) has its own independent existence, which cannot be ignored. The fact that the holding company has no employees does not necessarily mean it is a conduit company required to transfer the dividends onward.
The court also determined that, in terms of the burden of proof, the company seeking withholding tax relief must prove that it meets the relevant treaty requirements. On the other hand, the tax authority of the ‘source country’ that refuses to grant treaty relief to the “beneficial owner” bears the burden of proof and must prove the existence of objective and subjective circumstances indicating tax avoidance, similar to any “artificiality claim” (however, the tax authority is not required to prove who the true beneficial owner is, as this information is in the taxpayer’s possession.)
As noted, this decision represents a significant development in the field of international taxation, particularly for foreign companies investing in Israeli companies. The court ruled that the tax holding companies cannot be disregarded, and that the ITA must, in appropriate circumstances, grant them the full tax benefits provided under Israel’s double tax treaties.
