UBS AG v HM Revenue & Customs

This is an appeal by UBS AG, a Swiss bank, as successor to Swiss Bank Corporation (“SBC”), from a decision of the Special Commissioners (John S Avery Jones and Julian Ghosh) on 7 June 2005 (“the Decision”) dismissing an appeal from the refusal by the Commissioners of Inland Revenue of a claim for relief under s.243 of the Income and Corporation Taxes Act 1988 (“the Taxes Act”) in respect of SBC’s London branch (“the Branch”) for the accounting periods ending on 31.12.93, 31.12.95 and 31.12.96.

References in this judgment to statutory provisions are, unless otherwise indicated, references to the provisions of the Taxes Act in force at the relevant time.

The Appellant claims that, by virtue of Article 23(2) of the double taxation convention between the UK and Switzerland (“the Treaty”), it is entitled to the same tax credits under s.243 on dividends received by the Branch during the relevant accounting periods as could be claimed by a UK resident company (“a UK company”).

The Special Commissioners agreed with the Appellant that the Treaty entitles the Appellant to relief under s.243, but held that such right under the Treaty has not been incorporated into UK law by s.788(3)(a).

On this appeal, the Appellant challenges the Special Commissioners’ finding on the meaning and effect of s.788(3)(a). The Appellant also raises on the appeal, without objection by the Respondents, the Commissioners of Her Majesty’s Revenue and Customs (“HMRC”), a new argument that its right under the Treaty to s.243 tax credits has been incorporated into UK law by s.788(3)(d).

HMRC challenge, by a Respondents’ Notice, the Special Commissioners’ finding that the Treaty confers on the Appellant an entitlement to tax credits under s.243 in respect of dividends received by the Branch during the relevant accounting periods.

There was an agreed statement of facts before the Special Commissioners as follows:

“A.

UBS AG and Swiss Bank Corporation

(1)

UBS AG (“UBS”) is a bank resident in Switzerland, Swiss Bank Corporation (“SBC”) and Union Bank of Switzerland each having merged into UBS in 1998 by way of mergers under Swiss law. UBS is therefore now the successor to the business of SBC.

(2)

SBC, at all material times, was a bank resident in Switzerland that owned a number of subsidiaries operating in many countries and otherwise conducted a banking business through branches located in many countries.

(3)

SBC, at all material times, carried on a banking business in London through a branch (“the Appellant”). The agreed corporation tax computations show that, as at 1 January 1993, 1995 and 1996, the Appellant had accumulated substantial trading losses from the conduct of its banking business in London of the following cumulative amounts: £215,900,346, £515,978,719 and £595,220,041 respectively.

B.

The Appellant’s activities as a market maker

(4)

The Appellant acted as a market maker on the London Stock Exchange. In other words, it held itself out in compliance with the rules of that exchange as willing to buy and sell securities at a price specified by it and was recognised as so doing by the Council of the Stock Exchange.

(5)

In the course of its activities as a market maker it (a) received dividends from United Kingdom resident companies and (b) received and paid “manufactured dividends” (as that term is used in section 737 of and Schedule 23A to the Taxes Act 1988).

(6)

The dividends received arose in respect of securities held by the Appellant on the applicable dividend record date.

(7)

The manufactured dividends received arose primarily in consequence of stock lending transactions engaged in by the Appellant over dividend payment record dates or purchases which remained unsettled over such dates. As a consequence of those transactions, the Appellant did not receive the dividends to which it would otherwise have been entitled and the borrower or the seller would make a payment to the Appellant to compensate it for the loss of the dividend. The manufactured dividends paid arose primarily in the same circumstances save that the Appellant was the borrower or the seller rather than the lender.

C.

Dividend income received

(8)

During the accounting periods comprising the calendar years 1993, 1995 and 1996 the surplus of UK dividends (and manufactured dividends) received by the Appellant over manufactured dividends paid amounted in value to £233,282,021 (the “Distributions”). Had the Appellant been a person resident in the United Kingdom, the Distributions would have carried with them tax credits, as provided by section 231 of the Taxes Act 1988, of £58,320,506.

(9)

The figures in respect of each of the accounting periods in question are as follows:

Period	Surplus of UK dividends (and manufactured dividends) received by the Appellant over manufactured dividends paid	Income tax credit claimed
1993	£37,000,638	£9,250,160
1995	£122,447,408	£30,611,852
1996	£73,833,975	£18,458,494

The Claim and Appeal

The Special Commissioners also found that the Appellant distributed the whole of its commercial profit to its head office.

It is not in dispute that, for the purposes of this appeal, no distinction is to be made between manufactured dividends and real dividends.

The Treaty is based on the OECD Model Tax Convention of 1977, which was adopted as a Recommendation of the Council of the OECD on 11 April 1977.

Article 23(2) is as follows:

“(2)

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.”

The OECD Model Convention has a Commentary explaining the terms of the Model.

Corporation tax was first introduced by the Finance Act 1965. Under the system of corporation tax originally introduced a company paid corporation tax on its profits; distributions to the shareholders were paid subject to the deduction of Schedule F tax; and the company was liable to account to the Revenue for the tax deducted.

The Finance Act 1972 substituted an “imputation” system of corporation tax. That system applied in the UK between 1973 and 1999 to the taxation of distributions (typically dividends). The principal features of the imputation system, summarised by the Court of Appeal in Pirelli Cable Holding NV –v- Inland Revenue Commissioners [2003] EWCA Civ 1849, [2004] STC 130 at para [4] were: (1) the company paid corporation tax on all its profits, whether or not distributed; (2) income tax was no longer deducted from distributions; (3) a company making distributions to its shareholders made a payment of Advance Corporation Tax (“ACT”) in respect of such distributions; (4) ACT paid in respect of distributions made in an accounting period was to be set off against the corporation tax, often called mainstream corporation tax, on the company’s profits for that period; (5) a UK resident individual recipient of a distribution in respect of which ACT was payable was entitled to a tax credit corresponding to the ACT.

