Burlington: Good News For The Secondary Debt Market

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In HMRC v Burlington Loan Management DAC, the Upper Tribunal upheld that the anti-abuse provision in the UK/Ireland double tax treaty didn't apply, allowing Burlington to claim tax relief. The case underscores careful consideration of double tax treaties in structuring transactions.
UK Tax
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In HMRC v Burlington Loan Management DAC [2024] UKUT 152 (TCC) ("Burlington") the Upper Tribunal ("UT") dismissed HMRC's appeal, holding that the First-tier Tribunal ("FTT") was right to conclude that the anti-abuse provision in the UK/Ireland double tax treaty (the "Treaty") did not apply to the transaction under consideration.

Background

We covered the decision of the FTT in September 2022.1We have briefly summarised the facts of the case below. In Burlington, the Cayman Islands company ("SICL") had a debt claim against Lehman Brothers International Europe ("LBIE"), a UK company. The debt claim was sold from SICL to Burlington Loan Management DAC ("BLM") (an Irish tax resident company) by way of an interim assignment to Jefferies. LBIE paid interest in respect of the debt claim to BLM net of withholding on account of UK income tax.

Article 12(1) of the Treaty allocates taxing rights over interest exclusively to the state in which the recipient is resident (in this case, Ireland), rather than the source state (in this case, the UK), unless the anti-abuse provision in Article 12(5) of the Treaty applies.

BLM applied to HMRC for a refund of the UK income tax withheld under Article 12(1) of the Treaty. However, HMRC argued that "the main purpose or one of the main purposes" of the interim assignment to BLM was to take advantage of the exemption from withholding tax in the Treaty. HMRC argued that, on this basis, the anti-abuse provision at Article 12(5) of the Treaty should have applied and relief under Article 12(1) of the Treaty should not be available. The FTT found in favour of the taxpayer.

On appeal, the question before the UT was whether the assignment to BLM had the "main purpose or one of the main purposes" of taking advantage of the benefits under Article 12(1) of the Treaty.

The UT upheld the decision of the FTT, separating its analysis of HMRC's appeal into five grounds, each of which was dismissed by the UT. We consider each of these grounds below.

Ground 1: Interpretation of Article 12(5) of the Treaty

The UT considered the commentary on the OECD model convention along with other sources in determining the object and purpose of Article 12(5) of the Treaty. The UT found that the core purpose of Article 12 of the Treaty is simply to determine which of the two Treaty states (namely the UK or Ireland) should have taxing rights over interest which arises from a source in one of the states but where the interest is beneficially owned by a resident of the other state.

The UT had to consider whether there was something abusive, in the particular circumstances of the appeal, for Ireland alone to tax interest beneficially owned by a company resident in Ireland.

The UT considered whether it mattered that SICL knew that BLM was exempt from withholding on account of UK income tax. Contrary to the FTT's interpretation, the UT found that the FTT went too far in saying that a necessary condition for Article 12(5) of the Treaty to apply was for SICL to have known that the purchaser of the SAAD Claim would be relying on Article 12(1) specifically. The UT considered this to be an "unjustified gloss on the actual words chosen by the contracting States in concluding the treaty."2

Neither did theUT accept HMRC's submission Article 12(5) of the Treaty should always apply in a case where the person assigning the interest on a debt claim (in this case, SICL) was had knowledge that the purchaser would not suffer withholding on account of UK income tax as a result of the Treaty. The UT found this interpretation would turn the treaty provision "into something fundamentally different."3

In the UT's view, the question as to whether there has been treaty abuse is for the FTT to determine by considering all the circumstances of the case.

Ground 2: The FTT Overlooked the UK WHT Arbitrage

HMRC submitted that the FTT failed to take into account that "UK [withholding tax] was the sole (or, in any event, main) reason for the assignment taking place." 4 HMRC argued that the economic effect of the transaction was similar to a conduit arrangement: interest was being routed from the UK into the Cayman Islands via Ireland and escaping UK tax and that relief under the Treaty should have been denied.

The UT disagreed with HMRC's arguments and agreed with the FTT's conclusion that the presence of any UK withholding tax arbitrage did not conclusively mean that Article 12(5) of the Treaty was satisfied. The UT held that the FTT was right to focus on whether the parties' subjective purpose in entering into the transaction constituted an abuse of the Treaty. The UT noted that there would be a number of indications for those purposes. Therefore it was wrong to treat "arbitrage" as decisive on its own rather than as an element for the FTT to weigh in the balance.

Grounds 3 and 4: Specific Errors of Law in Determining BLM's Purpose and SICL's Purpose

HMRC argued there were errors in the way the FTT determined BLM's purpose in entering into the assignment. HMRC claimed the FTT failed to recognise that that there was no separate commercial purpose asthe profit was entirely dependent on BLM taking advantage of the Treaty.

The UT found that the determination by the FTT was not reached on a flawed basis and none of the points raised by HMRC "undermine the cogency of the FTT's conclusions".5 The UT noted that the FTT's core conclusion was that for BLM the existence of the Treaty was simply the setting in which the assignment took place and that the FTT could not find anything abusive in BLM, as an Irish resident company which beneficially owned the interest, taking the benefit of Article 12(1) of the Treaty.

Similarly on ground 4, the UT disagreed with the submissions put forward by HMRC and held there were no errors of law in the FTT's findings concerning SICL's purpose. The FTT found that SICL did not care about (or even know about) Article 12(1) of the Treaty on 8 February 2018 (being the date the commercial deal was agreed) and it did not care about it on 12 February 2018 either (being the date on which SICL became aware of the Treaty benefits). The UT found that the FTT was right to conclude that SICL's object or purpose in entering into the assignment did not change from 8 February to 12 February 2018, namely once SICL found out about the possible availability of benefits under the Treaty. HMRC had additional criticisms of the way in which the FTT assessed SICL's purpose in entering into the transaction. However, the UT rejected each of these criticisms.

Ground 5: No Reasonable Tribunal Could Have Made the Decision

HMRC attempted to argue that the decision reached by the FTT was one no reasonable tribunal could have reached, citing Edwards v Bairstow6, which concerned an error of fact. The UT's decision provided very limited analysis of this ground, which was similarly unsuccessful.

Takeaway Points

The UT's decision in Burlington is a welcome decision given the FTT's comments as regards the potential "enormous" impact on the secondary debt market if purchasers were to be denied the benefit of the a double taxation treaty in the circumstances under consideration in the Burlington appeal. Insofar as Burlington confirms that relief under a UK double tax treaty from the obligation to withhold on account of UK income tax will not necessarily be denied where unconnected third parties price a transaction by reference to such relief being available, this position should be more aligned with the expectation of market participants.

In addition, the UT also noted that the FTT had gone "too far" in concluding that a necessary condition for Article 12(5) to apply was the knowledge that the taxpayer would be relying on obtaining relief under the Treaty. However, the UT confirmed that Article 12(5) of the Treaty was not confined to cases involving only artificial steps or arrangements. Taxpayers should therefore continue to give careful consideration to applications for relief under double tax treaties, perhaps particularly where discussion over the potential availability of reliefs from withholding tax under those treaties forms a key element, and potentially main purpose, of the transaction structuring.

Footnotes

1. https://www.cadwalader.com/brass-tax/index.php?nid=61&eid=239

2. Burlington, paragraph 67.

3. Burlington, paragraph 70.

4. Burlington, paragraph 75.

5. Burlington, paragraph 101.

6. Edwards v Bairstow [1956] AC 14.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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