Treaty-Based Nondiscrimination:UK Sees It!

Cases on the non-discrimination clauses of tax treaties are scarce. Therefore a reference to a recent case from the UK should be of interest to the readers. The case, even though revelling the intricacies of UK law, can be said to prove a position increasingly stated by several scholars, namely that there will be in the years to come increasing litigation in the courts about the scope of the non-discrimination article. Such surge can also be said to be linked to the broadening of the boundaries of the nondiscrimination principle under EC Law.

In an article titled “Treaty-Based Nondiscrimination: Now You See It Now You Don't”, Sanford H. Goldberg demonstrated the difficulties of articulating a consistent and rational standard to apply to determine when discrimination exists. Several articles of Scholars have also demonstrated that the consequences of Art. 24 of the OECD Model are more uncertain than those of any other article of the OECD Model. In the case summarized below, the UK high court granted, on the basis of the non-discrimination clause, the possibility for a permanent establishment (PE) to claim tax credits that were otherwise only available to resident companies.

The U.K. High Court, in the case UBS AG v. Her Majesty's Revenue and Customs (HMRC), ([2006] EWHC 117 (Ch)) allowed a claim by UBS's U.K. branches that the PE nondiscrimination article in the tax treaty between the UK and Switzerland. allows UBS to offset losses against certain dividend income to claim the U.K. tax credits applicable to such dividends.

UBS, a Swiss bank, was appealing from a decision of 7 June 2005 from the UK Special Commissioners (lead by tow renowned specialists such as John Avery Jones and Julian Ghosh) that denied a claim on the basis of Article 23(2) of the treaty between the UK and Switzerland that is entitled to the same tax credits on dividends received by the branch as could be claimed by a UK resident company. In their decision, the Special Commissioners basically agreed with UBS that the Treaty entitles the branch to the tax credits but held that such right under the Treaty was not incorporated into UK law.

UBS, which acted as a market maker on the London Stock Exchange received dividends from UK resident companies and received and paid “manufactured dividends” (primarily in consequence of stock lending transactions). The UBS case concerned years 1993 to 1996, when ACT and the right to receive a tax credit were still in force (the right to receive a tax credit was first abolished in 1997, and the full Advance Corporation Tax system was abolished in 1999). Under U.K. domestic law such a claim could be made by a UK resident company, but not by a non-resident company like UBS.

Under the UK “imputation” system of corporation tax a company paid corporation tax on all its profits, whether or not distributed. A company making distributions to its shareholders made a payment of (ACT) in respect of such distributions. The ACT paid was then set off against the corporation tax, often called mainstream corporation tax (MCT), on the company’s profits for that period. A non-corporate shareholder could set the tax credit off against his or its liability for income tax. A corporate shareholder resident in the UK would have received a tax credit in the form of franked investment income which franked its liability to account for ACT in respect of dividends which it paid.

For the purposes of the UBS case, the two critical issues 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 decision analysed two issues: (1) whether the UBS claims to a tax credits are within the nondiscrimination article of the Treaty; and (2) whether the UBS claim to a tax credit is a claim for “relief… from corporation tax” within the UK law that incorporates treaties into UK legal system (dualist system).

With regards to the first issue, the Court started by stating that Art. 23(2) of the treaty between the UK and Switzerland is based on the OECD Model of 1977, and reads 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 High Court ultimately agreed with the Special Commissioners, which considered that payment of the tax credit is part of the levying of taxation and that the taxation on UBS was less favourably levied. The UK resident company in exactly the same circumstances could claim from the UK tax authorities a payment in respect of the tax credit and UBS could not.

The High Court rejected therefore all aspects of the UK tax authorities objections to the application of the PE nondiscrimination article.

First, the UK revenue contended that Art. 23(2) had no application because no taxation was “levied” “on” UBS within the meaning of that Article. There were merely claims to a tax credit, which were rejected. The UK revenue submitted, in effect, that the PE non-discrimination article is not engaged at all if there are no taxable profits, after offset of losses, capable of giving rise to a charge to tax. The High Court, rejecting thereby the references made to both Klaus Vogel and the OECD Commentaries, considered that there is nothing in Art. 23(2) to restrict it to a narrower meaning.

Secondly, the UK revenue submitted that Art. 23(2) requires a comparison between UBS 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 would be correct the UK Company would not have been able to invoke the said tax credits. The High Court, referred to the arguments of the Special Commissioners, to reject such claim and considered that it is the nature of a permanent establishment that it cannot pay dividends and so that should be outside the comparison (i.e. the two entities are different in this respect and no meaningful comparison can be made).

With regards to the second issue under discussion (i.e. whether the UBS claim is a claim for “relief… from corporation tax” within the UK law), it is important to note that the Special Commissioners previously concluded that the relevant provisions of the treaty had not been incorporated into U.K. law. The Special Commissioners concluded on their Decision, that “the right to the payment of the tax credit under (the relevant sections of UK law) was not a payment which “reduces the [corporation] tax which would otherwise be payable”.

In this regard, the High Court noted that no conclusive answer to this part of the appeal can be found in the recent decisions of Park J. in NEC Semi-Conductors or the judgments of the Court of Appeal on the appeal from his decision which were discussed in a recent post.

In summary, the High court considered that a tax credit payable to the company 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 such tax credit mechanism, but it has nothing to do with giving relief from corporation tax. In conclusion, the High Court considered that the right to invoke the tax credit mechanism and the consequent payment of the tax credit did not fall within the words “relief… from corporation tax” as incorporated into UK domestic law.

Nevertheless the case did not end there, because an alternative argument, based on different paragraph of the UK section, was accepted by the High Court, which ultimately resulted in the victory of the appeal by UBS. This resulted in the admittance by the Court that UK rules, incorporating the treaty into U.K. law, automatically entitled a foreign company to payment of the tax credits.

Further Reading
Kees van Raad, Issues in the application of tax treaty non-discrimination clauses, BIFD, 1988/8-9, pp.347 – 352
In this article the author analyses various issues concerning the application of the OECD Model Convention non-discrimination provision (Art. 24). The article primarily focuses on general issues arising in connection with non-discrimination clauses in tax treaties. Included in the discussion are the permanent establishment clause, the nationality clause and the control clause of Art. 24.

John F. Avery Jones et al., The Non-Discrimination Article in Tax Treaties – part I & II, British Tax Review, 1991-10, pp. 359 – 385 and 1991-11, pp. 421 – 452
Article 24 of the OECD Model Convention, the non-discrimination article, raises several questions regarding interpretation, application and effect. The authors examine in detail these issues and each of the provisions contained in this article by drawing upon the OECD Commentary on the 1977 OECD Model Convention and the domestic legislation, court decisions and treaty practices.

Sanford H. Goldberg and Peter A. Glicklich, Treaty-Based Nondiscrimination: Now You See It Now You Don't, Florida Tax Review, Vol. 1 (1992), no. 2 ; p. 51-113
This article analyses the nondiscrimination concept, evaluates its general acceptance worldwide, explores its inconsistent application in the United States, and considers whether it makes sense to continue including a nondiscrimination article in future US income tax treaties.