HM Revenue & Customs v UBS AG

UBS AG (“UBS”) , a bank resident in Switzerland, succeeded to the banking business of the Swiss Bank Corporation (“SBC”), following a merger in 1998. SBC carried on a banking business through a branch in London. In the relevant accounting periods, at the year end in 1993, 1995 and 1996, that branch, which I shall also call UBS, had substantial trading losses brought forward. That branch was a “permanent establishment” within the meaning of the UK-Switzerland Double Taxation Convention of 8 December 1977 (“the Convention”). Had that branch been a company resident in the United Kingdom, it would have been entitled to a tax credit in each of those years. But such a tax credit was denied to UBS. UBS contends that that refusal is discrimination prohibited by Article 23(2) of the Convention and that proscription has been incorporated into UK law by the combined effect of the Double Taxation Relief (Taxes on Income) (Switzerland) Order 1978 (S.I.1978/1408) and Section 788 of the Income and Corporation Taxes Act 1988 (“The Taxes Act”).

Following the refusal of its claim, UBS appealed to the Special Commissioners. They dismissed the appeal on the basis that, although the refusal of the tax credit amounted to discrimination proscribed by the Convention, discrimination in relation to entitlement to a tax credit had not been incorporated into UK law by the operation of Section 788(3)(a) (see [2005] STC (SCD) 589 and [2006] STC 716). But the Special Commissioners did toy with an idea, not canvassed before them, that UBS might succeed under Section 788(3)(d) (see paragraph 41 of their decision).

This suggestion was adopted by UBS on appeal to Etherton J. He agreed with the Special Commissioners’ conclusions in relation to Article 23(2) and Section 788(3)(a). But he held that the denial of a right to a tax credit amounted to an infringement of the non-discrimination provision which was given effect by Section 788(3)(d). (see [2006] STC 716 at 739).

Accordingly, HM Revenue and Customs (“the Revenue”) appeal against Etherton J’s decision in relation to his interpretation of Article 23(2) of the Convention and of Section 788(3)(d). UBS appeal against the judge’s conclusions in relation to Section 788(3)(a), an issue which does not arise if the judge was correct in his views as to the effect of Section 788(3)(d). No further proem is required. New readers can read all about the facts and statutory provisions in the decision of the Special Commissioners and the judgment of Etherton J. Old readers should begin here.

The Convention has no effect in UK law without legislation. The Convention takes effect by the Order in Council, to which I have already referred, made under Section 788(1). Paragraph 2 of the 1978 Order made the declaration identified in section 788(1). Accordingly the Convention, set out in full to the Schedule to the Order, has effect in accordance with section 788(3). This provides :-

It is, thus, apparent that section 788 may not fully incorporate a Double Taxation Convention (“DTA”). The Special Commissioners gave a number of examples where this has occurred (see paragraph 42 of their Decision). Nolan LJ recalled in R v IRC ex p Commerzbank AG [1991] 68 TC 252 that provisions in double tax conventions may benefit only one party (260D). The terms of section 788(3) show that the draftsman did not intend that everything in a DTA should become part of the law of the United Kingdom (see e.g. Park J in NEC Semi-Conductors v IRC [2004] STC 489 at paragraphs 9, 10, 35-38, the first two paragraphs cited with approval in this court at [2006] EWCA Civ 25 at paragraph 25). Ex p. Commerzbank itself provides an illustration of the limited effect of section 788(3) ; although a refusal of repayment supplement offended the non-discrimination provision in the German Convention, the bank had no effective remedy in domestic law for that breach because repayment supplement is not covered by section 788(3).

Section 788(3) identifies those arrangements which will have effect. But it does so in terms which appear to require:-

The Convention, like all the DTAs based on the Organisation for Economic Co-operation and Development (“OECD”) 1977 Model, and its more recent 1992 revision and updates, contains provisions which provide for the scope of the Convention (see e.g. Articles 1 and 2), for definitions within the Convention, 3, 4 and 5 (which defines permanent establishment as including a branch) and substantive provisions. Articles 6-21 of the Convention are substantive provisions. One might expect to be able to look at one of those provisions and resolve the statutory question posed by section 788(3), namely does that Article provide for any one of the matters within section 788(3)(a)-(d)? If that substantive provision does so provide, then it has effect in UK law. Art 10 of the Convention is an example of such a provision. This Article makes provision for the taxation of dividends derived either from a company resident in Switzerland (10(1)) or in the United Kingdom (10(2)). It makes provision for tax credits (10(3)) which sets a ceiling on the rate at which a tax credit on a dividend is to be calculated. In some circumstances art 10(3)(c) confers a tax credit on a non-resident company. (The extent to which that provision had been given effect in domestic law by section 788(3)(d) was the subject of dispute in Pirelli Cable Holdings v IRC [2006] 1 WLR 400 (HL). I shall need to return to this article later, but for present purposes it provides a useful starting point to demonstrate the process for determining whether a provision in the Convention has been incorporated into United Kingdom law.

But arts 23 (1) and (2) make no provision. They contain prohibitions:-

The first Convention with Switzerland was signed on 30 September 1954. The earliest predecessor to Section 788, so far as I can find, was contained in section 51 of the Finance (No. 2) Act 1945. Whilst it is easy to accept that those negotiating the Convention on behalf of the UK will have been aware that not all the provisions of the Convention will have effect by virtue of section 788(3), it is less palatable to conceive that they intended Articles 23(1) and (2) to be mere windy rhetoric, on the basis that they make no substantive provision for anything.

Accordingly, I take the view that there must be some process by which the non-discrimination provision can be given effect in United Kingdom law. After all, it was accepted that a similar provision in the Japanese Convention (in NEC) would have had effect if ACT had been corporation tax in respect of income or chargeable gains within section 788(3)(a), and so would such a provision in the German Convention had repayment supplement come within section 788(3)(b) (ex p Commerzbank).