Critically, unlike the system which operated between 1965 and 1973, when income tax under Schedule F was deducted by the company from the dividends paid to its shareholders, after 1973 ACT was not so deducted but was an additional payment to be made by the company to the Revenue. The ACT was “imputed” to the distribution and so “franked” it. For the purposes of the present proceedings, the two critical limbs of the ACT system were that, firstly, ACT was credited against the paying company’s corporation tax and, second, a UK resident individual recipient of the dividend was entitled to a tax credit corresponding to the ACT which covered his liability to pay basic rate tax on the dividend.

The right to receive payment of the tax credit was abolished in 1997, and ACT was itself abolished in 1999. This appeal, however, concerns the years 1993 to 1996 when ACT and the right to receive a tax credit were in force.

Section 11 concerns the charge to corporation tax on a company not resident in the UK (“a foreign company”). So far as relevant, it provides as follows:

“11.

Companies not resident in the United Kingdom

(1)

A company not resident in the United Kingdom shall not be within the charge to corporation tax unless it carries on a trade in the United Kingdom through a branch or agency but, if it does so, it shall, subject to any exceptions provided for by the Corporation Tax Acts, be chargeable to corporation tax on all its chargeable profits wherever arising.

(2)For the purposes of corporation tax the chargeable profits of a company not resident in the United Kingdom but carrying on a trade there through a branch or agency shall be-

(a)

any trading income arising directly or indirectly through or from the branch or agency, and any income from property or rights used by, or held by or for, the branch or agency (but so that this paragraph shall not include distributions received from companies resident in the United Kingdom); and

(b)

…”

Section 208, which provides that UK company distributions are not generally chargeable to corporation tax, is as follows:

“208.

UK company distributions not generally chargeable to corporation tax

Except as otherwise provided by the Corporation Tax Acts, corporation tax shall not be chargeable on dividends and other distributions of a company resident in the United Kingdom, nor shall any such dividends or distributions be taken into account in computing income for corporation tax.”

Section 231 in Chapter IV of Part VI concerns tax credits. So far as relevant to the appeal, it provides as follows:

Tax credits for certain recipients of qualifying distributions

Chapter V of Part VI concerns ACT and franked investment income. The following provisions are relevant to the appeal:

“238.

Interpretation of terms and collection of ACT

(1)

In this Chapter-

“franked investment income” means income of a company resident in the United Kingdom which consists of a distribution in respect of which the company is entitled to a tax credit (and which accordingly represents income equal to the aggregate of the amount or value of the distribution and the amount of that credit) …

“franked payment” means the sum of the amount or value of a qualifying distribution and such proportion of that amount or value as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made…

…

“surplus of franked investment income” means any such excess as is mentioned in subsection (3) of section 241 …

“tax credit” means a tax credit under section 231;

and references to any accounting or other period in which a franked payment is made are references to the period in which the distribution in question is made.”

“241.

Calculation of ACT where company receives franked investment income

(1)

Where in any accounting period a company receives franked investment income the company shall not be liable to pay advance corporation tax in respect of qualifying distributions made by it in that period unless the amount of the franked payments made by it in that period exceeds the amount of that income.

(2)…

(3)If the amount of franked investment income received by a company in an accounting period exceeds the amount of the franked payments made by it in that period the excess shall be carried forward to the next accounting period and treated for the purposes of this section (including any further application of this subsection) as franked investment income received by the company in that period.”

“242.

Set-off of losses etc. against surplus of franked investment income

(1)

Where a company has a surplus of franked investment income for any accounting period-

(a)

the company may, on making a claim for the purpose, require that the amount of the surplus shall for all or any of the purposes mentioned in subsection (2) below be treated as if it were a like amount of profits chargeable to corporation tax; and

(b)

… the provisions mentioned in subsection (2) below shall apply in accordance with this section to reduce the amount of the surplus for purposes of section 241(3); and

(c)

the company shall be entitled to have paid to it the amount of the tax credit comprised in the amount of franked investment income by which the surplus is so reduced.

(2)

The purposes for which a claim may be made under subsection (1) above are those of –

(a)

the setting of trading losses against total profits under section 393A(1) [ set off of losses against profits of the same or an earlier account period];

…

(5)

Where-

(a)

on a claim made under this section for any accounting period relief is given in respect of the whole or part of any loss incurred in a trade, or of any amount which could be treated as a loss under section 393(9); and

(b)

in a later accounting period the franked payments made by the company exceed its franked investment income;

then (unless the company has ceased to carry on the trade or to be within the charge to corporation tax in respect of it) the company shall, for the purposes of section 393(1) [set off of losses against trading income in succeeding accounting periods], be treated as having, in the accounting period ending immediately before the beginning of the later accounting period mentioned in paragraph (b) above, incurred a loss equal to whichever is the lesser of-

(i)

the excess referred to in paragraph (b) above; and

(ii)

the amount in respect of which relief was given as mentioned in paragraph (a) above or so much of that amount as remains after deduction of any part of it dealt with under this subsection in relation to an earlier accounting period.”

“243 Set-off loss brought forward

(1)

Where a company has a surplus of franked investment income for any accounting period, the company, instead of or in addition to making a claim under section 242, may on making a claim for the purpose require that the surplus shall be taken into account for relief under section 393(1) up to the amount of franked investment income for the accounting period which, if chargeable to corporation tax, would have been so taken into accountby virtue of section 393(8); and (subject to the restriction to that amount of franked investment income) the following subsections shall have effect where the company makes a claim under this section for any accounting period.

(2)

The amount to which the claim relates shall for the purposes of the claim be treated as trading income of the accounting period.”

….

“244.

Further provisions relating to claims under section 242 or 243

(1)…

(2)

Where in consequence of a claim under either section 242 or section 243 for any accounting period a company is entitled to payment of a sum in respect of tax credit-

(a)

an amount equal to that sum shall be deducted from any advance corporation tax which apart from this subsection would fall, under section 239, to be set against the company’s liability to corporation tax for the next accounting period or the benefit of which could be surrendered under section 240; and

(b)

if that amount exceeds that advance corporation tax or there is no such advance corporation tax, that excess or that amount (as the case may be) shall be carried forward and similarly deducted in relation to the following accounting period and so on.”

