Treaty relief for UK withholding tax – taxpayer win in the First-tier Tribunal

Insight on the application of tax treaty anti-avoidance rules from taxpayer win in Burlington Loan Management DAC.

Insight on the application of tax treaty anti-avoidance rules from taxpayer win in Burling

Many factors influence the pricing of transactions in securities in international financial markets. Where, as will often be the case, those factors include that not all market participants will be equally exposed to withholding tax (WHT) in respect of the securities concerned, questions can be raised as to whether the inclusion of anti-avoidance provisions in the relevant double tax treaties (DTTs) could result in the denial of treaty benefits. Those questions have become increasingly relevant following the inclusion of the principal purpose test (PPT) in many treaties as a result of the OECD’s actions to prevent treaty abuse. With a lack of existing clear UK precedents in this area, financial markets participants will be keenly examining the decision of the First-tier Tribunal (FTT) in the Burlington Loan Management DAC case to understand how it might impact these debates.

The Burlington case itself involved the acquisition by an Irish company (the principal European fund investment corporate vehicle for a US-based asset manager) of a claim in the UK administration of Lehman Brothers. The principal amount of the claim had already been settled, but the acquisition gave the Irish company the right to receive interest which had accrued in respect of the claim prior to its settlement. The dispute centred on whether the Irish company was entitled under the UK-Ireland DTT to recover from HMRC the UK WHT deducted from the subsequent payment of the accrued interest by the administrators.

HMRC’s refusal of the claim was grounded solely on Article 12(5) of the DTT, which denied relief where it was a “main purpose … of any person concerned with the creation or assignment of the debt-claim … to take advantage of” the relevant provisions of the DTT. This anti-avoidance rule was argued to apply because the debt-claim was ultimately acquired by the Irish company from a Cayman incorporated company which would not itself have been able to recover the UK WHT, with the economic effect of the pricing of the transaction being to split the benefit of the UK WHT recovery between the parties.

Whilst the case turned on its facts, the decision notes that counsel for HMRC accepted that a natural inference from HMRC’s position was that any similarly worded anti-avoidance rule would block access to treaty benefits in any case where a purchaser in a treaty jurisdiction acquires a security from a seller in a non-treaty jurisdiction, the market price reflects the fact that some market participants have a lower exposure to UK WHT, and the seller is aware that the purchaser is such a participant. In essence, HMRC argued that a seller in this scenario must be understood to have a main purpose of seeking to benefit from the relieving provisions of the DTT between the UK and the purchaser’s jurisdiction.

As the FTT noted, this position (if correct) could have “an enormous impact” on the market. This is particularly so, given there is a clear overlap with the PPT now included in many UK DTTs which can deny treaty benefits if “obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit”.

Although the FTT decision contains many points of interest, for those considering the application of the PPT to typical market transactions, the focus will be on the FTT’s reasoning for rejecting HMRC’s arguments on this point.

Firstly, the FTT took the view that, given the potential market impact, HMRC’s position could not reflect the intended scope of Article 12(5).

Secondly, whilst firmly rejecting the view that Article 12(5) and equivalents could only apply to transactions involving ‘artificial’ elements, the FTT concluded that in context it required ’something more’ than simply selling a debt-claim outright for a market price which reflects the fact that some market participants have tax attributes the seller does not have. In particular, when dealing with an outright sale, the FTT considered that a seller’s only purpose would be to realise the debt-claim at a price which reflects the market.

Whilst this conclusion will provide some reassurance in relation to other transactions involving outright sales, the distinction drawn by the FTT between this scenario and those in which the seller retains an indirect economic interest in the debt claim (noted as a typical feature of ‘treaty shopping’ arrangements) leaves room for debate as to the status of less straightforward transactions. For example, it is unclear how the FTT would assess the stock loan and repo transactions which form an important part of the market.

Transactions of this kind frequently form ‘chains’, limiting the visibility of many participants over who (if anybody) will ultimately be seeking to claim relief and under what treaty. In this context, the FTT’s view that this kind of visibility was essential if Article 12(5) was to bite, may become particularly significant. As with much of the FTT’s analysis, however, the key question will be the extent to which this conclusion (if upheld on any appeal) can be read across to the PPT and similar provisions.