A treaty position is only as good as the chain that claims it.

A holding chain is often drawn to a tax opinion. The adviser identifies a treaty between the source state and a holding jurisdiction, the article that reduces or removes the source state's tax on a dividend, an interest payment or a gain, and the conditions under which the article applies. The chain is formed to match: a company in the holding jurisdiction, between the fund and the asset, and the opinion is filed. The opinion is in the adviser's name and it is the adviser's. What the structure has to do is produce, every year for the life of the holding, the facts on which the opinion was conditional, and that is the part most chains are not designed for, because the opinion is read once and the conditions are for a decade. An opinion that is filed is an opinion that was read once; the conditions are read every quarter or they are not met.

This note sets out the four conditions on which every treaty opinion rests, what each requires the structure to produce, the source state's own rules and how they move, the opinion's scope and what it does not cover, how the conditions are carried as facts with parties and calendars, the conduit problem in intra-group financing, India's position as the hardest case, the adviser's watching brief, a comparison, a worked position as a type, cases, what each party holds, the sequence, questions, terms and what to read.

Residence

The holding company must be resident in its jurisdiction under that jurisdiction's own law and under the treaty's own test, which in most treaties turns on where the company is effectively managed, and which the source state's authority tests against facts. Residence is produced by directors resident in the jurisdiction, meetings held there, decisions taken there on papers, and a minute book that shows it. It is undone by a manager's team taking the decisions elsewhere and the board ratifying, by a quorum the manager's staff make alone, or by a bank account operated from the manager's office. A certificate of residence from the holding jurisdiction's authority is evidence the source state may ask for, and the certificate is issued on the jurisdiction's own test, which the structure meets or does not.

Beneficial ownership

The holding company must be the beneficial owner of the income or the gain, which is a question about what it does with what it receives and whether it is legally or practically bound to pass it on. A company that receives a dividend and is obliged, by a loan agreement, a distribution policy, a back-to-back arrangement or a standing instruction, to pay it up the chain within days is a conduit, and treaty benefits are denied to conduits in most of the world, under the treaty's own beneficial-ownership language and under the source state's anti-conduit rules. Beneficial ownership is produced by the holding company retaining what it receives for a period, by its board deciding to distribute on papers that show the decision was the board's, and by intra-group financing drafted so that no upstream payment is obliged by a downstream receipt.

Purpose

Most treaties now carry a principal-purpose test: the benefit is denied where obtaining it was one of the principal purposes of the arrangement, unless granting it would be in accordance with the treaty's object and purpose. The test is met by the holding company having a function beyond the treaty, the same test the chain room applies to every layer: it holds several assets, it employs people, it carries on a business, it answers a question for the lender or the ownership regime that the treaty does not. A company whose only function is the treaty fails the test by definition, and a structure paper that cannot state the layer's function without mentioning the treaty has stated the problem.

The source state's own rules

The source state's domestic law decides what it taxes and how it treats the holder, and it changes. India's position on the treatment of holders under particular treaties has moved more than once, with grandfathering for some investments and not others, and a chain into India is read against the rule on the day of exit rather than the day of entry. Other source states have introduced anti-avoidance rules that override treaty positions the adviser opined on, have renegotiated treaties, or have changed their own characterisation of what a holder receives. The condition is that the rule on the day of the relevant transaction is the rule the structure meets, and the adviser's watching brief is the only way to know.

The opinion's scope

An opinion is read for what it covers. An opinion on the treatment of dividends during the holding period does not cover the treatment of a gain on sale, of interest on shareholder loans, of a distribution in kind, of a liquidation or of a sale of the holding company's own shares. An opinion on the source state's tax does not cover the holding jurisdiction's own tax on the company's receipts or distributions, or the fund's jurisdiction's treatment of what the fund receives. An opinion given on the rules as they stood does not cover the rules as they stand. The opinion is commissioned for the four exit routes and for each kind of receipt at formation, and its conditions for each are carried as facts.

Carrying the conditions as facts

Each condition is a fact the structure produces or fails to produce, and each has a party and a calendar.

Residence is produced by the board: resident directors, meetings in the jurisdiction, papers, deliberation, minutes. The party is the corporate services provider and the directors; the calendar is quarterly.

Beneficial ownership is produced by the holding company retaining discretion over what it receives: no back-to-back loan that obliges an upstream payment, no distribution policy that binds the board, a period of retention and a board decision to distribute. The party is the board and counsel; the calendar is each receipt.