Section 393 in Chapter II of Part X (loss relief and group relief) is, so far as relevant to the appeal, as follows:

“393 Losses other than terminal losses

(1)

Where in any accounting period a company carrying on a trade incurs a loss in the trade, the loss shall be set off for the purposes of corporation tax against any trading income from the trade in succeeding accounting periods; and (so long as the company continues to carry on the trade) its trading income from the trade in any succeeding accounting period shall then be treated as reduced by the amount of the loss, or by so much of that amount as cannot, under this subsection or on a claim (if made) under section 393A(1) be relieved against income or profits of an earlier accounting period.

…

(8)

For the purposes of this section “trading income” means, in relation to any trade, the income which falls or would fall to be included in respect of the trade in the total profits of the company; but where-

(a)

in an accounting period a company incurs a loss in a trade in respect of which it is within the charge to corporation tax under Case I or V of Schedule D, and

(b)

in any later accounting period to which the loss or any part of it is carried forward under subsection (1) above relief in respect thereof cannot be given, or cannot wholly be given, because the amount of the trading income of the trade is insufficient,

any interest or dividends on investments which would fall to be taken into account as trading receipts in computing that trading income but for the fact that they have been subjected to tax under other provisions shall be treated for the purposes of subsection (1) above as if they were trading income of the trade.

Section 788, in Chapter I of Part XVIII (double tax relief) is, so far as relevant to the appeal, as follows:

“788.

Relief by agreement with other countries

(1)

If Her Majesty by Order in Council declares that arrangements specified in the Order have been made with the government of any territory outside the United Kingdom with a view to affording relief from double taxation in relation to-

(a)

income tax,

(b)

corporation tax in respect of income or chargeable gains, and

(c)

any taxes of a similar character to those taxes imposed by the laws of that territory,

and that it is expedient that those arrangements should have effect, then those arrangements shall have effect in accordance with subsection (3) below.

(2)

…

(3)

Subject to the provisions of this Part, the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide-

(a)

for relief from income tax, or from corporation tax in respect of income or chargeable gains; or

…

(d)

for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident.

(6)

… a claim for relief under subsection (3)(a) above shall be made to the Board.

(10)

Before any Order in Council proposed to be made under this section is submitted to Her Majesty in Council, a draft of the Order shall be laid before the House of Commons and the Order shall not be so submitted unless an Address is presented to Her Majesty by that House praying that the Order be made.”

Double taxation conventions aside, only a UK company is entitled to the relief under s. 243. This follows from the definition of “franked investment income” in s. 238(1), which restricts such income to the income of a UK company.

It is common ground that, notwithstanding the absence in s.243 of any such express provision for payment of the tax credit to the company as is to be found in s. 242(1)(c), invocation by a company of s. 243 (1) entitles the company to payment of the tax credit.

The first issue I have to consider is whether the inability of the Appellant to invoke s. 243 and secure the tax credit is a contravention of Article 23(2). The Special Commissioners held that it was. Their conclusion was stated as follows in para. [25] of their Decision:

“25.

We consider that payment of the tax credit is part of the levying of taxation and that the taxation on the Appellant is less favourably levied. The UK resident company in exactly the same circumstances can claim from the Revenue a payment in respect of the tax credit; the Appellant cannot. In a later accounting period the UK resident company which pays more dividends than it receives will automatically receive a greater benefit at the cost of the claim being reversed and being repaid in the form of ACT that cannot be set against mainstream corporation tax, which the Appellant cannot. We do not describe this as a comparison between a conditional and (if the Appellant succeeds) an absolute one. Rather, it is payment to the hypothetical UK resident of at least the sum in respect of the tax credit, and possibly more; and (if the Appellant succeeds) a payment to the Appellant equal to that sum, but never a greater sum. In the words of the Commentary “it is the result alone which counts.” Nothing can obscure the difference that before the application of the non-discrimination article the UK resident can on making a claim receive cash from the Revenue in respect of the tax credit, while the Appellant cannot. That, in our view, is clearly taxation less favourably levied on the Appellant.”

That part of their decision is, as I have said, challenged by HMRC by way of a Respondent’s Notice.

There is no dispute between the parties that the correct approach of the Court to the interpretation of the Treaty is that described by Mummery J in IRC v Commerzbank [1990] STC 285, in a passage approved by the Court of Appeal in Memec v IRC [1998] STC 754, 766g, in which he summarised as follows the approach to treaty interpretation laid down by the House of Lords in Fothergill v Monarch Airlines [1981] AC 251:

“(1)

It is necessary to look first for a clear meaning of the words used in the relevant article of the convention, bearing in mind that ‘consideration of the purpose of an enactment is always a legitimate part of the process of interpretation’: per Lord Wilberforce (at 272) and Lord Scarman (at 294). A strictly literal approach to interpretation is not appropriate in construing legislation which gives effect to or incorporates an international treaty: per Lord Fraser (at 285) and Lord Scarman (at 290). A literal interpretation may be obviously inconsistent with the purposes of the particular article or of the treaty as a whole. If the provisions of a particular article are ambiguous, it may be possible to resolve that ambiguity by giving a purposive construction to the convention looking at it as a whole by reference to its language as set out in the relevant United Kingdom legislative instrument: per Lord Diplock (at 279).

(2)

The process of interpretation should take account of the fact that –

“The language of an international convention has not been chosen by an English parliamentary draftsman. It is neither couched in the conventional English legislative idiom nor designed to be construed exclusively by English judges. It is addressed to a much wider and more varied judicial audience than is an Act of Parliament which deals with purely domestic law. It should be interpreted, as Lord Wilberforce put it in James Buchanan &Co Ltd v Babco Forwarding & Shipping (UK) Limited, [1987] AC 141 at 152, “unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation”: per Lord Diplock (at 281-282) and Lord Scarman (at 293).

(3)

Among those principles is the general principle of international law, now embodied in art 31(1) of the Vienna Convention on the Law of Treaties, that ‘a treaty should be interpreted in good faith and in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose’. A similar principle is expressed in slightly different terms in McNair’s The Law of Treaties (1961) p 365, where it is stated that the task of applying or construing or interpreting a treaty is ‘the duty of giving effect to the expressed intention of the parties, that is, their intention as expressed in the words used by them in the light of the surrounding circumstances’. It is also stated in that work (p 366) that references to the primary necessity of giving effect to the ‘plain terms’ of a treaty or construing words according to their ‘general and ordinary meaning’ or their ‘natural signification’ are to be a starting point or prima facie guide and ‘cannot be allowed to obstruct the essential quest in the application of treaties, namely the search for the real intention of the contracting parties in using the language employed by them’.