I shall not at this stage attempt to interpret art 23(2). Whatever it means it is plain that the prohibition is directed at the domestic system of taxation within the countries of the two parties. In order to determine whether a party is in breach of its treaty obligation, it is necessary, first to determine whether the relevant provision of domestic tax infringes the prohibition imposed by the 23. If there is an infringement, the next issue is to determine whether the taxpayer within the scope of the prohibition, in casu, the permanent establishment, can rely upon that infringement under domestic law.

I suggest that in relation to Article 23 (1) and (2), the means by which the prohibitions take effect under United Kingdom law are as follows. It is necessary, firstly, to determine whether the domestic provisions in question infringe the non-discrimination Article. In the instant case, the first issue is whether the fact that a non-resident company is not entitled to a tax credit under section 231(1) or section 243 infringes Article 23(2). That question turns on the meaning of the words taxation less favourably levied.

If the domestic provision does infringe the prohibition against discrimination, the second stage is to identify what it is that the victim of discrimination seeks in order to achieve equal treatment under domestic law. The prohibition against non-discrimination can only be effective if the Convention overrides the relevant provision in United Kingdom law (“notwithstanding anything in any enactment”) and requires the United Kingdom to remove the discrimination by putting the victim in the same position as its comparator, in the instant appeal a UK resident corporate shareholder. Subject to one qualification, if the remedy which the victim seeks to cure discrimination contrary to art 23(2) falls within section 788(3)(a)-(d), then the non-discrimination Article does have effect in United Kingdom law. In the terms of 788(3), the remedial requirement inherent in art 23(2) may be said to provide for one of the matters identified in those sub-sections.

But there is one important qualification to that process. If a substantive provision of the Convention makes provision for that which a victim of discrimination seeks in order to secure equality of treatment, it is the substantive provision which must prevail. As I have said, art 23 is targeted against provisions of domestic legislation (see the definition of tax in art 3(1) of the Convention). It does not purport to override substantive provisions of the Convention. Indeed, it would be curious if it did, since those substantive provisions will have been the product of hard bargaining, as it was described by Lord Walker in Pirelli [97]. If the Convention makes specific provision for one of the matters identified in section 788(3)(a)-(d), then there is no room for any additional provision, to which that section gives effect, by virtue of the remedial process inherent in Article 23. This is of significance when I turn to consider the arguments relating to section 788(3)(d).

Accordingly, the proper approach, in my judgment, is to analyse the provisions on which UBS rely for the purposes of determining :-

whether their effect is that taxation is less favourable levied on UBS, as an undoubted permanent establishment ;

whether that which UBS seeks in order to secure equal treatment is the subject of any specific provision within the Convention;

if not, whether that which UBS seeks in order to secure equal treatment falls within section 788(3)(a) or (d).

This approach requires, firstly, that the words the taxation…shall not be less favourably levied be construed.

The Revenue persists in its contention that art 23 (2) has no application because, in the relevant years, UBS had no liability to tax; the provisions on which it seeks to rely impose no greater burden on it than on any company resident in the UK. They cannot be said to provide relief to an establishment which has suffered and will suffer no burden. In short, taxation is not less favourably levied in any year in which the permanent establishment has no liability to pay any tax.

Both the Special Commissioners and Etherton J rejected this submission. The Special Commissioners construed the words in Article 23(2) as covering payment of the tax credits claimed by UBS:-

Etherton J said :-

I agree with the Special Commissioners and with Etherton J. The prohibition in Article 23(2) is a prohibition against less favourable treatment in the imposition of tax on permanent establishments. Mr. Gardiner QC reminded us of Lord Dunedin’s famous trichotomy of liability, assessment and collection in Whitney v IRC [1926]AC 37 at 52 :-

The basis of computation must form part of the first stage, the imposition of liability. Only when that basis has been identified can there be any liability. The process of working out a corporation tax computation, and making a return to the Revenue follows the basis of computation laid down in the relevant parts of the Taxes Act. Both counsel showed commendable tact in treating these propositions of tax law as being so basic as to require no support, although they are to be found in no less an authority than Hoffmann J., as he then was, in Jones v O’Brien [1988] STC 615 at 623j-624a.

The determination of the entitlement of a company resident in the United Kingdom to a tax credit is part of the process of computation of its liability. Entitlement depends upon receipt of a qualifying distribution, as defined by section 14(2) of the Taxes Act, from a company resident in the United Kingdom (see section 231(1)). I shall return later to the issue as to how that entitlement may be deployed by a resident company, in the context of section 788(3). For present purposes, it is sufficient to observe that although a company will only receive a tax credit when it makes a claim, in its return under section 42(5A) and (10A) of the Taxes Management Act 1970 (pursuant to the references to claims in sections 242(1)(a) and 243(1)), the basis of entitlement is logically prior and forms part of the system whereby taxation is imposed. The French text of the Convention has equal authority (see the closing words of the Order). Its reference to :

Since both parties prayed in aid the OECD commentary on Article 24 of the Model Convention, from which Article 23 is derived, I did not find it of assistance. Both paragraph 21 ( cited by the judge at paragraph 32 ) and paragraph 20, which the judge did not cite have something for both sides. Paragraphs 19-21 read :-

The commentary is persuasive (see Mummery J’s summary, approved by this court in Memec plc v IRC [1988] STC 754 at 766, and cited at paragraph 27 of the judgment). To some extent paragraph 21 assists UBS, in its reference to treatment as regards tax but its reasoning is not of sufficient cogency to provide real assistance. In particular, the contrast in the language of sub-clauses (1) and (5), which prohibit more burdensome taxation and connected requirements and the language of (3) defies sensible explanation. If, as the Revenue contends, sub-clause (2) was intended to confine non-discrimination to what Dr Vogel called what must be paid (see citation by the judge at paragraph 30) there is no reason why the negotiators did not adopt the reference to more burdensome taxation, the expression they used elsewhere. The omission of any reference to treatment is unnecessary by virtue of the reference to taxation being levied. Dr. Vogel’s commentary is from a respected authority. But I disagree with him.

