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Judgment
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| 1. PT Indofood Sukses Makmur TBK (“the Parent Guarantor”) is a company incorporated in the Republic of Indonesia. It carries on a substantial business in the production and distribution of food. In 2002 it wished to raise capital by the issue of loan notes on the international market. Had it done so itself it would have been obliged under Indonesian law to deduct 20% of the interest payable to the noteholders and pay it to the Indonesian Revenue on account of the noteholders’ liability for Indonesian tax in respect of their entitlement to interest arising in Indonesia. This liability (“withholding tax”) could be reduced to 10% if the issue of the loan notes was made by a wholly owned subsidiary incorporated in the Republic of Mauritius and the capital so raised was lent on to the Parent Guarantor on terms which complied with the conditions specified in the Indonesian/Mauritius Double Tax Agreement (“the Mauritian DTA”). Accordingly the Parent Guarantor procured the incorporation in Mauritius of the claimant Indofood International Finance Ltd (“the Issuer”). On 18th June 2002 the Issuer issued US$280m 10.375% loan notes. On the same day, the Issuer lent the capital so raised to the Parent Guarantor on substantially the same terms. The issue, servicing and redemption of the loan notes and the loan to the Parent Guarantor were regulated by the conditions indorsed on the loan notes (“the Note Conditions”), a Trust Deed dated 18th June 2002 (“the Trust Deed”) under which the defendant JPMorgan Chase Bank N.A. (“the Trustee”) was appointed trustee for the noteholders, a Paying Agency Agreement (“the Agency Agreement”) whereby the Trustee was also appointed as the Principal Paying Agent and a Credit Agreement (“the Loan Agreement”) containing the terms of the loan made by the Issuer to the Parent Guarantor. I shall refer to each of those documents in more detail later. 2. The Note Conditions provided that the notes would be redeemed at par on 18th June 2007 but might be redeemed earlier if there were a change in the law of Indonesia whereby the obligation of the Parent Guarantor to deduct withholding tax from the interest payable to the Issuer under the Loan Agreement exceeded the rate of 10% for which the Mauritian DTA provided. In that event, subject to conditions not material to this appeal, the Issuer might redeem the loan notes earlier if, but only if, “...such obligation cannot be avoided by the issuer....taking reasonable measures available to it...” 3. On 24th June 2004 the Republic of Indonesia gave notice to determine the Mauritian DTA with effect from 1st January 2005. One consequence would be that thenceforth, the obligation of the Parent Guarantor to deduct withholding tax from the interest payments it was liable to make to the Issuer would be increased to 20%. Moreover, by then both interest and exchange rates had moved against the Parent Guarantor to such an extent that it was in the commercial interests of the Parent Guarantor, but not of the noteholders, that the loan notes should be redeemed as soon as possible. 4. On 20th August 2004, the Issuer gave notice to the Trustee of its intention to redeem the loan notes. It certified that there was no reasonable measure that the Parent Guarantor could take to avoid the liability to deduct withholding tax at the higher rate of 20%. On 18th November 2004, the Issuer sent a draft redemption notice to the Trustee seeking its approval to the redemption of the loan notes on 29th December 2004. On 22nd November 2004, the Trustee refused to give its approval on the ground that the Issuer was not entitled to redeem the loan notes because the Trustee was not satisfied that there were no reasonable measures available whereby to avoid the increased liability for withholding tax. On 15th February 2005 the Issuer issued a Part 8 claim seeking the determination of the court on questions designed to ascertain if it was then entitled to redeem the loan notes. The claim came before Etherton J. In his judgment given on 14th April 2005 he decided that the test whether there were reasonable measures available to the Parent Guarantor to avoid the additional liability to Indonesian withholding tax was an objective one. In addition, he ruled that the onus was on the Issuer to establish the unavailability of such measures. As the establishment of such unavailability involved issues of fact, he gave directions for further evidence and adjourned the trial. Neither party appealed from the order of Etherton J. 5. The adjourned hearing commenced before Evans-Lombe J on 22nd July 2005. By then, the reasonable measures alleged by the Trustee to be available to the Issuer and the Parent Guarantor were limited to the migration of the Issuer to, or the substitution for the Issuer, or interposition between the Parent Guarantor and the Issuer, of a company incorporated in the Netherlands, Luxembourg or the United Kingdom. At the hearing it was accepted that the only ‘measure’ to be considered was the interposition of a company incorporated in the Netherlands (“Newco”) between the Issuer and the Parent Guarantor. It was suggested by the Trustee that such interposition could be effected by an assignment by the Issuer to Newco of the benefit of the loan agreement between the Issuer and the Parent Guarantor. The consequence, as alleged by the Trustee, would be that under the Double Tax Agreement between the Republic of Indonesia and the Kingdom of the Netherlands (“the Dutch DTA”) the withholding tax payable by the Parent Guarantor in respect of its obligation to pay interest to Newco would be 10% or less. 6. Thus, in principle, the issues before Evans-Lombe J fell into two categories, namely (1) could the interposition of Newco between the Parent Guarantor and the Issuer reduce the rate of