(4)

If the adoption of this approach to the article leaves the meaning of the relevant provision unclear or ambiguous or leads to a result which is manifestly absurd or unreasonable recourse may be had to ‘supplementary means of interpretation’ including travaux préparatoires: per Lord Diplock (at 282) referring to art 32 of the Vienna Convention, which came into force after the conclusion of this double taxation convention, but codified an already existing principle of public international law. See also Lord Fraser (at 287) and Lord Scarman (at 294).

(5)

Subsequent commentaries on a convention or treaty have persuasive value only, depending on the cogency of their reasoning. Similarly, decisions of foreign courts on the interpretation of a convention or treaty text depend for their authority on the reputation and status of the court in question: per Lord Diplock (at 283- 284) and per Lord Scarman (at 295).

(6)

Aids to the interpretation of a treaty such as travaux préparatoires, international case law and the writings of jurists are not a substitute for study of the terms of the convention. Their use is discretionary, not mandatory, depending, for example, on the relevance of such material and the weight to be attached to it: per Lord Scarman (at 294).”

There are three aspects to this part of HMRC’s case.

First, HMRC contend that Article 23(2) has no application in the present case because no taxation was “levied” “on” the Appellant within the meaning of that Article. There were merely claims to a tax credit, which were rejected. Mr. Ewart referred to the following definition of “levy” in the Shorter Oxford English Dictionary (5^th ed):

“1.

Raise (contributions, taxes) or impose (a rate, toll, fee, etc) as a levy… b … c Impose a levy on (a person)”

Mr David Ewart, counsel for HMRC, contended that no tax had been “levied” “on” the Appellant in respect of the relevant accounting period because brought forward losses of the Branch exceeded taxable income for those years. The submission is, in effect, that Article 23(2) is not engaged at all if there are no taxable profits, after offset of losses, capable of giving rise to a charge to tax. He referred, in support of that contention to the following passage in para. [126] of Vogel on Double Taxation Conventions concerning Article 24 of the OECD Model Convention (corresponding to Article 23 of the Treaty):

“Article 24 (3) [corresponding to Article 23(2) of the Treaty] calls for a comparison of thepermanent establishment’s taxationand that of a comparable enterprise. A juxtaposition of the wording of Art. 24 (3) and that of Art. 24 (1) and (5) reveals unmistakably that ‘taxation’ in the case under review means merely the direct burden of tax, i.e.,what must be paid in terms of money. Contrary to Art. 24 (1), Art. 24 (3) refers only to ‘less favourably levied’ taxation and not to ‘other taxation’ as well. Moreover, contrary to Art. 24 (1) and (5), it does not refer to the ‘requirements connected’ with taxation. When the taxation procedure applied to a permanent establishment differs from that applied to domestic enterprises, this consequently does not violate Art 24. (3) … Thus, in particular, imposition of the tax attributable to a permanent establishment by withholding at the source, rather than by way of assessment, is no discrimination prohibited by Art 24. (3), provided that withholding would not result in a higher amount of tax ...”

Mr. Ewart also referred to, and relied upon, paras. 21 and 24ff of the OECD Commentary on Article 24 of the OECD Model Convention. He points out that there is no discussion there of anything similar to the tax credit under s. 243.

Paragraph 21 of the Commentary is as follows:

“By the terms of the first sentence of paragraph 3, the taxation of a permanent establishment shall not be less favourably levied in the State concerned than the taxation levied on enterprises of that State carrying on the same activities. The purpose of this provision is to end all discrimination in the treatment of permanent establishments as compared with resident enterprises belonging to the same sector of activities, as regards taxes based on business activities, and especially taxes on business profits.”

I reject Mr. Ewart’s submission on the meaning of “levied” “on” in Article 23(2) of the Treaty. The levying of tax is a broad concept. As the dictionary definition shows, it encompasses, in its ordinary sense, the imposition of a tax. The imposition of a tax does not denote that a taxpayer will actually be liable to pay an amount of tax after, for example, allowances and reliefs. The tax is imposed, or “levied”, but, in accordance with the tax provisions, there may be nothing to be paid by a particular taxpayer in respect of it. There is nothing in Article 23(2) to restrict it to a narrower meaning. The tax credit payable in consequence of the invocation of s.243 is part of the levying of corporation tax, notwithstanding that s.243 only operates in circumstances where the company’s losses are such that there could never be any question of a liability to make an actual payment of tax.

I do not find the citation from Vogel of assistance. It is not clear that the author had in mind the type of situation with which I am concerned; if he did, and he intended to express the view that something like a tax credit under s.243 cannot fall within the provisions of Article 24(3) of the Model Convention, his proposition or conclusion is mere assertion, unsupported by any relevant analysis.

Nor do I find Mr. Ewart’s references to the Commentary on the OECD Model Convention helpful to HMRC’s case. There is nothing in the Commentary which points with any certainty to an intention to exclude something like the right to invoke s. 243 and obtain payment of the tax credit. On the contrary, para 21 of the Commentary is more consistent with the Appellant’s case and the approach taken by the Special Commissioners.

Second, Mr Ewart submitted that Article 23(2) requires a comparison between the Branch, as if it were an independent company, and a UK company “carrying on the same activities”, including the distribution of all its profits to its parent company. If that assumption is correct, Mr Ewart submitted, then the UK company would not have been able to invoke s. 243 because, on the facts, its franked payments in the years 1993 to 1996 would have exceeded its franked investment income. In this context, Mr Ewart also referred to and relied upon the provisions of Article 7(2) of the Treaty, which are as follows:

“(2)

Subject to the provisions of paragraph (3), where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributable to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar activities and dealing wholly independently with the enterprise of which it is a permanent establishment.”

The Special Commissioners rejected that submission. They said as follows, in para. [13] of their Decision:

“13.

