Spc00738

DOUBLE TAXATION RELIEF – effect of s 795A Taxes Act 1988 – whether the reasonable steps include entering into a different transaction – no – appeal allowed

THE SPECIAL COMMISSIONERS

	HILL SAMUEL INVESTMENTS LIMITED	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioners: 	DR JOHN F. AVERY JONES CBE 
						EDWARD SADLER

Sitting in public in London on 9 February 2009

David Milne QC and Rupert Baldry, counsel, instructed by Linklaters LLP, for the Appellant

David Ewart QC and Mr Richard Vallat, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1.	Hill Samuel Investments Limited (“the Appellant”) appeals against amendments to its corporation tax self-assessment returns for the years ended 31 December 2000 and 2001 on the basis that the Appellant was not entitled to double taxation relief for US tax.  The Appellant was represented by Mr David Milne QC and Mr Rupert Baldry, and the Respondents (“HMRC”) by Mr David Ewart QC and Mr Richard Vallat.
2.	The issue in this appeal is whether the Appellant is prevented by s 795A of the Taxes Act 1988 from claiming double taxation relief.
3.	There was an agreed statement of facts as follows:
HSIL and background
(1)	Hill Samuel Investments Limited (“HSIL”) is, and was at all relevant times, a private limited company incorporated in England and Wales and resident in the UK for the purposes of UK tax.
(2)	HSIL was at all relevant times, a direct 100 per cent. subsidiary of Lloyds TSB Bank Plc (“LTSB Bank”), which was at all relevant times, a direct 100 per cent. subsidiary of Lloyds TSB Group Plc (“LTSB”), a public limited company incorporated in England and Wales and listed on the London Stock Exchange.
(3)	HSIL’s claim for double taxation relief arises from its being a partner in two separate and unrelated partnerships, each of which was established under the laws of Delaware in the US: “US Partnership A” and “US Partnership B” (each a “US Partnership” and together the “US Partnerships”).
(4)	Although there was no relationship between the two US Partnerships, they were both structured in similar ways, as illustrated in figures 1 and 2 below, which show the structure of the US Partnerships prior to and following HSIL becoming a partner.

Structure Diagrams
Figure 1 - structure diagram of the US Partnerships prior to HSIL becoming a partner