There is no warrant for limiting the prohibition against discrimination merely to the stage of collection; it makes no sense to do so. Collection depends upon the prior processes of computation, liability and return or assessment. The substantive provisions of the Convention make such provision for the treatment of non-residents of one of the parties, coming within the purview of the tax system of the other, as the parties agreed. Under those provisions, a non-resident might, indeed, be treated differently than a resident, as Article 23(3) recognises. But, apart from the substantive provisions, Article 23(2) distinguishes permanent establishments from other non-residents and requires their tax to be computed and their liability to be determined as if they were companies resident in the United Kingdom. The process of determining whether a company is entitled to a tax credit is part of the process by which, as Lord Dunedin would have put it, liability is declared.

In the light of that construction of art 23(2), it might be said that the refusal of the tax credit to UBS, in circumstances in which a United Kingdom corporate shareholder would be entitled to such a tax credit under section 243, infringes art. 23(2). UBS cannot take advantage of section 243 because, since it is not a company resident in the United Kingdom, it is not in receipt of franked investment income, as defined in section 238(1). It is not entitled to a tax credit under section 231 for a similar reason; it is not resident in the United Kingdom. But this apparent discrimination is of no avail unless UBS can show that by virtue of section 788(3), it can rely on that infringement of art 23(2) in domestic law. I turn then to the contention that the discrimination of which complaint is made can be cured in a manner which falls within section 788(3) (a) or (d). I shall start with consideration of section 788(3)(d) because I believe that analysis of considerations relevant to that sub-section will assist in a conclusion on (3)(a), which neither the Special Commissioners nor Etherton J thought availed UBS.

Section 788(3)(d) gives effect to those arrangements which provide for conferring the right to a tax credit under section 231 in respect of qualifying distributions. Mr Ewart’s primary submission was that Article 23(2) conferred nothing. The only rights to a tax credit which are conferred on companies resident in Switzerland are those conferred by Article 10(3)(c). That provision is not applicable since UBS AG, in Switzerland, does not control any proportion of the voting power, so far as we know, of the companies paying the dividend. In those circumstances Article 7(1) applies (see Article 10(5)) and confers power on the United Kingdom to tax the business profits attributable to UBS’s permanent establishment in the United Kingdom.

The purpose of section 788(3)(d) was explained by Lord Walker in Pirelli Holding NV v IRC[2006] 1 WLR 400 at paragraph 97, page 428:-

These observations were made in the context of an issue whether art 10(3)(c) in the Netherlands and Italian Conventions, drafted in similar terms to those of 10(3)(c) in the Switzerland Convention, meant a tax credit under section 231, to which there was no entitlement unless the company paying the dividend was liable to pay ACT. The resolution of that issue against the claimant companies, who had made a group election and had thus avoided payment of ACT, is of no significance in this appeal. There was no issue but that the entitlement to the tax credit claimed depended on the proper interpretation of Article 10(3)(c). It was on that substantive provision that the claimant companies depended, and on that provision that their Lordships’ House focussed.

UBS cannot rely on any provision within Article 10 as conferring a right to a tax credit. There is none. Etherton J, for the reasons he gives at paragraph 68, accepted UBS’s contention that it was claiming entitlement to a tax credit under section 231 in respect of qualifying distributions. But that is of no avail unless UBS can identify a provision in Article 10 which confers such a right. It cannot do so.

I agree with Etherton J in so far as his construction of the relevant provisions of the Taxes Act demonstrates that entitlement to a tax credit under section 243, and section 242(1)(c), is an entitlement to a tax credit under section 231. A claim under section 243(1) is made instead of or in addition to a claim under section 242(1). It is made for the purpose of setting the surplus of franked investment income over franked payments (as defined in section 238(1)) against losses which have been carried forward pursuant to section 393(1). But the entitlement to the tax credit, implied in section 243 but explicit in section 242(1)(c) is an entitlement to a tax credit under section 231(1).

The provisions of interpretation, definition and computation in Part VI of the Taxes Act make that proposition good. Section 832(1) defines any reference to a tax credit as a tax credit under section 231, unless the context otherwise requires. Entitlement to a tax credit is conferred by section 231(1). Save in what Lord Walker described as rare cases and in an unimportant exception (see Pirelli 427G), a corporate shareholder has no power to claim payment of a tax credit under section 231, in contrast to section 231(3) in the case of an individual. Its entitlement to payment of a tax credit under section 231(1) is conferred by section 242(1)(c) and by implication under section 243. In contrast to the provisions of section 231, which refer to claims to payment 231(2) and 231(3), section 242 refers to a claim to set off against losses, in the current or earlier accounting periods, a surplus of franked investment income (section 242(1)(a) and (2)(a)). The entitlement to be paid an “amount of the tax credit”, calculated by reference to the amount of surplus used as set off, is conferred by section 242(1)(c); the entitlement follows as a statutory consequence of the claim to deploy the surplus franked investment income in one of the ways identified in section 242(2).

But this is of no avail to UBS. The claim it makes to remedy the discrimination is for such tax credit, as would have been conferred on a resident corporate shareholder under section 231, read with section 243. But the Convention makes express provision for such tax credits to which non-resident corporate shareholders are entitled in accordance with the express agreement of the contracting parties.

