England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		7th October 2005

The Hon. Mr. Justice Evans-Lombe:


 


1. In this case Indofood International Finance Ltd ("the Issuer") seeks a declaration determining whether it is presently entitled to redeem certain loan notes issued by it to the holders of those notes ("the Noteholders"). The loan notes are US$280M, 10.37% Guaranteed Notes due in 2007 ("the Notes"). The Notes were issued on 18^th June 2002 following an offer made in an offering circular dated 11^th June 2002.
2. The Issuer is a company incorporated with limited liability under the laws of Mauritius for the sole purpose of issuing the Notes. It is the wholly owned subsidiary of PT Indofood Sukses Makmur Tbk. ("the Parent Guarantor"), a company incorporated with limited liability under the laws of the Republic of Indonesia and whose shares are listed on the Jakarta stock exchange. I will refer to the Parent Guarantor and its subsidiaries collectively as ("Indofood"). Indofood's business is food production and distribution. It is the premier processed food production company in Indonesia. The Parent Guarantor, amongst others guaranteed repayment by the Issuer of the Notes.
3. The defendant, JPMorgan Chase Bank ("the Trustee") which is a company incorporated with limited liability in the State of New York and a chartered commercial bank, through its registered London branch is trustee under a trust deed dated the 18^th June 2002 of the Notes. By an agency agreement of the same date the Trustee undertook to perform the functions of registrar and paying agent in relation to the Notes. By a loan agreement also of the same date the Issuer undertook to provide the proceeds of the Notes to the Parent Guarantor, and the Parent Guarantor undertook to pay interest to the Issuer to enable it to fulfil its interest obligations under the Notes.
4. At the time of the issue of the Notes, Indonesia was party to a Double Taxation Agreement ("DTA") with Mauritius. In Indonesia a withholding tax is payable in respect of interest payments at the rate of 20% if payment is to non-residents and 15% if to residents. This is a tax on the recipient of the interest but is collected by imposing an obligation on the payer of the interest in Indonesia to deduct the tax due and account for it to the Indonesian tax authorities. But for the provisions of the DTA the Parent Guarantor would have been bound to deduct tax from its interest payments to the Issuer at the rate of 20%. Article 11(2) of the DTA between Indonesia and Mauritius restricted that tax to 10%.
5. The terms and conditions of the Notes are contained in the original offering circular and are endorsed on each Note. Condition 5 of the Notes provided for interest to accrue daily and to be paid semi-annually in arrears on the 18^th June and 18^th December. Condition 8 provided that the Noteholders were to receive, and thus the Issuer was to receive from the Parent Guarantor, interest at the rate of 10.375% net and free from any tax. It was necessary, therefore, that the amount payable by the Parent Guarantor to the Issuer be grossed up to allow for the deduction of withholding tax so that after deduction of that tax the Issuer and through it the Noteholders received interest at the rate of 10.375%. With 10% withholding tax the grossed up rate payable by the Parent Guarantor was 11.53%. With 20% withholding tax that rate was 12.97%. The amount of the withholding tax payable thus had an appreciable effect on the financing costs to the Parent Guarantor.
6. Under condition 6 of the Notes they were to be redeemed on the 18^th June 2007 unless earlier redeemed. Condition 6 of the Notes set out the redemption provisions as follows:-

"6. REDEMPTION AND PURCHASE

(a) Scheduled redemption: Unless previously redeemed, or purchased and cancelled, the Notes will be redeemed at their principal amount on 18 June 2007, subject as provided in Condition 7 (Payments).

(b) Redemption for tax reasons: The Notes may be redeemed at the option if the Issuer in whole, but not in part, at any time, on giving not less than 30 nor more than 60 days' notice to the Noteholders (which notice shall be irrevocable) at their principal amount, together with interest accrued to the date fixed for redemption.

The right of the Issuer to redeem the Notes is only exercisable if the Issuer determines and satisfies the Trustee in the manner prescribed below immediately prior to the giving of such notice that as a result of any change in, or amendment to, the laws or treaties (or any regulations or rulings promulgated thereunder) of Mauritius or the Republic of Indonesia (or any political subdivision or taxing authority thereof or therein) affecting taxation, or any change in official position regarding the application or interpretation of such laws, treaties, regulations or rulings (including a holding judgment or order by a court of competent jurisdiction), which change, amendment, application or interpretation becomes effective on or after 18 June 2002:

(i) with respect to any payment due or to become due under the Notes, the Issuer is, or on the next Interest Payment Date would be, required to pay additional amounts as provided or referred to in Condition 7 (Taxation) on or in respect thereof; or

(ii) any Guarantor is, or on the next Interest Payment Date would be, unable for reasons outside of its control to procure payment by the Issuer and, with respect to any payment due or to become due under the relevant Guarantee of the Notes, such Guarantor is, or on the next Interest Payment Date would be, required to deduct or withhold any tax of the Republic of Indonesia (or any political subdivision or taxing authority thereof or therein) at a rate in excess of 20 per cent (calculated without giving effect to any reduction of the rate of withholding tax available under any tax treaty to which the Republic of Indonesia is a party); or

(iii) with respect to any payment by any Guarantor to the Issuer to enable the Issuer to make any payment of principal of, or interest on, the Notes or the additional amounts (if any), such Guarantor is, or on the next Interest Payment Date would be, required to deduct or withhold any tax of the Republic of Indonesia (or any political subdivision or taxing authority thereof or therein) at a rate in excess of 10 per cent (calculated after giving effect to any reduction of the rate of withholding tax available under any tax treaty between Mauritius and the Republic of Indonesia),

and such obligation cannot be avoided by the Issuer (or such Guarantor, as the case may be) taking reasonable measures available to it; provided however, that no such notice of redemption shall be given earlier than 90 days prior to the earliest date on which the Issuer or such Guarantor would be obliged to pay such additional amounts or such Guarantor would be obliged to make such withholding or deduction if a payment in respect of the Notes were then due or (as the case may be) a demand under the relevant Guarantee of the Notes was then made."

