The FTT decision in The Felixstowe Dock and Railway Company & Others v Commissioners for HMRC [2011] UKFTT 838, which was released on December 19 2011, builds on the Philips Electronics and FCE Bank cases. In addition, the decision contains an interesting interpretation point on section 410 Income and Corporation Taxes Act (ICTA), suggesting that companies need to be wary of how they approach buyout transactions in joint ventures.
The applicants were UK resident companies in the Hutchison Whampoa group, whose ultimate parent, Hutchison Whampoa Limited (Hutchison), was resident in Hong Kong. They had claimed consortium relief for losses in the joint venture (that is, the consortium company), Hutchison 3G UK (3G). The link company with the Hutchison Whampoa group was resident in Luxembourg.
The FTT was asked to consider three questions:
· Is the fact that the UK requires a link company to be UK resident a breach of the freedom of establishment where the ultimate parent of the group is resident outside the EU?
· What effect does the non-discrimination article in the UK/Luxembourg double taxation convention have on the claims?
· What is the impact of section 410 ICTA (which precludes group relief where certain specified “arrangements” exist) on the claims?
The first question has been referred to the Court of Justice of the European Union (CJEU) and overlaps with the preliminary reference from the Upper Tribunal in C-18/11 Philips Electronics, which was heard in the CJEU on February 16 2012.
The referrals in both cases concern the condition in the UK’s legislation that the link company (that is, the company which is common to the consortium and to the company group of which in both cases the claimant is a member) has to be UK resident or carrying on a trade in the UK through a permanent establishment. In both cases, the referring tribunal also asks whether, if this constitutes a breach of EU law, the UK nevertheless has to provide a remedy to the UK claimant company, which (in the words of the reference) has not exercised the freedom of establishment.
Role of non-EU companies
The facts of the two cases differ in that the Hutchison group also includes some non-EU companies in the chain of companies linking the surrendering company to the claimant company. HMRC argue that the presence of a non-EU ultimate parent, here in Hong Kong, would mean that article 49 is not engaged.
The question for the CJEU is of general interest to non-EU parented groups making group relief claims. HMRC argue that as group relief is an advantage to the group as a whole, the company which would be disadvantaged by any breach of EU law as a result of the link company condition would be the ultimate parent, which is resident outside the EU. Accordingly, they say that for the applicants to claim that they are entitled to group relief is in effect a claim by them for a benefit which should be enjoyed by the Hong Kong resident parent company. Taking this argument to its natural conclusion would suggest that HMRC would not accept that a company resident in the EU is protected by the freedom of establishment where its ultimate parent is resident outside the EU, as the benefit of any claim would theoretically always end up in the hands of the ultimate parent. This is also the approach that HMRC appear to have adopted in arguing that M&S-style group relief claims are inapplicable to groups with a structure identical to that of M&S save that they are owned by a non-EU resident ultimate parent. The taxpayers have long argued that the ultimate ownership of an entity is irrelevant in considering that entity’s treaty rights.
Non-discrimination in view
As to the second question, the wording of the non-discrimination article (NDA) in the OECD’s model treaty prohibits a company in State A owned by a resident of State B from being “subjected in [State A] to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises in [State A] are or may be subjected.”
In the Upper Tribunal’s decision last October in FCE Bank v HMRC [2011] UKUT 420 (TCC), the UK’s pre-Finance Act 2000 group relief rules were found to be in breach of the NDA in the UK/US double taxation convention. FCE’s group relief claim for the surrender of losses between sister UK subsidiaries of a common US parent was denied on the basis that, by operation of section 413(5) of ICTA, the companies did not form a group for the purposes of transferring group losses. The Upper Tribunal decided that the claimant company did suffer taxation which was “other or more burdensome” by reason of the US residency of its parent. However, HMRC have appealed this decision and the Court of Appeal will hear the appeal later in the year.
In the Felixstowe case, a similar question arose in relation to the NDA at article 25(6) of the UK/Luxembourg double taxation convention. Here, the applicants sought to invoke the terms of the NDA in respect of the relationship between the Luxembourg resident link company and the UK resident consortium company (3G). Unlike FCE, therefore, the UK company in question was not the company which had suffered the taxation; rather it was the company seeking to surrender the losses.