Purpose is produced by the holding company having a function: holding several assets, employing people, carrying on a business, or answering a question for the lender or the ownership regime. The party is the structure's designer; the calendar is formation and every change.

The source-state rule is watched by the adviser, on a calendar the structure paper names, with the exit test re-run when it changes.

Why the conditions are the opinion

An opinion reads, in form, as a conclusion: the treaty applies and the withholding is reduced. In substance it is a list of conditions with a conclusion attached, and the adviser has written the conditions because the adviser knows which of them the source state will test. A manager who reads the conclusion and files the opinion has read the part the adviser did not write for the manager. The conditions are the part written for the manager, and they are written as things the manager must cause to be true: a resident board, a retained receipt, a function, a rule watched. The opinion is the adviser's; the conditions are the structure's; and the position is the two together, which is why a chain drawn to the conclusion and not to the conditions has half an opinion.

The same is true of every position a chain claims: a category under an ownership law, a regulatory look-through blocked, a liability cut off. Each is an opinion with conditions, and each is held by producing the conditions for the life of the holding.

The holding jurisdiction's own tax

A treaty layer sits in a jurisdiction with its own tax rules, and the opinion covers them or it does not. The jurisdiction may tax the holding company's receipts, its gains or its distributions, may have its own substance requirements for its own reliefs, may require a certificate of residence that it issues on its own test, and may have its own anti-avoidance rule. A holding jurisdiction chosen for its treaty with the source state is read for its own regime as closely as for the treaty, because a withholding the source state removes and the holding jurisdiction reimposes is a withholding the fund pays. The opinion names both, and the structure paper carries both.

The fund's jurisdiction above

The fund's own jurisdiction reads what the fund receives from the holding company, and the treaty between the holding jurisdiction and the fund's jurisdiction, or the absence of one, governs the holding company's distributions up. A chain designed for the source state's treaty with the holding jurisdiction and not for the holding jurisdiction's treatment of distributions to the centre has solved the first border and not the second. The centres' own regimes treat the fund's receipts on their own terms, and the adviser's opinion runs the whole chain from the asset to the fund.

Where it surfaces

At the source state's inquiry, when the minute books, the financing and the function are read.

At the renegotiation, when nobody read the grandfathering date against the second tranche.

At the exit, when the gain's treatment was never in the opinion's scope.

At the holding jurisdiction's own tax, when the withholding the treaty removed is reimposed on the way up.

At the lender's back-to-back loan, drafted for convenience, which made the interest a conduit's.

The cost of getting it wrong

A position lost costs the source state's tax for the years claimed, with interest and penalties where the state imposes them, and in some states a reassessment of every year open. It costs the exit, if the gain's treatment was assumed. It costs the credibility of the manager's other opinions with the register, which reads a lost position as a manager that did not produce what it promised. The conditions cost substance, careful financing, a function and a watching brief, each a budget line the structure paper carries. A manager that compares the two at formation carries the conditions.

The conduit problem in intra-group financing

The commonest way a treaty layer becomes a conduit is its own financing. The fund lends to the holding company, which lends to the asset company; the asset company pays interest to the holding company, which pays interest to the fund on a matching loan with matching terms and matching dates. The holding company receives and pays the same amount on the same day under a legal obligation, and the source state reads it as a conduit for the interest. The cure is financing drafted without the match: the holding company's loan from the fund on different terms, with the holding company's own discretion over its distributions and its own retained margin, and a board that decides each payment. The tax adviser reads the financing for the conduit problem before it is signed, because a match drafted for convenience is a position lost.

India as the hardest case

India's place-of-effective-management test, its general anti-avoidance rule, its renegotiation of treaties that once gave capital-gains relief, its grandfathering of investments made before stated dates and not after, and its authority's appetite for applying all of them make the chain above an Indian asset a chain whose every condition is tested. The treaty positions chains into India rely on are positions about residence, beneficial ownership and purpose, read on the day of exit under the rules then in force, with the grandfathering date as a fact of the investment's own history. A manager that entered India on an opinion given before a renegotiation and did not ask for it to be read again has a position it may not hold, and the Indian authority reads the position at exit with the renegotiation in hand.

The adviser's watching brief

The adviser's engagement is drafted to include a watching brief: a duty to inform the manager of changes in the source state's rules, the treaty, the holding jurisdiction's rules and the fund's jurisdiction's rules that reach the opinion, on a calendar, with a re-reading of the opinion on each. The brief is a cost and it is the only way the condition about the source state's rule is met. A manager whose adviser's engagement ended at the opinion has an opinion about a world that has moved.

