ON APPEAL FROM UPPER TRIBUNAL TAX AND CHANCERY
Neutral Citation Number: [2020] EWCA Civ 1128Case No: A3/2019/3060IN THE COURT OF APPEAL (CIVIL DIVISION)ON APPEAL FROM UPPER TRIBUNAL TAX AND CHANCERY CHAMBERMarcus Smith J & Upper Tribunal Judge Timothy Herrington[2019] UKUT 0277 (TCC)Royal Courts of JusticeStrand, London, WC2A 2LLDate: 28 August 2020Before :LORD JUSTICE PATTENLORD JUSTICE SINGHandLADY JUSTICE ROSE--------------------Between :(1) IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION)(2) IRISH NATIONWIDE BUILDING SOCIETY- and THE COMMISSIONERS FORHER MAJESTY’S REVENUE AND ------------------Philip Baker QC and Imran Afzal (instructed by Sharpe Pritchard LLP) for theAppellantsDavid Milne QC and Jonathan Bremner QC (instructed by HMRC Solicitor’s Office) forthe RespondentsHearing dates : 14 and 15 July 2020---------------------Approved JudgmentCovid-19 Protocol: This judgment was handed down remotely by circulation to the parties'representatives by email, release to BAILII and publication on the Courts and TribunalsJudiciary website. The date and time for hand-down is deemed to be at 10:30am on Friday,28 August 2020.
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRCLord Justice Patten :Introduction1.Both Appellants are companies registered in the Republic of Ireland which, during therelevant accounting periods covered by this appeal, carried on business through abranch 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 1988and in 1991 was granted branch status by the Bank of England which enabled it toundertake regulated financial services including the taking of deposits. IrishNationwide 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 itsbusiness became the provision of sterling-based finance to the developers ofresidential property operating in the UK market. The finance was raised from anumber of sources including the wholesale market in London, sterling deposits at itsUK branches and in an Isle of Man subsidiary of INBS, and inter-bank funding.2.Both companies became insolvent as a result of the financial crisis which affected theproperty market from 2007 onwards. INBS is now a shell company and IBRC is inliquidation. But in the years with which this appeal is concerned they operatedprofitable businesses through their UK branches which rendered them liable to UKcorporation tax.3.Section 11 of the Income and Corporation Taxes Act 1988 (“TA 1988”) as in force atthe material time between 2003 and 2007 provided as follows:“(1) A company not resident in the United Kingdom is withinthe charge to corporation tax if, and only if, it carries on a tradein the United Kingdom through a permanent establishment inthe United Kingdom.(2) If it does so, it is chargeable to corporation tax, subject toany exceptions provided for by the Corporation Tax Acts, onall profits, wherever arising, that are attributable to itspermanent establishment in the United Kingdom.”4.“Permanent establishment” (“PE”) was defined by s.148(1)(a) of the Finance Act2003 (“FA 2003”) as “a fixed place of business through which the business of acompany is wholly or partly carried on”. It is common ground that both the UKbranches we are concerned with satisfied this description.5.No guidance is given by s.11 TA 1988 itself as to the correct basis for identifying orcalculating which of the company’s profits should be treated as attributable to its PEin the UK but some further guidance was provided by s.149(2) FA 2003 which as wellas substituting the replacement subsections (1) and (2) of section 11 as set out abovealso inserted into TA 1988 a new s.11AA in respect of accounting periods after 31December 2002. It provided as follows:“(1) This section provides for determining for the purposes ofcorporation tax the amount of the profits attributable to a
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRCpermanent establishment in the United Kingdom of a companythat is not resident in the United Kingdom (“the non-residentcompany”).(2) There shall be attributed to the permanent establishment theprofits it would have made if it were a distinct and separateenterprise, engaged in the same or similar activities under thesame or similar conditions, dealing wholly independently withthe non-resident company.