Art 10(3)(c) expressly confers on a Swiss non-resident corporate shareholder an entitlement to a tax credit equal to one half of an individual resident’s entitlement, when one or more of a group owns at least ten per cent of the voting power of the paying company. The dividend and the half tax credit is subject to a tax of not more than 5 per cent (see art 10(2)(a) and the closing words of art 10(4)). It reads:-

The purpose of art 10 and similar provisions in other DTAs was explained by Lord Scott in Pirelli (at paragraph 51 and Lord Walker at 97). It was to make express provision for the taxation of non-resident shareholders in receipt of dividends derived from companies resident in one of the contracting states. It limited the entitlement and the amount of tax credits. It conferred no entitlement on a permanent establishment of a non-resident enterprise. On the contrary it made express provision under art 10(5) :-

Thus the only entitlement to a tax credit under the Convention is that which is conferred in the circumstances identified in art 10(3)(c). It is inconceivable that having expressly agreed a limited entitlement to a tax credit, that agreement should be overridden by the prohibition in relation to permanent establishments in art 23(2), not least when there is specific reference to such establishments in art 10(3)(c) and art 10 (5).

Those specific references within art 10 reveal what the parties agreed as to dividends and tax credits in relation to permanent establishments. I cannot accept that any further provision for a tax credit can be inferred from the general non-discrimination provision in art 23(2), let alone its implicit remedial effect.

There is further support for that conclusion to be found in considering the many DTAs agreed around the world. Some DTAs provide for tax credits to companies resident in other countries (e.g. the limited tax credit in the DTA with the United States, to which Union Texas International Corp v Critchley [1990] 63 TC 244] referred), some restrict tax credits to individuals (e.g. Malta and New Zealand) and in some DTAs no entitlement to a tax credit is conferred at all (e.g. Germany, Swaziland and Uzbekistan, among about forty three others). But, for example, both the German and Swaziland DTAs contain non-discrimination clauses in identical terms to art 23(2). I do not think it can seriously be suggested that where the parties have agreed that there shall be no entitlement to a tax credit, such a right arises by implication.

Art 10(3)(c) is given effect in United Kingdom law by section 788(3)(d). The parties made express provision for the tax treatment of dividends received from companies resident in the United Kingdom by the permanent establishments of non-resident Swiss enterprises, without any entitlement to a tax credit. Art 10(5) is given effect in domestic law by section 788(3)(c).

Accordingly, I disagree with Etherton J, who, it seems, was not presented with an argument in the same terms as that with which we were faced. The only provision in the Convention which confers a non-resident with a right to a tax credit in respect of qualifying distributions is art 10. It is that provision alone to which effect is given by section 788(3)(d).

Consideration of the arguments advanced in relation to section 788(3)(d) reveal, to my mind, that UBS is not seeking equal treatment in respect of a relief from corporation tax, within section 788(3)(a), at all. I agree, in that respect, with the conclusions of the Special Commissioners (at 36-39) and of Etherton J (at 56-62). In brief, the Special Commissioners concluded that the claim to set off carried forward losses against a surplus of franked investment income (section 243(1)), treated for that purpose as trading income (section 243(2)), was mere machinery for calculating an entitlement to a tax credit.

The reference in section 788(3)(a) to an arrangement which provides for relief from corporation tax in respect of income is a reference to that which reduces or eliminates the tax which would otherwise be payable (see Lord Hoffmann in Taylor v MEPC Holdings Ltd [2003] UKHL 270, [2004] 1 WLR 82 para 10). The essential dispute centres on the significance of the fact that the amount of UBS’s surplus of franked investment income (i.e. the excess of dividends plus associated tax credit received over dividends plus ACT paid) is treated as trading income for the purposes of the claim (section 243(2)). The Revenue contend that that is merely a matter of machinery; that process merely enables the payment of the amount of the tax credit to which UBS is entitled to be calculated. Corporation tax is not chargeable on distributions or dividends (section 208 and, in relation to permanent establishments of a non-resident company, section 11(2)(a)). The tax credit which UBS claims does not and cannot relieve UBS from any liability to corporation tax because it has none.

UBS contends that, on the contrary, section 243 is a claim for relief for losses under section 393(1). Section 393(1) is, beyond doubt, a provision which gives relief from corporation tax, as the heading to Chapter II indicates “LOSS RELIEF: CORPORATION TAX”. The claim which UBS makes is to loss relief for corporation tax. The consequence of the claim for relief is an entitlement to a tax credit, but that consequential entitlement is not to be confused with that for which a claim is made, relief from corporation tax.

It should be recalled that, UBS submits, but for the exemption from corporation tax in section 208 the franked investment income of a bank or share dealer or other investment company, carrying on similar financial activities to UBS, would be regarded as trading income. The effect of section 243(2) read with section 393(8) is to remove the effect of the exemption from corporation tax for loss relief purposes. That effect derives from the words :

Accordingly, the claim which UBS seeks to make is a claim for relief from corporation tax because it is a claim to set off against gross income, including tax credits and past trading losses. Since the result of the computation is nil profit and nil liability the person “relieved” is entitled to payment of the tax credit comprised in the gross income against which the losses carried forward have been set. The error of the judge in paragraphs 58-59 lay in failing to appreciate the significance of section 243, which brings into charge to corporation tax, income (scilicet the franked investment income and tax credit) for the purposes of giving relief for losses under section 393(1).

I agree with Mr Gardiner QC for UBS, that it is of no assistance to describe the entitlement to payments under section 243 and 243 as “anomalous” (judgment paragraph 58). Parliament clearly intended to confer those entitlements, even though there was no risk that the income which had borne ACT, paid by the company making the distribution, could be subjected to tax twice since that income was exempt when received by a corporate shareholder. I am also prepared to accept that a payment of tax credit under section 243 may in some circumstances reduce and in others extinguish a United Kingdom resident company’s tax liability. But the argument does not, to my mind, carry UBS far enough.

