Aozora - Unilateral credit for US withholding tax allowed even where no treaty relief available

In Aozora GMAC Investments Ltd v HMRC [2021] UKFTT 99 TC, the First-tier Tribunal (FTT) has held that section 793A(3), Income and Corporation Taxes Act 1988 (ICTA), did not prevent a UK taxpayer obtaining unilateral relief from UK tax in respect of US withholding tax despite failing to qualify for treaty relief.

Background

Aozora GMAC Investments Ltd (Aozora) was a UK-resident subsidiary of a Japanese bank.  Aozora itself had two subsidiaries in the US, one of which, in November 2006, borrowed from it $217,770,000 for a little over 10 years at a fixed annual interest rate of 12%.  

Interest income accrued on the loan for the periods ending March 2007 to March 2009, and the US subsidiary withheld US tax from each payment, as required by US law.  In March 2008, Aozora applied to the US tax authorities for relief under the US-UK double tax treaty (the DTT), but the application was refused on the basis that the limitation of benefits clause in the DTT applied.

Unable to access relief from withholding at source in the US, Aozora  claimed unilateral relief by way of credit under section 790, ICTA.  HMRC issued closure notices on the basis that section 793A(3), ICTA, prevented Aozora from obtaining relief.  

Aozora appealed to the FTT.  

Legislation

Article 11 of the DTT provides that interest arising in one Contracting State and beneficially owned by a resident of the other is taxable only in the other state (where the taxpayer is resident).

Article 24(4)(a) of the DTT provides that in certain circumstances, US tax payable in the US shall be allowed as a credit against any UK tax computed by reference to the same profits, income or chargeable gains. 

Article 23(1) of the DTT provides that the benefits of the DTT apply (subject to limited exemptions) only to a 'qualified person' fulfilling certain conditions.

Section 790, ICTA, provided, at the material time, that unilateral relief was to be given in respect of tax payable on income and chargeable gains to the extent taxed overseas by allowing a credit against UK income tax or corporation tax.  Section 793A, ICTA, operates to deny unilateral relief in circumstances where certain double tax treaties (including the DTT) allow credit in respect of an amount of tax.  In particular, section 793A(3) provides that: "Where arrangements made in relation to a territory outside the United Kingdom contain express provision to the effect that relief by way of credit shall not be given under the arrangements in cases or circumstances specified or described in the arrangements, then neither shall credit by way of unilateral relief be allowed in those cases or circumstances".

FTT decision

The appeal was allowed.

Aozora placed great reliance on the inclusion of the word 'express' in section 793A(3).  It argued that this meant that the relevant provision must state, in terms, that relief by way of credit was not to be given in order for section 793A(3) to have effect and prevent a unilateral credit from being applied.  'Express' was not being used in contradistinction to 'implied', since there was no scope for terms to be implied into treaties within the Vienna Convention on the Law of Treaties. It simply meant that the provision must state that relief by way of credit was not to be given.   

HMRC argued that section 793A(3) should be construed using normal (domestic) principles of statutory construction and that, accordingly, the section operated to deny unilateral credit relief if the DTT had the effect of denying relief.  Since Article 23 of the DTT precluded Aozora from benefiting from Article 24, it followed that unilateral relief should not be available in the UK.  The purpose of section 793A(3) was, so HMRC argued, to ensure that the provisions agreed by states in double tax treaties were respected in domestic law.     

The FTT agreed with Aozora.  The DTT was not explicit as to the circumstances in which credit relief was to be denied and Article 23 was not an express provision to the effect that relief by way of credit shall not be given.  In the view of the FTT, the purpose of section 793A(3) was not to ensure that a balance negotiated between parties to double tax treaties was not upset – double tax treaties were not executed with a view to determining how the UK would tax its own residents.  The DTT itself envisaged that taxpayers might face a lighter burden of taxation domestically than under the DTT.  

Although tax considerations had played a part in the decision to finance Aozora's US subsidiary through the UK, rather than directly from Japan (home of its ultimate parent), this did not preclude unilateral relief from applying.  

Comment  

Aozora had previously brought (unsuccessful) judicial review proceedings in the context of this dispute, in relation to whether a statement made in HMRC's International Manual gave rise to an enforceable legitimate expectation. Our commentary on the Court of Appeal's decision in that case can be read here.  

A strict application of domestic legislation in the context of international taxation is to be welcomed.  The Limitation on Benefits clause in the DTT provides a highly mechanistic set of criteria to determine who can benefit from the treaty. It is perhaps fitting that the interpretation of the UK's domestic legislation in this context should yield a similarly mechanistic result (even if, in practice, this meant that the taxpayer obtained relief).  Had there been even a suggestion of 'main purpose' to the tests set out in either the DTT or the UK's domestic legislation, the FTT might have reached a different conclusion.

The decision can be viewed here.