US Co

US Manager Partner

US Partner

US Partnership

Assets

Figure 2 - structure diagram of the US Partnerships with HSIL as a partner 

Assets

US Co

US Manager Partner

HSIL

US Partner

US Partnership

Retirement Agreement

Detailed description of the transactions
This description of HSIL’s involvement in the US Partnerships (the “Transactions”) is in three sections:
(a)	Section A describes the US Partnerships and the income which arose to the US Partnerships during the year ended 31 December 2000 (the “2000 Period”) and the year ended 31 December 2001 (the “2001 Period”) (together the “Periods”);
(b)	Section B describes the US Federal Income Tax (“US Tax”) treatment of the Transactions; and
(c)	Section C describes what the US Tax treatment of the Transactions would have been had the US Partnerships not made elections for US Tax purposes, known as “check-the-box” elections (each an “Election”), to be treated as corporations for US Tax purposes.
Section A - the US Partnerships and the income which arose to the US Partnerships during the Periods
The US Partnership A Transaction (“Transaction A”)
The establishment of US Partnership A
(5)	US Partnership A is a general partnership which was established under the laws of Delaware between “US Manager Partner A” and “US Partner A” pursuant to a general partnership agreement dated 28 September 1999 (“US Partnership Agreement A”).
(6)	US Manager Partner A and US Partner A are, and were at all relevant times, limited liability companies established under the laws of Delaware, resident for tax purposes in the US and direct 100 per cent. subsidiaries of “US Co A”.
(7)	US Co A is, and was at all relevant times, a corporation established under the laws of Delaware, resident for tax purposes in the US and an indirect subsidiary of “US Counterparty A”.
(8)	None of US Manager Partner A, US Partner A, US Co A and US Counterparty A is or has at any time been related to any member of the LTSB group.
(9)	US Partnership A elected to be treated as a corporation for US Tax purposes by means of a check-the-box election (“Election A”) made on 21 October 1999 and effective from 14 October 1999.
(10)	At no time was any person other than US Manager Partner A entitled to make Election A on behalf of US Partnership A. 
(11)	Prior to HSIL’s investment in US Partnership A, the assets of the partnership consisted of US$1000. 
HSIL becoming a partner in US Partnership A
(12)	By a procurement agreement dated 28 December 1999 US Co A agreed with US Partnership A that it would procure a third party to (or would itself) be admitted as a partner of US Partnership A and make a contribution of £350 million to the capital of US Partnership A.  
(13)	By an invitation letter dated 28 December 1999 US Co A invited HSIL to become a partner in US Partnership A and make a £350 million contribution to the capital of US Partnership A (“US Partnership A Interest”).
(14)	By an admission agreement dated 31 January 2000 (“Admission Agreement A”) US Manager Partner A and US Partner A agreed to admit HSIL as a general partner of US Partnership A upon a contribution to the capital of US Partnership A of £350 million being made by HSIL. The capital accounts of the partners following HSIL becoming a partner were US Manager Partner A US$88,128,258.40 (11.95%), US Partner A US$81,349,161.60 (11.03%) and HSIL US$568,225,000.00 (equivalent to £350m) (77.02%). 
(15)	US Manager Partner A and US Partner A made various factual representations and warranties to HSIL in accordance with Admission Agreement A, including that Election A had been made previously.
(16)	Pursuant to Admission Agreement A and an amended version of US Partnership Agreement A dated 31 January 2000, US Partnership A’s profits and losses were allocated 95 per cent. to HSIL, 2.6 per cent. to US Manager Partner A, and 2.4 per cent. to US Partner A. 
(17)	US Partnership A subscribed US$737,702,420 of its capital for shares in a US company that invested in publicly traded debt securities (“FASIT Prefs”), which carried the right to a fixed monthly dividend payable in sterling on the first business day of each month and which comprised the “regular interests” of a corporation that qualified as a Fixed Asset Securitisation Investment Trust (a “FASIT”) for US Tax purposes. 
(18)	Substantially all of US Partnerships A’s income while HSIL was a partner was derived from the source described in paragraph 17 above.
(19)	By an agreement dated 31 January 2000 (“Retirement Agreement A”) HSIL agreed to retire from, and US Co A agreed to be admitted to, US Partnership A on a date falling on or around 31 December 2004, subject to provisions providing for such retirement and admission to take place earlier in specified circumstances.  Retirement Agreement A provided for US Co A to pay to HSIL, on the date of such retirement and admission, £350 million (being the capital contributed to US Partnership A by HSIL) subject to certain adjustments.  Retirement Agreement A acknowledged that under Delaware partnership law, HSIL was and remained a partner of US Partnership A and was entitled to receive distributions from US Partnership A for its own account at all times on or prior to HSIL’s retirement pursuant to Retirement Agreement A.
