Irish Bank Resolution Corporation Ltd v Revenue And Customs

Factual and Procedural Background

Two Appellants, Company A and Company B, are Irish-registered companies that operated UK branches during the relevant accounting periods. Company A, formerly known as another entity, opened a UK office in 1988 and obtained branch status in 1991, allowing it to provide regulated financial services including deposit-taking. Company B opened a retail branch in the UK in 1994, focusing on sterling-based finance for residential property developers. Both companies became insolvent following the 2007 financial crisis but operated profitable UK branches liable to UK corporation tax during the periods in question.

The dispute concerns the application of section 11AA(3)(b) of the Income and Corporation Taxes Act 1988 ("TA 1988") as amended by the Finance Act 2003 ("FA 2003"), which governs the attribution of profits to permanent establishments ("PE") of non-resident companies for UK corporation tax purposes. HM Revenue & Customs ("HMRC") disallowed certain interest deductions incurred by the UK branches, applying a Capital Attribution Tax Adjustment ("CATA") that notionally attributed additional free capital to the PE, thereby reducing allowable interest deductions.

The Appellants challenged this treatment, arguing that the domestic provisions and their application conflicted with the UK's obligations under the 1976 Double Taxation Convention ("1976 Convention") between the UK and Ireland, particularly Article 8 which governs the taxation of profits attributable to PEs. The case progressed through the First-tier Tribunal and Upper Tribunal, both of which dismissed the Appellants' appeals, leading to the present appeal.

Legal Issues Presented

1. Whether the UK domestic legislation, specifically section 11AA(3)(b) TA 1988, is consistent with the UK's obligations under Article 8(2) of the 1976 Convention regarding the attribution of profits to a PE.
2. Whether the application of the Capital Attribution Tax Adjustment (CATA), which notionally attributes additional free capital to the PE and disallows certain interest expenses, is permissible under the 1976 Convention.
3. Whether the phrase "same or similar conditions" in Article 8(2) of the 1976 Convention requires that the PE’s actual ratio of free to borrowed capital be applied, thereby precluding adjustments such as CATA.
4. The relevance and effect of OECD model conventions and commentaries, including the 2008 and 2010 versions, on the interpretation of Article 8(2) of the 1976 Convention.
5. The weight to be given to past unilateral tax practices and foreign court decisions in interpreting the treaty provisions.

Arguments of the Parties

Appellants' Arguments

• The Appellants contend that Article 8(2) of the 1976 Convention requires profits to be attributed to the PE on the basis that it operates under the "same or similar conditions" as it actually did, including the actual ratio of free to borrowed capital.
• They argue that section 11AA(3)(b) TA 1988, as applied by HMRC through the CATA, impermissibly adjusts the capital attributed to the PE, disallowing interest expenses actually incurred, which conflicts with the treaty.
• The Appellants assert that any valid implementation of capital attribution consistent with the treaty requires a substantive amendment to the 1976 Convention, such as that reflected in the 2010 OECD model convention, which the UK has not adopted.
• They rely on the principle that the treaty, as incorporated by section 788(3) TA 1988, overrides conflicting domestic legislation, thus invalidating the application of section 11AA(3)(b) in this context.
• The Appellants also invoke Article 8(3) of the 1976 Convention to argue that disallowing interest expenses incurred for the PE’s purposes is inconsistent with the treaty.
• They challenge the admissibility and effect of unilateral past tax practices and the 2008 OECD Commentary, asserting that these represent substantive changes not applicable retrospectively.

Respondent's (HMRC) Arguments

• HMRC submits that section 11AA(3)(b) is consistent with the 1976 Convention, particularly Article 8(2), which permits attributing profits to a PE as if it were a distinct and separate enterprise dealing at arm's length with the rest of the enterprise.
• They argue that the CATA is an appropriate method of capital attribution to reflect the arm's length principle and that the phrase "same or similar conditions" does not preclude adjustments to the capital structure of the PE.
• HMRC relies heavily on the 2008 OECD Commentary and related reports, which endorse capital attribution as a well-recognised and permissible method under the authorised OECD approach.
• They contend that the 1976 Convention and the OECD model conventions have always allowed a degree of flexibility in the methods of attributing profits and that the CATA falls within this scope.
• HMRC rejects the Appellants’ reliance on unilateral past tax practices, emphasizing that such unilateral conduct cannot affect treaty interpretation absent bilateral agreement.
• They highlight the constitutional position that primary legislation enacted by Parliament, such as section 11AA, must be given effect unless overridden by treaty provisions, and that the doctrine of implied repeal does not apply to double taxation treaties incorporated by section 788(3).

Table of Precedents Cited

Court's Reasoning and Analysis

The court undertook a detailed analysis of the relevant statutory provisions, the 1976 Convention, and the OECD model conventions and commentaries. It emphasized that the UK domestic legislation, specifically section 11AA(3)(b) TA 1988, must be construed consistently with the UK's treaty obligations under the 1976 Convention as incorporated by section 788(3) TA 1988.

The court noted that Article 8(2) of the 1976 Convention requires profits to be attributed to a PE as 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 PE. The phrase "same or similar conditions" was interpreted contextually and purposively. The court rejected the Appellants' argument that this phrase requires the PE’s actual ratio of free to borrowed capital to be applied without adjustment.

The court reasoned that such a restrictive interpretation would undermine the purpose of the treaty provisions by preventing any departure from the PE's actual accounting treatment, thereby frustrating the arm's length principle and uniform application of the attribution rules. It found that the CATA methodology, which notionally attributes free capital to the PE to reflect an arm's length capital structure, is consistent with the treaty’s objectives and wording.

The court gave significant weight to the 2008 OECD Commentary and related reports, which endorse capital attribution as a permissible and well-recognized method under the authorised OECD approach. It concluded that the 2008 Commentary does not introduce substantive changes incompatible with the 1976 Convention but rather articulates methods consistent with its longstanding provisions.

The court also rejected reliance on unilateral past tax practices and the Appellants' arguments that the 2010 OECD model convention represents a necessary amendment to permit capital attribution. It found that the treaty language and the OECD materials provide sufficient flexibility for the UK’s approach.

In addressing foreign decisions, the court acknowledged their relevance but distinguished them on factual and legal grounds, noting that none preclude the form of capital attribution employed by HMRC.

Finally, the court addressed constitutional and international law principles, affirming the supremacy of primary legislation but recognizing that, where a double taxation treaty overrides domestic law under section 788(3), that treaty interpretation governs. The court confirmed that unilateral administrative practices cannot alter treaty meaning absent bilateral agreement.

Holding and Implications

The appeal is dismissed.

The court held that section 11AA(3)(b) TA 1988, as applied by HMRC through the Capital Attribution Tax Adjustment, is consistent with the UK's obligations under Article 8(2) of the 1976 Double Taxation Convention. The phrase "same or similar conditions" in the treaty does not mandate application of the PE’s actual capital structure without adjustment, and the method of notionally attributing free capital to the PE is a permissible implementation of the arm's length principle.

This decision confirms the validity of the UK’s approach to attributing profits to permanent establishments in line with international tax principles and OECD guidance. It clarifies that domestic tax legislation implementing capital attribution adjustments is not precluded by the treaty, and that unilateral past tax practices do not affect treaty interpretation. No new precedent altering the fundamental principles of treaty interpretation or the arm's length principle was established; rather, the ruling affirms existing frameworks.