7. The issue in this case centres on the passage in condition 6 of the Notes which I have underlined above which I will call "the Proviso". It is clear that that provision is intended to prevent the Issuer, on the occurrence of a material tax change; from requiring the Notes to be redeemed unless it was not possible by taking "reasonable measures available to it" to avoid the effect of the tax changes, in particular, as events have turned out to avoid being subjected to an increase in the withholding tax over the rate of 10%.
8. As later described with effect from the 1^st January 2005 the DTA between Indonesia and Mauritius was terminated by the Government of Indonesia. The effect of that termination was to increase the rate of withholding tax payable from 10% to 20% thereby increasing the burden in servicing the Notes of the Issuer and Parent Guarantor.
9. Meanwhile between July 2002 when the Notes were issued and the termination of the Indonesia/Mauritius DTA the financial market rates for the borrowing of money had moved in favour of borrowers so that the Parent Guarantor was in a position to replace its loan from the Issuer with a loan from other sources at a materially reduced rate of interest. That change in the financial markets also meant that the Loan Notes themselves commanded a premium on the market. It follows that the commercial interest of the Parent Guarantor and the Issuer was best served by being able to redeem the Notes and that of the Noteholders represented by the Trustee was best served by avoiding such redemption.
10. On the 24^th June 2004 the Director General of Taxation in Indonesia ("The DGT"), the relevant authority in Indonesia for the purpose, gave notice of the termination of the Indonesia/Mauritius DTA with effect from the 1^st January 2005. On the 18^th November 2004 the Issuer sent a draft Notice Of Redemption to the Trustee for approval and publication seeking redemption of the Notes on the 29^th December 2004. On the 22^nd November 2004 the Trustee refused its approval, a position it has maintained since. The Trustee contended that whether or not the conditions of the Proviso were met was a matter for the subjective judgment of the Trustee and required the Issuer to provide extensive further information, in particular, information about the possibility of making use of the jurisdictions of other countries having DTAs with Indonesia through which to channel the payment of interest by the Parent Guarantor and thus obtain the benefit of double taxation relief.
11. In the face of the Trustee's refusal to give approval to a redemption notice, the Issuer commenced Part 8 proceedings on the 15^th February 2005. The issues for determination in relation to the Notes are set out in paragraph 16 of the claim form as follows:-

"16.1 whether, on the true construction of Condition 6(b) of the Terms and Conditions of the Notes, the right of the Issuer to redeem the Notes requires the Issuer to "satisfy" the Trustee

(a) only that one of the events specified in sub-paragraphs (b)(i)-(iii) inclusive of Condition 6 has occurred, or, alternatively

(b) both that one or more of the events referred to in subparagraphs (b)(i)-(iii) inclusive of Condition 6 has occurred and that the additional obligation which arises as a result of any change in, or amendment to, the laws or the treaties of Mauritius or the Republic of Indonesia cannot be avoided by the Issuer or the Guarantor, as the case may be, taking reasonable measures available to it;

16.2 whether, on the true construction of the Terms and Conditions of the Notes and on the evidence, the Issuer is entitled to redeem the Notes in accordance with Condition 6(b) (page 32)."

12. After the issue of the claim form the Trustee conceded that as a result of the termination of the Indonesia/Mauritius DTA there had been a change in the laws of Mauritius or Indonesia affecting taxation within the terms of condition 6(b)(iii) and thus that there had taken place a relevant event which, subject to the Proviso, would trigger the Issuer's right to redeem the Notes.
13. By clause 14.1 of the Trust Deed, to which the Parent Guarantor, the Issuer and the Trustee are parties, "all matters arising from or connected with it are governed by and shall be construed in accordance with English law". By clause 14.2 "the Courts of England have exclusive jurisdiction to settle any dispute arising from or connected with" the Trust Deed.
14. The case came before Mr Justice Etherton who found, first, that the inability of the Parent Guarantor to avoid the additional withholding tax obligation by taking reasonable measures available to it was to be determined on an objective test and not to the subjective satisfaction of the Trustee and, secondly, that the burden was on the Issuer to show that the additional withholding tax obligation could not be avoided by the Issuer taking reasonable measures pursuant to the Proviso. Mr Justice Etherton declined to deal with the issue of whether such reasonable measures were available to be taken because that was, in part at least, a question of fact. That issue falls to me to decide on the evidence, mainly that of experts, which I have received.
15. The OECD has produced a model double taxation treaty for the regulation of the inter-relationship between the tax laws of its member states where profits or other income is generated in one state payable to entities resident in another state and taxable in both states. Indonesia is not a member of the OECD but has double taxation treaties with more than 30 nations. Those treaties, in particular the Indonesia/Mauritius DTA and the DTAs between Indonesia and the Netherlands, Luxembourg and the United Kingdom closely follow the form of the OECD model convention.
16. The DGT is the equivalent, in Indonesia, of the United Kingdom Inland Revenue. Its decisions on contested tax matters are appealable initially to an internal tribunal from the decisions of which appeal lies to the Indonesian Tax Court. I will refer to these two bodies together as the "Indonesian Tax Authorities". It is accepted that a DTA, once agreed between Indonesia and a third state, forms part of the domestic law of Indonesia to be construed in accordance with its terms. It is also accepted that the Indonesian Tax Authorities will be guided, in their construction of a DTA, by the official commentary published by the OECD, commenting on the provisions of the model convention, and by the various private commentaries on the provisions of that convention, in particular, that of Mr Philip Baker QC from which commentary passages were cited to me by both parties. It is also accepted, as one would expect, that the Indonesian Tax Court is entirely independent of the DGT and routinely reverses its decisions and those of its internal tribunal on tax matters. That point was expressly raised in the course of cross-examination and so I hope that I will be excused from sounding patronising in mentioning it.
17. By clause 11.1.5 and 11.1.6 of the Trust Deed the Issuer is bound to indemnify the Trustee in respect of all costs and expenses incurred by it in connection with the performance of its duties as trustee. In the course of the argument leading up to these proceedings the Trustee required the Issuer to investigate the provisions of a number of other DTAs between Indonesia and third countries in order to determine whether the benefits of double taxation relief could be achieved by channelling the interest payable by the Parent Guarantor through an entity resident in one of those countries. In addition the Trustee incurred expenses of its own in similar investigations. In the result the number of countries through which it was thought this might reasonably be done were narrowed down to three, the Netherlands, Luxembourg and the United Kingdom. Of these the Netherlands and Luxembourg were thought to be preferable to the United Kingdom on grounds of complication and costs. It then emerged that as between the Netherlands and Luxembourg there was little to choose but the Netherlands was marginally more favourable and, accordingly, in this court argument concentrated on the provisions of the Indonesia/Netherlands DTA ("The Netherlands DTA"). Because of past history, with the resulting close trading relations, it was likely that this would be the case. Notwithstanding that the possibility of using the provisions of the Netherlands DTA appeared the most attractive it was the contention on behalf of the Issuer that the Indonesian Tax Authorities would not accept that the benefits conferred by the Netherlands DTA would be available if the interest payable by the Parent Guarantor were channelled through a Netherlands resident entity.
18. The purpose of the Netherlands DTA is described in the heading to the treaty as being "for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income." For the purposes of this judgment the following provisions of the Netherlands DTA are relevant:-