We do not consider that profit distributions should be included in the comparison. It is the nature of a permanent establishment that it cannot pay dividends and so that is outside the comparison; indeed if it were, under a classical corporation tax system on which the Model is based, such a comparison would imply that a state could impose a branch profits tax as equivalent to the withholding tax on dividends without breaching the non-discrimination article, which cannot be right. Mr Ewart did not go this far but he included the payment of dividends in the comparison in this case because the imputation system and tax credits were bound up with the payment of dividends. We consider that it is inherent in any comparison between a permanent establishment and a resident company that one must ignore the distribution of profits. The two entities are different in this respect and no meaningful comparison can be made.”

I agree with that analysis and conclusion.

Article 5(2) of the Treaty states that:

“The term “permanent establishment” includes especially:

(a)

a place of management,

(b)

a branch,

(c)

an office,

(d)

a factory,

(e)

a workshop and

(f)

a mine, an oil or gas well, a quarry or any other place of extraction of natural resources”

Any profits generated by the activities of a permanent establishment of those kinds necessarily belong to the enterprise of which it forms part. There is no question of any payment of dividends by the permanent establishment. It cannot sensibly have been the intention of the parties to the Treaty to make the Article 23(2) comparison on the hypothesis that the permanent establishment was making payment of share dividends to a parent company equal to all its distributable profits. There is nothing in Article 7(2) which so requires. That Article is dealing with a quite different issue, namely what part of the profits generated by the enterprise, of which the permanent establishment forms part, can fairly be attributed to the activities of the permanent establishment. Moreover, on the actual facts of the present case, as Mr. Gardiner observed, the Branch, if operating as a separate company, could not have declared dividends in view of the losses that had been incurred.

Third, Mr Ewart submitted that the Appellant was not treated less favourably than a UK company within the meaning and intent of Article 23(2) since a UK company, like the Appellant, was not liable for corporation tax on its dividends from UK companies comprised in its franked investment income. Section 243 enabled the UK company voluntarily to bring such dividends into charge to corporation tax, which they would not otherwise have borne.

That submission is really a different facet of Mr. Ewart’s first submission and must, in the light of my analysis and conclusion on that submission and rejection of it, fail for the same reasons.

Accordingly, I agree with the Special Commissioners that, for the reasons stated by them in para. [25] of their Decision, tax is less favourably levied on the Appellant within Article 23(2) of the Treaty, by virtue of the inability of the Appellant (as a foreign company and so unable to receive or make franked payments), on the one hand, and the ability of a UK company, on the other hand, to invoke s.243.

I now turn to the issue whether the Appellant’s claim to a tax credit under s.243 is a claim for “relief… from corporation tax” within s.788(3)(a).

The Special Commissioners concluded, in para. [37] of their Decision, that “the payment of the tax credit in the circumstances of s.243 is a relief”. They concluded, however, that it is not a relief from corporation tax. Their reasons were expressed as follows in para. [38] of their Decision:

“In the year in question the Appellant was potentially liable to corporation tax but had trading losses and received dividends that were exempt from corporation tax, and so did not pay any corporation tax. Unlike s.231(3), there was no question of that exemption giving an automatic right to a payment of the tax credit if the amount of the tax credit exceeded the Appellant’s liability to corporation tax. The Appellant’s corporation tax liability was the same whether or not it received the payment of the tax credit… [T]he Appellant’s liability to corporation tax in this case could never have been adjusted by the payment of the tax credit. This is a matter of principle, independent of the facts. Put another way, the right to the payment of the tax credit under ss 242 and 243 is not a payment which “reduces the [corporation] tax which would otherwise be payable” (Taylor v MEPC Holdings Ltd [2004] STC 123, 126 per Lord Hoffman at [10]). The payment arises once the final corporation tax has been agreed and does not adjust it.”

Mr. Gardiner submits that the analysis and conclusion of the Special Commissioners are flawed because they failed to take account of the interrelationship between ss. 243 and 393. His submissions on this aspect may be summarised briefly as follows.

First, he says, the combined effect of ss. 393(1) and (8) is to bring into charge to corporation tax as trading income dividends from, for example, foreign companies which (by virtue, for example, of ss. 123(2) and 208) are already subject to tax, and so would not otherwise form part of the company’s trading income for corporation tax purposes. The result of losses being set off against such dividends under s. 393(1) is the repayment of the tax paid.

Second, Mr Gardiner submits, s. 243(1) and (2) enable the company to treat surplus franked investment income (of the same kind as the dividends within s. 393(8) – i.e. the dividends from shares held by a share trader as distinct from shares held as investments) as falling within the charge to corporation tax under s. 393(1). The amount so brought into charge includes both the dividend and the tax credit: see the definition of franked investment income in s. 238(1). The result of losses being set off against such income under s. 393(1) is that the tax credit comprised in the amount of the franked investment income so applied is paid to the company. Mr Gardiner emphasises that the process under s. 243 involves a recognition that the dividend comprised in the surplus franked investment income has been charged to tax, and the whole object of treating the gross sum as trading income of the accounting period is to enable an amount equal to that tax to be recovered. The effect is to override s. 208 and the exclusion of distributions by s. 11(2)(a). The position of the company is thereby made similar to that of an individual under s.231(3) and of a company under s. 231(2).

Third, Mr Gardiner submits, what is recovered from the Revenue is corporation tax, and so the relief is relief against corporation tax. It must be corporation tax, he says, because a company is only liable to pay corporation tax. He points to the preamble to the Act which states that it is: “An Act to consolidate certain of the enactments relating to income tax and corporation tax ….”, and to s. 832(3) in which “tax” is defined to mean either income tax or corporation tax: he submits that the tax credit can therefore only be a tax credit in respect of income tax or corporation tax.

Finally, and by way of a general analytical comment, Mr Gardiner says that the process under s. 243, which results in the payment of the tax credit, is merely the ordinary application of the second basic element of the imputation principle, namely that the recipient of the dividend is given a tax credit, corresponding to the ACT, in recognition of the fact that the dividend has already borne tax.