In seeking to secure equal treatment under art 23(2), UBS is not seeking relief from anything; it has no liability. It seeks payment of a tax credit, in an amount calculated by reference to the distributions it has received. It is not seeking relief because there is no liability to an amount of tax which would otherwise be payable. For that reason, which attempts merely to echo the reasoning of the Special Commissioners, and but for the reference to an anomaly, of the judge, I reject the contention that UBS is entitled to invoke art 23(2). That which it seeks, in order to secure equal treatment, is not within section 788(3)(a).

Moreover, if that which UBS seeks was to be regarded as relief against corporation tax, the result would be the same as that to which I objected in relation to section 788(3)(d). UBS would have secured for itself entitlement to a tax credit outwith the express agreement of the parties in relation to tax credits, as contained in art 10.

For these reasons I would allow the Revenue’s appeal against the judge’s decision under section 788(3)(d) and reject UBS’s claim to a tax credit in the accounting periods in issue.

I have had the benefit of reading the draft judgment of Moses LJ. I am grateful to him for setting out the issues in this complex appeal with such clarity. I agree with him that this appeal from the decision, now reported at [2006] STC 716, should be allowed, but I would do so not only against the judge’s decision under section 788(3)(d) of the Income and Corporations Taxes Act 1988 (“the 1988 Act”) but also against the judge’s decision under art 23 (on non-discrimination) of the double tax convention (“the convention”) with Switzerland as well. In agreement with Moses LJ, I would dismiss the respondent’s notice seeking to overturn the judge’s decision on section 788(3)(a).

In my judgment, for the reasons set out below:

The right, granted to shareholders of United Kingdom resident companies, to receive and use the tax credit on qualifying distributions, corresponding to the advance corporation tax (“ACT”) paid by such companies on those distributions (referred to below as the “associated tax credit”), is not part of the levying of taxation on a permanent establishment for the purposes of art 23(2) of the convention;

In any event, the claim for relief equivalent to that available to a United Kingdom resident company in the limited circumstances set out in section 243 is not a claim “for relief … from corporation tax” for the purposes of section 788(3)(a) of the 1988 Act;

Relief equivalent to that available to a United Kingdom resident company in the limited circumstances set out in section 243 is not a “right to a tax credit under section 231 in respect of qualifying distributions made … by companies which are [resident in the United Kingdom]” for the purposes of section 788 (3)(d).

It is therefore on the first of these conclusions that I have come to a different conclusion from that of Moses LJ.

The issues to be resolved on this appeal arise out of the operation of the partial imputation system adopted for the taxation of dividends in the United Kingdom in the period 1973 to 1999, and some explanation of that system is required. Lord Nicholls of Birkenhead summarised that system in his speech in Pirelli Cable Holdings NV v IRC [2006] 1 WLR 401 in the following terms:

In Deutsche Morgan Grenfell Group Plc v IRC [2006] 3 WLR 781 at [3], Lord Hoffmann, having described provisions relating to ACT, pointed out that "the Revenue thereby obtained early payment of the tax and, in cases in which the company's liability for [mainstream corporation tax] turned out to be less than it had paid as ACT, payment of tax which would not otherwise have fallen due.”

Neither the permanent establishments of non-resident companies nor UK resident companies were subject to a charge to corporation tax on distributions received (sections 11(2)(b) and 208 of the 1988 Act). This ensured that the dividend was taxed only once, that is in the hands of the distributing company. The question of utilising the associated tax credit accompanying a dividend to reduce ACT payable on distributions by the recipient does not arise in the case of a permanent establishment, because it (not being a separate legal entity) cannot itself pay a dividend. Non-resident companies, unlike resident companies, could on the face of the relevant section (section 243) neither utilise accumulated tax credits on dividends received by them against losses nor claim a payment in lieu. UBS can only put itself in the position of a resident company for this purpose if it can claim relief equivalent to that given to resident companies under section 243 by invoking art 23(2) of the convention, that is, if it can show that, without such relief, taxation would be less favourably levied on it than on a resident company for the purposes of art 23(2) of the convention.

UBS is a non-resident enterprise. In the years 1993, 1995 and 1996, dividends were paid to the permanent establishment of UBS within United Kingdom by United Kingdom resident companies. Those companies paid ACT on these dividends. A permanent establishment was not entitled to receive any tax credit on distributions received by it from a United Kingdom resident company making a qualifying distribution (see section 231 of the 1988 Act), or to treat such distributions and tax credit as franked investment income (see the definition in section 238 of that Act, set out below, of “franked investment income”, by virtue of which only UK resident companies could have such income).

The 1988 Act provides:

A double tax treaty, such as the convention, does not have automatic effect in domestic law. It has to be implemented by domestic legislation, now to be found in section 788 of the 1988 Act. This provides for a double tax treaty to be implemented by Order in Council. In this case, the Order in Council giving effect to the convention is the Double Taxation Relief (Taxes on Income) (Switzerland) Order 1978 (1978 S. I. 1408). The convention has effect in domestic law only so far as the arrangements in the convention fall within the arrangements given effect by section 788(3) of the 1988 Act. The arrangements referred to in the opening words of section 788(3) are the arrangements specified in the Order, namely the arrangements in the convention.

I shall need to refer in particular to arts 23, 10 and 7 of the convention. Moses LJ has set out the whole of art 23 in his judgment and it is sufficient for my purpose to set out paras (1) to (3):

Nationals of a Contracting State shall not be subjected in the other contracting state to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other state in the same circumstances are or may be subjected.

The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.

Nothing contained in this Article shall be construed as obliging a Contracting State to grant individuals not resident in that state any of the personal allowances and reliefs which are granted to individuals so resident.”