"Article 4 Fiscal Domicile

1. For the purpose of this Agreement, the term "resident of one of the two States" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or other criterion of a similar nature….

4. Where by reason of the provisions of paragraph 1 a person other than an individual and other than an enterprise to which the provisions of article 8 apply [not applicable] is a resident of both States, then it shall be deemed to be a resident of the State in which its place of effective management is situated. If the competent authorities of the two States consider that a place of effective management is present in both States, they shall settle the question by mutual agreement.

Article 5 Permanent Establishment

1. For the purpose of this Agreement, the term "permanent establishment" means a fixed place of business in which the business of the enterprise is wholly or partly carried on.

2. The term "permanent establishment" shall include especially

(a) a place of management;

(b) a branch;

(c) an office;

(d) a factor;

(e) a workshop;

(f) a farm or plantation;

(g) a mine, an oil-well, quarry or other place of extraction of natural resources;

3. The term "permanent establishment" likewise encompasses:

(a) a building site…[inapplicable]

(b) the furnishing of services [inapplicable]

4. The term "permanent establishment" shall not be deemed to include

[(a) to (e) inapplicable]…

8. The fact that the company which is a resident of one of the States controls or is controlled by a company which is a resident of the other State or which carries on business in that other State (whether though a permanent establishment or otherwise), shall not itself constitute either company a permanent establishment of the other.

Article 11 Interest

1. Interest arising in one of the two States and paid to a resident of the other State may be taxed in that other State.

2. However, such interest may also be taxed in the State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest.

3. …

4. Notwithstanding the provision of paragraph 2, interest arising in one of the two States shall be taxable only in the other State if the beneficial owner of the interest is a resident of the other State and if the interest is paid on a loan made for a period of more than 2 years or is paid in connection with the sale on credit of any industrial, commercial or scientific equipment.

5. The competent authorities of the two States shall by mutual agreement settle the mode of application of paragraphs 2, 3 and 4.

6. …

7. The provisions of paragraphs 1 and 2 shall not apply if the recipient of the interest, being a resident of one of the two States, has in the other State in which the interest arises a permanent establishment with which the debt-claim from which the interest arises is effectively connected. In such a case, the provisions of Article 7 shall apply.

8. …

9. Where, owing to a special relationship between the payer and the recipient or between both of them and some other person, the amount of the interest paid, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the recipient in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each State, due regard being had to the other provisions of this Agreement."

19. It is the contention of the Trustee that the benefits of double taxation relief could be re-obtained, after the abrogation of the Indonesia/Mauritius DTA, by restructuring the loan arrangements, contained in the Trust Deed and its supporting agreements, so that the interest payable by the Parent Guarantor is passed through an entity resident in the Netherlands. This can be achieved, it is submitted, through the interposition of a new company, to which I will refer as "Newco" so resident, alternatively the migration of the Issuer to become so resident by moving its place of effective management to the Netherlands or by the substitution of a Newco as lender to the Parent Guarantor also resident in the Netherlands. Of these three possibilities the Trustee prefers "interposition" on grounds of cost and simplicity of arrangements.
20. It is proposed that Newco will be incorporated in Holland, will keep all its records, whether of trading, incorporation, shareholding, or otherwise, in Holland. It will be accounted for, including for all tax purposes, in Holland by Netherlands auditors. It will comply in all respects with Netherlands registration requirements. It will have no fixed place of business in Indonesia. All of its directors will be resident in Holland even if their nationality is Indonesian.
21. It was explained to me that, for a finance company of this kind to be accepted by the Netherlands Revenue Authorities as being resident for tax purposes in the Netherlands, it was necessary to comply with those Authorities' "substance and risk" requirements. These requirements prescribed that the relevant company must be fully capitalised up to a defined level and that, where the purpose of the company was the provision of loan facilities that those facilities must be made available on the basis of a transaction yielding a profit to the lending company and thus to be lent at a rate of interest greater than that at which the proceeds of the interest payments are accounted for to the providers of the finance from which the loan is made, here the Noteholders via the Issuer. The minimum resulting "spread" is fixed by the Netherlands Revenue Authorities. Newco would comply in all respects with these requirements.
22. Having incorporated Newco in the Netherlands in this way it is proposed that the benefit of the loan agreement between the Issuer as lender and the Parent Guarantor as borrower would be assigned by the Issuer to Newco and so the Parent Guarantor would be paying interest on that loan to Newco a company resident in the Netherlands which would then pay to the Issuer an amount sufficient to ensure that the Issuer would be enabled to pay the Noteholders' interest at the rate due under the Notes. I will hereafter refer to the proposals set out in the previous four paragraphs as "the Proposed Restructuring".
23. It is common ground that:-

1) Whether or not the Proposed Restructuring constitutes reasonable measures within the Proviso depends on:-

a) Whether the Proposed Restructuring will make the Parent Guarantor eligible to receive the benefits conferred by the Netherlands DTA and that, in the final analysis, this is a matter for the Indonesian Tax Authorities and ultimately the Indonesian Tax Court. This question sub-divides into two as follows:-

i) Whether or not Newco is resident for tax purposes outside Indonesia and inside the Netherlands.

ii) Whether Newco is "beneficially entitled" to the interest payable by the Parent Guarantor to it within the meaning of article 11.2 of the Netherlands DTA.

and

b) Whether it is reasonable to impose on the Issuer the costs of setting up the Proposed Restructuring and any additional running costs over the costs incurred in running the loan arrangements under the Indonesia/Mauritius DTA prior to the abrogation of that treaty.

