Royal Bank of Canada: A common sense approach to tax treaty interpretation

Introduction

In Royal Bank of Canada v HMRC [2023] EWCA Civ 695, the Court of Appeal upheld the taxpayer's appeal in a case relating to the interpretation of the UK-Canada double tax treaty (the "Treaty").  The Court of Appeal's judgment represents a victory for common sense.  The Court held that certain payments made to the taxpayer fell within the scope of the "business profits" article of the treaty rather than the "immovable property" article and were therefore exclusively taxable in Canada.  HMRC contended that the payments were income from immovable property on the basis that they were consideration for the right to work oil deposits in the North Sea.  This was implausible because, as the Court of Appeal recognised, the taxpayer in this case had never had any right to work the relevant deposits, and instead had a right to receive payments calculated by reference to the value of oil extracted from a North Sea field.

Relevance for other taxpayers

While the immediate conclusions from the Court of Appeal's judgment are unlikely to be of wide application, the Court of Appeal's judgment provides (at [23]-[30]) a convenient summary of the approach that the Courts have adopted in relation to tax treaty interpretation. Some of the principles adopted by the Courts in this area are as follows:

1. As a treaty between two states or territories, a tax treaty should be interpreted in line with the Vienna Convention on the Law of Treaties ("VCLT").  Article 31(1) of the VCLT states that a "treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose."
2. The UK's tax treaties are also not to be interpreted in a parochial manner.  Instead, they should be interpreted in a way that is "international, not exclusively English" and in a manner that is "unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation".
3. The Courts may make reference to the Commentaries which accompany the Model Tax Treaty (typically OECD but in certain cases UN) on which the relevant treaty is based.  While the Commentaries may be useful, they are not necessarily determinative.  They "are to be given such persuasive force as aids to interpretation as the cogency of their reasoning deserves".

The Court of Appeal's judgment also confirms that light may be shed on the meaning and scope of provisions within a particular double tax treaty by reference to the provisions of other double tax treaties to which the UK or the other treaty state is party.  While this evidence was not determinative in this particular case, the Court of Appeal's judgment expands the material on which other taxpayers may draw in disputes with HMRC relating to the interpretation of tax treaties.

The Court of Appeal's judgment is also notable as it is one of a number of tax-related decisions in recent months where the judgment has been given by Lady Justice Falk.  It may be the case that, following her appointment to the Court of Appeal last year, the Court is seeking to draw on Lady Justice Falk's previous experience in the Tax Tribunals (and before that as a longstanding tax practitioner).

Background

Royal Bank of Canada ("RBC") is a company that is incorporated and tax resident in Canada. As its name suggests, it carries on a banking business in Canada (as well as certain other jurisdictions).  RBC has a branch in the UK (in  London) but it was common ground that the payments in issue in this case were not connected with that permanent establishment; instead, HMRC contended that RBC's right to receive the payments in question gave rise to a separate deemed permanent establishment under UK tax law.

In the 1980s, RBC provided a loan to Sulpetro Limited ("Sulpetro"), a Canadian oil company with activities around the world.  One of Sulpetro's subsidiaries (Sulpetro (UK) Limited or "SUKL") was granted a licence to undertake oil exploration and exploitation activities in the Buchan field in the North Sea, and it was agreed that Sulpetro would pay for the costs of exploration and exploitation in return for receiving all of the oil extracted from the field.  When SUKL was later sold to BP in 1986, together with Supletro's rights to receive oil from SUKL, BP agreed that that, in addition to certain other payments, it would make "royalty" payments to Supletro in respect of the production undertaken at the Buchan field (the "Payments").  The Payments were roughly equal to 50% of the amount by which the market value of each barrel of oil produced at the Buchan field exceeded US$20.

When Sulpetro entered financial difficulties in the 1990s and went into receivership, RBC (as a creditor of Sulpetro) became entitled to receive the Payments under the terms of a court order.  BP subsequently transferred its interest in the Buchan field to Talisman Energy Inc. ("Talisman"), which was later acquired by Repsol.  As such, in the tax years which are relevant to the dispute (the appeal concerns assessments and amendments for periods from 2008 to 2015), the Payments were made by Talisman to RBC.

Relevant provisions from the UK-Canada Double Tax Treaty  

Under the "business profits" article of the Treaty (Article 7), the profits of an entity that is tax resident in Canada will, as a general rule, be taxable in Canada rather than the UK.  An exception to this rule is where the Canadian entity carries on business in the UK through a UK permanent establishment.  In that case, the UK would be able to tax any profits attributable to the Canadian entity's permanent establishment in the UK.

