On 22 September 2017, the First-tier Tribunal3 held that the attribution of notional equity and loan capital to a UK permanent establishment of a non-resident company (PE) as required by UK legislation governing the profits of a PE that are subject to UK corporation tax is compatible with the provisions of the UK/Irish double tax treaty (DTT). The PEs in question were not allowed a corporation tax deduction for interest, to the extent disallowed by the relevant UK legislation.
Section 11AA(3)(b) of the Income and Corporation Taxes Act 1988 (now rewritten to the CTA 2009), as in force at the relevant time, provided that for the purposes of determining the profits of a non-resident company that are attributable to a PE “it shall…be assumed that the PE has such equity and loan capital as it could reasonably be expected to have [were the PE a distinct and separate enterprise, engaged in similar activities under similar conditions, dealing independently with the non-UK company]”.
The UK/Irish DTT (which prevails over UK legislation where there is conflict) provided simply that only such profits attributable to a PE may be taxed in the UK, again on the basis of a ‘distinct and separate’ enterprise, and that deductions shall be allowed in the UK for expenses that are incurred for the purposes of the PE “whether in the [UK] or elsewhere”.
The appellants in these joined appeals argued that the DTT should override the UK legislation, which required an attribution of ‘notional’ capital which differed from the actual level of capital employed by the PE.
The Tribunal held that the UK legislation was not incompatible with the DTT. Specifically it held that section 11AA(3)(b) was not inconsistent with the OECD model treaty commentaries published up to the relevant time. The UK rules were an application of the general principle set out in the OECD model treaty (on which the UK/Irish DTT was based) and, as such, “do no more than give effect to the [DTT] requirements”.