withholding tax in respect of the interest payable by the former under the Loan Agreement to 10% or less? And if so (2) was it reasonable for the Issuer/Parent Guarantor to adopt that measure? In the first category there were issues as to the interpretation and application of the Dutch DTA by the courts in Indonesia in relation to (a) whether Newco would be the beneficial owner of the interest payable by the Parent Guarantor, (b) whether Newco would be resident in Holland and © whether the interposition of Newco could be achieved without the creation of a new loan by the novation of the Loan Agreement. In the second category there were issues, primarily as to comparative cost, whether even if such a measure was available, it would be reasonable for the Issuer/Parent Guarantor to take it. 7. Both parties adduced a substantial body of expert evidence as to the operation of the Dutch DTA in Holland and Indonesia and the law of those two countries on which there was much cross-examination. The hearing before Evans-Lombe J concluded on 29th July 2005. He communicated his decision to the parties on 2nd August, released his judgment in draft on 5th September and formally handed it down on 7th October. In his judgment Evans-Lombe J elided the two categories of issue to which I have referred and applied a test of ‘reasonable certainty’. By that test he concluded each of the issues in both categories in favour of the Trustee. The Issuer appeals, with the permission of the judge, from his decision on all those issues and the Trustee, with the like permission, appeals from his decision to apply a test of reasonable certainty. Thus the issues for our determination are: (1) whether the judge was right to apply a test of ‘reasonable certainty’; (2) whether, by the appropriate test, for the purposes of the Dutch DTA, (a) Newco would be the beneficial owner of the interest payable by the Parent Guarantor, (b) Newco would be resident in Holland, © the obligation of the Parent Guarantor to pay interest would, after the assignment to Newco, be that originally owed by the Parent Guarantor to the Issuer under the Loan Agreement; (3) whether, assuming an answer to each of the issues summarised in paragraph (2) to be in favour of the Trustee, it would be reasonable for the Issuer/Parent Guarantor to interpose Newco. I will consider each of those issues in due course, but first it is necessary to set out the facts in a good deal more detail. The Facts 8. The Mauritian DTA was made in December 1996. It was in substantially the same form as the later Dutch DTA but there were two material differences. The first related to the definition of a “resident” contained in Article 4. It did not include the provision later found in Article 4.4 of the Dutch DTA relating to the place of effective management of a body corporate. The other material difference is that it did not include any provision comparable to Article 11.4 of the Dutch DTA whereby the rate of withholding tax might be reduced to nil. (See paragraph 14 below) The essential common feature of both is contained in Article 11.2 of the Mauritian DTA. That provides that interest may be taxable in the contracting state in which it arises “...but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10% of the gross amount of the interest.” The issue of the loan notes was designed to obtain, if possible, the benefit of that provision. 9. The loan notes were issued following an Offering Circular dated 11th June 2002. As I have indicated in paragraph 1 above, it involved four material documents. The first is the loan note itself on which the Note Conditions were inscribed. They prescribed that the issue was of US$280m 10.375% Guaranteed Notes due 2007 subject to and with the benefit of the Trust Deed. Condition 2 described the status of the loan notes as direct, general and unconditional obligations of the Issuer unconditionally and irrevocably and jointly and severally guaranteed by the Parent Guarantor and four named subsidiaries of the Parent Guarantor. Condition 3 contained a number of restrictive covenants whereby the Parent Guarantor undertook that neither it nor any subsidiary company would engage in certain specified activities which might dilute its assets. For present purposes it is sufficient to refer to the headings which, broadly described their effects as “negative pledge”, “limitation of incurrence of indebtedness”, “fixed assets disposal”, “consolidation, mergers and sales of assets”, “acquisitions”, “dividends by Parent Guarantor”, “limitation on restrictions on dividends by Group Subsidiaries”, “restriction of group subsidiary indebtedness”, “limitation on Issuer’s conduct of business” and “sale of subsidiary guarantor”. Condition 5 provided for the loan notes to bear interest payable semi-annually in arrear on 18th June and 18th December in each year. Such interest was to be paid, as prescribed by condition 7(b), by the paying agents in New York. Condition 6 contained the provisions for redemption to which I have already made sufficient reference in paragraph 2 above. 10. The Trust Deed, also made on 18th June 2002, provided for the appointment of the Trustee. By clause 2.1 the Issuer covenanted with the Trustee to pay the amounts due on the loan notes in accordance with the Loan Conditions. By clause 4 the Parent Guarantor and four named subsidiaries guaranteed to the Trustee payment of all sums due under the Note Conditions or the Trust Deed. By clause 5 the Issuer and each of the Guarantors covenanted with the Trustee to comply with the provisions of the Trust Deed and the Note Conditions. Clause 6 contained additional covenants by the Issuer and the Guarantors with the Trustee. Clause 7 provided for the Trustee to agree to modifications of certain conditions of the Trust Deed, including the substitution of the Issuer. 