The Civil Division of the Court of Appeal handed down its judgment in Bayfine UK v HM Revenue and Customs [2011] EWCA Civ 304 on 23 March 2011. This case concerns the availability of double taxation relief pursuant to article 23 of the US/UK Double Taxation Convention (“the Treaty”) (as set out in Part I of Schedule 1 to the Double Taxation Relief (Taxes on Income)(The United States of America) Order 1980 SI 1980/568), or alternatively unilateral relief from double taxation under {2291801|section 790 of the Income and Taxes Act 1988 (“the 1988 Act”).

The appellant was a company resident for tax purposes in the UK, and the transactions in question were self-cancelling forward contracts with Bank of America, under which either the appellant or another member of its group of companies would make a large gain or large loss but it was not known at the outset which would make the gain and which the loss. In the event, the appellant made a profit and the other company made an equivalent loss. The transactions in question had no commercial purpose and were carried out for the purpose of taking advantage of the different treatment of profits in US and UK tax law. The appellant’s profits were taxed in the US as being those of its parent company but the appellant was liable for tax in the UK in a way falling outside the Treaty and giving rise to the risk of double taxation. The appellant claimed double taxation relief under article 23 of the Treaty for tax paid by the parent company, so that no further tax was payable in the UK in respect of that profit.

HMRC rejected the claim for double taxation relief under the Treaty or alternatively under section 795A of the 1988 Act. The Special Commissioners, in turn, upheld HMRC’s decision, concluding that that under the Treaty its profits were taxable on the UK, that the UK had exclusive taxing rights and that the US could only tax those profits under the saving clause in Article 1(3). The primary right to tax was thus that of the UK. The income was deemed to have a UK source under article 23(3) and this meant that the UK did not have to give credit for the tax imposed on the parent company, even though it was resident in the US. Additionally, since the source of its profits was in the UK, unilateral relief was not available by virtue of section 790(4) of the 1988 Act.

Peter Smith J in the High Court, in contrast, held that the source of the appellant’s profit was in the US and thus unilateral relief under section 790(4) was available. The exercise of the saving clause overrode the provisions of article 7 and accordingly the UK had to give credit for the US tax under article 23(2). While accepting that the state of the source has the primary right to impose the tax, regard had to be given to the question of which state imposed the tax first.

Lady Justice Arden, delivering the lead judgment of the Court of Appeal considered three issues: whether HMRC was bound to give relief to the appellant under the provisions of the Treaty; if not, whether HMRC was bound to allow unilateral relief under section 790 of the 1988 Act; and whether relief was restricted by section 795A of the 1988 Act to the extent that the parent company could take steps to reclaim UK tax paid in the US.

The Court held that article 1(4) set out merely the outcome to be achieved, but not the manner in which that outcome was to be achieved, while under article 1(3), a contracting state was entitled to depart from the Treaty, but only if there was no interference with the operation of certain articles, including article 23. The purpose of article 23 was to eliminate double taxation and prevent the avoidance of taxation, which included unilaterally imposing taxation “as if the [Treaty] had not come into effect”. Whatever a contracting state did under the saving clause should not affect the proper application of the articles specified in article 1(4), and these articles had to be given a purposive interpretation. The purposes of art 23 would not be achieved if, where the US was imposing tax on the basis of the saving clause, double taxation occurred and each contracting state had to give relief.

It was clear from the structure of article 1(4) that it was the tax levied in the state exercising the saving clause power that had to give way, and thus HMRC had not been bound to give relief to the appellant. Under article 23(3), the source of the appellant’s profit for the purposes of art 23(2) was in the US, but that did not necessarily mean that the UK had an obligation under article 23 to give relief against US tax paid on that profit. The US authorities on the other hand were obliged to give relief.

Similarly, HMRC was not bound to allow unilateral relief under section 790 of the 1988 Act. The parent company was entitled to claim credit in the US for the UK tax paid, and it was only to the extent it could not do so that the appellant could claim relief under section 790. If credit were not available in the UK, then it could be held that section 790 applied not only to the situation where there was no Treaty provision but also to the situation where the provision in the Treaty was for some reason inadequate or deficient to give the taxpayer from double taxation.

The Court saw no reason why Parliament would not have wished to achieve that result, and, moreover, the subsequent insertion of section 793A made it clear that unilateral relief applied not just to voids in treaties but also to situations where there was a provision which did not apply in a particular situation. However, section 790 could not be used to override a treaty which by virtue of section 788 had effect in domestic law. The words “providing for such relief” in section 790(1) could properly be interpreted as meaning “making provision with respect to such relief” in order to give effect to the obvious purpose of section 790 of giving relief where it was otherwise not available under the Treaty.

The Court thus allowed the appeal on the first two issues, and dismissed the appeal with respect to the last one.