2) The Parent Guarantor would lose any benefit under the Netherlands DTA that it was entitled to if Newco had, or later acquired, a "permanent establishment" in Indonesia within paragraph 11.7 of the Netherlands DTA.

3) Under the Proposed Restructuring the Parent Guarantor would be unable to obtain the full benefit of the Netherlands DTA if, having a "special relationship" with Newco it were to be found that the rate of interest payable to Newco exceeded the market rate at the relevant time, in which case, only such part of the interest payable as amounted to the market rate would attract withholding tax at the privileged rate.

4) There is an issue whether, on the basis that the Proposed Restructuring would conform with article 11.2, it would also conform with article 11.4, as being a loan for more than two years, in which case the eligible withholding tax would be reduced to nil and thus the position, so far as withholding tax is concerned of the Issuer would be better than it was under the Indonesia/Mauritius DTA, when no less than 10 % was payable, there being no equivalent in that treaty of paragraph 11.4. The resolution of this issue impacts on the question of whether the additional costs of introducing and maintaining the loan under the Proposed Restructuring are reasonable.

5) As under paragraph 1) the issues summarised under paragraphs 2.3 and 4 are ultimately a matter for the Indonesian Tax Authorities if, and when, the Proposed Restructuring is put into effect.

24. In deciding whether the proviso permits the Trustee to decline permission for the giving of notice to redeem the Notes I have to form a view as to how the Indonesian Tax Authorities will react to the Proposed Restructuring if it is put into effect. Since this involves taking a view on the likely decision of another court, namely, the Indonesian Tax Court, this is an unusual role for a British judge.
25. In performing this unusual function Mr Popplewell for the Issuer submitted that before concluding that the Trustee was entitled to refuse permission for notice to redeem, I must be reasonably certain that the Indonesian Tax Authorities would permit the benefit of the Netherlands DTA to be taken by the Parent Guarantor if the Proposed Restructuring were to be put into effect. To do otherwise, he submitted, and apply a "balance of probabilities" test, would not give effect to the requirement of reasonableness in the measures required by the Proviso. The court must have reasonable certainty as to the outcome before requiring the Issuer to embark on the costs of putting the Proposed Restructuring into effect. Rather less than two years of the original five year period of the loan remains unexpired. While the issue remains undetermined the Issuer and the Parent Guarantor are having to find interest at a rate exceeding the current market rate and the Issuer is paying withholding tax at 20% of that rate. If the court's forecast of the ultimate reaction of the Indonesian Tax Authorities to the Proposed Restructuring turns out to be wrong it is likely that that conclusion will only be reached after litigation and the passage of a substantial time which may well take up the remaining period of the loan. The Parent Guarantor would be bound to account for the withholding tax throughout that period and so the Issuer would lose the benefit of the right to redeem under condition 6 of the Notes whether or not this court correctly forecast the reaction of the Indonesian Tax Authorities.
26. In this context Mr Popplewell emphasised an exchange of correspondence between the Parent Guarantor and the DGT by letters dated the 10^th and 24^th June 2005 respectively in which the opinion of the DGT on the acceptability of the Proposed Restructuring was sought. The response of the DGT is contained in paragraph 3 of its letter of the 24^th June 2005 which, in English translation reads as follows:-

"3. Based on the facts, circumstances and regulations described above, the following are some guidance and confirmation on the matters in question:

a. In accordance with its original title of the tax treaty that is "Agreement (Convention) between the Government of the Republic of Indonesia and the Government of ... for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income", and the OECD and UN Commentary on Model Tax Convention, one of the underlying objectives of the establishment of the tax treaty is for the avoidance of double taxation and for the prevention of tax avoidance and evasion in respect to taxes on income.

b. Treaty Shopping is an abuse/improper use of the tax treaty as they are contrary to the objectives of the establishment of the treaty itself. Treaty shopping may occur where taxpayers who are not residents of Contracting States seek to obtain the benefits of a tax treaty by organizing a corporation or other legal entity in one of the Contracting States to serve as a conduit for income earned in the other Contracting State.

c. Therefore, any types of financing structures which will be adopted by PT ISM and IIFL that is contrary to the objectives of the tax treaty will not be eligible under the Indonesian tax laws. On the facts and circumstances as stated in your letter, as the main purpose of the new financing structure to be adopted by PT ISM and IIFL is clearly to avoid the increased withholding tax as a result of the termination of the Indonesia-Mauritius Tax Treaty and to take advantage of the provisions of the tax treaty of another country, accession to treaty benefits will be denied.

d. In accordance with the principle of Indonesian Income Tax Law which is "substance over form", and also in accordance with OECD and UN Commentary on Model Tax Convention, the term beneficial owner which has been set as one eligibility requirements for the application of withholding tax rate on interest specified in the treaty is an anti abusive rule intended to limit the accession to the benefits provided by the treaty to only those who have the actual rights for such entitlement. Therefore, the term "beneficial owner" means the actual owner of the interest income who truly has the full right to enjoy directly the benefits of that interest income. Consequently, conduit company and nominee such as the NewCo will not be regarded as the actual owner of the income. Thus, the rate that shall be applied is in accordance with the Indonesian Income Tax Law which is 20%.

