With Article 7 of the OECD's Multilateral Instrument containing a Principal Purpose Test (or PPT) tax authorities, taxpayers and tax advisers alike are going to have to spend more time in the future considering when an arrangement or transaction might be considered to have a principal purpose of obtaining a treaty benefit. The UK First-tier Tribunal's (or FTT's) recent decision in Burlington Loan Management on the main purpose test in Article 12 of the UK/Ireland double tax treaty is therefore rather timely and instructive.
The facts in Burlington were relatively straightforward. SAAD Investments Company (or SICL), a Cayman company, had a debt claim of a principal amount of c. £140m against Lehman Brothers International (Europe) (or LBIE). LBIE was of course part of the Lehman Brothers group and went into administration in 2008. SICL itself had been in liquidation since 2009. In 2016, the principal amount of the claim was paid in full by LBIE's administrators, leaving c. £90m of interest still to be paid. There was a secondary market in claims against LBIE and the liquidators of SICL engaged Jefferies, a broker, to sell SICL's claim. In March 2018 the claim was sold by SICL to Jefferies for £82.4m and then by Jefferies to Burlington Loan Management (or BLM) for £83.55m. BLM was an Irish resident company and the principal European fund investment corporate vehicle for Davidson Kempner Capital Management with approximately $6.9bn in assets at that time.
The administrators of LBIE paid the claim to BLM net of c. £18m of UK income tax. BLM applied to HMRC, the UK tax authority, for a refund of that tax under Article 12(1) of the UK/Ireland double tax treaty which provided:
"Interest derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State".
However, HMRC argued that Article 12(5) prevented Article 12(1) applying in this case. Article 12(5) provided:
"The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the debt-claim in respect of which the interest is paid to take advantage of this Article by means of that creation or assignment."
At first blush, it might seem surprising that HMRC chose to litigate this case at all as a market sale form one unconnected party to another. However, the evidence was that both SICL and BLM knew that SICL would suffer 20% withholding tax on interest payments made directly to it but BLM would not and the pricing of the transactions effectively split the benefit of BLM's being entitled to gross payment between SICL and BLM (after deducting Jefferies' turn for acting as middleman). HMRC effectively argued that, in substance, it amounted to a conduit or treaty shopping case which should fall within Article 12(5) because, in economic terms, SICL was taking advantage of Article 12(1) by selling to BLM for a greater sum than it could have realised itself.
In a well-reasoned judgment, the FTT dismissed the taxpayer's arguments that the "person" in Article 12(5) must be a person resident in one of the Contracting States (and so could not be SICL) and that Article 12(5) was only engaged where there were abusive or artificial steps. Although "taking advantage" itself has a negative connotation, the language of Article 12(5) itself was not so limited. The FTT also found that the burden of proof here lay with HMRC to show that Article 12(5) was engaged and, with a nod to the recent Upper Tribunal decision in Blackrock, that a company's purposes are to be determined subjectively in the light of all of the evidence including inevitable and inextricable consequences.
The FTT then proceeded to analyse this by asking four questions:
- Did BLM have, as a main purpose in the assignment of the claim, taking advantage of Article 12(1) itself?
- Did BLM have, as a main purpose in the assignment of the claim, enabling SICL to take advantage of Article 12(1)?
- Did SICL have, as a main purpose in the assignment of the claim, taking advantage of Article 12(1) itself?
- Did SICL have, as a main purpose in the assignment of the claim, enabling BLM to take advantage of Article 12(1)?
In answering the first question the FTT drew an important distinction between a person's purpose in doing something and the person's implicit understanding of the consequence of doing that thing. BLM was a long-standing Irish resident which had previously received UK source interest without withholding tax. It was an "accepted fact" by the "guiding minds" of BLM that UK withholding tax was not a permanent cost for BLM because of its Irish residence. However, the mere fact that BLM was aware that it was entitled to benefit from Article 12(1), and took that entitlement into account when calculating the price it was prepared to offer for the claim, did not mean that obtaining that benefit was a main purpose of acquiring the claim. It was simply a factor which informed the value of the relevant claim to BLM. BLM's sole purpose in acquiring the claim, the FTT found, was to realise a profit by reference to the difference between the price paid for the claim and the amount ultimately received in respect of it.
With regard to the second question, the FTT found that BLM was acting solely for its own benefit, not SICL's. And, in any event, the FTT thought that the second and fourth questions were likely irrelevant in any event as the better interpretation was that Article 12(5) required a person to have a main purpose of taking advantage of Article 12(1) itself, not enabling someone else to do so.
With regard to the third question, the FTT drew a distinction between the outright sale by a person of a debt claim for a market price which reflects the fact that the purchaser has tax attributes which it does not have, such as an exemption for withholding tax, and conduit or treaty shopping cases. In the latter case, the seller usually retains some form of interest in the claim. Here SICL's only purpose, as seller, was to realise the debt claim at a price which reflects the market. SICL's ability to avoid UK withholding tax on the interest derived from the fact that it had disposed of the right to that interest at a market price and therefore no longer had any right to receive it.
As to the fourth question, again, like BLM, SICL was acting only for its own benefit.
This was a very sensible decision and feels like the right place to draw the line. An outright sale of an asset to an unconnected person who is entitled to treaty benefits in respect of it by a person who is not and where both parties are aware of that fact and that is reflected in the pricing of the sale ought not to fall foul of a treaty purpose test in the absence of evidence of either:
- some sort of skin in the game for the seller as to whether or not treaty relief is actually obtained such as an adjustment to consideration. Clearly not the case here where the purchase by BLM was an outright market purchase for a fixed price where BLM alone took the risk of Article 12(1) applying (or not); or
- the purchaser having been established in the relevant jurisdiction in order to benefit from the relevant treaty. Again, that was clearly not the case here, given that BLM was a long-standing Irish resident of significant substance.