Bayfine UK Products and Bayfine UK v HM Revenue and Customs
Jurisdiction | England & Wales |
Judgment Date | 19 November 2008 |
Date | 19 November 2008 |
Court | Special Commissioners (UK) |
special commissioners decision
Dr John F. Avery Jones CBE, Edward Sadler
Jonathan Peacock QC and Francis Fitzpatrick, counsel, instructed by Slaughter and May for the Appellants
David Ewart QC and Richard Vallatt, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents
Debt contracts - whether self-cancelling contracts can be looked at together - yes but Finance Act 1994 section 165s. 165 FA 1994 still not applicable - in the light of Tower MCashback can the Revenue raise Finance Act 1994 section 167s. 167 FA 1994 having made their amendment to the self-assessment under s. 165 - yes - whether s. 167 applies - noDouble taxation relief - US ignoring UK subsidiary with unlimited liability for US tax purposes and taxing the parent on the subsidiary's profit - whether unilateral relief for US tax paid by the parent - no - whether treaty relief under US-UK tax treaty (1975) - no - whether, had relief been available, certain steps would be reasonable to take to reduce US tax - no - appeal dismissed
The special commissioners decided that a UK subsidiary of a US corporation was not entitled to double tax relief in respect of a profit arising from its participation in a forward contract with a third party. The first taxing right was with the UK. There was no credit to be given because at that stage there was no US tax because the saving clause only came into operation if the Treaty (excluding the saving clause) prevented the US from taxing. Accordingly, the taxing rights should be that the UK taxed first. The US could then tax by virtue of the saving clause, giving relief for the UK tax by applying the deemed source rule, and there was no further round of relief by the UK.
The taxpayer companies were both UK subsidiaries of a US corporation (BDE). The taxpayers entered into forward contracts, as a result of which the first taxpayer (BUKP) made a substantial loss and the second taxpayer (BUK) made a substantial profit. BUKP surrendered the substantial part of its loss as group relief. BUK sought to extinguish its UK tax liability by claiming double tax relief for US tax which the parent company had paid on the same profit.
The US Revenue Service taxed the profit in the hands of BDE on the basis that, for US federal income tax purposes, BUK was classified as a "disregarded entity" separate from its owner on account of its having a single shareholder and unlimited liability, so that for US tax purposes the profits in question we treated as profits of BDE. The UK Revenue and Customs rejected BUK's claim to double taxation relief, and BUK appealed.
Whether the taxpayer was entitled to double tax relief.
The special commissioners (Dr John Avery Jones and Edward Sadler) (dismissing the appeal) said that the problem of interpreting the Treaty arose because the UK considered the resident taxpayer to be BUK while the US treated BDE as the resident taxpayer because it disregarded BUK. If the same taxpayer was a resident of both states the dual residence provisions of the Treaty would resolve residence in favour of one of them for the purpose of applying the Treaty. However, the Treaty was silent about what to do when they were different persons. From the US point of view, BUK, as an unlimited company with one shareholder, was a "disregarded entity" for US federal income tax purposes. Such disregard was restricted to tax purposes; there was no suggestion that the US would disregard BUK for other purposes. The result was that what the UK regarded as the income of BUK was regarded for US tax purposes as income of its parent company, BDE.
Whereas the UK looked solely to BUK in relation to the taxation of the profits in question, the US was not contending that the only relevant enterprise was BDE. Article 7 gave the US exclusive taxing rights in relation to BDE's profits in any event. The US recognised that if it disregarded a UK resident entity it would have to accept the UK's right to tax that entity. The experts were therefore viewing the matter from the UK point of view, saying that, while the UK might read art. 7 as saying the US might not tax, it was overridden by art. 1(3) ("the saving clause"). That resulted in there being two residence states for the purpose of the Treaty. Dual residence of a single person was solved by the Treaty dual residence provision the result of which was to give a single residence for the purposes of the Treaty. But that did not apply here because each regarded a different entity as its resident. So the issue was who gave credit for the other state's tax.