Paragraph 9 of Article 11 of the Tax Treaty between Indonesia and the United Kingdom as cited in point I e above is an example of "a specific anti-avoidance rule" which set "limitation of tax benefits", for which if there is "the creation or assignment of the debt-claim", whose objective is obviously for gaining treaty benefits provided by Article 11 of the tax treaty, as stated in your letter, thus the rate that shall be applied is 20%.

e. A mere submission or presentation of an original Certificate of Domicile is only one of the ways to verify whether or not parties gaining benefits provided by the tax treaty are the ones that truly have the rights to them. If it is considered to be necessary to verify such parties, further audit or investigation may be undertaken through a normal audit procedure, including that of under the framework of mutual agreement procedures and exchange of information based on the provisions of the related tax treaties.

f. If parties conducting transactions are not parties that have the rights to enjoy the benefits provided by the treaty including if the NewCo is a company established under the criteria of the provision of Article 29 of the Tax Treaty between Indonesia and Luxembourg, thus provisions of the domestic tax, laws shall apply.

g. The NewCo will be regarded as a resident of Indonesia if the composition of the board of directors and management^; of the NewCo meets the criteria set by the provision of Article 4 of the Tax Treaty between Indonesia and the Netherlands, Tax Treaty between Indonesia and^: the United Kingdom, or Tax Treaty between Indonesia and Luxembourg. Alternatively, the NewCo will be regarded as having a Permanent Establishment in Indonesia if the composition of the board of directors and management of the NewCo meets the criteria set by the provision of Article 5 of the tax treaties.

h. If "interposition" scheme is to be adopted and established in the Netherlands, the provision of paragraph 4 of Article 11of the Tax Treaty between Indonesia and the Netherlands cannot be applied since the mode of application between competent authority of Indonesia and the Netherlands has not been settled by mutual agreement.

i. Any additional interest expenses incurred due to a restructuring scheme adopted are fiscally deductible in so far they meet the criteria set by Article 6 and Article 9 of the Indonesian Income Tax Law."

27. Mr Popplewell pointed out that on the facts of the present case the DGT were under no tax gathering incentive to give a biased view against the Trustee. If the Issuer has a right to redeem withholding tax will cease whereas, on one view, withholding tax at 10% will still be recoverable under the Proposed Restructuring.
28. Mr Sheldon for the Trustee submitted that on their true construction the inclusion in the Proviso of the words "and such obligation cannot be avoided by the Issuer", in particular, the word "cannot" meant that reasonable certainty was not required.
29. I accept Mr Popplewell's submissions for the Issuer on this point. I will consider the contents of the DGT's letter of the 24^th June 2005 in due course but it seems to me that this court should apply a "reasonable certainty" test in coming to any conclusion as to the likely reaction of the Indonesian Tax Authorities to the putting into effect of the Proposed Restructuring.
30. The underlying facts of the case are not in issue. The only evidential issues between the parties arose as a result of the conflict between their respective expert witnesses. Each side produced expert evidence of the relevant law and practice in the field of double taxation of the Netherlands and Indonesia and also of Luxembourg and the United Kingdom with relation to Indonesia. In the result, as I have already said, the parties concentrated on the law and practice of Indonesia and the Netherlands. The reports were jointly produced by more than one expert but cross-examination in each field was largely confined to one witness only. On questions of Indonesian law and practice Professor Mansury was tendered for cross-examination by the Issuer. Mr Hadibroto was also briefly cross-examined but his evidence added little to that to Professor Mansury. On the Trustee's side Mr Sutanto was cross-examined as to Indonesian law and practice although, again, Mr Shah was briefly cross-examined. In the field of Netherlands law and practice Mr Elias was tendered for cross-examination by the Issuer and Mr van Casteren for the Trustee.

Eligibility - Residence

31. I turn to consider the issue of eligibility – firstly, residence described at paragraph 23 1(a) above namely whether if the Proposed Restructuring is carried out as I have outlined, it will constitute Newco as resident in the Netherlands and not in Indonesia. I have come to the clear conclusion that in those circumstances Newco would indeed be treated as resident in the Netherlands for tax purposes both in the view of the Netherlands Tax Authorities and of the Indonesian Tax Authorities. As to the former this was conceded by Mr Elias the Issuer's Netherlands expert. Professor Mansury initially also conceded that this would be the view of the Indonesian Tax Authorities but later sought to withdraw the concession on two grounds, the first, because he characterised Newco a "Conduit company", that is a company through which value passed between the parties to a financial transaction for the purpose of achieving a tax advantage but which otherwise did not have any material effect on the transaction in question. The second reason put forward by Professor Mansury was that by reason of the control of Newco by the Parent Guarantor, Newco's place of effective management would be Indonesia by reason of the operation of article 4 paragraph 4 of the Netherlands DTA.
32. Paragraph 13 of the OECD report entitled "Double Tax Convention And The Use Of Conduit Companies" (the "conduit companies report") under the heading "The general situation" says:-

"13 Normally under the OECD Model the conduit company is regarded as a person [Article 3 paragraph 1(a) and (b)] resident in the State of conduit (Article 4)s it is therefore entitled to claim the benefits of the treaty in it own name. There are of course situations where specific circumstances exclude the company from treaty benefits, but it is rarely possible to verify that such circumstances are present. This is the case for example where:

The entity used as a conduit is not recognised as a juridical person (being, for example, a partnership or a trust which may not be a "person" under the treaty provisions);

The company is not liable to tax in the State of conduit on the basis of its domicile, place of management or other criterion of a similar nature (e.g. because its Board of Directors does not meet in that State);

The assets and rights giving rise to the dividend interest and royalties have not effectively been transferred to the company so that it acts as a mere nominee when receiving payments of such income."

33. The conduit companies report goes on to say that it is for that reason that the OECD has included in its model an article, similar to article 4.1 of the Netherlands DTA, making it a condition of recognition that conduit companies are taxable in the State of proposed residence. It is probably for this reason that the Netherlands Tax Authorities have insisted on the substance requirement which I have set out above.
34. When in cross-examination Professor Mansury was confronted with this paragraph he was unable to reconcile it with paragraph 92 of his report.
35. As to Professor Mansury's second ground for resiling from his concession, this seems to me to confuse the control of the company by its shareholders with the management of the company by its directors. Thus a parent company may control a subsidiary by its power to appoint and remove directors. However, it is the board of directors of the subsidiary company which actually controls the trading operations of that company and owes to the subsidiary company fiduciary duties in that regard. It is they who will be held accountable for the actions of the subsidiary company under the relevant companies legislation. In almost all cases a subsidiary's board will accept and carry out the policy of the board of its parent because their commercial interests will usually coincide. There will, however, be instances when the board of a subsidiary may be forced to stand out to the point of resignation against the wishes of its parent in order, for example, to support the interests of its separate creditors. This point is well illustrated by the recent decision of Mr Justice Park in Wood & anr v Holden [2005] EWHC 547, decided in the context of a double taxation treaty see in particular paragraphs 21 to 28 of the judgment in that case.
36. The DGT appears to be supporting the Issuer's position on this point in the first sentence of paragraph 3(g) of its letter of the 24^th June but I am not able to understand from this the basis on which it does so. Mr Popplewell for the Issuer did not really press the claimant's case on the residence of Newco.