By condition · by fact	What it requires	Who produces it	When	What undoes it
Residence	Effective management in the jurisdiction	Resident directors; the provider	Quarterly, and at every decision	Decisions taken by the manager's team elsewhere; ratification
Beneficial ownership	Discretion over receipts; no obligation to pass on	The board; counsel drafting the financing	Each receipt	Back-to-back loans; binding distribution policies; standing instructions
Purpose	A function beyond the treaty	The structure's designer	Formation and every change	A layer whose only function is the treaty
The source state's rule	The rule on the day of the transaction	The adviser, on a watching brief	Continuously	A change nobody read

A timeline, as a type

Month one: the asset is identified; the adviser is engaged for an opinion covering dividends, interest, gains on each exit route, distributions in kind and liquidation, with a watching brief. Month two: the opinion arrives with four conditions per position; the structure paper carries each as a fact with a party and a calendar. Month three: the holding company is formed with a resident board, a provider agreement, a second function and financing drafted without a match. Year one: four quarterly meetings; a dividend retained for a quarter and distributed on a board decision. Year two: the adviser's quarterly note reports a proposed change in the source state; the exit test is re-run. Year three: the renegotiation with a grandfathering date; the investment's tranches are read against it; the second tranche is brought forward to precede the date. Year six: the exit; the source state's authority reads the books, the financing and the function; the certificate of residence is produced; the position stands.

The structure paper's page

The structure paper's treaty page carries: the position claimed, the treaty and the article; the four conditions, each as a fact with a party and a calendar; the opinion's scope, route by route and receipt by receipt; the holding jurisdiction's own regime and the fund's jurisdiction's treatment of distributions up; the financing's drafting against the conduit problem; the function beyond the treaty, stated without the word treaty; the grandfathering dates, where any; and the watching brief's engagement and calendar. The page is read by the register's counsel before subscription, by the lender for the chain it secures, and by the buyer at exit for the position it inherits or does not.

The register's own treaties

The register's own treaty positions sit above the fund's, and a holder reads the chain for what reaches it. A sovereign with its own exemption in the source state, a pension institution with a treaty position of its own, a holder in a jurisdiction with no treaty at all: each reads the fund's chain for whether the fund's position helps, hinders or is irrelevant to its own. A parallel vehicle exists for the holder whose own position the main fund's chain would damage, and the treaty page tells the manager which holders those are before the first approach.

Reading the opinion with the lender

A lender to the chain reads the treaty page for two things: whether the withholding the treaty removes is part of the cash flow it lends against, and whether the holding company's substance, which the lender's security depends on, is the same substance the treaty depends on. It is, and a lender that finds the substance budgeted and produced lends against a chain whose cash flows and authority are both real. A lender that finds a circular-resolution minute book reads the treaty position as at risk and the security's authority as questionable in the same reading, and prices both.

The certificate of residence

Most source states ask a foreign holder claiming treaty benefits for a certificate of residence from the holding jurisdiction's authority, issued for the year in question. The holding jurisdiction issues it on its own test, which may require the company to show effective management, substance or tax status there, and a company that cannot obtain the certificate cannot claim the treaty whatever the opinion says. The certificate is a fact the structure produces annually, and its application is on the calendar.

The collapse of a layer whose position is lost

A treaty layer whose position is lost, by a renegotiation, a rule change or a failure of substance, is a layer with no function, and it is collapsed before the exit rather than carried into it. The collapse is a transfer of the asset or the holding company up the chain with the registry's recording, the lender's consent, the adviser's reading of the transfer itself and the layer's liquidation, and it is cheaper than running a layer that does nothing and explaining it to a buyer. The adviser's note that reports the loss reports the collapse as the next step.

The firm's line

The firm designs the chain so that each condition has a named fact, a named party who produces it and a named date, and writes the function of each layer in words that do not mention the treaty. The adviser signs the opinion and keeps the watching brief. The manager signs the structure and budgets the substance. The position survives when all three know what the others have undertaken, and it fails when each assumed the others had it in hand. The structure paper is the document in which the three undertakings sit on one page, and it is the reason the firm reads the opinion for its conditions rather than its conclusion.