The 2000 Period
(20)	During the part of the 2000 Period for which HSIL was a partner:
(a)	US Partnership A’s income (before tax) totalled US$45,208,462 (the “2000 A Income”).  The 2000 A Income represented dividends on the FASIT Prefs of US$45,241,702 less expenses of US$33,240; 
(b)	US Partnership A was subject to, and paid, US Tax of US$15,822,962 on the 2000 A Income;
(c)	HSIL’s proportionate share of the 2000 A Income was US$42,948,039 (the “2000 HSIL A Income”); and  
(d)	HSIL received the 2000 HSIL A Income net of its proportionate share of US Tax, which was US$15,031,814, i.e. it received £18,415,833.
The 2001 Period
(21)	During the 2001 Period:
(a)	US Partnership A’s income (before tax) totalled US$47,059,848 (the “2001 A Income”).  The 2001 A Income represented US$47,094,563 of dividends on the FASIT Prefs less expenses of US$34,715;
(b)	US Partnership A was subject to, and paid, US Tax of US$16,470,947 on the 2001 A Income;
(c)	HSIL’s proportionate share of the 2001 A Income was US$44,706,856 (the “2001 HSIL A Income”); and 
(d)	HSIL received the 2001 HSIL A Income net of its proportionate share of US Tax which was  US$15,647,400, i.e. it received £20,090,000.
The US Partnership B Transaction (”Transaction B”)
The establishment of US Partnership B
(22)	US Partnership B is a general partnership which was established under the laws of Delaware between “US Manager Partner B” and “US Partner B” pursuant to a general partnership agreement dated 16 December 1998 (“US Partnership Agreement B”).
(23)	US Manager Partner B and US Partner B are, and were at all relevant times, limited liability companies established under the laws of Delaware, resident for tax purposes in the US and direct 100 per cent. subsidiaries of “US Co B”.
(24)	US Co B is, and was at all relevant times, a corporation established under the laws of Delaware resident for tax purposes in the US and an indirect subsidiary of “US Counterparty B”.
(25)	None of US Manager Partner B, US Partner B, US Co B and US Counterparty B is or has at any time been related to any member of the LTSB group.
(26)	US Partnership B elected to be treated as a corporation for US Tax purposes by means of a check-the-box election (“Election B”) made on 20 January 1999 and effective from 16 December 1998. 
(27)	At no time was any person other than US Manager Partner B entitled to make Election B on behalf of US Partnership B.
HSIL becoming a partner in US Partnership B
(28)	By an invitation letter dated 2 May 2000 US Co B invited HSIL to become a partner in US Partnership B and make a £350 million contribution to the capital of US Partnership B (“US Partnership B Interest”).
(29)	By an admission agreement dated 2 May 2000 (“Admission Agreement B”) US Manager Partner B and US Partner B agreed to admit HSIL as a general partner of US Partnership B upon a contribution to the capital of US Partnership B of £350 million being made by HSIL. US Manager Partner B then made a capital repayment to US Co B following which the capital accounts of the partners were US Manager Partner B US$158,605,180 (20.77%), US Partner B US$53,591,630 (7.02%) and HSIL US$551,250,000.00 (equivalent to £350m) (72.21%).
(30)	As a condition to HSIL becoming a partner in US Partnership B, US Co B made various factual representations and warranties to HSIL relating to the state of US Co B, US Partner B, US Manager Partner B and US Partnership B, including that Election B had been made previously.
(31)	Pursuant to Admission Agreement B and an amended version of US Partnership Agreement B dated 2 May 2000, US Partnership B’s profits and losses were allocated 99 per cent. to HSIL, 0.75 per cent. to US Manager Partner B, and 0.25 per cent. to US Partner B.
(32)	US Partnership B:
(a)	subscribed US$225,000,000 of its capital for shares in a US company that invested in US real estate assets (“REIT Prefs”), which carried the right to a fixed quarterly dividend payable on the 15th April, 15th June, 15th September and 15th December; and
(b)	invested US$540,616,520 of its capital in an interest in certain let commercial property (the “Property”), on which the lessee of the Property was required to make rental payments quarterly on the same dates as in 32.1 above at all relevant times. 
(33)	All of US Partnerships B’s income while HSIL was a partner was derived from the two sources described in paragraph 32 above.  The investment in the Property had already been made prior to HSIL’s admission as a partner.