(3) In applying subsection (2) –(a) it shall be assumed that the permanent establishmenthas the same credit rating as the non-resident company, and(b) it shall also be assumed that the permanentestablishment has such equity and loan capital as it couldreasonably be expected to have in the circumstancesspecified in that subsection.No deduction may be made in respect of costs in excess ofthose that would have been incurred on those assumptions.”6.This appeal is primarily concerned with s.11AA(3)(b). In reliance on theseprovisions, HMRC have disallowed as part of the Appellants’ calculation of profitsthe deduction of some of the interest which is shown in the accounts of the UKbranches as an expense of the borrowings made by the branches in order to financetheir lending business. HMRC have done so using what is described as a CapitalAttribution Tax Adjustment (“CATA”) which includes attributing to the PE notionaladditional free capital in cases where it is said that a PE operating as a distinct andseparate enterprise in the manner contemplated by s.11AA(2) would have had ahigher amount of free capital and therefore a correspondingly lower amount ofborrowed capital. The result of applying the CATA to the accounts of the twobranches in this case has been to disallow interest which was actually paid to thirdparties in the market as part of their cost of borrowing. But s.11AA(3)(b) canobviously be engaged in a wide variety of cases involving many different types ofcompanies including those where a PE may have very little free capital or even thirdparty borrowings and may depend for its capital on internal financing arrangementswithin the company which have little or no correspondence to the arm’s length marketconditions contemplated by s.11AA(2).7.The ability of the UK to tax the profits of a non-resident company brings with it theobvious possibility of double taxation. The provisions of s.11 TA 1988 are by nomeans unique to the UK and can be found replicated in one form or another in the taxregimes of a significant number of other countries. To alleviate this problem, theOrganisation for Economic Co-operation and Development (“the OECD”) has since1963 published a series of model double taxation conventions with accompanyingcommentaries in order to provide a suggested basis for the allocation of profits to aPE. In 1976 the UK and Ireland entered into such a convention (“the 1976
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRCConvention”) which came into force domestically with the making of the DoubleTaxation Relief (Taxes on Income) (Republic of Ireland) Order 1976.8.The 1976 Convention itself is, of course, an international treaty between sovereignstates but it impacts on domestic tax legislation because under s.788(3) TA 1988 thearrangements contained in a double taxation convention, once confirmed by Order inCouncil, have effect in relation to income tax and corporation tax “notwithstandinganything in any enactment”. It is common ground on this appeal that the provisionsof s.11AA(3)(b) are therefore effective only if and in so far as they provide a meansof determining the profits of the company attributable to the PE that is within thescope of and therefore permissible under the relevant terms of the 1976 Convention.9.The 1976 Convention covers all forms of direct taxation on income and profitsincluding capital gains. Article 5 contains a definition of permanent establishment inthe same terms as s.148(1)(a) FA 2003 which includes a branch. Business profits areaddressed in Article 8 in the following terms:“(1) The profits of an enterprise of a Contracting State shall betaxable only in that State unless the enterprise carries onbusiness in the other Contracting State through a permanentestablishment situated therein. If the enterprise carries onbusiness as aforesaid, the profits of the enterprise may be taxedin the other State but only so much of them as is attributable tothat permanent establishment.(2) Subject to the provisions of paragraph (3) of this Article,where an enterprise of a Contracting State carries on businessin the other Contracting State through a permanentestablishment situated therein, there shall in each ContractingState be attributed to that permanent establishment the profitswhich it might be expected to make if it were a distinct andseparate enterprise engaged in the same or similar activitiesunder the same or similar conditions and dealing at arm’slength with the enterprise of which it is a permanentestablishment.(3) In the determination of the profits of a permanentestablishment, there shall be allowed as deductions expenses ofthe enterprise which are incurred for the purposes of thepermanent establishment, including executive and generaladministrative expenses so incurred, whether in the State inwhich the permanent establishment is situated or elsewhere.(4) Nothing in the foregoing provisions of this Article shallaffect any of the provisions of the law of a Contracting Staterelating specifically to the liability to tax of a life assurancecompany not having its head office in that Contracting State.
