HMRC v Burlington Loan Management DAC is an important decision for the smooth running of secondary debt markets. It is also a helpful precedent for tax authorities, taxpayers and tax advisers alike as they 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 in light of the principal purpose test in Article 7 of the OECD's Multilateral Instrument. 

The case involved the secondary market in claims against Lehman Brothers International (Europe), a UK company. One such claim was sold by SICL, a Cayman company, to a broker for £82.4m and from the broker to an Irish resident company, Burlington Loan Management (BLM), for £83.55m. Both SICL and BLM knew that SICL would suffer 20% UK withholding tax (WHT) on interest payments made directly to it, but BLM would not (because of the UK/Ireland DTT) and the pricing effectively split the benefit of the gross payment (after deducting the broker’s turn). There was no mechanism to adjust the price if BLM suffered UK WHT on the interest. 

BLM was willing to pay more for the assignment than the debt was worth to SICL because it had to compete with other bidders who were likely also exempt from UK WHT whether on the basis of a treaty, or otherwise. SICL wanted to get the best price it could for the sale. HMRC submitted the case 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.

Central to this case is the interpretation of the anti-abuse provision in Article 12(5) of the UK-Ireland double tax treaty which prevents treaty exemption from WHT on interest where “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.’

The First-tier Tribunal (FTT) had concluded that Article 12(5) did not apply as neither SICL nor BLM had a main purpose of taking advantage of Article 12(1) (the exemption from WHT). The Upper Tribunal (UT) dismissed HMRC’s appeal on all grounds.

The first ground of HMRC’s appeal, and the only one I will go into detail about here, is that the FTT had made an error of law in construing Article 12(5) and so approached the analysis of SICL’s purpose wrongly. The other four grounds involved challenges to evaluative factual conclusions that the FTT reached and HMRC failed to overcome the high hurdle for these to succeed.

What is the correct interpretation of Article 12(5) and does it apply to UK WHT arbitrage?

In the UT’s view, the correct starting point is that, unless there is an abusive arrangement falling within Article 12(5), BLM, as an Irish tax resident and beneficial owner of the interest, is to be taxed only in Ireland on the interest. So how do you determine whether there is an abusive arrangement? The UT concluded it is for the FTT to determine the subjective purposes of both the seller and the purchaser, considering all the circumstances of the case. 

The UT concluded that the FTT had not made an error of law in making the determination they did and that HMRC’s construction of Article 12(5) would turn it into something fundamentally different – it would be a provision directed at the avoidance of UK WHT by the seller, applicable whether or not the seller actually knew the basis on which the purchaser did not suffer a UK tax charge, so long as the mechanism for the UK WHT avoidance was the treaty. UK WHT arbitrage is not enough on its own to mean that Article 12(5) is satisfied, the FTT was right to take into account all of the circumstances to determine if there has been an abuse of the treaty.

Although the UT did not accept HMRC’s submission on Article 12(5), they did take a different view from the FTT on the significance of knowledge of reliance on Article 12(1). The FTT concluded that in order for Article 12(5) to apply, SICL had to know the purchaser of the claim would be relying on Article 12(1) specifically. The UT described this as an “unjustified gloss on the actual words chosen by the contracting States in concluding the treaty.” This unjustified gloss was not material to the FTT’s decision, however. 

No requirement for artificiality

The UT also rejected the taxpayer’s argument (as had the FTT) that Article 12(5) applies only where there are “artificial” steps or arrangements. Although the artificial use of a conduit company is an example of improper use of the treaty at which Article 12(5) is targeted, it cannot be confined to cases which involve only artificial steps or arrangements.