This case relates to an ongoing disagreement between Aozora and HMRC relating to interest withholding tax ('WHT'). Aozora is a Japanese commercial bank with operations worldwide. The case concerns a loan from Aozora UK to Aozora US, on which interest was payable over three years from 2007 to 2009.
Article 11(1) of the UK/US double tax agreement ('DTA') provides:
Article 11(1) of the UK/US double tax agreement ('DTA') provides:
"Interest arising in a Contracting State and beneficially owned by a resident
of the other Contracting State shall be taxable only in that other State."
In this case the interest arose in the US, and was beneficially owned in the UK. Therefore, it would be taxable in the UK if all other requirements of Article 11 and the DTA in general were met. Otherwise, 30% US WHT would apply.
Other DTA requirements
Article 23 - Limitation of benefits
Article 23 is an anti 'treaty shopping' provision which is common in tax treaties involving the US, Article 23(1) provides:
"...a resident of a Contracting
State that derives income, profits or gains from the other Contracting State shall be
entitled to all the benefits of this Convention otherwise accorded to residents of a
Contracting State only if such resident is a "qualified person".
A qualified person can be:
- An individual;
- A public company;
- A private company (provided it meets particular ownership requirements);
- Other entities (provided they meet particular ownership requirements) .
In this case Aozora UK was not considered to be a qualified person, and therefore, was not automatically entitled to 'all the benefits of this convention'. There is one last resort under the DTA, paragraph 23(6) allows a taxpayer to access relief if:
"...the competent authority of the other Contracting State
determines that the establishment, acquisition or maintenance of such resident and the
conduct of its operations did not have as one of its principal purposes the obtaining of
benefits under this Convention."
This is known as the 'competent authority' relief. Paragraph (6) also provides that the tax authority assessing the claim must consult with the tax authority of the other country as part of that process.
In this case the IRS denied Aozora competent authority relief. The decision was not presented in court so it is unclear whether or not HMRC were consulted.
As Aozora was denied relief under the UK/US DTA, its effective tax rate on the interest income was 51% (being 30% tax in both countries), unless unilateral relief was available in the UK.
Unilateral tax relief
Where income arises and is taxed in a foreign country, for example from rent received in that foreign country, and it is also taxable under UK law, 'unilateral' relief may be available to the taxpayer. Section 9 of the TIOPA 2010 provides:
"Credit for tax—
(a) paid under the law of the territory,
(b) calculated by reference to income arising, or any chargeable gain accruing, in the territory, and
(c) corresponding to UK tax,
is to be allowed against any income tax or corporation tax calculated by reference to that income or gain."
Under that section the 30% US WHT could be credited against UK corporation tax for that income. However, section 11(3) provides a key caveat:
"If double taxation arrangements made in relation to the territory contain express provision to the effect that relief by way of credit is not to be given under the arrangements in cases or circumstances specified or described in the arrangements, credit is not allowed under section 9 or 10 in those cases or circumstances."
In more straightforward terms - where an express provision of a DTA denies relief, neither can unilateral relief be claimed. In this case it resulted in an effective tax rate of 51% on the interest income received by Aozora UK.
The Judge offered some background to the development of this provision, noting that the introduction of section 11(3) followed an intensive HMRC review of double tax relief, which included a 72 page discussion paper and proceeding workshop for 'those interested in the topic...'¹
HMRCs manual
HMRC published guidance on section 11(3) upon its introduction in 2003. It said:
"[Section 11(3)] provides a restriction to credit relief under [section 9]. It provides that where a double taxation treaty contains an express provision to the effect that relief by way of credit shall not be given in particular cases or circumstances specified or described in the agreement, then neither shall credit by way of unilateral relief be allowed in those cases or circumstances. The provision has effect for arrangements made after 20 March 2000. At 1 April 2003 the only provisions to which [section 11(3)] applies is Article 24(4)(c) of the new UK/US DTA"
As Aozora was denied relief under the UK/US DTA, its effective tax rate on the interest income was 51% (being 30% tax in both countries), unless unilateral relief was available in the UK.
Unilateral tax relief
Where income arises and is taxed in a foreign country, for example from rent received in that foreign country, and it is also taxable under UK law, 'unilateral' relief may be available to the taxpayer. Section 9 of the TIOPA 2010 provides:
"Credit for tax—
(a) paid under the law of the territory,
(b) calculated by reference to income arising, or any chargeable gain accruing, in the territory, and
(c) corresponding to UK tax,
is to be allowed against any income tax or corporation tax calculated by reference to that income or gain."