Despite the taxpayers’ contention otherwise, the FTT distinguished this case from FCE Bank on that very basis. Counsel for the applicants had sought to argue that the inability of 3G to surrender its losses amounted to “taxation” which was “other or more burdensome” and also “any requirement connected therewith” that was similarly other or more burdensome, in that the purpose of the NDA was to prevent differences in tax treatment based solely on foreign ownership. HMRC’s counsel argued that 3G had not been “subject to taxation”. Furthermore, the loss of a payment for surrendering losses was an opportunity lost not an obligation. Any “other requirement” must be connected to taxation to which the company in question was subject, and, in any event, could only relate to an obligation and not an opportunity lost.
The FTT accepted that, though there was a difference in treatment of 3G by reason of the non-UK link company, this did not lead to 3G paying more tax. It was not therefore “subject to taxation”. The core question, therefore, was whether the difference in treatment resulted in “any requirement connected therewith” which was “other or more burdensome”. The FTT refused to take a narrow approach to the DTC wording and decided that to give effect to the DTC it was necessary to see what it was trying to prevent: different treatment. The reference to “subject to taxation…” was found not to concern a particular liability or burden but was a reference to the relevant contracting state’s tax regime in general. This meant that it was enough to look at the situation as a whole, and preventing relief would preclude 3G from benefiting from a payment for relief which its UK-owned comparator could have obtained. Having reviewed the authorities and the OECD’s commentary on the model treaty, the FTT found that the inability of 3G to make use of its losses by surrender and its inability therefore to obtain a payment for group relief, did breach the NDA. Section 788 ICTA thus enabled the applicants to obtain their relief.
Agreements trip up taxpayers
Unfortunately for the taxpayers, the FTT found against them on a third issue: the question of whether certain agreements that Hutchison had entered into with the other consortium members to buy their indirect holdings in 3G amounted to “arrangements” under section 410 ICTA, thus precluding the consortium relief from being claimed. Share purchase agreements (SPAs) were entered into between Hutchison and KPN Mobile and NTT DoCoMo to acquire their interests in 3G. The purchases were not completed and thus the shares were not transferred until some 18 and 12 months respectively after the date of the SPAs, so the quantum of losses at stake was significant.
The taxpayers had argued for a purposive approach to interpretation of the legislation, in that because section 410 was an anti-avoidance provision the “arrangements” referred to must be “avoidance arrangements”. Furthermore, they submitted that section 410(2) was not intended to penalise commercial arrangements and that the operation of section 410 to exclude relief for the intervening period, despite the fact that consortium relief could be validly claimed before the date of the SPAs and group relief after the date of transfer of the shares, would produce an absurd result. Again the FTT looked at the ordinary meaning of the words and concluded that arrangements of any kind were caught; “arrangements” did not just mean “tax avoidance arrangements” and so the taxpayers were denied the relief from the date of the SPAs. The FTT was not prepared to construe the legislation in a way so clearly against its obvious meaning. If Parliament had wished to prevent such an anomaly they would have done so.
On the current state of the law, therefore, taxpayers should exercise caution about buyout rights in joint ventures where group or consortium relief may be an issue and in particular be wary of long periods between agreement and actual transfer of shares.
It has to be expected that the FTT decision will be appealed to the Upper Tribunal on the domestic law points and, of course, it will be early to mid-2013 before the CJEU delivers its judgment on the preliminary reference. Taxpayers will therefore have to wait patiently before receiving final determination of these wide-ranging issues.
Michael Anderson (anderson.michael@dorsey.com) is a partner and
Nicola Hine (hine.nicola@dorsey.com) is a trainee solicitor in the London office of Dorsey & Whitney
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------Philip Baker QC and Nicola Shaw, instructed by Ernst & Young, for the appellants (the Felixstowe Dock and Railway Company Limited & Others)
David Goy QC and Gerry Facenna, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the respondents