(34)	By an agreement dated 2 May 2000 (“Retirement Agreement B”) HSIL agreed to retire from, and US Co B agreed to be admitted to, US Partnership B on a date falling on or around 31 March 2005 subject to provisions providing for such retirement and admission to take place earlier in specified circumstances.  Retirement Agreement B provided for US Co B to pay to HSIL, on the date of such retirement and admission, £350 million (being the capital contributed to US Partnership B by HSIL) subject to certain adjustments. Retirement Agreement B acknowledged that under Delaware partnership law HSIL was and remained a partner of US Partnership B and was entitled to receive distributions from US Partnership B for its own account at all times on or prior to HSIL’s retirement pursuant to Retirement Agreement B.
The 2000 Period
(35)	During the 2000 Period:
(a)	for the part of the year for which HSIL was a partner, US Partnership B’s income (before tax) totalled US$28,726,000 (the “2000 B Income”). The 2000 B Income represented US$18,346,000 derived from the Property and US$10,720,000 of dividends on the REIT Prefs, net of a US$340,000 foreign exchange related loss; 
(b)	US Partnership B was subject to, and paid, US Tax of US$13,556,379 on the income for the full calendar year. US$10,054,000 was attributable to the period 2 May to 31 December;
(c)	HSIL’s proportionate share of the 2000 B Income was US$28,439,000 (the “2000 HSIL B Income”); and
(d)	HSIL received the 2000 HSIL B Income net of its proportionate share of US Tax, which was US$9,953,000, i.e. it received US$18,486,000.  
The 2001 Period
(36)	During the 2001 Period:
(a)	US Partnership B’s income (before tax) totalled US$42,986,988 (the “2001 B Income”). The 2001 B Income represented US$27,085,505 derived from the Property and US$16,041,544 of dividends on the REIT Prefs, net of a US$140,061 foreign exchange related loss;
(b)	US Partnership B was subject to, and paid, US Tax of US$15,045,446 on the 2001 B Income;
(c)	HSIL’s proportionate share of the 2001 B Income was US$42,557,118 (the “2001 HSIL B Income”); and
(d)	HSIL received the 2001 HSIL B Income net of its proportionate share of US Tax, which was US$14,894,991, i.e. it received US$27,662,127.
Section B - The US Tax Treatment of the Transactions
Transaction A
(37)	For US Tax purposes, at all relevant times:
(a)	US Co A was a corporation resident in the US and was not treated as part of US Counterparty’s consolidated group;
(b)	US Manager Partner A and US Partner A were each treated as transparent entities (i.e., as branches of US Co A) and were both therefore treated as branches of US Co A; 
(c)	as a result of Election A having been made, US Partnership A was treated as a corporation resident in the US rather than a partnership; and
(d)	US Co A did not elect to file a consolidated US Tax return with US Partnership A.  Accordingly, each of US Co A and US Partnership A was severally liable for US Tax liabilities on its own income.
Prior to HSIL becoming a partner
(38)	Prior to HSIL becoming a partner in US Partnership A, US Co A was treated for US Tax purposes as owning all of the equity interests in US Partnership A.
Following HSIL becoming a partner
(39)	Following HSIL becoming a partner in US Partnership A the US Tax treatment did not follow the legal form: US Co A was treated for US Tax purposes as if (a) it owned HSIL's interest in US Partnership A, i.e. it were the equity owner instead of HSIL; and (b) it had borrowed from HSIL an amount equal to HSIL's contribution to the capital of US Partnership A. The interest rate on the deemed loan was treated as an amount determined by reference to the terms of Retirement Agreement A. US Co A accrued deductions in respect of the deemed interest independently of the income being earned by or withdrawn from US Partnership A.
The treatment of the income
(40)	In accordance with the treatment set out above, the 2000 A Income and the 2001 A Income (together the “A Income”), including the 2000 HSIL A Income and the 2001 HSIL A Income, was treated for US Tax purposes as being income of US Partnership A.
(41)	Consequently, US Partnership A was liable for US Tax on that income and the A Income was subject to US Tax at the rate of 35 per cent., as set out at paragraphs 20 and 21 above.
(42)	US Partnership A filed its own US Tax returns for the 2000 Period and the 2001 Period and paid the US Tax it was legally liable for . 
(43)	Since a loan was treated as having been made from HSIL to US Co A, US Co A was treated as having borrowed an amount equal to HSIL’s capital contribution and withdrawals of profit from US Partnership A by HSIL were treated as distributions paid to US Co A followed by payments by US Co A to HSIL under the deemed loan. Similarly, payment by US Co A to HSIL under Retirement Agreement A was treated as payment of any remaining interest and principal in respect of the deemed loan.
(44)	By reason of US Co A’s deemed ownership of HSIL’s interest in US Partnership A for US Tax Purposes, any net A Income deemed to be distributed to US Co A by US Partnership A was not subject to any additional US Tax in US Co A’s hands.
US Co
(45)	For US Tax purposes, US Co A had received net taxable income of US$494,854 for the 2000 Period and net taxable income of US$125,642 for the 2001 Period. In each case, the gross income reflected in those amounts was primarily attributable to assets and activities unrelated to its being a partner in US Partnership A.
