In a decision of significance for the secondary debt market, the Court of Appeal in Burlington has unanimously dismissed HMRC’s appeal. The judgment confirms the approach to construing and applying treaty purpose tests.

Burlington Loan Management (BLM), an Irish-resident company, claimed treaty relief from UK withholding tax (WHT) in respect of UK source interest. The interest arose on a debt claim assigned to it by an unconnected Cayman company, which would itself have suffered WHT in full had it continued to hold the debt claim. The price paid for the debt claim reflected BLM’s expectation to be able to benefit from the UK/Ireland double tax treaty (the DTT).

BLM’s claim for a refund of WHT was brought under Article 12(1) of the DTT which provided:

"Interest derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State".

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."

The First-tier Tribunal and the Upper Tribunal had both decided in favour of the taxpayer that Article 12(5) did not apply and the Court of Appeal agreed that the main purpose test was not satisfied. Consequently, the interest received by BLM could be taxed only in Ireland and BLM was entitled to a repayment of around £18m WHT. 

Does there need to be artificiality in order for the anti-abuse provision to apply?

No. The Court of Appeal agreed with the First-tier Tribunal and the Upper Tribunal that there is no requirement in Article 12(5) of any artificial steps or arrangements. A commercial transaction can be caught by the anti-abuse provision if one or both of the parties to the assignment had a main purpose of taking advantage of Article 12(1) by means of assignment of the debt claim.

What does it mean to “take advantage of” the exemption from interest WHT under a treaty?

The Court of Appeal concluded that “to take advantage of” does not mean the same as “obtain the benefit of” – something more is required. This was as expected because the Court of Appeal had already considered the meaning of materially identical terms in the UK/Japan treaty in the VietJet case last year and reached this same conclusion about what taking advantage of requires. 

The tax benefit in question, relief from withholding tax on UK interest, was one intended to be conferred by the Treaty. Legislative context is crucial and as Lady Justice Falk explained about purpose tests more generally: “Where the tax advantage in question is specifically conferred by legislation then it cannot have been intended that it should inevitably be denied by a “main purpose” rule if it forms part of the economics of a transaction.”

In the absence of an abusive arrangement falling within Article 12(5), BLM as resident of Ireland and beneficial owner of the assigned claim, was only to be taxed on the interest in Ireland.

What is the object and purpose of the DTT?

For an arrangement to be abusive under Article 12(5), it must be contrary to the object and purpose of the DTT in its application to the taxpayer. The purpose of a DTT, as stated in the OECD commentary, is to encourage commerce between convention states by ensuring their residents are not subject to international double taxation. Article 12(1) fulfils this aim by providing only the state of residence of the recipient shall tax the interest and the other state will provide an exemption from WHT or the ability to claim relief for tax withheld at source.

HMRC argued that BLM’s reliance on Article 12(1) was contrary to the object and purpose of the DTT. HMRC contended that the analysis should start from the position prior to the assignment in which the interest in the hands of the assignor would have been subject to WHT. The argument then proceeded that because the result of the assignment would change this position, the parties should be regarded as having shared a “profit” made at HMRC’s expense. The Court of Appeal agreed with the Upper Tribunal that the correct starting point is that by the UK agreeing to Article 12(1), BLM as resident of Ireland and the beneficial owner of the debt claim, should be taxed on the interest payable only in Ireland. BLM’s reliance on Article 12(1) to offer a higher price for the debt claim was entirely in line with the objects and purposes of the DTT.

As Lord Justice Snowden stated: “It is no part of the object and purpose of Article 12 to maximise tax revenues for HMRC, and Article 12(5) does not prohibit assignments simply on the basis that they have the consequence that less tax will be recoverable by HMRC than if the assignment had not taken place.”

Which case law is relevant to the interpretation of the “main purposes” test in the DTT?

The parties had agreed that the treaty should be interpreted based on the English case law on purpose (such as BlackRock and Kwik-Fit). The Court of Appeal expressed reservations about whether this was in fact the correct approach, although nothing turned on this, expressing the opinion that as a treaty is negotiated by the governments that are party to it, it should not be interpreted solely by UK domestic case law. Instead, the wider principles of interpretation of treaties outlined in Royal Bank of Canada should be taken into account so that a consistent interpretation is adopted internationally.