Under the "income from immovable property" article of the Treaty (Article 6), income from immovable property situated in the UK may be taxed in the UK, even if the recipient of the income is tax resident in Canada.  Under Article 6(2) of the Treaty, "immovable property" is defined as including "rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources".

Earlier decisions

The dispute between RBC and Canada related to whether the Payments were taxable in the UK under relevant provisions of the Corporation Tax Act 2009 ("CTA 2009") and, if so, whether the terms of the Treaty meant that the UK had surrendered its taxing right.  If the Payments fell within the scope of Article 6 of the Treaty, the UK would have retained its taxing right.  If, however, the Payments fell within the scope of Article 7, the UK would have surrendered its taxing right and the Payments would be taxable only in Canada.

Both the First-tier Tribunal and the Upper Tribunal decided both issues in HMRC's favour. In each case, the relevant Tribunal held that the Payments were taxable in the UK under CTA 2009, on the basis that the Payments were profits from exploration or exploitation rights in the UK sector of the continental shelf, and so were deemed to be profits of a permanent establishment in the UK.  Both Tribunals also decided that the UK had not surrendered its taxing right, because the payments fell within the scope of Article 6 of the Treaty.

The Court of Appeal's decision

The Court of Appeal's decision was given by Lady Justice Falk (with whom Lady Justice Asplin and Lord Justice Nugee agreed).  Overturning the decisions of the First-tier Tribunal and the Upper Tribunal, the Court of Appeal held that the Payments did not constitute "income from immovable property" for the purposes of the Treaty and instead fell within the scope of the "business profits" article.  As such, because the Payments were not attributable to a permanent establishment of RBC in the UK (with the meaning of the Treaty), the Treaty gave Canada an exclusive taxing right over the Payments.

The Court of Appeal reached this conclusion on the following grounds (each of which on its own was sufficient for RBC to succeed):

1. The relevant part of the definition of "immovable property" in Article 6 only covers payments made to a person who has a continuing interest in the land in question, such as where payments are made to a party in return for that party granting another party the right to work mineral deposits.  This was established by the Court of Appeal with reference to the French text of Article 6 (because the French text of the Treaty has equal weight to the English text), the other articles of the Treaty and relevant OECD Commentary (the parties agreed to use the 2005 version of the Commentary, which was the version in place during the tax years which were under appeal).  The Court of Appeal also made reference to relevant articles from other double tax treaties to which either the UK or Canada is party.  RBC did not hold, and had never held, any interest in the Buchan field and therefore the Payments could not be said to be income of RBC from immovable property within the meaning of Article 6.
2. In any event, Sulpetro had never had any right to extract oil from the Buchan field.  Instead, this right belonged to SUKL, a subsidiary of Sulpetro.  Sulpetro had the right to set the work program for the extraction process but it did not undertake (and had no right to undertake) the extraction, which was undertaken by SUKL alone.  As such, the Payments were not payments as consideration for the right to work the relevant oil deposits, because Sulpetro (and later RBC, following Sulpetro's entry into receivership and subsequent dissolution) never had any such right.

The approach taken by the Court of Appeal to the interpretation of Article 6 accords with the common sense meaning of income from immovable property, requiring a direct link with the immovable property in question (in this case, an oil field in the UK continental shelf).  In considering one of the arguments raised by HMRC, Falk LJ said, "… the Payments are in any event calculated by reference to the sale price of a movable asset, being the oil extracted from the Buchan field.  Any link to immovable property is insufficiently direct for the Payments to be treated as derived from immovable property.  The source is not land or any interest in land."

The Court of Appeal also held that, as regards RBC, the Payments did not fall within the scope of the "capital gains" article of the Treaty (Article 13).  This was unsurprising because RBC had not alienated rights or other assets relating to oil extraction in return for receiving the Payments.  It had no such rights to alienate.  Instead, RBC had merely inherited Sulpetro's entitlement to the Payments.Having decided the case on the basis that the Treaty prevents the UK from taxing the Payments, the Court of Appeal chose not to address the question of whether the Payments would have been taxable under UK law (in particular, whether the Payments gave rise to a deemed permanent establishment of RBC in the UK under s. 1313 CTA 2009) had the Treaty not applied.  The Court of Appeal noted that its decision not to address this question was not an endorsement of the approach adopted to this issue by the Tribunals below, and expressed doubt about the conclusion that RBC's entitlement to the Payments was a right to the benefit of the oil extracted from the field.  As such, the proper interpretation of s. 1313 CTA 2009 remains an open question.

Notwithstanding the cogency of the Court of Appeal's reasoning, it remains to be seen whether HMRC will apply for permission to appeal to the Supreme Court.