Court of Appeal rejects Treaty challenge to the United Kingdom’s “capital attribution” tax legislation

Irish Bank Resolution Corporation Ltd v HMRC [2020] EWCA Civ 1128 concerns the compatibility of UK tax legislation with the business profits article (article 8(2)) of the UK / Ireland Double Taxation Convention of 1976 (the “UK / Ireland Treaty”).   

A non-UK resident company is chargeable to corporation tax if it conducts a trade in the UK through a permanent establishment (“PE”).  A PE is merely a fixed place of business of the company (e.g. an office); it has no legal personality of its own distinct from the head office.  As corporation tax is charged on all profits attributable to the PE, a calculation has to be made to determine the appropriate attribution for tax purposes.    

The question which arose in Irish Bank Resolution Corporation was whether the attribution method chosen by the UK was compatible with the requirements of the UK / Ireland Treaty.  The UK legislation (section 11AA Income and Corporation Taxes Act 1988, now rewritten to section 21 Corporation Tax Act 2009) requires the profits of a PE to be computed using the debt and equity capital which the PE could reasonably be expected to have had if it had been a distinct and separate enterprise operating under certain specified conditions.  This process is known as a “capital attribution tax adjustment”. 

In this case, the PEs had prepared their accounts on a basis that did not reflect the UK legislation.  The basis adopted by the PEs substantially reduced the amount of equity capital attributable to each PE (and correspondingly increased its debt capital) for the purposes of computing its taxable profits.  As deductions are only available in relation to the cost of debt financing (i.e. interest costs) the taxpayers’ approach would have reduced the PEs’ UK corporation tax liabilities by around £20 million. 

The taxpayers argued that the debt financing identified in the accounts of the PEs was the appropriate amount to be used for tax purposes and that the exercise required by the UK legislation contravened the UK / Ireland Treaty.  The Court of Appeal disagreed and accepted HMRC’s submission that there was nothing in the Treaty which precluded the operation of the UK legislation. 

Jonathan Bremner QC acted for HMRC.  The Judgment can be found here