Mr Gardiner places weight on the analysis and decision of Jonathan Parker LJ, with whom the other two members of the Court of Appeal agreed, in IRC v Trustees of the Sema Group Pension Scheme [2002] EWCA Civ 1857. In that case, the trustees of an approved pension scheme, which was exempt from income tax on income derived from investments, sold shares in a buy back and became entitled to receive tax credits from the distribution element of the re-purchase price. By reason of the trustees being exempt from tax, there was no liability against which the tax credits could be set, and the amount of the credits was therefore paid to the trustees. One of the questions that arose was whether the trustees had received a “tax advantage” in consequence of the buy-backs. The expression “tax advantage” was defined by s.709(1) as “a relief… from, or repayment… of, tax”. Neither party argued that receipt of the tax credit was a “repayment” of tax because the trustees had not paid tax, and so there was nothing to be repaid. The question before the Court of Appeal was, therefore, whether the tax credit was a “relief” from tax. The Court of Appeal decided that it was.

The Special Commissioners distinguished the Sema case. They said in para [38]:

“The trustees could theoretically (we say nothing about how realistic this prospect is) have been liable to income tax on, say, trading income. In that case the tax credit would have reduced this income tax liability. So the right to payment of the tax credit, being a right to a payment of the difference between an income tax liability and the tax credit is a relief from income tax. The nil liability to income tax on the trustees, in SEMA, depended in the facts (i.e. whether the trustees had taxable income). The position of the Appellant is different here… The trustees’ liability to income tax in SEMA was dependent on the facts, which might have been (at least in theory) adjusted by the tax credit; the Appellant’s liability to corporation tax in this case could never have been adjusted by the payment of the tax credit.”

Mr Gardiner’s submissions on the Special Commissioners’ approach to Sema are summarised as follows in paragraph 27 of the Appellant’s skeleton argument:

“27.

The Appellant therefore submits that there is no valid distinction between its position and the position in SEMA:

(1)

There is no relevant distinction between the income tax and corporation tax positions as suggested by the SCs turning simply on the existence of an express mechanical set-off provision inapplicable on the facts of either case. A set-off against a liability to tax is a relief from the liability to tax applicable to the taxpayer. The payment of a tax credit to him (when he has no liability) is a relief from the same tax. Analytically, there can be no difference.

(2)

The only liability to which the individual trustees in SEMA could have been liable was income tax. The only tax to which the Appellant could have been liable was corporation tax. The tax credit paid to the trustees in SEMA represented in their hands a payment of an income tax credit since they could have been liable to no other tax. Any payment of a tax credit to the Appellant must be a corporation tax credit since the Appellant could be liable to no other tax. Moreover, sections 243 and 393 are fundamental to the way in which the latter taxpayer’s overall liability, its corporation tax liability, is computed. Indeed, as the SCs acknowledged at paragraph 15:

“the application of ss.242 and 243 entitles a UK resident company to a payment of a sum of money (equal to the “tax credit”) which is self-evidently calculated to give relief for losses sustained by that UK resident company while within the charge of corporation tax”.

Mr Gardiner, in his oral submissions, also relied on the decision of Sir John Vinelott in IRC v Universities SuperannuationScheme Limited [1997] STC 1, in which he held that the word “relief” in the definition of “tax advantage” in s.709(1) was a word of wide import, and that exemption of the income of an exempt body was “relief” from tax within that definition. That decision was followed by Lightman J, at first instance, in Sema.

Mr Gardiner’s submissions on this aspect of the appeal were closely argued and attractively presented. I have reached the conclusion, however, that the appeal against the Special Commissioners’ decision on s.788(3)(a) must be dismissed.

By way of preliminary observation, I should record that both sides are agreed that no conclusive answer to this part of the appeal can be found in the decision of Park J. in NEC Semi-Conductors Ltd v. IRC [2003] EWHC 2813 (Ch), [2004] STC 489, or the very recent judgments of the Court of Appeal on the appeal from his decision (under the name Boake Allen Limited & Os v HMRC [2006] EWCA Civ 25). That was a case, conducted under a group litigation order, concerning claims by UK companies, which were required to pay ACT on paying dividends to their parents, which were foreign companies, that they were subject to more burdensome tax requirements than a company with a UK parent (which could elect to pay such dividend without incurring a charge to ACT), contrary to the non-discrimination clause in the relevant double taxation conventions (all of which were in broadly similar terms to Article 23 of the Treaty in the present case). Park J, and Lloyd LJ, with whom the other members of the Court of Appeal agreed on this point, held that the non-discrimination provision of the conventions was not, in this regard, incorporated into UK law by s. 788(3)(a). In his judgment, Lloyd LJ (in paras. [45] – [62]) considered the provisions of s. 788 in the light of the history of corporation tax and ACT. He agreed with Park J that the natural meaning of “corporation tax in respect of income or chargeable gains” in s.788(1)(a) was to refer to mainstream corporation tax only, and not ACT, and concluded (at para. [61]): “that the natural meaning of s. 788(3) is that the only provisions concerning ACT which are given direct effect as part of UK tax law are those referred to in subsection (3)(d) as regards tax credits.” As I have said, both sides before me are agreed that, on analysis, Boake does not provide a conclusive answer to the Appellant’s case on the proper meaning and application of s. 788(3)(a) in the context of its claim based on Article 23(2) of the Treaty and the right to invoke relief under s. 243 and to claim the consequent tax credit.

The proper approach to the interpretation of s. 788(3) (now endorsed by the Court of Appeal in Boake) was described as follows by Park J in NEC Semi-Conductors Ltd, at paras [38] and [51]:

“38.

