MEMEC Plc v Inland Revenue

Factual and Procedural Background

The Appellant, an English company ("Plaintiff"), sought relief from UK corporation tax for the accounting periods ending 31 December 1986, 1987, and 1988. The relief claims related to German trade tax paid by two German subsidiary trading companies ("the Subsidiaries") wholly owned by a German holding company ("Company B"), itself wholly owned by the Plaintiff. The Plaintiff's claims were made under a double taxation convention between the UK and Germany, as well as under UK Income and Corporation Taxes Acts of 1970 and 1988.

The tax authorities ("Defendant") refused the claims, and the Plaintiff's appeals were dismissed by a Special Commissioner. Subsequently, on appeal by way of Case Stated, the High Court Judge dismissed the appeal. The Plaintiff then appealed to the Court of Appeal.

In 1985, the Plaintiff and Company B entered into a silent partnership agreement under German law, whereby the Plaintiff became a silent partner entitled to a contractual share of Company B’s profits. This arrangement aimed to reduce German tax liabilities by avoiding German corporation tax at the Company B level and increasing the net profits received by the Plaintiff after German withholding tax.

The central tax issue was whether the Plaintiff was entitled to UK tax credit for the German trade tax paid by the Subsidiaries, given the silent partnership structure which altered the flow and characterization of income and dividends within the corporate group.

Legal Issues Presented

1. Whether the silent partnership should be treated as transparent for UK corporation tax purposes, such that dividends paid by the Subsidiaries to Company B are treated as paid to the Plaintiff.
2. Whether the term "dividends" in Article XVIII of the double taxation convention includes the Plaintiff’s share of profits from the silent partnership, as defined in Article VI.
3. Whether the term "dividends" in Part XVIII of the Income and Corporation Taxes Act 1988 encompasses the Plaintiff’s share of the profits under the silent partnership.

Arguments of the Parties

Appellant's Arguments

• The silent partnership should be treated as transparent, so that dividends paid by the Subsidiaries to Company B should be treated as dividends paid directly to the Plaintiff.
• The Plaintiff’s share of the profits from the silent partnership should be treated as dividends under Article XVIII and thus eligible for credit of underlying German trade tax.
• The UK tax legislation, particularly sections 790, 800, and 801 of the 1988 Act, supports credit relief for the German trade tax borne by the Subsidiaries.
• Credit for the trade tax is necessary to avoid economic double taxation and the silent partnership was not formed to avoid UK tax.
• The definition of "dividends" in Article VI(4) of the convention, which includes income derived by a sleeping (silent) partner, should apply to Article XVIII and relevant UK tax provisions.

Respondent's Arguments

• The silent partnership is not transparent for UK tax purposes; the Plaintiff does not have a proprietary interest in the Subsidiaries’ shares or dividends.
• The term "dividends" in Article XVIII is narrower and does not include the Plaintiff’s share of profits from the silent partnership.
• The UK legislation’s ordinary meaning of "dividend" requires a payment related to shares in a company, which the silent partnership payment is not.
• The Plaintiff’s reliance on sections 790, 800, and 801 fails because these provisions presuppose conventional dividends paid by a company, not contractual profit shares from a partnership.
• The double taxation convention and UK law should be interpreted consistently with their drafting and purpose, which excludes the silent partnership profits from dividend treatment.

Table of Precedents Cited

Court's Reasoning and Analysis

The Court examined whether the silent partnership should be treated as transparent for UK tax purposes, focusing on the nature of the partnership and the legal rights of the Plaintiff. The Court found that unlike English or Scottish partnerships, the silent partnership does not confer proprietary rights to the Plaintiff over the Subsidiaries’ shares or dividends. The Plaintiff's interest was purely contractual, lacking joint business activity or liability for debts, distinguishing it from transparent partnerships.

The Court also considered the meaning of "dividends" in the double taxation convention. It held that the definition of dividends in Article VI(4), which includes income of a silent partner, does not apply to Article XVIII, which governs relief from double taxation. The absence of a definition in Article XVIII and the structure of the convention indicated that "dividends" there should have a narrower meaning aligned with UK law.

Regarding UK domestic law, the Court reasoned that the ordinary meaning of "dividend" in the 1988 Act requires a payment related to shares in a company, which the silent partnership profit share is not. The statutory provisions relied upon by the Plaintiff (ss. 790, 800, 801) presuppose conventional dividends paid by companies and do not extend to contractual profit shares from a silent partnership.

The Court emphasized the purposive interpretation of the convention, seeking symmetry between distributive and relieving provisions, but concluded that the drafting and context supported the narrower interpretation applied.

Holding and Implications

The Court DISMISSED the Plaintiff's appeal, upholding the decisions of the Special Commissioner and the High Court Judge.

The direct effect is that the Plaintiff is not entitled to UK tax credit for the German trade tax paid by the Subsidiaries via the silent partnership arrangement. The Court confirmed that the silent partnership is not transparent for UK corporation tax purposes, and the Plaintiff’s share of profits under that partnership is not treated as dividends under the double taxation convention or UK tax law.

No new legal precedent was established beyond the clarification of the application of the convention and UK tax statutes to silent partnerships and the interpretation of "dividends" in this context.