Tax

In The Commissioners for His Majesty’s Revenue and Customs (“HMRC”) v GE Financial Investments (“GEFI”) [2024] EWCA Civ 797, the Court of Appeal was asked to determine whether GEFI was a resident of the United States for the purposes of the UK-US double tax treaty (the “Treaty”) and thus entitled to double tax relief (“Issue 1”) or, in the alternative, whether GEFI was entitled to relief under the Treaty because it carried on a business in the United States (“Issue 2”). The Court of Appeal handed down its decision on 17 July 2024 and held that GEFI was neither resident in the United States nor did it carry on a business in the United States for Treaty purposes.

Background

• GEFI is a UK incorporated company and, as a result, subject to UK tax on its worldwide income.
• GEFI was the limited partner of a Delaware limited partnership, the general partner of which was GE Financial Investments Inc. (“GEFI Inc”). For US tax planning purposes, the shares of GEFI and GEFI Inc. were “stapled” (meaning they had to be traded together) and, as a result, GEFI was treated for US federal income tax purposes as a US corporation and subject to US tax on its worldwide income.
• HMRC contended that GEFI was not entitled to credit for US tax paid on US source income against UK tax on the same income on the basis it was not resident in the United States for the purposes of the Treaty and nor did it carry on business in the United States through a permanent establishment and, therefore, was not entitled to Treaty benefits.
• The First Tier Tribunal (the “FTT”) found in favour of HMRC on both Issue 1 and Issue 2.
• The Upper Tribunal (the “UT”) reversed the FTT’s decision, holding that GEFI was a “resident” and thus entitled to relief. However, although it did not affect the outcome, the UT agreed with HMRC on Issue 2.
• HMRC appealed the UT’s decision to the Court of Appeal. The taxpayer maintained that the UT had been correct on Issue 1 and argued in the alternative that GEFI was carrying on a “business” in the US (i.e. that the FTT and the UT had been wrong on Issue 2). The Court of Appeal reversed the UT’s decision and found for HMRC on both Issues.

Court of Appeal on Issue 1

Article 4(1) of the UK-US double tax treaty provides:

“…the “resident of a Contracting State” means, for the purposes of this Convention, any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or profits attributable to a permanent establishment in that State.” (Emphasis added.)

GEFI argued for a ‘functional interpretation’ of Article 4(1). In their view, the list included in the definition of “resident” simply establishes the need for taxation to be on a worldwide, rather than source, basis. Therefore, anything which gives rise to a worldwide liability to tax, such as the US rule applying to stapling of shares to a US corporation, should be sufficient to satisfy the “other criterion of a similar nature” definition and render the relevant entity a resident for Treaty purposes. (This argument had been accepted by the UT.) HMRC, on the other hand, argued for a ‘territorial interpretation’. Their position is that, in order to be a “resident”, the liability to tax needs to arise by reason of an attachment or personal connection which the taxpayer has with the country in question and that simply being subject to tax on worldwide income in that country is not sufficient to denote residence.

After considering the Treaty itself, principles of treaty interpretation set out in the Vienna Convention, case law, OECD and academic commentaries, the Court of Appeal found in favour of HMRC. The Court concluded that “the first sentence of Article 4(1) requires both the existence of a local connection falling within the enumerated criteria or which is of a similar nature to those criteria, and that that connection attracts worldwide taxation”. Although GEFI was subject to tax in the United States on its worldwide income, its connection to the US was not sufficient. Being treated as a US domestic corporation as a result of share stapling does not constitute a criteria “of a similar nature” to the other listed circumstances for these purposes.

Court of Appeal on Issue 2

As mentioned above, the UT had decided in HMRC’s favour on Issue 2 and the Court of Appeal’s discussion was more limited on this point. The Court determined that the FTT had not made a material error of law on this point and it upheld the FTT and UT decision that GEFI was not carrying on a business in the US as it was merely a passive holding vehicle. While the Court commented that it was not necessarily the case that UK tax law principles should be applied without reference to broader treaty interpretation principles, the leading judge did go on to discuss the meaning of “business” for UK tax purposes. She noted that “business” was wider than “trade”. Even though GEFI had held some large loan receivables, the test was a qualitative one and the FTT had not made a mistake in concluding that GEFI was acting as a passive holding vehicle.

Key takeaways from the decision

The decision may seem unfair in that GEFI was subjected to double tax (although it was noted that, if UK tax is payable, GEFI may be entitled to relief under US domestic law). This case demonstrates that just because an entity’s profits are subject to tax in a country doesn’t mean it will be a resident of, or carrying on a business in, that country for treaty purposes. As a result, a company may be subject to double taxation notwithstanding that the double tax treaties are intended to allocate taxing rights and limit double tax issues.