GE Financial Investments: The Debate Over Treaty Residence Continues

On June 29, 2023, the UK Upper Tribunal rendered its decision in GE Financial Investments ([2023] UKUT 00146), allowing foreign tax credits claimed by GE Financial Investments (“GEFI UK”), a UK corporation, in respect of US income taxes that it had paid as a deemed US domestic corporation, pursuant to a provision in the US Internal Revenue Code (“the Code”). The Upper Tribunal thereby reversed the 2021 decision of the First-Tier Tribunal in this case ([2021] UKFTT 0210 (TC)).

The primary issue in the case is of fundamental importance to tax treaty law: whether a domestic deemed residence rule that imposes comprehensive taxation can, on that basis alone, establish treaty residence, or whether a factual or legal connection to the taxing jurisdiction is an added requirement. The secondary issue in the case—what the threshold is for finding that a party that holds debt obligations is carrying on a business through a permanent establishment—is equally interesting but is beyond the scope of this article.

The Upper Tribunal’s decision has been appealed to the English Court of Appeal, and it is expected that the case may go all the way up to the UK Supreme Court. Therefore, the reasons of the Upper Tribunal are likely only the second instalment in an ongoing saga.

The case concerned a Delaware limited partnership (the “Delaware LP”) that was formed between GEFI UK, as limited partner, and a Delaware corporation, GE Financial Investments Inc. (“GEFI US”), as general partner. Crucially, the shares of GEFI UK and GEFI US were “stapled,” such that one company’s shares could not be sold unless the sale included all of that company’s shares and all of the other company’s shares. The Delaware LP’s activities consisted of holding five debt obligations issued by members of the partnership’s corporate group, with a total principal amount in excess of US $2.8 billion.

As a UK-formed corporation, GEFI UK was liable to UK tax on its worldwide income. However, because it was a “stapled” foreign corporation, pursuant to section 269B of the Code it was also deemed a US domestic corporation that was prohibited from claiming an exemption or a reduction from US income tax under any US tax treaty.

From 2003 to 2008, GEFI UK’s share of profits earned by the Delaware LP totalled approximately US $790 million. GEFI UK paid approximately US $303 million in US income tax on that share of partnership income. GEFI UK claimed foreign tax credits for the US tax paid against its UK income tax owing. Its claim was based on article 24 of the 2001 UK-US tax treaty (“the treaty”) because of an unusual rule in article 4(5) to the effect that if the competent authorities cannot agree on how to tax a dual-resident company, the United Kingdom must give that company credit for the non-UK tax and the United States must be given primary taxing rights. His Majesty’s Revenue & Customs (HMRC) denied the credits and assessed approximately £ 125 million of UK income tax against GEFI UK, which challenged the assessment.

The case turned on the primary issue of whether GEFI UK, while a tax resident of the United Kingdom, was also a resident of the United States for the purposes of the treaty and, as such, was entitled to UK double tax relief under article 24 thereof.

In order to be a UK or US resident for treaty purposes, article 4(1) provides that one must be “liable to tax” in that state, and the liability must be by reason of domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature.

It was not disputed that GEFI UK was liable to UK tax on its worldwide income by reason of being incorporated in the United Kingdom and, therefore, a resident of the United Kingdom under article 4(1). Although the company was subject to US tax on a comprehensive basis, the question before the UK courts, with respect to US residence, was whether the US tax liability of GEFI UK was imposed by reason of the company’s “domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature.”

The taxpayer argued that it was subject to comprehensive US income tax by reason of the share staple with GEFI US, and that this factor qualified as a “criterion of a similar nature.” In the taxpayer’s view, the connecting factors in article 4(1)—that is, domicile, residence, citizenship, place of management, and place of incorporation—must simply be viewed as bases for comprehensive tax liability under domestic law and should not be construed as requiring a territorial link to the state where residence is asserted, as was argued by HMRC. However, the taxpayer submitted that even if such factors do mandate such a link, it satisfied this requirement because (1) its share staple with GEFI US was akin to its being incorporated in the United States, and (2) the share-stapling rules applied only if GEFI UK was a subsidiary of a US corporation.

The First-Tier Tribunal rejected the taxpayer’s arguments on the basis that a tax on worldwide income is not, in itself, sufficient to establish residence for the purposes of the treaty; there must, in addition, be a “connection” or an “attachment” to the contracting state in question, which was found to be missing in this case.