Under that section the 30% US WHT could be credited against UK corporation tax for that income. However, section 11(3) provides a key caveat:
"If double taxation arrangements made in relation to the territory contain express provision to the effect that relief by way of credit is not to be given under the arrangements in cases or circumstances specified or described in the arrangements, credit is not allowed under section 9 or 10 in those cases or circumstances."
In more straightforward terms - where an express provision of a DTA denies relief, neither can unilateral relief be claimed. In this case it resulted in an effective tax rate of 51% on the interest income received by Aozora UK.
The Judge offered some background to the development of this provision, noting that the introduction of section 11(3) followed an intensive HMRC review of double tax relief, which included a 72 page discussion paper and proceeding workshop for 'those interested in the topic...'¹
HMRCs manual
HMRC published guidance on section 11(3) upon its introduction in 2003. It said:
"[Section 11(3)] provides a restriction to credit relief under [section 9]. It provides that where a double taxation treaty contains an express provision to the effect that relief by way of credit shall not be given in particular cases or circumstances specified or described in the agreement, then neither shall credit by way of unilateral relief be allowed in those cases or circumstances. The provision has effect for arrangements made after 20 March 2000. At 1 April 2003 the only provisions to which [section 11(3)] applies is Article 24(4)(c) of the new UK/US DTA"
What is Article 24?
Article 24(4) provides clarity regarding how double tax relief works. Paragraphs (4)(a) and (4)(b) state (unsurprisingly) that if relief is claimed in one state it cannot be claimed in the other.
Paragraph 24(4)(c) denies relief in the case of a specific arrangement which results in a tax credit by way of arbitrage due to the different treatment of interest and dividends between the US and UK. The Judge went into more detail:
"I did read Article 24(4)(c) several times, in a futile endeavour to understand its purpose. Some enlightenment did, however, emerge from the helpful "Department of the [United States] Treasury Technical Explanation of the Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains" ("the Note").
It appears from the Note that Article 24(4)(c) was inserted in the Treaty at the behest of the UK Government, as an anti-avoidance provision to deal with what was perceived to be a very specific arbitrage device intended to generate a tax credit against UK corporation tax that was considered to be unjustified. In the relevant scenario a US corporation would sell stock in a US subsidiary to a UK resident company, with an obligation at some point to repurchase the stock ("a repo"). US revenue law looked at the commercial reality, treated the repo as a secured loan to the US corporation, any "dividend" paid to the UK company as a payment of interest by the US corporation, and, semble, the stock and "dividend" as beneficially owned by the debtor US corporation. For UK corporation tax, however, the "dividend" had to be treated as genuine, and the UK company would be positioned to obtain credit against UK tax in respect of an appropriate part of the profits of the US corporation, notwithstanding the fact that the US corporation had fully deducted the "dividend"/interest payment for the purposes of stating its US taxable income – a form of double tax relief successfully arbitraged through the different treatment of the transaction in the two jurisdictions."²
Paragraph (c) is the above-mentioned 'express provision'.
Nothing in Article 24 was contravened in this case. What is important is that in 2007 HMRCs guidance claimed that this was the only express provision denying both treaty relief and unilateral relief under the UKs entire collection of DTAs.
Paragraph 24(4)(c) denies relief in the case of a specific arrangement which results in a tax credit by way of arbitrage due to the different treatment of interest and dividends between the US and UK. The Judge went into more detail:
"I did read Article 24(4)(c) several times, in a futile endeavour to understand its purpose. Some enlightenment did, however, emerge from the helpful "Department of the [United States] Treasury Technical Explanation of the Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains" ("the Note").
It appears from the Note that Article 24(4)(c) was inserted in the Treaty at the behest of the UK Government, as an anti-avoidance provision to deal with what was perceived to be a very specific arbitrage device intended to generate a tax credit against UK corporation tax that was considered to be unjustified. In the relevant scenario a US corporation would sell stock in a US subsidiary to a UK resident company, with an obligation at some point to repurchase the stock ("a repo"). US revenue law looked at the commercial reality, treated the repo as a secured loan to the US corporation, any "dividend" paid to the UK company as a payment of interest by the US corporation, and, semble, the stock and "dividend" as beneficially owned by the debtor US corporation. For UK corporation tax, however, the "dividend" had to be treated as genuine, and the UK company would be positioned to obtain credit against UK tax in respect of an appropriate part of the profits of the US corporation, notwithstanding the fact that the US corporation had fully deducted the "dividend"/interest payment for the purposes of stating its US taxable income – a form of double tax relief successfully arbitraged through the different treatment of the transaction in the two jurisdictions."²
Paragraph (c) is the above-mentioned 'express provision'.
