All has ended well for the Royal Bank of Canada (RBC) following the Supreme Court’s majority decision (4:1) that the UK does not have taxing rights over the “royalty” payments RBC received. The value of these payments was dependant on the price and volume of oil extracted from a field in the UK continental shelf. The Supreme Court has now confirmed that this was insufficient to give the UK taxing rights. But it is interesting to unpick some of the points in the majority judgment and in the dissent, especially the difference in approach to purposive construction.

What payments did RBC receive?

RBC is a Canadian company carrying on a banking business. Sulpetro, a Canadian company, together with its UK subsidiary, SUKL, carried on oil exploration/exploitation activities in the Buchan Field, within the UK continental shelf. The licence to explore and exploit the Buchan Field was granted by the UK government to SUKL and not to Sulpetro as the requirements at the time were that such a licence could be granted only to a UK incorporated company. 

An agreement, referred to as the Illustrative Agreement, was entered into between Sulpetro and SUKL governing the rights and obligations of both parties in respect of the oil exploration/exploitation activities. Under this Agreement, Sulpetro had all the economic benefits and risks of these activities. Sulpetro subsequently sold all its assets, including its shares in SUKL, to BP and as part of the consideration for the transaction BP agreed to make “royalty” payments each quarter to Sulpetro in respect of all production from the Buchan Field broadly equal to half the amount by which the market value of each barrel of oil produced exceeded US$20. 

So where did RBC come into this? The Canadian head office of RBC had made a loan to Sulpetro and CAD $185m was outstanding on this loan when Sulpetro went into receivership. RBC wrote this off as a bad debt but the right to receive payments from BP was then assigned to RBC under a Canadian court order. RBC treated the receipts as income of its Canadian banking business accounted for as partial recovery of the bad debt, paying Canadian corporate tax on them. RBC accordingly did not report them in its UK tax return. BP later novated the contract to Talisman on the transfer of its interest in the Buchan Field to Talisman and Talisman continued making the payments to RBC. 

Alarm bells rang for HMRC when it realised that BP, and then Talisman, had treated the payments as deductible in computing their ring-fence profits from their UK oil exploitation trades whereas RBC had not paid any UK tax on the payments received. A tax specialist in the “Large Business London – Oil & Gas” section of HMRC described this as looking like a hole in the ring-fence. Discovery assessments were subsequently made by HMRC on the basis that the payments to RBC were profits of a separate ring-fence trade carried on through a deemed permanent establishment in the UK under section 1313 of the Corporation Tax Act 2009 (CTA 2009). The total amount of tax at stake, without interest, was around £19m.

On what basis did HMRC argue that UK tax should be imposed on RBC?

HMRC relied on Article 6 of the UK/Canada double tax treaty which gives the right to tax income from immoveable property to the State in which the property producing such income is situated. So, the question for the Supreme Court was whether the payments were income from immoveable property in the UK. If they were, because the oil field was in the UK, the UK would have taxing rights over the income. It would then be necessary to look at UK domestic legislation to see if the UK had exercised those taxing rights.

Article 6(2) provides an expanded definition of what is “immovable property” which includes rights to payments “as consideration for the working of, or the right to work….natural resources.” The issue was whether Sulpetro acquired under the Illustrative Agreement the “right to work” the Buchan Field within the meaning of Article 6(2) and if so, were the payments BP (then Talisman) made to RBC “consideration” for those rights as they were made in return for Sulpetro agreeing to give up those rights so that BP (then Talisman) could acquire those rights from SUKL under its own Illustrative Agreement?

What did the Supreme Court decide?

The majority of the Supreme Court agreed with the Court of Appeal that the right to work was held by SUKL, not Sulpetro as SUKL held the licence to work the Buchan Field. Sulpetro provided the funds and equipment necessary to enable SUKL to discharge its obligations under the licence, but it was SUKL which was responsible for working the field. Sulpetro had the right to require SUKL to work the natural resources but did not have the right to work the resources itself. This meant that Article 6(2) did not give the UK taxing rights over the payments made to RBC. Even if it did, the majority concluded that payments were not “consideration” within the meaning of Article 6(2) for the right to work.

Lord Briggs, finding himself “in lonely disagreement” reached a different conclusion applying the treaty to the facts. His approach was to treat the treaty as analogous to a taxing statute and apply the Ramsay principle of purposive construction to the treaty (explored in more detail below). This required him to ascertain the purpose of Article 6(2) of the treaty and to apply that interpretation to the facts of the case. He asked what the rights were that Sulpetro enjoyed under the Illustrative Agreement and whether, “viewed realistically and in the round” by virtue of those rights Sulpetro had the right to work the share of the hydrocarbons in the Buchan Oil field allocated to SUKL under the licence from the UK government. 

Lord Briggs agreed with the FTT and UT that the realistic view of the arrangements was that Sulpetro was “working” the Buchan Oil field. According to Lord Briggs “when the only other candidate for the role is its wholly owned subsidiary, acting as its puppet at no charge, at no profit or risk of loss, the impression that its parent is the person conducting the activity becomes irresistible.” The contractual rights of Sulpetro were key to his analysis: “It was not just a case of a parent invading the business space of its subsidiary because the subsidiary could be compelled not to object.” 

Adopting the ordinary meaning of “consideration” rather than the more restricted version adopted by the majority, Lord Briggs concluded that the right to the payments clearly constituted consideration for the conferral on BP of the right to work. In his view, the payments to RBC were income from immovable property over which the UK had taxing rights under Article 6 of the UK/Canada Treaty and the payments were taxable under section 1313 CTA 2009.

Role of Ramsay and purposive construction

It is unusual to see a split Supreme Court judgment, in particular on a purposive construction/realistic view of the facts issue. But this is what we have in this case and it is a shame if it now muddies the waters again. In his dissent, Lord Briggs emphasises that case law shows Ramsay is not a special principle limited to avoidance cases but is a general principle of statutory construction. “The need to take a realistic view of the transaction simply reflects the intention which may reasonably be attributed, in the case of a statute to the legislature, and in the case of a treaty to its parties. It is not just some magic weapon with which to defeat tax avoidance.” Lady Rose, on the other hand, supported by the majority, seemed to have a narrower view of when the Ramsay principle applies referring to the “greater tendency of the courts to neutralise the effect of tax avoidance schemes by looking at the reality of a transaction to see whether it is a transaction that was intended to be caught by a particular taxing provision” and did not consider it appropriate on the facts of this case to look at the transaction as a whole: “No one here has suggested that the Ramsay principle has any application to the present facts and nothing in this judgment casts doubt on the efficacy of those principles where they apply.”

Interpretation of section 1313 CTA 2009

The question of whether the payments fell within the UK domestic charging provision of section 1313 did not need to be determined because the majority of the Supreme Court had already concluded that the UK did not have taxing rights under the UK/Canada treaty. However, the Supreme Court concluded that, if the payments were within Article 6(2), they would have been within section 1313(2)(b) as profits arising to a non-UK resident company from rights to the benefit of oil produced by an activity carried on in connection with the exploitation of natural resources situated in the UK. 

But the Supreme Court clarified that section 1313 would not apply to tax any payments made to persons financing oil-related projects simply because the payments are computed by reference to the price of oil or because the debt finance is funded by proceeds of oil sales.