Eligibility – Beneficial Ownership

37. I turn to consider the issue under paragraph 23 1(a)(ii) above namely, whether Newco would be the "beneficial owner" of the interest becoming due from the Parent Guarantor so as to bring it within paragraph 11.2 of the Netherlands DTA. I have again come to the clear conclusion that it would be such beneficial owner.
38. I will start by looking at the present loan structure. Simultaneously with entering into the trust deed the Issuer entered into a loan agreement with the Parent Guarantor expiring after five years at an interest rate of 10.375 % payable half yearly. Also simultaneously the Issuer became liable under the conditions attached to the Notes to account to the Noteholders for interest on the face value of those Notes which they had subscribed at the same rate of interest. There are thus two loan agreements between the Issuer and the various Noteholders, and between the Issuer and the Parent Guarantor. The Issuer received the interest in question from the Parent Guarantor as lender under the terms of its loan agreement with its parent. It meets its obligations to the Noteholders from the interest it receives from the Parent Guarantor. However it is in no sense a trustee or fiduciary for the Noteholders of the interest it receives. Condition 2(a) of the conditions of the Notes states:-

"2(a) Status of the Notes: The Notes constitute direct, general and unconditional obligations of the Issuer which will at all times rank pari passu and without any preference among themselves and at least pari passu with all other present and future unsecured obligations of the Issuer, save for such obligations as may be preferred by provisions of law that are both mandatory and of general application."

39. Thus, in any insolvency of the Issuer, undistributed interest received from the Parent Guarantor would form part of the assets of the Issuer available to be distributed to its creditors generally, including the Noteholders, pari passu. The Proposed Restructuring would transfer the benefit of the loan agreement with the Parent Guarantor from the Issuer to Newco in consideration of which Newco would indemnify the Issuer against its obligation to pay the Noteholders the amounts due under their loan notes.
40. As Professor Baker notes at paragraph 10B-09 of his commentary on the OECD Model convention "The requirement that the recipient of the dividends be the "beneficial owner" (the French version of the Model uses: bénéficiaire effectif - both language versions of the Model are equally authoritative) was added when the text of the Model was revised in 1977, and was added to prevent abuse in the form of treaty-shopping. Unfortunately, the meaning of the phrase still remains less than fully clear."
41. At paragraph 14 of the conduit companies report to which I have already referred the following appears at sub paragraph (b) :-

"b) Articles 10 to 12 of the OECD Model deny the limitation of tax in the State of source on dividends, interest and royalties if the conduit company is not its "beneficial owner". Thus the limitation is not available when, economically, it would benefit a person not entitled to it who interposed the conduit company as an intermediary between himself and the payer of the income (paragraphs 12, 8 and 4 of the Commentary to Articles 10, 11 and 12 respectively). The Commentaries mention the case of a nominee or agent. The provisions would, however, apply also to other cases where a person enters into contracts or takes over obligations under which he has a similar function to those of a nominee or an agent. Thus a conduit company can normally not be regarded as the beneficial owner if, though the formal owner of certain assets, it has very narrow powers which render it a mere fiduciary or an administrator acting on account of the interested parties (most likely the shareholders of the conduit company). In practice, however, it will usually be difficult for the country of source to show that the conduit company is not the beneficial owner. The fact that its main function is to hold assets or rights is not itself sufficient to categorise it as a mere intermediary, although this may indicate that further examination is necessary. This examination will in any case be highly burdensome for the country of source and not even the country of residence of the conduit company may have the necessary information regarding the shareholders of the conduit company, the company's relationships to the shareholders or other interested parties or the decision-making process of the conduit company. So even an exchange of information between the country of source and the country of the conduit company may not solve the problem. It is apparently in view of these difficulties that the Commentaries on the 1977 OECD Model mentioned the possibility of defining more specifically during bilateral negotiations the treatment that should be applicable to such companies (cf. paragraph 22 of the Commentary on Article 10)."

42. Thus, although there is no official guidance on the construction of "beneficial owner", where those words are being applied to a set of facts which render their application ambiguous it must follow that a construction should be placed on them which denies the benefit of double taxation relief to an applicant who can be characterised as "treaty shopping". It is clear that the original loan by the Noteholders through the Issuer to the Parent Guarantor amounted to treaty shopping in the sense that there was no other reason why they should have done so through a Mauritian company save for the purpose of taking advantage of the double taxation treaty between Indonesia and Mauritius. Equally the Proposed Restructuring of that loan through Newco resident in Holland constitutes treaty shopping. In both cases the Noteholders were or would not be resident for tax purposes in the country of residence of the Issuer or Newco to which the relevant DTA applied.
43. In the course of his cross-examination Professor Mansury accepted that the Indonesian Tax Authorities, or, certainly the Indonesian Tax Court would adopt the international construction of the meaning of "beneficial owner" in construing article 11.2 of the Netherlands DTA. He also accepted that not all conduit companies, assuming Newco is properly so categorised, will for that reason alone, fail the beneficial owner test while maintaining that Newco would fail that test but without being able to explain to me, in terms that I could understand, why it would fail. The same can be said of paragraph 3(d) of the letter of the 24^th June where the DGT appear to adopt a similar position. The DGT categorise Newco as a "conduit company and nominee" and thus not able to be "beneficial owner" of the interest becoming due from the Parent Guarantor because it would not have "the full right to enjoy directly the benefits of that interest income".
44. Professor Mansury's and the DGT's categorisation of Newco as a conduit company and nominee is to be contrasted with the Indonesian Tax Authority's treatment of the Issuer equally the product of treaty shopping. Thus, despite what were plainly Indonesian concerns about the uses to which the Indonesia/Mauritius DTA were being put no attempt was made to deny the benefits of double taxation relief to the loan being made by the Issuer to the Parent Guarantor on the ground that the Issuer was not the beneficial owner of the interest becoming due, while that DTA was still in force. There seems to be no justifiable reason why Newco should be treated differently simply because it is, by assignment, the successor to the Issuer as lender to the Parent Guarantor.
45. At paragraph 10B-10.4 of his book Professor Baker referring to the official commentary on the OECD model convention says this:-

