An Irish bank has lost its case at the Court of Appeal (CoA) regarding the attribution of free capital to UK banking branches.  The bank had lost its case at the Upper Tribunal and the CoA has affirmed that judgement.

The bank, now being wound down as a victim of the banking crisis in 2008, had been profitable and the case concerned years where the bank was profitable.  HMRC sought to limit the amount of interest deducted by the branches in their corporation tax returns by reference to a capital attribution tax adjustment (CATA).  This CATA considered that some of the branches’ funding should be considered ‘free’ capital, that it was equity like and couldn’t incur an interest expense.  The bank disagreed stating that the double tax treaty the CATA was supposed to be implementing didn’t support such a model.

The treaty in question was the 1976 treaty between Ireland and the UK (the 1976 Treaty).  In 2008 the OECD issued a report and updated its commentaries on how to interpret the model treaty that the 1976 Treaty was based on.  These reports and updated commentary referred specifically to tax adjustments necessary to ensure that banking branches were considered to have adequate free capital to support their operations, assets held and risks assumed.  The question was whether these later commentaries could be relied upon as the 1976 Treaty had been concluded many years earlier so couldn’t have been the parties’ intention at the time.

CoA found that it wasn’t necessary to rely on the later, 2008, reports and commentaries as the wording of the 1976 Treaty hadn’t changed much over time and market practice had shown that many tax authorities were using models, similar to the CATA to allocate free capital to banking branches.  The 2008 reports and commentaries had only helped to find models that could be uniformly applied and hadn’t introduced the concept as it was already being applied.  Evidence was found that certain models were used from the early post war period, 1950s, even though these models were later shown to be inadequate.

The wording of the 1976 Treaty was to be interpreted in a fairly wide manner so differing models could be used to arrive at the result intended by the parties to the Treaty at the time.  The bank in question hadn’t used a differing model but had sought to deduct all interest.

The decision can be found at: Irish Bank Resolution Corporation Ltd v Revenue And Customs – Find case law (nationalarchives.gov.uk)

While it wasn’t part of the case, if the bank had used a model to attribute capital to the branches it is possible that this model would have been accepted over HMRC’s CATA where it could be shown that the competing model accurately reflected the capital deemed to be held by the branches to cover their operations, assets held and risks assumed.

Please contact us if you have any questions on the OECD Authorised Approach to allocating capital to branches or have any other international tax query.  We are experienced with these issues.