Bayfine UK v HM Revenue and Customs

A double-taxation convention must be construed purposively, giving effect both to the elimination of double taxation and to the prevention of fiscal avoidance, including double relief. Where a contracting state taxes under a saving clause, the credit provisions must not be applied so as to require credit in both states. A deemed-source rule within the credit article governs source for that article, but does not compel relief contrary to the saving clause and the treaty’s purposes.

Unilateral relief cannot override treaty arrangements given domestic effect. In any event, a restriction on foreign-tax credit based on reasonable mitigating steps does not require a taxpayer to procure steps by an independent third party beyond its control.

Bayfine UK Ltd, a United Kingdom-resident company, made a profit on self-cancelling forward contracts. The same profit was taxed in the United States in the hands of its United States parent under the United States check-the-box regulations. Bayfine claimed credit in the United Kingdom for that United States tax.

The Special Commissioners rejected treaty and unilateral relief. Peter Smith J allowed Bayfine’s appeal, holding that the United Kingdom had to give treaty credit and that unilateral relief was also available. HMRC appealed.

The issues were whether the United Kingdom had to give credit under the United States/United Kingdom treaty, whether unilateral relief was available under the Income and Taxes Act 1988, and, if so, whether relief was restricted by the reasonable-steps requirement.

1. HMRC’s appeal was allowed on the treaty and unilateral-relief issues. The court held that the Treaty had to be interpreted purposively as an international instrument. Its purposes included both relieving double taxation and preventing fiscal avoidance. Those purposes excluded an interpretation requiring both contracting states to give credit for tax on the same income.

2. The United States’ taxation of the United States parent under the saving clause in article 1(3) could be taxation imposed in accordance with the Treaty. However, article 1(4) required the specified provisions, including article 23, to operate consistently with their purpose. Article 23 could not therefore require the United Kingdom to give credit where that would also oblige the United States to give credit and produce double relief.

3. Article 23(3) supplied the deemed-source rule for all purposes of article 23. It was neither confined to juridical double taxation nor merely a tie-breaker where the states disagreed on source. Although the profit was deemed to have a United States source for article 23(2), the United Kingdom was not obliged to give credit. The United States was instead obliged to give credit for United Kingdom tax after that tax had been paid.

4. Section 790 of the Income and Taxes Act 1988 could not be used to override treaty arrangements given domestic effect by section 788. The court accepted, as an alternative observation, that unilateral relief could fill a genuine deficiency in treaty relief. It did not apply where the treaty arrangements required the foreign state to grant the relevant credit.

5. The court’s conclusion made section 795A unnecessary to the result. If it had arisen, reasonable steps did not include steps which had to be taken by a third party beyond the taxpayer’s control, even where that third party was a group company. The court rejected both a rule confining the inquiry to credit available when the United Kingdom claim was made and a rule giving priority to the state in which tax was paid first.

• Court of Appeal (Civil Division): HMRC’s appeal was allowed on treaty relief and unilateral relief. The appeal was dismissed on the alternative section 795A issue, which did not arise on the court’s principal conclusions.
• High Court (Chancery Division): Peter Smith J allowed Bayfine’s appeal from the Special Commissioners: [2010] EWHC 609 (Ch).
• Special Commissioners: The taxpayer’s claims to treaty relief and unilateral relief were rejected.