"The essence of this Commentary is to explain that the "beneficial ownership" limitation is intended to exclude:

(a) mere nominees or agents, who are not treated as owners of the income in their country of residence;

(b) any other conduit who though the formal owner of the income, has very narrow powers over the income which render the conduit a mere fiduciary or administrator of the income on behalf of the beneficial owner.

It is worth making the point that, as seems clear from this amended Commentary, the mere fact that the recipient may be viewed as a conduit does not mean that it is not the beneficial owner."

46. It is clear that Newco, just as the Issuer, will not be a nominee or agent for any other party and, not being any sort of trustee or fiduciary, will have power to dispose of the interest when received as it wishes, although it will be constrained by its contractual obligation to the Issuer to apply the proceeds of the interest payments in performance of those obligations.
47. It was submitted by Mr Popplewell that the interest would pass through the hands of Newco and out to the Issuer for transmission to the Noteholders without being taxed in the hands of Newco. I reject that submission. It is apparent that for Netherlands taxation purposes Newco's receipt of interest will be treated as taxable income in its hands and it will be taxed on the profit shown on its operations in which that interest will be shown as a receipt and its payments to the Issuer as an expense. The taxable profit will amount to the spread which the Netherlands Tax Authorities will insist on as part of their substance requirements but also contributing to those profits will be earnings from the fact that Newco will, also in accordance with those requirements, have been capitalised and will be earning profit from the investment of the amount of that capital.
48. At paragraph 10B-15 Professor Baker writes as follows:-

"10B-15 The practical question remains whether, for example, a company under the control of another-and therefore likely (though not legally obliged) to pay to its ultimate owner any sums received-could be regarded as beneficial owner of the dividends it receives. Or, to take another example, suppose that a member of a multinational group borrows money and then lends the money on to another group company: the two loans are not tied together, and the lending company is not obliged to use the interest it receives to pay interest on the loan it received-in practice, however, it is likely to do so. Adopting the approach of the OECD Commentary (paragraph 12, as amended in 2003), the issue is whether the recipient company is an agent, or a nominee, or a conduit which has, as a practical matter, very narrow powers over the income which render it a mere fiduciary or administrator. As a practical approach, one can ask whose income the dividends (interest/royalties) are in reality. One way to test this is to ask: what would happen if the recipient went bankrupt before paying over the income to the intended, ultimate recipient? If the ultimate recipient could claim the funds as its own, then the funds are properly regarded as already belonging to the ultimate recipient. If, however, the ultimate recipient would simply be one of the creditors of the actual recipient (if even that), then the funds properly belong to the actual recipient.

It is worth remembering that there are many forms of treaty shopping, and not all states have a uniform view on what constitutes abuse of a tax treaty relationship. The beneficial ownership limitation is intended to counter one-particularly abusive-form of treaty shopping: by the use of agents, nominees or conduits who are mere fiduciaries. If Contracting states wish to provide more extensive anti-abuse provisions, they are at liberty to agree to put these in their treaties (and many do so, which is strong proof that the beneficial ownership limitation is of only limited scope)."

49. It is clear to me that in the absence of any trust or fiduciary relationship between Newco and the Issuer, in an insolvency of Newco undistributed interest received from the Parent Guarantor would be an asset of Newco for distribution amongst its creditors generally, including the Issuer, pari passu.
50. It seems to me that there can be no ambiguity in the application of the concept of beneficial ownership to the loan transaction as proposed to be restructured. The beneficial owner of interest received under a loan transaction must be the lender. As a result of the proposed assignment of the benefit of the loan agreement between the Issuer and the Parent Guarantor, by the Issuer to Newco, Newco will be the lender. In no sense will Newco be acting as nominee or administrator for the Issuer or the Noteholders. It will merely be contractually bound to indemnify the Issuer against its obligations to those Noteholders. The Noteholders will have no claim to be the beneficial owners of the interest. They would be in no position to claim the interest from the Parent Guarantor and for that reason or otherwise to suggest that Newco will hold the interest when received on trust for them. After restructuring there will have to be some entity that qualifies as beneficial owner of the interest. It seems to me there will be only one candidate for that, namely, Newco. In fact if one is considering the "substance" of Newco as beneficial owner of the interest, its position is stronger than that of the Issuer, because, by contrast with the Issuer, it will be receiving interest from the Parent Guarantor at a greater rate than that for which it will be indemnifying the Issuer in making payments to the Noteholders. It follows that if the Indonesian Tax Authorities were prepared to tolerate the current arrangements and confer the benefit of double taxation relief pursuant to the Indonesia/Mauritius DTA while it was in force, a fortiori they should be prepared to give that relief after the Proposed Restructuring has been put into force.

Permanent Establishment

51. I turn to consider the issue under paragraph 23 (2) above namely whether Newco would be required to have or would have a "permanent establishment" within Indonesia thus losing the benefit of the Netherlands DTA pursuant to article 11.7. Since Mr Elias conceded that there would be no necessity under Netherlands law for Newco to maintain any sort of permanent establishment, such as an office, in Indonesia and one can assume that the management of Newco would not take any step which would result in the loss of that benefit by setting up such a permanent establishment, any argument for the Issuer under this head also clearly fails.