(46)	US Co A was liable for, and paid, US Tax of US$173,199 for the 2000 Period and US$43,975 for the 2001 Period.
Transaction B
(47)	For US Tax purposes, at all relevant times:
(a)	US Co B was a corporation resident in the US and was not treated as part of US Counterparty’s consolidated group;
(b)	US Manager Partner B and US Partner B were each treated as transparent entities (i.e., as branches of US Co B) and were both therefore treated as branches of US Co B; 
(c)	as a result of the Election having been made, US Partnership B was treated as a corporation resident in the US rather than a partnership; and
(d)	US Co B did not elect to file a consolidated US Tax return with US Partnership B. Accordingly, each of US Co B and US Partnership B was severally liable for US Tax liabilities on their own income. 
Prior to HSIL becoming a partner
(48)	Prior to HSIL becoming a partner in US Partnership B, US Co B was treated for US Tax purposes as owning all of the equity interests in US Partnership B.
Following HSIL becoming a partner
(49)	Following HSIL becoming a partner in US Partnership B the US Tax treatment did not follow the legal form: US Co B was treated for US Tax purposes as if (a) it owned HSIL's interest in US Partnership B, i.e. it were the equity owner instead of HSIL; and (b) it had borrowed from HSIL an amount equal to HSIL's contribution to the capital of US Partnership B.  The interest rate on the deemed loan was treated as an amount determined by reference to the terms of Retirement Agreement B. US Co B accrued deductions in respect of the deemed interest independently of the income being earned by or withdrawn from US Partnership B.
The treatment of the income
(50)	In accordance with the treatment set out above, the 2000 B Income and the 2001 B Income (together the “B Income”), including the 2000 HSIL B Income and the 2001 HSIL B Income, was treated for US Tax purposes as being income of US Partnership B.
(51)	Consequently, US Partnership B was liable for US Tax on that income and the Income was subject to US Tax at the rate of 35 per cent., as set out at paragraphs 35 and 36 above.
(52)	US Partnership B filed its own US Tax returns for the 2000 Period and the 2001 Period and paid the US Tax it was legally liable for.  
(53)	Since a loan was treated as having been made from HSIL to US Co B, US Co B was treated as having borrowed an amount equal to HSIL’s capital contribution and withdrawals of profit from US Partnership B by HSIL were treated as distributions paid to US Co B followed by payments by US Co B to HSIL under the deemed loan. Similarly, payment by US Co B to HSIL under Retirement Agreement B was treated as payment of any remaining accrued interest and principal in respect of the deemed loan.
(54)	By reason of US Co B’s deemed ownership of HSIL’s interest in US Partnership B for US Tax Purposes, any net B Income deemed to be distributed to US Co B by US Partnership B was not subject to any additional US Tax in US Co B’s hands.
US Co
(55)	For US Tax purposes, US Co B had received net taxable income of US$211,217,493 for the 2000 Period and net taxable income of US$330,698,556 for the 2001 Period. In each case, the gross income reflected in those amounts was primarily attributable to assets and activities unrelated to its being a partner in US Partnership B.
(56)	US Co B was liable for, and paid, US Tax of US$73,926,123 for the 2000 Period and US$115,744,495 for the 2001 Period.
Part C - The US Tax treatment of the Transactions had the Counterparties not made the Elections
Transaction A
(57)	At all relevant times for US Tax purposes:
(a)	US Co A, US Manager Partner A and US Partner A would each have been treated as described in paragraphs 37 in the same manner as was the case with the Election having been made; and
(b)	US Partnership A would have been treated as a transparent (or “disregarded”) entity and would therefore have been treated as a branch of US Co A. 
Prior to HSIL becoming a partner 
(58)	Prior to HSIL becoming a partner in US Partnership A, US Co A would have been treated for US Tax purposes as owning all of the assets of US Partnership A. 
Following HSIL becoming a partner 
(59)	Following HSIL becoming a partner in US Partnership A US Co A would have been treated for US Tax purposes as if (a) it owned HSIL's interest in US Partnership (as at paragraph 39 above); and (b) it had borrowed from HSIL an amount equal to HSIL's contribution to the capital of US Partnership A. Again, the interest rate on the deemed loan would have been treated as an amount determined by reference to the terms of Retirement Agreement A. US Co A would have accrued deductions in respect of the deemed interest independently of the income being earned by or withdrawn from US Partnership A.
The treatment of the Income