11. The Paying Agency Agreement appointed the Trustee as the Principal Paying Agent for the Issuer, each of the Guarantors and, on the occurrence of an event of default or potential event of default, for the Trustee. Clause 7.1 provided that the Issuer “(failing which, the Guarantors)” would pay to the Principal Paying Agent, at an account of its nomination, one business day before the due date an amount equal to the interest falling due on the loan notes. By clauses 7.4 and 8.3.2 the Principal Paying Agent was required to apply the amount it had received under clause 7.1 in paying the amount due to the noteholders. 12. The Loan Agreement recited that the Issuer was a wholly owned subsidiary of the Parent Guarantor and had been “established as a special vehicle company to raise funds” on the international market. By clauses 1, 3, 4 and 5 the Issuer extended the credit, defined as the proceeds of the loan notes, to the Parent Guarantor for five years expiring on 18th June 2007 at the same rate of interest, namely 10.375%, but net of any withholding tax due by the Parent Guarantor. Clause 5A required all payments of principal and interest to be made in US dollars not later than two business days before the due date to the account nominated by the Issuer. By clause 5D the Parent Guarantor might set off any amount paid by it to a noteholder as guarantor against any amount due under the Loan Agreement to the Issuer. 13. The Note Conditions, the Trust Deed and the Paying Agency Agreement were each to be construed in accordance with English law, but the Loan Agreement was to be construed in accordance with the law of Indonesia. The structure was clear; two business days before the due date the Parent Guarantor was obliged to pay the sums due by it under the Loan Agreement to the account nominated by the Issuer; one business day before the due date the Issuer was obliged to pay the amount due to the noteholders to the Principal Paying Agent; on the due date the Principal Paying Agent was obliged to pay the noteholders. It was agreed on the hearing of the appeal that what had happened in fact was that the Parent Guarantor paid the sums due to the noteholders direct to the Trustee as Principal Paying Agent. 14. On 1st January 2004 the Dutch DTA, concluded in January 2002, came into force. It is described as “For the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income”. It applies to persons who are residents of one or both of the two states in respect of all taxes on income imposed by either of them. The relevant provisions are Articles 4.1, 4.4, 11.1, 11.2, 11.4 and 11.9. They are in the following terms: “Article 4 Fiscal Domicile 1. For the purposes 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. [2. 3.] 4. Where by reason of the provisions of paragraph 1 a person other than an individual ........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 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..... 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... 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.” Articles 4.4 and 11.4 were not to be found in the Mauritian DTA. 15. As I have mentioned, on 24th May 2004, the Republic of Indonesia terminated the Mauritian DTA with effect from 1st January 2005. It issued a lengthy statement explaining the problems to which the Mauritian DTA had given rise. In essence, they arose from the decision of the Government of Mauritius in 2001 to allow non-residents in Mauritius to use the Companies Act to set up various business agencies including special purpose vehicles and thereby enabled “non resident parties in Mauritius to commit treaty shopping and treaty tax abuse by exploiting the Double Tax Avoidance Agreement for tax evasion in the country where tax rate is higher (in Indonesia)” Without the benefit of Article 11.2 of the Mauritian DTA the rate of withholding tax for which the Parent Guarantor was liable in respect of the interest payable to the Issuer under the Loan Agreement would go up to the standard rate of 20% from 1st January 2005. 16. It was in those circumstances that between August and November 2004 the Issuer sought to redeem the loan notes but failed to satisfy the Trustee that there were no reasonable measures available to the Issuer to avoid the obligation to pay withholding tax at more than 10%, being the proviso to its right to redeem conferred by condition 6(b) of the Note Conditions. Accordingly these proceedings were commenced on 15th February 2005. Following the decision of Etherton J on 14th April 2005 both parties were engaged in obtaining, inter alia, expert evidence as to the laws of the Netherlands and of Indonesia and the views of the Director General of Taxes in Indonesia (“DGT”) as to the application of the Dutch DTA. 17. On 10th June 2005 the Parent Guarantor wrote to DGT seeking “guidance and confirmation of a special relationship transaction”. One of the transactions on which such advice was sought was the interposition of a Dutch registered company between the Parent Guarantor and the Issuer on the basis that the Issuer would assign the benefit of the Loan Agreement to Newco and Newco would enter into a new agreement with the Issuer. The letter then referred, inter alia, to Articles 11.2 and 11.4 of the Dutch DTA. The position taken by the Trustee was described. The Parent Guarantor then asked whether, if Newco was a company incorporated in the Netherlands and it was interposed as described, the Issuer would be allowed the reduction of withholding tax to 10% for which Article 11.2 provided, in particular on the interpretation of “beneficial ownership” and whether Newco would be regarded as the beneficial owner of the interest payable by the Parent Guarantor. In addition the Parent Guarantor asked if, following the assignment of the loan by the Issuer to Newco, it would be regarded as having a term of more than two years for the purpose of Article 11.4. | |
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