Art 23(2) is in the same terms as the part of art 24 of the Organisation of Economic Cooperation and Development (OECD) model tax convention from which it is derived. On questions of interpretation of the OECD convention, the commentary published with it is of persuasive value: see per Mummery J in the IRC v Commerzbank AG [1990] STC 285.

Art 23 forms part of an international treaty between the United Kingdom and Switzerland. Accordingly, it must be interpreted in the manner applicable to such treaties and this means, among other things, that it should be interpreted in the light of its object and purpose: see generally per Mummery J. in IRC v Commerzbank AG, approved by this court in Memec plc v IRC [1998] STC 754 at 766. The convention is in general intended to apply notwithstanding any changes in the fiscal law of either the United Kingdom or Switzerland (see art 2(2)) and accordingly art 23(2) potentially applies not just to the law of taxation as understood at the date of the negotiation of the convention but also on an ongoing basis to taxation subsequently imposed. This is one of the reasons why art 23(2) is expressed in general terms rather than with specificity. In this respect, art 23(2) is different from some other provisions of the convention, for example art 10. Thus the court must seek out the meaning of the general provisions in art 23(2), giving each phrase its proper effect and consider whether art 23(2) has effect in relation to the particular provision of domestic law in issue. This exercise is also to be performed by the Swiss courts in relation to the domestic law of Switzerland. There is no court with power to interpret the convention authoritatively, and we have not been shown any decision of any Swiss court on the convention or any foreign court on the OECD convention. If art 23(2) has effect in relation to any provision of domestic law, the court has to ask whether art 23(2), as so applied, falls within paras (a) to (d) of section 788(3).

When interpreting a double tax convention, it is important to recall that double tax treaties are generally the subject of hard bargaining between contracting states (as to this, see the comments of Lord Walker in the Pirelli case at [97]), and that contracting states have their own reasons for entering into such treaties. For instance, a contracting state may take into account considerations of its own fiscal policy. In so doing, it would be open to it to take the view (for example) that it should confer generous tax benefits on non-residents with a view to encouraging investment in its own state. But, likewise, it might take the contrary view that it did not wish to encourage investment (for example) by an enterprise resident in the other contracting state which carried on business within its own jurisdiction, but made losses, and thus paid no tax. These are not questions for the court interpreting the treaty, but underscore the need for the court to interpret the treaty and any implementing legislation with attention to its precise terms.

Art 2 of the convention defines “United Kingdom tax” as including corporation tax (subject to the provisions of art 2(2) with which we are not concerned). Art 3(2) lays down a special rule about the attribution of meaning to terms that are not defined in the convention. It provides:

No argument was addressed to art 3(2) in the course of the hearing before us, but in my judgment regard must be had to it as it lays down that, in the application of the convention, the United Kingdom is to give that meaning to a term, not defined in the convention, which that term has under the law of United Kingdom concerning income and corporation tax. This rule, which is similar to that in art 3(2) of the OECD convention, applies unless the context otherwise requires. If this is the rule in relation to the application of the convention in practice, it must also apply to the interpretation of the convention by the court. It has the apparent effect of domesticating certain terms in the convention to national law. However, it applies only to terms which are not defined by the convention, and it does not apply if the convention makes it clear that some other meaning applies. Furthermore, the term must be one which is defined by the relevant domestic tax law, in this case income tax or corporation tax. There may be a question as to whether for this purpose the term must actually be defined by the statute imposing liability to tax or corporation tax.

Art 10 of the convention deals with dividends and it provides so far as material as follows:

Art 7 provides so far as material:

The first issue on this appeal is whether by withholding the benefit of associated tax credits from the permanent establishment of a Swiss enterprise, “the taxation on a permanent establishment” has been “less favourably levied” for the purpose of art 23(2).

This is a complex issue, and it may assist if I first summarise my reasoning for concluding that article 23(2) is not engaged:

Art 23(2) requires a comparison to be made between the ultimate tax position of a permanent establishment and that of a UK enterprise, that is, between the tax chargeable on each such entity after the proper deductions have been made.

A permanent establishment cannot use its associated tax credits in the same way as the UK enterprise (a) because it cannot set franked investment income against distributions which it itself makes (section 241 of the 1988 Act) and (b) because it cannot set franked investment income against its losses and obtain payment of any surplus (section 242 and 243 of the 1988 Act). Inability to set franked investment income against distributions does not carry any consequences under art 23(2).

The setting off of franked investment income against losses does not result in the reduction of the tax bill of a United Kingdom enterprise. The most that happens is that there may be an increase in the tax bill of that enterprise in the future. This consequence does not engage art 23.

Art 10 of the convention gives Swiss residents the right to set associated tax credits against the liability to United Kingdom income tax and to claim payment of the balance. Permanent establishments are excluded from these provisions. This is a further indication that art 23 is not engaged by the failure of the 1988 Act to extend to permanent establishments of Swiss enterprises the right to offset franked investment income against losses and claim payment of the surplus.

In the paragraphs which follow, I explain how I have reached those conclusions. A number of preliminary points can be made. I start with some points about the interpretation of art 23(2). The opening words “the taxation” are not defined in the convention. There is no suggestion that these words are defined by statute for the purposes of the relevant charging provisions in domestic law.

In Whitney v IRC [1926] AC 37 at 52 (a case about super tax), in the passage which Moses LJ has set out in para 22 of his judgment, Lord Dunedin held that the imposition of tax involved three stages: liability, assessment and collection. But he did so in general terms and without defining taxation for the purpose of any statutory provision. In any event, whatever the term “the taxation” means in English law, it is clear that it cannot have a meaning in art 23(2) divorced from its context in art 23(2) (as to this, see further below) and more generally the convention. For these reasons I do not consider that national law can be applied to the interpretation of this term by virtue of art 3(2) of the convention. It must, therefore, have an autonomous meaning in the convention. Accordingly, it will not automatically involve the trichotomy of liability, assessment and collection referred to by Lord Dunedin.