Special Relationship

52. I turn to consider the issue under paragraph 23 (3) namely whether, there being a special relationship between Newco and its parent, the Parent Guarantor, double taxation relief would only be available after the Proposed Restructuring on so much of the interest payable as would be indicated by the market rates at the time that restructuring was made effective, see Article 11.9. Strictly this is not an issue which falls within the parameters of these proceedings since it only comes for consideration once it is determined that the Proposed Restructuring would attract double taxation relief under the Netherlands DTA. It is however relevant to the issue of reasonable cost.
53. It was submitted by Mr Popplewell that the Proposed Restructuring involves the granting of a fresh loan in the process of that restructuring and that article 11.9 would come into play because the rate charged would remain 10.375% whereas the market rate for such a loan today would be much less.
54. I reject this submission. I am prepared to assume that the parent subsidiary relationship between the Parent Guarantor and Newco would constitute a special relationship within Article 11.9. The Proposed Restructuring does not involve the creation of a new loan but rather the assignment of the benefit of an existing loan which, at the time it was negotiated in 2002, the rate of interest agreed was, it is accepted, the then market rate. It seems to me clear therefore that article 11.9 has no application to the Proposed Restructuring.

Nil Rate of Tax

55. I turn to consider the issue described at paragraph 23 (4), namely, whether the Proposed Restructuring would attract the nil rate of withholding tax under article 11.4 because the loan in question was for a period of more than two years. It was submitted that the Proposed Restructuring in some unexplained way involved either the granting of a new loan for the unexpired portion of the old loan or the unexpired period of the old loan was to be treated as the period of that loan once assigned to Newco and thus the relevant period for the purposes of article 11.4. It seems to me that these submissions were misconceived. What we are here dealing with is the restructuring of a loan arrangement involving the assignment of a loan to Newco which has run for three years and has a period of rather less than two years still to run. Accordingly it seems to me clear that such a loan would fall within the provisions of article 11.4 the issue of beneficial ownership having been concluded in favour of the Trustee.

Other Issues

56. It was submitted to me by Mr Popplewell that I should be cautious in arriving at any conclusion on the basis of reasonable certainty as to the likely outcome if the Proposed Restructuring is put into effect since this involves second guessing the likely result of an investigation by the Indonesian Tax Authorities of the resulting loan arrangements, particularly, in view of the views expressed by the DGT in their letter of the 24^th June. He urged me to bear in mind that, although the Indonesian Tax Court would arrive at its conclusion independently from the view expressed by the DGT, that court would be operating under a different system to this court, namely, a civil law system similar to that operated in the majority of the courts of Continental Europe where the practice is to pay less attention to the precise wording of any statute or code but to give effect to what the court perceives as being the overall purpose of the legislation in question. That court would inevitably be more familiar with the principles of domestic Indonesian Tax law, in particular the principle of "substance over form" spoken of by the DGT in their letter of the 24^th June. He urged me to place particular weight on the view expressed by the DGT in that letter.
57. I would be very willing to give weight to those views if I was able to understand from the letter the basis upon which it is said that Newco would not be treated as resident in the Netherlands whereas the Issuer was treated as resident in Mauritius and how it is said that Newco would not to be treated as beneficially entitled to the interest being paid by the Parent Guarantor under the guiding principle of "substance over form" whereas the Issuer was to be so treated. It does not seem to be an adequate explanation for this difference in treatment that the situation of the Issuer was the product of the original loan arrangements whereas that of Newco would be the product of a restructuring of those arrangements. The Issuer's presence in Mauritius was entirely to take advantage of the Indonesia/Mauritius DTA while that lasted just as that of Newco in Holland will be to take advantage of the Netherlands DTA. In my judgment and with the greatest respect, the letter of the 24^th June reveals a failure properly to analyse the application of a DTA to the facts of the case applying the principles to be derived from the available materials for the construction of the provisions of a DTA based on the OECD model, as it is accepted they should be applied. In arriving at my conclusion as to eligibility I am not conscious of applying principles of construction peculiar to an English Court. As the history of the Indonesia/Mauritius DTA illustrates, if the Indonesian Authorities object to the use being made of any DTA between Indonesia and a particular country, their remedy is, either to negotiate a variation of its terms to exclude the perceived abuse, or to revoke the treaty. The DTA between the United Kingdom and Indonesia contains an anti-avoidance provision which might well have produced a different result in this case. Such a provision does not find any place in the Netherlands DTA.

Reasonable Cost

58. I turn to consider the question of reasonable cost which I understand to be one exclusively for this court and not the Indonesian Court.
59. I accept Mr Popplewell's submission that the appropriate comparator with which the likely cost of setting up the Proposed Restructuring and thereafter its running costs (which would take account of any resulting reduction in Indonesian withholding tax but also tax incurred in Holland by Newco), is to be compared, is the amount of the additional 10% withholding tax now being incurred as a result of the Indonesian Tax Authorities imposing on the Parent Guarantor a 20% rate, an additional 10%, for the remaining period of the loan. This has been calculated at $1.8M.
60. If my conclusion on the application of article 11.4 is correct Indonesia will allow a nil rate of withholding tax or, if my conclusion on article 11.4 is rejected it will allow a rate limited to 10% which the Netherlands Tax Authorities would deduct from any Netherlands liability to tax of Newco. It is the Issuer's case that the cost of setting up the Proposed Restructuring, spread over the unexpired portion of the loan together with the running costs, will amount to approximately US$300,000. I accept that there should be added to those costs, the costs incurred by the Issuer in investigating the availability of alternative countries DTAs with Indonesia but only up to November 2004 the date when the Trustee rejected the Issuer's proposed notice to redeem. Because of the Issuers obligation to indemnify the Trustee against all costs that figure must include the investigation costs of both parties. The Issuer has estimated those costs at $490,000.
61. On the basis that my conclusion as to the applicability of article 11.4 is correct there would be a saving of $1.8M in Indonesian withholding tax but a consequent increase in Netherlands tax on Newco reflecting the fact that Newco would not be able to set-off against its liability to Netherlands tax any Indonesian withholding tax. As I understand Mr Elias' evidence these will at worst simply cancel each other out. In my judgment even taking the Issuer's estimate of the costs at their face value, and they are not accepted by the Trustee, the costs do not exceed the standard of reasonableness contained in the Proviso.
62. For these reasons it seems to me that the Issuer is not entitled to the relief which it claims.