The Treaty credit to be given by the US in art. 23(1) did not refer to the UK tax being in accordance with the Treaty (as did the UK's equivalent provision in art. 23(2)). Nationals were defined for the US to be its citizens, so that, unlike the OECD Model Tax Convention, a national referred only to individuals, and the same applied in the UK.
The purpose of art. 1(4) was that, while a state might tax under the saving clause as if the Treaty had not come into effect, the taxpayer could still claim some Treaty benefits. Those included not to be taxed in a discriminating manner by the other state and to be able to invoke the mutual agreement procedure to deal with differences arising between the two states. What was important here was the benefit of the elimination of double taxation. Since Treaty relief was given by reference to each state's domestic law, that did not confer any right to relief as such, but it did give the taxpayer the right to apply the Treaty source rule in art. 23(3) ("the deemed source rule") instead of the domestic source rule.
The purpose of the deemed source rule was merely to marry up the Treaty taxing rights with domestic law credit rules which were incorporated into the Treaty. Domestic law source rules might not match the Treaty taxing rights. With the deemed source rule one could be sure that there would in principle be credit for everything the other state was entitled to tax under the Treaty even though domestic credit rules would not source the income in the other state. The deemed source rule was applicable to move to the UK the source of income that the UK might tax in accordance with the Treaty.
The implication of art. 1(4) was that if the US taxed under the saving clause as if the Treaty had not come into effect, the specific exception for art. 23, and the consequent change in the source of the income by the deemed source rule, meant that the giving of credit by the state invoking the saving clause was in contemplation of the Treaty. The state invoking the saving clause on account of residence would be a second residence state and its taxing rights were subsidiary to the residence state applying the Treaty without the saving clause. Because of the incorporation by reference of domestic law credit provisions by art. 23(1) of the Treaty, whether or not the US gave relief was a matter of domestic law rather than interpretation of the Treaty.
In applying the Treaty in the UK to give relief for US tax, the person who was taxed in the US was irrelevant; all that was required was that both states' taxes were computed by reference to the same profits. The UK would not give credit under domestic unilateral relief because the source of the income was in the UK. If the deemed source rule in art. 23(3) changed that, the UK would have to give credit for the US tax on the same income because that now had a source in the US for the Treaty. The result was that each state said that it accepted that the other could tax in accordance with the Treaty, so that the source of the income was in the other state, and both states had to give credit for the other's tax.
The order in which tax was paid and credited was important. If tax was properly paid first in the UK without any credit for the US tax, it might be credited in the US. But if tax was properly paid first in the US (which had in fact occurred) and the UK had to give credit for the US tax, then there would be no net UK tax available for credit in the US. The fact that the Treaty did not say anything about who gave credit first left some doubt about whether that was the correct reading.
The way out of the circle in which both states taxed on a residence basis and on a literal reading of the Treaty both gave credit, was to consider who had the stronger taxing right. Undoubtedly that was the UK which was taxing a UK resident on UK source income, i.e. taxing on a residence plus source basis. The US was disregarding the UK taxpayer, but impliedly acknowledging that the UK had the better right to tax by saying that its taxation was by virtue of the saving clause. Accordingly, the first taxing right was with the UK. There was no credit to be given because at that stage there was no US tax because the saving clause only came into operation if the Treaty (excluding the saving clause) prevented the US from taxing.
The fact that art. 1(4) provided that art. 23 was applicable even though the saving clause allowed taxation as if the Treaty had not come into effect, demonstrated the secondary nature of taxation by virtue of the saving clause either as a secondary residence state, or, if taxed on the basis of citizenship, as secondary to taxation on the basis of residence. For the purpose of credit by the US the deemed source rule moved the source to the UK. For that limited purpose the UK had become the source state, although strictly it was the source plus residence state, and the US was now the residence, but not the source, state. The US should therefore give credit for the UK tax.
1. These are appeals by Bayfine UK Products ("BUKP"), an unlimited company incorporated in England in the Morgan Stanley Dean...
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Bayfine UK v HM Revenue and Customs
...States of America) Order 1980 (SI 1980/568). This was an appeal by the taxpayer company against a decision of the Special Commissioners ((2008) Sp C 719) that it was not entitled to double tax relief in respect of a profit arising from its participation in a forward contract with a third pa......