The recent decision of the United Kingdom’s First-Tier Tribunal in Burlington Loan Management DAC v. HMRC ( UKFTT 290 (TC)) considered a specific anti-avoidance rule in a tax treaty, and the case may provide a foretaste of the sorts of disputes that will arise under the principal purpose test in article 7 of the multilateral instrument (MLI).
SAAD Investments Company Ltd. (“SAAD”), a Cayman company, had an interest-bearing debt claim against Lehman Brothers International (Europe) (“Lehman UK”), a UK company. Following the full discharge by Lehman UK’s administrators, in September 2016, of the principal amount of the debt, SAAD retained the right to receive the interest payable in respect of the claim, amounting to £ 90 million. SAAD was not entitled to any treaty relief in respect of the debt claim and would have been subject to UK statutory withholding tax of 20 percent had Lehman UK paid SAAD the interest.
In February 2018, SAAD’s liquidators sold the right to receive interest to Burlington Loan Management DAC (“Burlington”), an Irish company, for an amount equal to 92 percent of the amount of the interest owing. In July 2018, Lehman UK’s administrators discharged the amount of the outstanding interest in full, paying 80 percent of the interest to Burlington and withholding 20 percent of the interest in compliance with their UK withholding tax obligations. Burlington applied to HM Revenue & Customs (HMRC) for a refund of the amount withheld in reliance on article 12(1) of the double taxation treaty between the United Kingdom and the Republic of Ireland, which provides relief from UK tax on interest derived and beneficially owned by an Irish resident. HMRC denied Burlington’s claim on the basis that article 12(5) of the treaty applied; this provision denies the benefit of article 12(1) if “it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the debt-claim in respect of which the interest is paid to take advantage of [article 12 of the treaty] by means of that creation or assignment.” Burlington appealed to the First-Tier Tribunal, which held that HMRC had not discharged its burden of proving that article 12(5) applied in the circumstances.
HMRC argued that Burlington was aware that the seller was likely to incur UK withholding tax if it retained the debt claim; this awareness accounted for the significant discount at which Burlington offered to purchase the debt claim (paragraph 156). Thus, according to HMRC, one of Burlington’s main purposes must have been to generate a profit from that discount in reliance on its exemption from UK withholding tax under article 12(1).
The tribunal disagreed with HMRC, finding instead that Burlington’s sole purpose was to realize a profit (paragraph 176). The tribunal accepted that Burlington was aware of its ability to benefit from article 12(1) of the treaty, but the tribunal found that ability to be merely a component in the calculation of the purchase price that Burlington was willing to pay; that ability did not form any part of Burlington’s purpose in acquiring the debt claim. It was merely part of the “scenery” in which Burlington made its offer (paragraph 174).
HMRC had also argued that SAAD must have known, on the basis of the offer price, that the purchaser was eligible for the benefits of a treaty. Therefore, according to HMRC, one of SAAD’s main purposes had been to take advantage of article 12(1) by assigning the debt for a price that reflected the purchaser’s exemption and thereby realizing more than it would have if it had held onto the asset (paragraph 157).
Again, the tribunal disagreed. It found that SAAD’s sole purpose had been to realize the claim for the best possible price and that it had agreed on that price in principle before even inquiring about the identity or the tax residence of the end purchaser (paragraph 187). Although SAAD had subsequently become aware of Burlington’s identity and the precise legal basis for its withholding tax exemption before finalizing the transaction (which the tribunal held to be a precondition for engaging article 12(5)), the tribunal declined (paragraphs 193-95) to find that SAAD, as a result of this awareness, had achieved one of its main purposes by taking advantage of article 12(1). The tribunal distinguished, in the process, between (1) situations where a person sells a debt claim outright for a purchase price that reflects the existence in the market of parties that are able to benefit from tax attributes that they do not themselves enjoy, and (2) situations that anti-avoidance provisions such as article 12(5) were intended to address, which typically involve the retention, by the resident of the non-treaty jurisdiction, of some indirect economic interest in the debt claim that allows that resident to take advantage of the treaty benefit indirectly (paragraphs 196-200).
The tribunal’s conclusion that article 12(5) does not apply in these circumstances seems well founded. It is comforting, in particular, to read the tribunal’s commercially sensible conclusion that an anti-avoidance rule that denies treaty benefits on the basis of a taxpayer’s purposes is not engaged merely because a taxpayer has knowledge of its tax position, including its entitlement to treaty benefits, and relies on that knowledge to determine the price at which it is willing to make an investment.
One troubling aspect of this case is the tribunal’s willingness to consider SAAD’s purpose as relevant to the article 12(5) analysis. The tribunal ultimately rejected HMRC’s arguments that one of SAAD’s main purposes was to take advantage of article 12(1), and it did suggest that article 12(5) was intended to apply only to transactions involving conduits or treaty shopping; however, its conclusion on this point was grounded in the specific facts. The tribunal may have left the door open to the perverse possibility that a taxpayer’s ability to access a treaty benefit will depend on an unrelated taxpayer’s purpose in entering into a transaction. This would be an inappropriate outcome, and it could result in similarly situated taxpayers being taxed differently because they acquired assets from counterparties with differing purposes—a consideration that should be entirely irrelevant to the analysis.
The tribunal’s reasoning may have been driven by article 12(5)’s particular focus on the purpose of “any person” —an emphasis lacking, perhaps, in most other anti-avoidance rules. (Notably, the principal purpose test in article 7 of the MLI does not refer to the purpose of “any person.”) It is to be hoped that subsequent cases will not endorse this reasoning, at least not with respect to provisions that lack a specific reference to “any person.”
Chris Sheridan and Jeffrey Shafer (with thanks to Jessica Charendoff)
Blake Cassels & Graydon LLP, Toronto