Irish Bank Resolution Corporation Ltd (in special liquidation) and Another v Revenue and Customs Commissioners
| Jurisdiction | UK Non-devolved |
| Judgment Date | 09 October 2019 |
| Neutral Citation | [2019] UKUT 277 (TCC) |
| Date | 09 October 2019 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
[2019] UKUT 277 (TCC)
Upper Tribunal (Tax and Chancery Chamber)
The Honourable Mr Justice Marcus Smith, Judge Timothy Herrington
Philip Baker, QC and Imran S Afzal, instructed by KPMG Belfast, appeared for the appellants
David Milne, QC and Jonathan Bremner, QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Corporation tax – UK branches of Irish banks – Interest expense – Whether deductible – Attribution of notional capital – ICTA 1988, s. 11AA(3)(b) – Construction and application of UK – Ireland DTC.
The Upper Tribunal rejected the taxpayers' appeals finding that notional capital must be attributed to the taxpayers' UK permanent establishments.
As it stood at the relevant time, ICTA 1988, s. 11AA(3)(b) provided that, for the purposes of calculating the level of profits to be attributed to a UK permanent establishment (PE) of a non-UK resident company, “it shall also be assumed that the PE has such equity and loan capital as it could reasonably be expected to have in the circumstances specified …”.
The issue to be resolved by the Upper Tribunal (UT) was whether the attribution of a notional level of capital to the UK PEs of two Irish banks, as required by the aforementioned section, precluded a corporation tax deduction for interest expense attributable to that notional level of capital. The taxpayers' position was that ICTA 1988, s. 11AA(3)(b) was incompatible with the United Kingdom and Republic of Ireland Double Tax Convention, art. 8 and that the terms of the latter prevailed. HMRC's position was that ICTA 1988, s. 11AA(3)(b) requires an assumption to be made that a PE has a certain level of capital, and that interest and other costs which would not have been incurred if the notional level of capital was in fact held, should be disallowed.
In making its judgment, the UT relied on various OECD publications as well as certain decisions of courts in other jurisdictions regarding conventions similar to the present Convention. Material relating to UK prior practice in relation to the taxation of PEs was however ruled inadmissible by the UT. The unilateral practice of a taxing authority – no matter how well-advised – is not material that can support or contradict a particular interpretation of a treaty.
The UT agreed with the submissions of the taxpayers' that the starting point for the attribution of profits to a UK PE was the actual accounting records of the PE, including (for example) the capital actually attributed to the PE. This however was only the starting point because it was perfectly possible for the accounting records of a PE to record the financial position of the PE, but in such a way as to fail to reflect the hypothesis that art. 8(2) required, namely that the PE must be treated as “if it were a distinct and separate enterprise engaged in the same or similar activities and dealing at arm's length with the enterprise of which it is a permanent establishment”. This, the UT considered, was clear from the wording of the Convention and was also supported by the 1963 OECD Commentary, which makes clear that the books of account “naturally form the starting point for any processes of adjustment in case adjustment is required to produce the amount of properly attributable profits”. Indeed, the 1963 Commentary explicitly refers to the need, in certain circumstances, to “rectify” a PE's books of account.
The UT considered that the conclusion reached as to the meaning of art. 8 was entirely consistent with the foreign case law it was shown in evidence. The Appellants' appeal was therefore dismissed.
The terms of the UK and Republic of Ireland Double Tax Convention were not inconsistent with the requirement in ICTA 1988, s. 11AA to attribute an amount of notional capital to a UK permanent establishment of a non-UK resident company. A capital attribution tax adjustment was therefore required to disallow any interest referable to the notional capital attribution. Note that this method was only one way in which to perform the calculation of a permanent establishment's profits as required by the Convention. HMRC did not go so far as to say that the Convention obliged this approach. For the purposes of rejecting the taxpayers' appeals, it was sufficient that the Convention not to preclude it.
[1] In the United Kingdom, as in many other jurisdictions, a company resident in the United Kingdom is within the charge to corporation tax in relation to all of its profits, wherever arising.
