Irish Bank Resolution Corporation Ltd v Revenue And Customs

Article 8(2) of a double-taxation convention permits a contracting state to calculate a permanent establishment’s profits by comparing it with a distinct and separate enterprise operating at arm’s length. The comparison is not confined to the establishment’s actual accounting treatment or its actual ratio of free to borrowed capital.

“Same or similar conditions” refers to the activities actually undertaken and the prevailing market conditions. It does not prevent a notional attribution of free capital where that is needed to calculate arm’s-length profits. A later OECD commentary may assist interpretation if it confirms, rather than substantively changes, the convention’s existing meaning. Unilateral administrative practice cannot alter a treaty’s meaning.

Irish Bank Resolution Corporation Ltd and Irish Nationwide Building Society were Irish companies trading through United Kingdom branches. HMRC used a capital attribution tax adjustment to attribute additional notional free capital to the branches. This reduced the interest deductions available in computing their UK corporation-tax profits.

The First-tier Tribunal dismissed the taxpayers’ appeals. The Upper Tribunal, in [2019] UKUT 0277 (TCC), dismissed further appeals. The taxpayers appealed, contending that Article 8 of the 1976 UK/Ireland double-taxation convention required the branches’ actual free-to-borrowed-capital ratios to be preserved and therefore prohibited the adjustment.

The central issue was whether Article 8(2) permitted the domestic capital-attribution method in section 11AA(3)(b).

1. Appeal dismissed. Article 8(2) of the 1976 Convention permitted the capital attribution tax adjustment. The Upper Tribunal was correct to reject the taxpayers’ construction.

2. Article 8(2) requires the profits that a permanent establishment would have made as a distinct and separate enterprise, conducting the same or similar activities under the same or similar conditions and dealing at arm’s length with its head office. The establishment’s actual accounts are the necessary starting point, but they are not conclusive. The treaty comparison may require its profits and expenses to be restated.

3. The phrase “same or similar conditions” concerns the business actually conducted through the permanent establishment and the market conditions at the relevant time. It prevents an attribution based on fictitious activities, income or business sources. It does not require the actual ratio of free to borrowed capital to be retained. Such a requirement would disable the separate-enterprise comparator from correcting the accounting treatment chosen within the overseas company.

4. Accordingly, a domestic method which notionally attributes sufficient free capital to support the functions, assets and risks of the establishment is capable of implementing Article 8(2). Section 11AA(3)(b) of the Income and Corporation Taxes Act 1988 was not inconsistent with the Convention. Article 8(3) created no separate bar, since it had to be read consistently with the permissible attribution exercise under Article 8(2).

5. The 2008 OECD Commentary was consistent with this construction but was not indispensable to it. The model-convention wording was deliberately non-exhaustive and allowed flexibility in implementing the arm’s-length hypothesis. The Commentary confirmed that a range of capital-attribution methods could be used; it did not make the method newly permissible only from 2010.

6. Treaty interpretation proceeds objectively, in good faith, from the text, context, object and purpose. A unilateral practice of one contracting state cannot affect a treaty’s meaning. Singh LJ further held that section 788(3) of the Income and Corporation Taxes Act 1988 gave the Convention priority over inconsistent domestic taxing provisions and was not displaced by implied repeal.

• Court of Appeal (Civil Division) Dismissed the taxpayers’ appeal and upheld the construction adopted below: [2020] EWCA Civ 1128.
• Upper Tribunal (Tax and Chancery Chamber) Dismissed the taxpayers’ appeals from the First-tier Tribunal: [2019] UKUT 0277 (TCC).
• First-tier Tribunal Dismissed the taxpayers’ appeals against HMRC’s corporation-tax assessments: [2017] UKFTT 0702 (TC).