Mr Aaronson urged that I should give a wide interpretation to the various matters listed in paras (a) and (d) [of s.788(3)], in order that as many provisions of Double Taxation Agreements as possible should be covered by s.788(3) and thereby made parts of domestic law. I do not see why I should do that. I intend to give a natural interpretation, neither wide not narrow, to those of the matters listed in paras (a) to (d) which are argued to cover the particular application of the non-discrimination article in point in this case. The matter principally relied on by the claimants is the reference in para (a) to providing for ‘relief from … corporation tax in respect of income or chargeable gains’. If, as is the case, I do not think that the natural interpretation of those words includes relief from ACT, I do not think that I should give an unnatural and extended interpretation to the words in order, through the non-discrimination article, to bring treaty relief from ACT within the scope of domestic law. I do not accept the submission that the structure of s.788(3) (or its statutory predecessors going back to the Finance Act 1945) evinces an intention on the part of the draftsman to list everything which might realistically be expected to be covered by a Double Taxation Agreement. If the draftsman’s intention had been to bring into domestic law everything contained in a Double Taxation Agreement he could have provided that ‘the arrangements shall, notwithstanding anything in any enactment, have effect’. And he could have left it at that. To my mind the structure of the sub-section shows clearly that the draftsman did not want to secure that everything in a Double Taxation Agreement should become part of domestic law. That is why he continued with the words ‘in relation to income tax and corporation tax in so far as they provide for’ the listed matters.”

“51.

Mr Aaronson also urged me to pay careful heed to a passage in the judgment of Diplock LJ in Salomon v Customs and Excise Comrs [1967] 2 QB 116, especially at 143. I have read the passage carefully, but in my opinion it is of no assistance for much the same reason as that which I have explained in connection with the articles of the Vienna Convention. Diplock LJ is analysing the approach to the interpretation of a United Kingdom statute which seeks to enact the effect of an international treaty, and to do so, not in the actual words of the treaty itself, but rather in terms which the parliamentary draftsman has chosen in order to reproduce what he understands the treaty to mean. The present case is not concerned with that sort of thing. Apart from anything else, in so far as the contents of a Double Taxation Agreement become part of United Kingdom law, they do so in the actual words of the agreement (the treaty) itself. There is no question of the United Kingdom draftsman seeking to reproduce in his own chosen wording what he conceives to be the effect of the wording of the treaty. I repeat that the crucial question in this case is not what the non-discrimination article of the Double Taxation Agreement means, but rather whether, given what it means, s.788 (3) has introduced that meaning into domestic tax law. That is a question of interpretation of s.788(3), and Diplock LJ’s remarks, important though they are in their context, are not relevant to it. Generally on this matter I agree with Mr Glick’s submissions that s.788 is a general enabling provision which traces back to 1945; it contemplates no particular treaty; and it is not appropriate to attempt to construe the breadth (or narrowness) of the enabling provision by reference to the detailed contents of subsequent treaties.”

Expressed most succinctly, this aspect of the appeal turns on whether the application of the second basic element of the imputation principle (i.e. that the recipient of the dividend is given a tax credit) in the particular circumstances of s. 243 can fairly be described as “relief from …corporation tax” within s. 788(3)(a). In my judgment, it cannot. The payment of the tax credit resulting from the application of s. 243 is, like the payment of the tax credit under s. 242, anomalous. Prior to a company invoking s. 243, the dividends comprised in its franked investment income do not form part of its income for corporation tax purposes: s. 208. If the company invokes s. 243, the franked investment income (i.e. the aggregate of the dividend and the tax credit) is brought into account as trading income, but only in circumstances in which there are losses available to be carried forward and set against such income under s. 393(1), so that there will be no corporation tax payable. Accordingly, neither before nor after the invocation of s. 243 do the dividends comprised in the franked investment income give rise to a charge to corporation tax on the recipient company. Payment of the dividend will have given rise to an obligation on the distributor company to pay ACT, but that payment is not a payment on account of any liability of the recipient company to corporation tax. The ACT is credited against the payer company’s mainstream corporation tax liability.

In summary, the tax credit payable to the company invoking s. 243 does not reduce any corporation tax liability of the company and is not a repayment of corporation tax deducted or withheld at source. That tax credit produces a financial benefit to the company invoking s. 243, but it has nothing to do with giving relief from corporation tax. There is no discernible reason for the tax credit other than as a hangover from, or rather the anomalous continuation of an aspect of, the tax regime before the introduction of the imputation system in 1973. Before that time, basic rate tax on dividends was deducted and withheld at source. Payment of a tax credit in the circumstances specified in s. 393(1), where tax has already been paid, would plainly be relief from tax. So, in the case of dividends from a non UK resident company (which are not within s. 208) and which have been subject to tax (under s. 123(2) and (3A) and Schedule 3), and are within s. 393(8), the re-payment of such tax by virtue of s. 393(1) is a relief from tax. By contrast, under the post 1973 imputation system, ACT is not a deduction at source or a withholding tax in respect of the dividends of a UK company.

I do not consider that any assistance is given by the decision of Sir John Vinelott in the USS case or the decisions of Lightman J and the Court of Appeal in Sema. Those cases concerned the proper interpretation of provisions governing a tax advantage obtained in consequence of a transaction in securities. It is well established that those provisions are to be given a wide meaning as a general attack on tax avoidance. That particular approach to interpretation is reflected in the following passage in the judgment of Jonathan Parker LJ in Sema at para [109] as follows:

“In my judgment, what the draftsman was manifestly trying to do when defining “tax advantage” in s.709(1) was to cover every situation in which the position of the taxpayer vis-à-vis the Revenue is improved in consequence of the particular transaction or transactions. As I read s.709 (1) the distinction between “relief” and “repayment” is not based on any conceptual difference between the two; the true interpretation of s.709(1) is in my judgment much simpler than that. In my judgment, “relief” in s.709(1) is intended to cover situations where the taxpayer’s liability is reduced, leaving a smaller sum to be paid, and “repayment” is intended to cover situations in which a payment is due from the Revenue. In the same way, the references to “increased relief” and “increased repayment” are directed at situations in which the taxpayer is otherwise entitled to a relief or repayment, with which the “relief” or “repayment” referred to in s.709(1) must be aggregated.”

That analysis has no obvious application to s.788(3). Indeed, as Mr Ewart observed, strictly the analysis of Jonathan Parker LJ is more consistent with HMRC’s case on this appeal than the case for the Appellant.

For those reasons, I conclude that the right to invoke s. 243 and the consequent payment of the tax credit do not fall within the words “relief… from corporation tax” in s. 788(3)(a).

As a further or alternative argument on this appeal, the Appellant relies on s.788(3)(d). This is, as I have already said, a new point, which was not taken below, but no objection is made by HMRC on that ground.