Reversing the decision of the lower court, the Upper Tribunal sided with the taxpayer, holding that the common denominator of “domicile, residence, citizenship, place of management, place of incorporation” is comprehensive taxation and that, according to the OECD commentaries on article 4, tax treaties do not lay down further standards for determining who is resident for the purpose of imposing full taxation; rather, they base their standards entirely on domestic laws. In taking this position, the Upper Tribunal effectively repudiated Klaus Vogel’s gospel on tax treaty law, according to which the list of criteria in article 4(1) requires not only a requirement of full taxation but also a personal connection to a state.

In short, the respective decisions of the First-Tier Tribunal and the Upper Tribunal propound competing views on the meaning of the phrase “by reason of . . . domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature.” The First-Tier Tribunal took the narrower approach, holding that treaty residence requires full taxation by reason of a personal connection to the taxing state, while the Upper Tribunal held that comprehensive taxation is enough—although it acknowledged that some connection to the jurisdiction is obviously necessary.

A couple of comments from a Canadian perspective are in order. First, the legal issue in this case figured in the discussions about the adoption (effective as of 2007) of new section 94 of the ITA—an anti-avoidance rule that targets foreign trusts funded with Canadian capital and deems an otherwise non-resident trust to be a resident of Canada in the presence of a resident contributor or a resident beneficiary. It was believed that such deemed residence would not qualify as valid residence under Canada’s tax treaties, thereby possibly frustrating, in part, the policy objectives of the rule. Ultimately, the Canadian government enacted a treaty override in section 4.3 of the Income Tax Conventions Interpretation Act (Canada). According to this provision, a trust that is deemed to be resident in Canada pursuant to subsection 94(3) of the ITA is also deemed to be a Canadian resident for the purposes of any applicable tax treaty, notwithstanding the provisions of the latter. Therefore, a view aligned with the First-Tier Tribunal’s decision seems to have been held, at least implicitly, in Canada. This point was debated, in connection with section 94 and its deemed residence rule for trusts, in Fundy Settlement (sub nom. Garron Family Trust v. The Queen, 2009 TCC 450; aff’d 2010 DTC 5189 (FCA)), although the Supreme Court declined to address the point (2012 DTC 5063).

A second comment we would offer, from a Canadian perspective, is that although the Upper Tribunal cited extensively from Alta Energy (2021 SCC 49) in support of its decision to the effect that states are free to define residence domestically, it omitted an important paragraph:

[59]  Nonetheless, I acknowledge that treaty partners do not have the unfettered liberty to alter or redefine residence as they wish for the purposes of a tax treaty. . . . Domestic law definitions of residence should therefore broadly correspond to international norms and not have the effect of redefining residence in a way “that takes the words unmistakably past their accepted usage” (Couzin, at p. 136), including the definitions of residence that were in effect in the two states at the time the Treaty was drafted.

Côté J found that the “legal seat” criterion for tax residence in Luxembourg law is consistent with international practice, which, broadly speaking, recognizes two main methods of determining corporate residence: (1) the “place of incorporation” (or “legal seat”) rule and (2) the “real seat” or (“place of effective management”) rule. A crucial element in the Upper Tribunal’s decision in GE Financial Investments was that the US deeming rule had been a feature of the Code for at least 17 years before the treaty was entered into (see paragraph 150).

In conclusion, in light of Alta Energy, the right answer to the dilemma in GE Financial Investments may lie midway between the UK First-Tier Tribunal’s position and the Upper Tribunal’s. In other words, countries may not be completely free to deem residence on the basis of random criteria (for example, a country may not deem all blue-eyed humans to be its tax residents) as long as such criteria result in comprehensive taxation; however, at the same time, it may be no more reasonable to expect residence to be based strictly on widely accepted forms of territorial connection. In particular, as the Upper Tribunal explains at paragraph 104, the list of anti-avoidance deemed residence rules is growing in a number of countries. Section 94 of the ITA is one such rule. Another is the US 80 percent threshold anti-inversion rule. Therefore, whether the stapled stock deemed residence rule in GE Financial Investments qualifies for treaty residence may properly be determined by the English Court of Appeal on the basis of whether such deemed residence broadly corresponds to international norms and does not cause “residence” to be redefined in a way that takes the words unmistakably past their accepted usage, as understood by the relevant treaty parties at the time the UK-US tax treaty was entered into.

Michael Kandev and Taj Kudhail
Davies Ward Phillips & Vineberg LLP, Montreal