Irish Bank Resolution Corporation Ltd (in Special Liquidation) v The Commissioners for HM Revenue and Customs
| Jurisdiction | England & Wales |
| Judge | Lord Justice Patten,Lady Justice Rose,Lord Justice Singh |
| Judgment Date | 28 August 2020 |
| Neutral Citation | [2020] EWCA Civ 1128 |
| Date | 28 August 2020 |
| Docket Number | Case No: A3/2019/3060 |
| Year | 2020 |
| Court | Court of Appeal (Civil Division) |
[2020] EWCA Civ 1128
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM UPPER TRIBUNAL TAX AND CHANCERY CHAMBER
Marcus Smith J & Upper Tribunal Judge Timothy Herrington
Royal Courts of Justice
Strand, London, WC2A 2LL
Lord Justice Patten
Lord Justice Singh
and
Lady Justice Rose
Case No: A3/2019/3060
Philip Baker QC and Imran Afzal (instructed by Sharpe Pritchard LLP) for the Appellants
David Milne QC and Jonathan Bremner QC (instructed by HMRC Solicitor's Office) for the Respondents
Hearing dates: 14 and 15 July 2020
Approved Judgment
Introduction
Both Appellants are companies registered in the Republic of Ireland which, during the relevant accounting periods covered by this appeal, carried on business through a branch in the United Kingdom. Irish Bank Resolution Corporation Limited (“IBRC”) was formerly Anglo Irish Bank Corporation plc. It opened an office in the UK in 1988 and in 1991 was granted branch status by the Bank of England which enabled it to undertake regulated financial services including the taking of deposits. Irish Nationwide Building Society (“INBS”) opened a retail branch in the UK (in Belfast) in 1994 and provided loans for the purchase of domestic property. Most of its business became the provision of sterling-based finance to the developers of residential property operating in the UK market. The finance was raised from a number of sources including the wholesale market in London, sterling deposits at its UK branches and in an Isle of Man subsidiary of INBS, and inter-bank funding.
Both companies became insolvent as a result of the financial crisis which affected the property market from 2007 onwards. INBS is now a shell company and IBRC is in liquidation. But in the years with which this appeal is concerned they operated profitable businesses through their UK branches which rendered them liable to UK corporation tax.
Section 11 of the Income and Corporation Taxes Act 1988 (“TA 1988”) as in force at the material time between 2003 and 2007 provided as follows:
“(1) 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.
(2) 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.”
“Permanent establishment” (“PE”) was defined by s.148(1)(a) of the Finance Act 2003 (“ FA 2003”) as “a fixed place of business … through which the business of a company is wholly or partly carried on”. It is common ground that both the UK branches we are concerned with satisfied this description.
No guidance is given by s.11 TA 1988 itself as to the correct basis for identifying or calculating which of the company's profits should be treated as attributable to its PE in the UK but some further guidance was provided by s.149(2) FA 2003 which as well as substituting the replacement subsections (1) and (2) of section 11 as set out above also inserted into TA 1988 a new s.11AA in respect of accounting periods after 31 December 2002. It provided as follows:
“(1) 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”).
(2) 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.
(3) In applying subsection (2) –
(a) it shall be assumed that the permanent establishment has the same credit rating as the non-resident company, and
(b) it 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.”
This appeal is primarily concerned with s.11AA(3)(b). In reliance on these provisions, HMRC have disallowed as part of the Appellants' calculation of profits the deduction of some of the interest which is shown in the accounts of the UK branches as an expense of the borrowings made by the branches in order to finance their lending business. HMRC have done so using what is described as a Capital Attribution Tax Adjustment (“CATA”) which includes attributing to the PE notional additional free capital in cases where it is said that a PE operating as a distinct and separate enterprise in the manner contemplated by s.11AA(2) would have had a higher amount of free capital and therefore a correspondingly lower amount of borrowed capital. The result of applying the CATA to the accounts of the two branches in this case has been to disallow interest which was actually paid to third parties in the market as part of their cost of borrowing. But s.11AA(3)(b) can obviously be engaged in a wide variety of cases involving many different types of companies including those where a PE may have very little free capital or even third party borrowings and may depend for its capital on internal financing arrangements within the company which have little or no correspondence to the arm's length market conditions contemplated by s.11AA(2).
The ability of the UK to tax the profits of a non-resident company brings with it the obvious possibility of double taxation. The provisions of s.11 TA 1988 are by no means unique to the UK and can be found replicated in one form or another in the tax regimes of a significant number of other countries. To alleviate this problem, the Organisation for Economic Co-operation and Development (“the OECD”) has since 1963 published a series of model double taxation conventions with accompanying commentaries in order to provide a suggested basis for the allocation of profits to a PE. In 1976 the UK and Ireland entered into such a convention (“the 1976 Convention”) which came into force domestically with the making of the Double Taxation Relief (Taxes on Income) (Republic of Ireland) Order 1976.
The 1976 Convention itself is, of course, an international treaty between sovereign states but it impacts on domestic tax legislation because under s.788(3) TA 1988 the arrangements contained in a double taxation convention, once confirmed by Order in Council, have effect in relation to income tax and corporation tax “notwithstanding anything in any enactment”. It is common ground on this appeal that the provisions of s.11AA(3)(b) are therefore effective only if and in so far as they provide a means of determining the profits of the company attributable to the PE that is within the scope of and therefore permissible under the relevant terms of the 1976 Convention.
The 1976 Convention covers all forms of direct taxation on income and profits including capital gains. Article 5 contains a definition of permanent establishment in the same terms as s.148(1)(a) FA 2003 which includes a branch. Business profits are addressed in Article 8 in the following terms:
“(1) The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.
(2) Subject to the provisions of paragraph (3) of this Article, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm's length with the enterprise of which it is a permanent establishment.
(3) In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses of the enterprise which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere.
(4) Nothing in the foregoing provisions of this Article shall affect any of the provisions of the law of a Contracting State relating specifically to the liability to tax of a life assurance company not having its head office in that Contracting State.
(5) No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.
(6) Where profits include items which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.”
One can see that the wording of Article 8(2) has been adopted almost verbatim in...
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