Upper Tribunal holds that UK legislation attributing notional capital to UK PE was consistent with UK-Irish tax treaty
Blog Tax Take

On 9 October 2019, the Upper Tribunal (UT) held⁴ that UK legislation⁵ setting out how equity and loan capital should be attributed to a UK permanent establishment (PE) of a non-resident company was consistent with the UK-Ireland double tax treaty (DTT).

Two Irish companies (Irish Bank and Irish Nationwide) traded in the UK through PEs here. Each PE filed UK tax returns and claimed interest deductions on amounts borrowed from the relevant Irish company.⁶

HMRC refused to allow such interest deductions, on the basis that the tax returns filed by the PEs understated the amount of equity capital of the PE (therefore overstating the PE’s loan capital, and therefore the interest charges). What was at dispute in this case was whether (as contended by Irish Bank and Irish Nationwide) the terms of the DTT took precedence over the UK legislation. In other words, whether (or not) the terms of the DTT precluded the application of the relevant UK legislation.

The UK legislation in question was section 11AA(3)(b) of ICTA 19887 . It provides that it shall be assumed, in attributing profits to the PE, that the PE has such equity and loan capital as it could reasonably be expected to have on the basis that the PE was a distinct and separate enterprise, dealing wholly independently with the non-resident company.

HMRC argued that section 11AA(3)(b) was one of the approaches in calculating a PE’s profits that was permitted by the DTT. The DTT neither obliged this approach, nor precluded it, meaning (in HMRC’s view) that the domestic law approach was permissible.

In construing the DTT, the UT held that prior HMRC practice as to the taxation of a UK PE should not be taken into account. The UT did, however, consider OECD publications and foreign case law as to similar DTTs in construing the DTT. The UT considered a number of OECD publications, published both before and after the DTT entered into force⁸. The UT concluded that the relevant terms of the DTT, when considered alongside the OECD publications (in particular the 2008 commentary), can be “complied with in a variety of ways”.

Therefore, despite the fact that the DTT did not contain wording equivalent to section 11AA(3) (b), this did not (in the UT’s view) preclude that UK provision from being relied upon by HMRC. The non-residents’ appeal was accordingly dismissed.

The decision can be viewed here.