As regards subject matter, “the taxation” must be limited to United Kingdom tax as defined in the convention (see above). Moreover, paras (1) and (5) both refer also to “any requirement connected therewith”, but that phrase is absent from para (2). The presence of the words “any requirement connected therewith” in other parts of the articles is an indication that the expression “the taxation” does not cover all aspects of liability to tax. It may therefore be limited to provisions which impose the tax, as distinct from collateral obligations of the taxpayer, such as the obligation to file a return. This approach is supported by the meaning of the word “levied” which on its ordinary meaning means “raised”. If that is so, art 23(2) has a more limited field of operation than say art 23(1). In argument, some significance was attached to the fact that art 23(3) refers to personal allowances and reliefs, but I doubt whether there is any significance in this reference because personal allowances and reliefs are analogous to the expenses of a business which are properly deducted in the calculation of profits of a business for the purpose of the charge to tax. Clearly the right to deduct such expenses is part of the “the taxation” on a permanent establishment (see further art 7(3)). The credits which a UK resident company receives in respect of qualifying distributions are very different from personal reliefs since they are credits against the mainstream corporation tax of the company paying a dividend and not a relief against the income of the recipient of the dividend.

A further preliminary point which I wish to make is this. Art 23(2) is a prohibition on less favourable provisions imposed on permanent establishments, as opposed to enterprises which are resident in the same state and carry on the same activities. This formula does not require that the contracting states enact the same charging provisions for both permanent establishments and resident enterprises. Indeed, it clearly permits more favourable treatment of permanent establishments of enterprises resident abroad, which might occur if the contracting state in which the permanent establishment was resident wished to encourage investment in its jurisdiction. Differences in tax treatment could clearly arise from separate charging provisions, but they could also arise from a separate regime of allowances and credits available to say resident enterprises, but not permanent establishments. This is again a pointer in the direction of the conclusion that art 23(2) is concerned with the end product of the application of domestic charging provisions to a permanent establishment.

The special commissioners, in their consideration of art 23(2) of the convention, took into account the Commentary to the OECD model convention, which they said the negotiators of the convention could be expected to have had before them when negotiating the convention. The Commentary states that in considering whether there has been a violation of art 23(2) “… it is the result alone which counts…” (decision, para 25 [2006] STC 716). In my judgment the Commentary can properly be prayed in aid in the interpretation of the equivalent provisions of the convention. In any event, art 23(2) on its ordinary interpretation requires a consideration of the result of the taxation provisions of the contracting state. This is because since art 23(2) prohibits taxation, which is “less favourably levied…on enterprises…carrying on the same activities”. This necessarily entails an assessment of the effect of the provision in question, rather than its literal terms.

Mr David Ewart QC, for the Revenue, relies on a passage from Professor Dr Klaus Vogel’s work, Double Tax Conventions (Kluwer, 3 ed, 1997, page 1316). In the Memec case, this court referred to Professor Dr Vogel as an acknowledged expert in this field. The passage in question in his work is as follows:

In my judgment, in this passage Professor Dr Vogel is making many of the points about interpretation arising from the differences of wording in the provisions of art 24 of OECD model convention that I have already made above in relation to the (so far as material) identically worded provisions of art 23. He concludes from those points that it is clear that “taxation” in the case of a permanent enterprise means merely the direct burden of tax. He then goes on to draw a distinction with provisions that might loosely be described as the machinery of taxation. Professor Dr Vogel is not saying that the direct burden of tax excludes the deduction of proper allowances and reliefs. Indeed, that would be contrary to the passage “i.e. what must be paid in terms of money”, which, like the OECD commentary, must be referring to the overall result of the application of all the relevant tax provisions and not the intermediate steps, and also to art 7(3). He therefore takes the view that it is only reliefs and allowances which reduce the charge to tax that are within art 23(2).

In my judgment, for the reasons given above, this view is correct. It has to be asked whether the associated tax credit serves to reduce the liability for tax in the case of the UK resident companies. The answer to this is that tax credit could be used to reduce the amount of ACT which a UK resident company paid on distributions which it made. But the permanent establishment of a non-resident company could not make a distribution. Art 23(2) required the position of the permanent establishment to be compared with that of the UK enterprise “carrying on the same activities”. It can be argued that for the purposes of this phrase it is simply necessary to compare the position of a UK enterprise carrying on a banking business with that of UBS’s permanent establishment in London, and that all that is required is a comparison of their trading activities. But a comparison of that kind does not allow a precise comparison of the tax position of the permanent establishment, and “activities” are not limited to trading activities. Applying if necessary a purposive interpretation to the convention, I consider that the comparison which must be made in this context is with the specific activity which the permanent establishment is carrying on and on which it is being taxed, and no other. Accordingly, no relevant comparison falls to be made with a UK enterprise which itself makes distributions. Put another way, it cannot be said that the system of taxation on permanent establishments was less favourable simply because they could not utilise the tax credit in operations (here, the making of distributions) which they could not carry out.

Resident companies can also use tax credits to reduce losses and, if they do this and still have a surplus of franked investment income, they can obtain payment of the surplus. The question is whether the process for offsetting losses creates a liability to tax against which the franked investment income is used. Section 242(1)(a) provides some support for this because it requires the franked investment income to be treated as if it were a like amount of profits chargeable to corporation tax. That formula does not have the effect of making the franked investment income profits: it simply of treating them as if they were profits. It is a drafting technique to enable a limited right to claim payment of surplus franked investment income to be conferred. Accordingly, section 242 does not in my judgment result in the creation of a liability to tax against which the franked investment income is set. In these circumstances, no tax is payable as a result of the offset process and so the tax credit does not reduce the charge to tax. Accordingly the claim to relief in the circumstances does not form part of the taxation on UK resident companies for the purposes of article 23(2).

