The Supreme Court (SC) has largely confirmed the Court of Appeal’s (CoA) earlier decision in relation to the application of the UK/Canada Double Tax Treaty (DTT) to royalty payments (Payments) to a non-resident Bank (Bank), and thereby dismissed HMRC’s appeal. The SC agreed that the DTT did not permit the UK to exercise taxing rights over the Bank’s receipts and thus the Payments were not subject to UK corporation tax.
Background
The Bank had advanced a secured loan to a Canadian entity to fund oil exploration and exploitation activities within the UK Continental Shelf. The Canadian entity ran into financial difficulties and went into insolvency. As a result, its right to receive the Payments from its UK subsidiary was assigned to the Bank for nil consideration. The Payments were contingent on the production from a UK oil field and calculated by reference to the price of the oil at the relevant time.
The CoA (in considering the scope of Article 6) disagreed with both the First-tier Tribunal and the Upper Tribunal decisions and was of the view that the better interpretation is that Article 6 is confined to rights to payments held by a person who has some continuing interest in the land in question, to which the rights can be attributed based on a close connection with the Source State.
The Supreme Court decision
HMRC appealed to the SC on two grounds, and in the words of the SC “pinned its colours exclusively to the mast of Article 6(2) as the tax provision catching the Payments”.
The SC agreed with the CoA that the Payments did not add up to the ‘right to work’ the oil field and, even if they had, were not ‘consideration’ for those rights.
In reaching its view the SC considered the legal difference between having a right to work and someone having a right to require another person to work, and the separate legal personalities of the parties to the arrangements. It also confirmed that the DTT determines how to attribute profits between jurisdictions, as opposed to whether they are taxable or not.
The SC also held that a party needs to have the ability to confer a right to work for a payment to be in ‘consideration’ for such right, and that was not the case here.
Turning to domestic law, the CoA refrained from expressing a conclusion as to whether section 1313 of Corporation Tax Act 2009 applied but the SC concluded that it did and that the Payments should be subject to ring fence taxation. This was on the basis that since the Payments were based on both the volume and price of oil, they in effect gave the Bank the benefit of the oil.
Although the SC stated that it did not see a risk of a potentially much broader application of ring fence taxation to financing structures with similar payment structures, it will be necessary for taxpayers to assess whether the terms are sufficient to be considered to transfer the benefit of oil.
The decision is also of interest and adds to the increasing case law on the approach to the interpretation of DTTs.