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRC(5) No profits shall be attributed to a permanent establishmentby reason of the mere purchase by that permanentestablishment of goods or merchandise for the enterprise.(6) Where profits include items which are dealt with separatelyin other Articles of this Convention, then the provisions ofthose Articles shall not be affected by the provisions of thisArticle.”10.One can see that the wording of Article 8(2) has been adopted almost verbatim ins.11AA(2). The only difference is the use in s.11AA(2) of the phrase “dealing whollyindependently with” which is found in Article 7(2) of the 1963, 1977 and 2008 modelconventions but it has not been suggested that the reference in Article 8(2) of the 1976Convention to “dealing at arm’s length” makes any material difference to the effect ofthe relevant provisions.11.The essence of the taxpayers’ argument is that the reference in Article 8(2) to the PEbeing treated as a distinct and separate enterprise “engaged in the same or similaractivities under the same or similar conditions” requires an assumption to be made notonly that the PE is engaged in the same or similar type of business to the one itactually carried on but also that it should be taken to have traded with the same ratioof free to borrowed capital as it actually employed during the relevant accountingperiod. On this basis, it is said the UK is precluded by s.788(3) from relying ons.11AA(3)(b) in so far as that would lead to an adjustment in the amount of freecapital it was taken to have employed in that period and a consequent disallowance ofsome of the interest charges on borrowed capital which it actually incurred. Mr BakerQC, for the Appellants, did, of course, recognise that if this construction of Article8(2) is right, it must follow that the same outcome would apply to a PE whichemployed no free capital at all in the relevant accounting period.12.Some reliance is also placed by Mr Baker on Article 8(3) of the 1976 Convention ifthe attribution of a notional amount of free capital to the PE would have the effect ofdisallowing the deductions which are mentioned. Article 8(3) is concerned with anallowance being made against the profits of the PE in respect of generaladministrative and other expenses incurred by the company itself in relation to the PE.In relation to administrative expenses, this seems to be a different exercise from thecalculation of the profits attributable to the PE from its own activities and it is notclear how, if at all, it could be impacted by the operation of the CATA. Thededuction of expenses incurred by the company might, however, be affected if theytook the form of expenses on borrowings incurred by the bank on monies that werethen used to capitalise the PE. It is however clear, and I think accepted by Mr Baker,that Article 8(3) cannot be construed so as to create an obstacle to the implementationof the CATA if, on the proper construction of Article 8(2), capital attribution ispermissible. The two must be read consistently with each other. For this reason,Article 8(3) has not really featured in the argument either here or before the UpperTribunal and the First-tier Tribunal.13.On the Appellants’ case, the ability of the UK to operate the domestic tax regimecontained in s.11AA(3)(b) depends upon it negotiating and concluding an amendmentto the 1976 Convention. This, Mr Baker says, could be achieved by the incorporation
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRCin the 1976 Convention of a new Article 8 replicating the terms of the 2010 OECDmodel convention which contains a number of linguistic changes. These, he says,were intended to give effect to an OECD review project that commenced in the late1990s and included a recognition that in a significant number of Member States thecalculation of the profits attributable to the PE of a non-resident company wasconsidered to be best achieved by a process of notionally capitalising the PE at thelevel at which it could reasonably be expected to have operated had it conducted itsbusiness as an independent enterprise of the kind contemplated by Article 8(2). TheAppellants’ case is that the implementation of this approach required a substantivechange to the terms of what was then Article 7 of the model convention and that thiswas achieved by the 2010 re-draft. Mr Milne QC, for HMRC, relies, however, on theamended OECD commentary on the model convention published in 2008 which hesays confirms that the approach based on an attribution of capital had long been usedby Member States to implement the provisions of Article 7 and was recognised by theOECD as permissible under the terms of Article 7 of the model convention in itsunamended form.14.Both the Upper Tribunal (Marcus Smith J and Judge Timothy Herrington) ([2019]UKUT 0277 TCC) (“UT”) and the First-tier Tribunal (Judge Colin Bishopp) ([2017]UKFTT 0702 (TC)) (“FtT”) relied upon the 2008 commentary in their reasons fordeciding to dismiss the