Section 243(2) has similar, but not identical, wording to that of section 242(2)(a). Relevantly, it provides that the amount of franked investment income which a company seeks to set off against losses brought forward is “for the purposes of the claim" treated as trading income of the accounting period. In my judgment, this formula is not effective to convert franked investment income into trading income for corporation tax purposes generally. Accordingly, a claim for relief under section 243 does not form part of the taxation of UK resident companies for the purposes of the art 23(2).

The contrary conclusion on the application of section 23(2) is expressed by the judge and accepted by Moses LJ. The judge held that the tax credit constitutes part of the levying of corporation tax even though the provision for payment of the surplus only operates in circumstances where there can never be any question of a liability to make an actual payment tax (judgment, para 33). As I have already explained, in my judgment, “the taxation”, for art 23 purposes, refers to the tax payable on the profits chargeable to tax less any relief or allowance which reduces it. That would not include the associated tax credit in this case, which does not reduce the charge to tax.

The judge also held that the utilisation of the associated tax credit against losses constituted “taxation” because it would accelerate the charge to tax if the permanent establishment subsequently made profits. In that event, the losses absorbed by franked investment income could not be set against those profits and tax will become payable earlier. In my judgment, a credit which does not directly reduce the charge to tax but which may possibly have an effect on it at some undefined point in the future does not constitute part of “the taxation” on UK enterprises for the purposes of art 23. The payment of the credit under section 242 or 243 will at the moment of payment have no effect on the current tax bill, and indeed may never have any effect on any future tax bill. It is simply a payment equivalent to the ACT originally paid by the company making the distribution. It is not a credit against any tax paid by the recipient (see further issue (ii) below).

Art 10(3) is consistent with the conclusion expressed above. This provision was inserted into the convention following the agreement of a protocol dated 5 March 1981, i.e. while the partial imputation system with which we are concerned was in force. In 1981, the Income and Corporation Taxes Act 1970 effectively provided for the same rights as one now conferred by sections 242 and 243, although section 393A was not introduced until 1991. Under art 10, the general rule is that Swiss residents receiving dividends from the UK resident companies with tax credits are entitled to the tax credit to which an individual resident and United Kingdom would have been entitled and to payment of the excess of that tax credit over his liability to United Kingdom tax (art 10(3)(c)). The exceptions to that general rule include the case of permanent establishments where the holding in right of which the dividend is paid is effectively connected with the permanent establishments’ business. The permanent establishment is liable to tax on its business activities by virtue of article 7. These provisions effectively recognise that a permanent establishment is not entitled to set an associated tax credit against its liability to tax or to the payment of the surplus of the tax credit over its liability to UK tax. It is hardly possible that the contracting states, having excluded permanent establishments from art 10, intended them to be able to claim to use the tax credit through art 23. For these reasons, I conclude that art 23 is not engaged in this case.

On the view which I have formed on the first issue, the second and third issues do not arise but I express also my conclusions on them on the basis that contrary to my view art 23 is engaged.

I agree with what Moses LJ has held on this issue and have little to add. UBS has to show that the utilisation of tax credits to offset losses would constitute a relief against corporation tax. Even if a provision for the payment of the tax credit is a relief for the reasons explained by Moses LJ, dividends received by a permanent establishment of non-resident company are not brought into the charge to corporation tax. As already explained, the fact that under section 242 franked investment income is treated as if it were profits does not convert that income into profits chargeable to tax. Under section 243, franked investment income is treated as trading income of the accounting period for the purposes only of the claim to offset losses. Accordingly, this section too is not effective to create profits chargeable to corporation tax. By making a payment of ACT, the company that paid the dividend has paid a sum to be set against its own “mainstream” corporation tax: see the passage already quoted from the speech of Lord Nicholls in the Pirelli case. Thus a refund of the tax credit to UBS would not be a payment of any tax paid on its account. In my judgment, it is not enough for UBS to point to the ultimate acceleration of corporation tax which would result from the absorption of its losses by offset against dividend income and tax credit for similar reasons to those given in relation to art 23. In my judgment, “relief …from corporation tax” for the purposes of section 788(3)(a) must be a relief from a charge to corporation tax which has arisen or which is certain to arise. For all these reasons, I agree that UBS’s claim does not fall within section 788(3)(a) and that accordingly the respondent's notice must be dismissed.

I agree with the judgment of Moses LJ and there is little that I wish to add on this issue. Since the convention excludes the entitlement to an associated tax credit in the case of a Swiss enterprise which carries on business in the United Kingdom through a permanent establishment and which has received dividends from United Kingdom companies through that permanent establishment, I agree with Moses LJ that UBS can place no reliance on art 23 for the purpose of establishing its claim to a tax credit. A claim by it under that article is inconsistent with what the parties to the convention expressly agreed in art 10. That being so, there is no provision within the convention for conferring on permanent establishments within art 10(5) “the right to a tax credit under section 231”. Some further support for this conclusion can be obtained from the fact that section 788(3)(d) uses the words “ under section 231” when those words are already included in the statutory definition of tax credit in section 832 of the 1988 act. The duplication of those words in section 788(3)(d) is a further indication that the tax credits referred to in section 788(3)(d) are limited to those expressly referred to in section 231 and not to those referred to in section 242 and (by implication only) section 243.

For these reasons, in my judgment, the appeal must in my judgment be allowed.

I concur with Arden and Moses LJJ on the two grounds on which they are in agreement, and accordingly, like them, would allow this appeal.

As to the further ground, relating to article 23(2) of the Convention, on which they have come to differing views, I prefer to express no opinion since it is not necessary to the court’s decision.