Nothing in Article 24 was contravened in this case. What is important is that in 2007 HMRCs guidance claimed that this was the only express provision denying both treaty relief and unilateral relief under the UKs entire collection of DTAs.
Contentions
Aozora agrees with the (former) wording of HMRCs manual - that Article 24(4)(c) is the only express provision which existed at the time. Aozora claims that it relied on this manual in 2006 and now requests that the High Court hold HMRC to its word by way of a Judicial Review into the reasonableness of HMRCs decisions in relation to this matter.
HMRC alleges that its manual stated an incorrect opinion in 2007, and has since updated its guidance. HMRC doesn't believe it should be held to its word in 2007 for a range of reasons, the principle being that its opinion did not give rise to a 'legitimate expectation' to taxpayers at the time.
Was there a legitimate expectation that HMRC would apply the law per the guidance?
A legitimate expectation first arises from a 'relevant representation'. HMRC says there was no representation because:³
- There was no 'clear, unambiguous' statement in the manual 'devoid of relevant qualification';
- an 'ordinarily sophisticated taxpayer' would have known that HMRC do not make the law, and a reading of HMRC's internal manual was not a substitute for an analysis of the legislation itself';
- 'the statement in INTM 151060 was made in an internal HMRC manual for the purpose of providing guidance to HMRC staff (albeit published more widely)';
- 'the statement in INTM 151060 was short and read literally was on its terms clearly incomplete;
- 'the statement in INTM was not given in response to a request by the Claimant or its advisors for a ruling on particular facts'.
Was the representation relied upon by Aozora?
As the taxpayer (Aozora UK) didn't exist while this structure was being contemplated, the Judge used Aozora Japan as the proxy for deciding whether or not there was reliance on HMRCs representation. The Judge ruled:
"On the evidence before me, therefore, the only conclusion that I can properly draw is that Aozora Japan was relying on, and was exclusively relying on, expert advice of Deloitte that unilateral credit would be available under UK law to a wholly owned subsidiary company resident in the UK in respect of taxed income received from the US by the UK subsidiary. Aozora Japan was unaware of the Manual and guidance and did not directly rely upon any representation made by HMRC about the meaning and scope of [s11(3)]."⁵
The Judge ruled that Aozora itself did not rely on the HMRC manual because neither they, nor their advisers, could show it formed a central part of the advice given or the decision made in 2006. The Court therefore found in favour of HMRC and rejected the application to hold HMRC to its view expressed in 2007.
This ruling highlights the importance for advisers of noting HMRCs position on pertinent issues and including this in written advice. (The Judge also noted that even if there was reliance by advisers, in court it must then be shown that the representation played a real and substantial part in giving the advice/that opinion.).
Conspicuous unfairness
If it were shown that the advice was relied on, a taxpayer would still need to show that it would be conspicuously unfair for HMRC to resile from its advice. The Judge mentioned:
"In my view, Aozora UK could not clear that hurdle in this case, unless it produced clear and compelling evidence that, by reason of its putative reliance on the relevant representation, it had suffered substantial detriment. It must show that, but for the advice that unilateral tax credit was available, it would not have made the business decision that it did, but would have made a business decision that was more favourable from a tax point of view. However, there is simply no evidence before the Court from Aozora Japan or Aozora UK as to what Aozora Japan would have done if they had been expressly (and, for this purpose, correctly) told that, by virtue of Article 23 of the Tax Treaty and s.793A(3), no unilateral credit would be available on the scenario under consideration."⁶
Moving forward
Aozora has lost its application to receive a unilateral tax credit on the ground that HMRC is legally bound to its guidance.
Whether or not HMRCs guidance is correct is a separate issue which will now be decided by the First Tier Tax Tribunal.⁷ The case will almost certainly cover whether or not unilateral tax relief is available to those failing the requirements of a Limitation of Benefits DTA Article - such as Article 23.
Notes
[1] p14
[2] p27-28
[3] p72
[4] p58
[5] p83
[6] p98
[7] Assuming there is no appeal from this decision to the Court of Appeal.
UK/US DTA: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/507431/usa-consolidated_-_in_force.pdf
[2] p27-28
[3] p72
[4] p58
[5] p83
[6] p98
[7] Assuming there is no appeal from this decision to the Court of Appeal.
UK/US DTA: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/507431/usa-consolidated_-_in_force.pdf
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