A position, as a type

A fund in a centre holds an asset in a source state through a holding company in a treaty jurisdiction. The opinion names the treaty, the article, and four conditions. The structure paper carries each: two resident directors and a resident quorum, quarterly meetings, a provider agreement naming the minute book; the holding company's loan from the fund on terms that do not match the asset company's, with a retained margin and a board decision on each distribution; a function for the holding company, which also holds a second asset and answers the lender's security question; and the adviser's watching brief with a quarterly note. In year three the source state renegotiates the treaty with a grandfathering date; the adviser's note catches it; the investment is grandfathered and the exit test is re-run on the new rule for any later acquisition. At exit in year six the source state's authority asks for the minute books, the financing and the function; the position stands.

Four cases, as types

A chain into a source state through a treaty company whose board consists of the administrator's staff, whose receipts are paid up within a week under a back-to-back loan, and whose only function is the treaty. The source state denies the benefit on all three grounds; the adviser's opinion, read again, was conditional on each; the fund pays the source state's tax, with interest, for the years claimed.

A chain into India drawn to a treaty position in year one on an opinion that ended with its delivery. The source-state rule changes in year four with a grandfathering date that the investment's second tranche falls after; nobody reads it; the exit in year six bears the tax on the second tranche that the model assumed the treaty removed.

A chain whose holding company holds three assets, employs two people, has a resident board that retains and decides on every receipt, and answers the lender's security question. The treaty position survives inquiry because the company exists for reasons the inquiry can see, and the adviser's note in year three caught the renegotiation.

A chain whose treaty company is substantive and whose financing is a back-to-back loan drafted by the lender's counsel for the lender's convenience. The source state reads the interest as conduit interest; the dividend position stands and the interest position falls, and the loss is the difference between the two rates for six years.

What each party holds

The manager holds the decision to claim the position, the structure paper's carrying of each condition as a fact, the budget for substance and the adviser's watching brief.

The tax adviser holds the opinion, its scope, its conditions and the watching brief, in its own name.

The holding company's board holds residence and beneficial ownership, by deciding in the jurisdiction and by retaining what it receives.

Counsel drafting the financing holds the conduit problem.

The structure's designer holds the function beyond the treaty.

The source state's authority holds the test, on the day.

The sequence

1. The opinion is commissioned for every kind of receipt and every exit route, and read for its conditions.
2. Each condition is written into the structure paper as a fact with a party and a calendar.
3. The holding company is designed with a function beyond the treaty.
4. The intra-group financing is drafted without a match, with the holding company's discretion and margin.
5. Substance is staffed and budgeted at the holding company as at every layer.
6. The adviser's watching brief is engaged, and the exit test is re-run on every change.

Questions a manager asks

Is the opinion a guarantee. It is the adviser's view on the rules as they stood, conditional on facts the structure produces; it is a guarantee of nothing the structure does not do.

How long does the holding company have to retain a receipt. Long enough, and with enough discretion, that the retention is real and the distribution is the board's decision; the adviser advises on the period, and a standing instruction to distribute on receipt is the opposite.

Can the holding company's only asset be the one investment. It can, if it has a function beyond the treaty, such as the lender's security layer or the ownership regime's category; a company with one asset and no other function is a company the purpose test reads.

What does the watching brief cost. An annual engagement and a quarterly note; against the position it protects, it is small.

What about grandfathering. A fact of the investment's own dates, read against the renegotiation's terms; tranches after the date are not grandfathered, and the drawdown schedule is read against it.

Does the treaty position affect the exit route. Always. A gain on a sale of the asset, a gain on a sale of the holding company and a distribution in kind are treated differently, and the opinion covers each or the exit test cannot run.

Terms used

Treaty position: the reduction or removal of a source state's tax under a treaty article, claimed by a holding company.

Residence: the condition that the holding company is effectively managed in its jurisdiction.

Beneficial ownership: the condition that the holding company holds what it receives for itself and is not obliged to pass it on.

Principal-purpose test: the treaty's denial of benefits where obtaining them was a principal purpose of the arrangement.

Conduit: a company obliged to pass on what it receives, denied treaty benefits.

Grandfathering: a renegotiated treaty's preservation of the old position for investments made before a date.

Watching brief: the adviser's continuing engagement to report changes that reach the opinion.

What to read

The adviser's opinion and its conditions; the treaty's residence, beneficial-ownership and principal-purpose articles; the source state's domestic rules, anti-avoidance rules and their history, with particular care for India; the intra-group financing documents; the holding jurisdiction's residence certificate rules. On this site, the holding chains room under Structures, the India family's room on holding Indian land, and the room on our role.