Upper Tribunal rejects HMRC’s appeal in alleged treaty abuse case
UT agrees that treaty anti-avoidance does not automatically apply if transaction pricing reflects differing levels of WHT exposure
Treaty anti-avoidance does not automatically apply
Many factors influence the pricing of transactions in securities in international financial markets. One of these factors can be that not all market participants will be equally exposed to withholding tax (WHT) in respect of the securities concerned, and in some cases the likely existence of participants with differing exposures may be a straightforward explanation of why particular transactions may make economic sense for all involved.
With the increasing prevalence of anti-avoidance provisions in double tax treaties (DTTs) (not least as a result of the OECD’s actions to prevent treaty abuse), the question can arise as to whether these will deny relief if, from an economic perspective, a transaction could be regarded as driven by the arbitrage between the parties’ differing WHT exposures and the parties are either aware of that fact or might reasonably infer it from the agreed pricing. That question – an important one for financial markets participants - is the issue at the heart of the Burlington Loan Management DAC case.
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 focused 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.
The First-tier Tribunal (FTT) concluded that this was not enough to engage the anti-avoidance rule, as while the pricing reflected the expected WHT benefits obtaining these was a consequence and not the main purpose of the assignment, and that on the facts of the case the Irish company was entitled to recover the UK WHT claimed. In doing so, the FTT observed that the case had been argued by HMRC in a way which (if correct) could have “an enormous impact” on the secondary debt market, as a natural inference from HMRC’s position was that any similarly worded anti-avoidance rule would block access to treaty benefits whenever a purchaser in a treaty jurisdiction acquired a security from a seller in a non-treaty jurisdiction, the market price reflected the fact that some market participants had a lower exposure to UK WHT, and the seller was aware that the purchaser was such a participant.
Unsurprisingly, the FTT’s rejection of HMRC’s approach was met with some relief by market participants and the rejection of its appeal by the Upper Tribunal (UT) will be similarly welcomed.
HMRC had made many detailed criticisms of the FTT’s analysis, but in essence many of these amounted to variations of an argument that the FTT had not given enough weight to the fact that the economics of the transaction were primarily driven by the differing exposures of the parties to UK WHT (and the parties would have been aware of that), instead giving weight to other less relevant factors.
The UT’s rejection of HMRC’s appeal was, at its simplest, because it did not agree that the various criticisms met the high standard of identifiable flaws in the FTT’s analysis which undermined the cogency of its conclusion in a way that would justify the UT interfering in its evaluation of the facts. For those considering this issue, however, it will be worth looking past that summary to consider the UT decision in detail.
That is firstly because the UT did agree with HMRC on some points to the extent that it accepted that it would be wrong to put significant weight on certain factors – the UT just didn’t accept that the FTT had done so. In considering this issue generally, therefore, it is helpful to read the FTT’s analysis in the light of the UT’s assessment.
Secondly, a recurring theme in the UT’s rejection of HMRC’s arguments was its view that these approached the question of the weight to be given to the different factors in applying the anti-avoidance rule in the DTT as if it were an anti-avoidance rule in UK domestic legislation. That meant that HMRC were “starting from the premise that, if UK WHT is being avoided, that alone is sufficient to constitute an abuse of the UK-Ireland treaty so long as the mechanism for the avoidance of the UK WHT was the treaty.” In the view of the UT, however, “that is the wrong premise” and the analysis should instead be focused on “whether there is something abusive, in the particular circumstances of this case, for Ireland alone to tax interest beneficially owned by a company resident in its territory.” This is an important reminder of the role of treaty anti-avoidance provisions and how an appreciation of that role can influence their application.