taxpayers’ appeals and a significant issue for us is whether theguidance contained in the 2008 OECD commentary is properly to be treated as nomore than confirmatory of the scope of the existing Article 7 or whether it didintroduce a substantive change in advocating the use of the CATA methodologywhich can only be given effect to by the adoption of the 2010 version of Article 7 ofthe model convention or something very similar.Principles of Construction15.Before I come to the OECD material it is necessary to say something about the correctapproach to the construction of the wording of the 1976 Convention. Article 31 of the1969 Vienna Convention on the Law of Treaties provides:“1. A treaty shall be interpreted in good faith in accordancewith the ordinary meaning to be given to the terms of the treatyin their context and in the light of its object and purpose.2. The context for the purpose of the interpretation of a treatyshall comprise, in addition to the text, including its preambleand annexes:(a) Any agreement relating to the treaty which was madebetween all the parties in connexion with the conclusion ofthe treaty;(b) Any instrument which was made by one or more partiesin connexion with the conclusion of the treaty and acceptedby the other parties as an instrument related to the treaty.3. There shall be taken into account, together with the context:
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRC(a) Any subsequent agreement between the partiesregarding the interpretation of the treaty or the applicationof its provisions;(b) Any subsequent practice in the application of the treatywhich establishes the agreement of the parties regarding itsinterpretation;(c) Any relevant rules of international law applicable in therelations between the parties.4. A special meaning shall be given to a term if it is establishedthat the parties so intended.”16.It was common ground that a convenient summary of these principles and the way inwhich they have been applied by the English courts is to be found in the judgment ofMummery J (as he then was) in Inland Revenue Commissioners v Commerzbank AG[1990] STC 285 at page 297 where the judge said:“Before I examine the contrary submissions of the Crown, it isnecessary to refer briefly to the approach to the interpretation ofprovisions, such as art XV, which have been agreed betweensovereign states in a convention or treaty and havesubsequently been given the force of law in the UnitedKingdom by reason of the implementing provisions of primaryor secondary legislation. The parties are agreed that the correctapproach is that laid down by the House of Lords in Fothergillv Monarch Airlines Ltd [1981] AC 251. That case gave rise toproblems of comparison with a foreign language text (that is,the French text of the Warsaw Convention) which are notpresent in these appeals. The House of Lords had to comparethe English text and the French text because of a provision inthe convention that the French text should prevail if there wasany inconsistency between it and the text in English. Puttingthat special feature on one side, that decision makes clear theapproach which should be adopted by the court.(1) It is necessary to look first for a clear meaning of the wordsused in the relevant article of the convention, bearing in mindthat 'consideration of the purpose of an enactment is always alegitimate part of the process of interpretation': per LordWilberforce (at 272) and Lord Scarman (at 294). A strictlyliteral approach to interpretation is not appropriate inconstruing legislation which gives effect to or incorporates aninternational treaty: per Lord Fraser (at 285) and Lord Scarman(at 290). A literal interpretation may be obviously inconsistentwith the purposes of the particular article or of the treaty as awhole. If the provisions of a particular article are ambiguous, itmay be possible to resolve that ambiguity by giving a purposiveconstruction to the convention looking at it as a whole by
Judgment Approved by the court for handing down.IRISH BANK RESOLUTION CORPORATIONLTD (IN SPECIAL LIQUIDATION) & ANOR VHMRCreference to its language [1990] STC 285 at 298 as set out inthe relevant United Kingdom legislative instrument: per LordDiplock (at 279).(2) The process of interpretation should take account of the factthat—'The language of an international convention has notbeen chosen by an English parliamentary draftsman.It is neither couched in the conventional Englishlegislative idiom nor designed to be construedexclusively by English judges. It is addressed to amuch wider and more varied judicial audience thanis an Act of Parliament which deals with purelydomestic law. It should be interpreted, as LordWilberforce put it in James Buchanan & Co. Ltd v.Babco Forwarding & Shipping (UK) Limited [1978]AC 141 at 152], “unconstrained by technical rulesof English law, or by English legal precedent, buton broad principles of general acceptation': per LordDiplock (at 281–
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