[2] Companies not resident in the United Kingdom are generally outwith the charge to corporation tax, unless a company carried on a trade in the United Kingdom through a permanent establishment in the United Kingdom. Section 11 of the Income and Corporation Taxes Act 1988 (“ICTA 1988”), as in force at the material times, provided:
- A company not resident in the United Kingdom is within the charge to corporation tax if, and only if, it carries on a trade in the United Kingdom through a permanent establishment in the United Kingdom.
- If it does so, it is chargeable to corporation tax, subject to any exceptions provided for by the Corporation Tax Acts, on all profits, wherever arising, that are attributable to its permanent establishment in the United Kingdom.
[3] Section 148(1)(a) of the Finance Act 2003 (“FA 2003”) defines a “permanent establishment” as “a fixed place of business … through which the business of a company is wholly or partly carried on”.
[4] As it stands, section 11 ICTA 1988 provides no guidance as to what profits are – and what profits are not – attributable to a corporation's permanent establishment. Some guidance is provided by section 11AA ICTA 1988, inserted into that statute by section 149(2) FA 2003. So far as material, section 11AA provides:
- This section provides for determining for the purposes of corporation tax the amount of the profits attributable to a permanent establishment in the United Kingdom of a company that is not resident in the United Kingdom (the non-resident company).
- There shall be attributed to the permanent establishment the profits it would have made if it were a distinct and separate enterprise, engaged in the same or similar activities under the same or similar conditions, dealing wholly independently with the non-resident company.
- In applying subsection (2) –it shall be assumed that the permanent establishment has the same credit rating as the non-resident company, andit shall also be assumed that the permanent establishment has such equity and loan capital as it could reasonably be expected to have in the circumstances specified in that subsection.
No deduction may be made in respect of costs in excess of those that would have been incurred on those assumptions.
Section 11AA ICTA 1988 came into effect in relation to accounting periods beginning after 31 December 2002.
[5] The difficulty, in terms of working out what profits are attributable to a permanent establishment arises, at least in part, out of the nature of a permanent establishment.
[6] A permanent establishment is not a separate legal person, distinct from the corporation of which it forms a part. For this reason, there is a terminological difficulty in describing dealings between a company and its permanent establishment, which translates into the difficulties of attribution that we have referred to:
- Because it is not possible for a person, acting in the same capacity, to deal with itself, it is in fact legally meaningless to say that a permanent establishment pays interest to the company or that the company transfers an asset to the permanent establishment. Such transactions can, in law, not take place and they amount to no more than internal bookkeeping on the part of the company.
- In saying this, we say nothing about the legitimacy or propriety of such book entries: this is simply an inevitable consequence of the fact that a permanent establishment is, in legal terms, indistinguishable from the company that has established it.
- For this reason, the fact that such transactions are legally without effect, does give rise to a terminological difficulty. We shall, in this decision, refer to the permanent establishment paying interest to the company or the payment of capital to the permanent establishment by the company as the best, shorthand, way of describing such dealings. However, at all times, we have in mind that these are not really legal transactions at all.
- For the same reason, there is a difficulty in attributing costs and profits to a permanent establishment. We have seen how section 11AA ICTA 1988 seeks to resolve that difficulty.
[7] Issues regarding the attribution of profits to a permanent establishment only arise where a company is resident in one jurisdiction and the permanent establishment is in another jurisdiction. In such cases, in order to avoid double taxation (where two jurisdictions tax the same profit) or double non-taxation (where a profit is taxed by neither jurisdiction), the rules of the two jurisdictions will need to co-ordinate. Typically, such co-ordination will be in the form of a double taxation convention between the jurisdictions involved and, generally speaking, such double taxation conventions are bilateral. The purpose of a double taxation convention between two states is to ensure that a person (and here, we are talking about companies) does not pay tax twice on the same income (here, profit). Such conventions will, typically, identify different classes of income and then allocate taxing rights to those classes of income as between the states party to the treaty.
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