The Appellant’s argument on s. 788(3)(d) may be summarised briefly as follows. The Appellant seeks the same tax credit that a UK company can procure by invoking s. 243. It is not in dispute that the tax credit payable in consequence of the invocation of s. 243 is comparable to the tax credit expressly specified in s. 242(1)(c). The expression “tax credit” is defined in s.832(1) as meaning “a tax credit under section 231”. Accordingly, the tax credit claimed by the Appellant is “ a tax credit under section 231 in respect of qualifying distributions made to [the Appellant] by companies which are [resident in the UK]” within the express words in section 788(3)(d).

Mr. Ewart’s answer to that argument is short. He submits that s. 788(3)(d) can have no application in the present case because the Appellant’s claim is a claim to a tax credit under s. 243, whereas s. 788(3)(d) expressly applies only to a claim to a tax credit under s. 231. He referred me to the following paragraphs in the judgment of the Court of Appeal in Pirelli, which was delivered by Peter Gibson LJ, as an explanation of the background to s. 788(3)(d):

“14.

A non-UK resident company which did not carry on a trade in the UK through a branch or agency was not chargeable to corporation tax. However it was chargeable to UK income tax under Sch F in respect of UK source income such as dividends paid by UK-resident companies. In the 1972 White Paper at para 32 mention was made of a power being taken to entitle a non-resident shareholder to receive a tax credit under a Double Taxation Agreement (DTA). It was envisaged that the particular terms on which non-resident shareholders would be entitled to tax credit in respect of a qualifying distribution under any DTA would be a matter for negotiation.

15.

That power is in s.788, which refers to DTAs as ‘arrangements’ made with the government of any territory outside the UK with a view to affording relief from double taxation in relation to (amongst other things) income tax and corporation tax. Section 788(3) provides, so far as material:

‘the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide-

(a)

for relief from income tax, or from corporation tax in respect of income or chargeable gains; or…

(d)

for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident.

16.

DTAs have been negotiated with, amongst other countries, Italy and the Netherlands. They grant to persons resident in those countries and holding shares in and receiving qualifying distributions from companies resident in the UK a right to tax credits under s.231. DTAs with other countries such as Germany make no provision for tax credits. Where a tax credit is granted, the general pattern is to grant the tax credit only in part and to make a reduced charge to tax on the aggregate of the amount of the dividend and the amount of the tax credit.”

“48.

What then is the significance of the words ‘tax credit under section 231’ in s.788(3)(d)? In our judgment the reference to s.231 was necessary in order to cause the tax credit to be aggregated with the distribution in respect of which the tax credit is conferred and so to be rendered chargeable to tax under para 2 of Sch F. We do not regard that reference as apt to import all the qualifications to the availability under the 1988 Act of tax credits.”

Mr. Ewart says that s. 788(3)(d) was intended to give effect to the type of provision in favour of individuals to be found in Article 10(3)(b) of the Treaty, as follows:

“(3)

However, as long as an individual resident in the United Kingdom is entitled to a tax credit in respect of dividends paid by a company resident in the United Kingdom, the following provisions of this paragraph shall apply instead of the provisions of paragraph (2):

(a)…

(b)

A resident of Switzerland who receives a dividend from a company which is a resident of the United Kingdom shall, subject to the provisions of sub-paragraphs (c) and (d) of this paragraph and provided he is the beneficial owner of the dividend, be entitled to the tax credit in respect thereof to which an individual resident in the United Kingdom would have been entitled and he received that dividend, and to the payment of any excess of that tax credit over his liability to United Kingdom tax.”

Mr Ewart submitted that, against that background, s.788(3)(d), on its proper interpretation, embraces only the right to a tax credit under ss.231(2) and (3), and does not extend to the right to the payment of a tax credit under ss.242 and 243.

In my judgment, the Appellant is entitled to succeed on this point, which is a short one. As Mr Gardiner observed, the expression “tax credit” is defined in s.832(1) to mean “a tax credit under section 231”. Section 238(1) similarly defines “tax credit” for the purposes of Chapter V of Part VI as meaning “a tax credit under section 231”. Section 242(1)(c) expressly confers on the company an entitlement to have paid to it “the amount of the tax credit” in the circumstances specified in s.242. As I have also pointed out earlier in this judgment, the parties are agreed that there is to be implied in s. 243 a similar right to payment of the tax credit under that section as is to be found in s.242(1)(c). It follows that the tax credit to which a company is entitled under the express provisions of s.242(1)(c) and under an implied provision in s. 243 is “a tax credit under section 231” within the definition of “tax credit” in s. 832(1). It is also clear, therefore, that the reference in that definition is to the tax credit described in section 231(1), and not the particular tax credit payable in the particular circumstances specified in s. 231(2) and (3). It follows that the reference to “a tax credit under section 231” in s. 788(3)(d) is also a reference to the tax credit specified in s.231(1), and is not confined to the particular tax credit payable in the particular circumstances specified in s. 231(2) and (3), but extends to the tax credit payable pursuant to s. 242(1)(c) and 243. That conclusion is entirely consistent with what Peter Gibson LJ said in para. [48] of Pirelli.

No admissible evidence has been adduced by HMRC to qualify that ordinary reading of the statutory language. Nor, on the face of it, does such an interpretation lead to an anomalous result. If, as is common ground, s. 788(3)(d) embraces s. 231(3), then the legislation undoubtedly contemplates the extension to foreign individuals of the anomalous financial benefit I have described earlier in this judgment as a hangover from the former tax regime under which tax was deducted at source on the payment of dividends. In other words, it contemplates the payment of a tax credit to a foreign individual even where, were the individual a UK taxpayer, there would be no charge to income tax because, for example, the taxpayer’s personal allowances and reliefs exceed taxable income, including the dividends, and even though there has been no deduction or withholding of tax at source. If that anomalous financial benefit is extended to a foreign individual, there is no obvious reason to adopt a forced interpretation of s. 788(3)(d) in order to prevent its extension to a foreign company.

For all those reasons, I allow the appeal on the basis of the new point, not taken by the Appellant before the Special Commissioners, on s.788(3)(d).