(60)	The A Income, including the HSIL A Income, would have been treated for US Tax purposes as income of US Co A. Withdrawals of profit from US Partnership A by HSIL would have been treated as withdrawals of profits by US Co A followed by payments by US Co A to HSIL under the deemed loan, and payment by US Co A to HSIL pursuant to Retirement Agreement A would have been treated as payments of any remaining accrued interest and principal by US Co A on the deemed loan. US Co A would have been entitled to the same deemed interest deductions in respect of that deemed loan that it was entitled to with Election A having been made. 
(61)	Consequently, the A Income would have been subject to US Tax at the rate of 35 per cent. .
(62)	In determining US Co A's US tax liability, US Co A would include the gross income from US Partnership A along with all its other items of gross income and include the accrued interest deductions on the deemed loan with all of its other items of deduction. It would not be possible for US Co A to somehow elect for the accrued interest deductions to be set against a specific item of income such as the income from US Partnership A. 
US Co A
(63)	For US Tax purposes US Co A would have had taxable income of US$45,703,316 for the 2000 Period and taxable income of US$47,185,490 for the 2001 Period. 
(64)	US Co A would have been liable for US Tax of US$15,996,161 for the 2000 Period and US$16,514,922 for the 2001 Period.
(65)	The taxable income of US Co A for each of the part of the 2000 Period when HSIL was a partner and the 2001 Period as stated in paragraph 76 above would have been higher by US$45,208,462 and US$47,059,848 respectively, precisely the amount of taxable income of US Partnership in each of the Periods where the Election was in effect.
(66)	The US Tax liability of US Co for each of the part of the 2000 Period when HSIL was a partner and the 2001 Period as stated in paragraph 77 above would have been higher by US$15,822,962 and US$16,470,947 respectively, precisely the amount of the US Tax liability of US Partnership in each of the Periods where the Election was in effect.  See paragraphs 20 and 21 above. 
Transaction B
(67)	At all relevant times for US Tax purposes:
(a)	US Co B, US Manager Partner B and US Partner B would each have been treated as described in paragraph 47 in the same manner as was the case with the Election having been made; and
(b)	US Partnership would have been treated as a transparent (or “disregarded”) entity and would therefore have been treated as a branch of US Co B.
Prior to HSIL becoming a partner 
(68)	Prior to HSIL becoming a partner in US Partnership B, US Co B would have been treated for US Tax purposes as owning all of the assets of US Partnership B.
Following HSIL becoming a partner 
(69)	Following HSIL becoming a partner in US Partnership US Co B would have been treated for US Tax purposes as if (a) it owned HSIL's interest in US Partnership B (as at paragraph 49 above); and (b) it had borrowed from HSIL an amount equal to HSIL's contribution to the capital of US Partnership B. Again, the interest rate on the deemed loan would have been treated as an amount determined by reference to the terms of Retirement Agreement B. US Co B would have accrued deductions in respect of the deemed interest independently of the income being earned by or withdrawn from US Partnership B.
The treatment of the Income
(70)	The B Income, including the HSIL B Income, would have been treated for US Tax purposes as income of US Co B Withdrawals of profit from US Partnership B by HSIL would have been treated as withdrawals of profits by US Co B followed by payments by US Co B to HSIL under the deemed loan, and payment by US Co B to HSIL pursuant to Retirement Agreement B would have been treated as payments of any remaining accrued interest and principal by US Co B on the deemed loan. US Co B would have been entitled to the same deemed interest deductions in respect of that deemed loan that it was entitled to with Election B having been made. 
(71)	Consequently, the B Income would have been subject to US Tax at the rate of 35 per cent. .
(72)	In determining US Co B's US tax liability, US Co B would include the gross income from US Partnership B along with all its other items of gross income and include the accrued interest deductions on the deemed loan with all of its other items of deduction. It would not be possible for US Co B to somehow elect for the accrued interest deductions to be set against a specific item of income such as the income from US Partnership B.
US Co
(73)	For US Tax purposes US Co B would have had taxable income of US$249,950,005 for the 2000 Period and taxable income of US$373,685,544 for the 2001 Period.
(74)	US Co would have been liable for US Tax of US$87,482,502 for the 2000 Period and US$130,789,940 for the 2001 Period.
(75)	The taxable income of US Co for each of the part of the 2000 Period when HSIL was a partner and the 2001 Period as stated in paragraph 73 above would have been higher by US$28,726,000 and US$42,986,988 respectively, precisely the amount of taxable income of US Partnership in each of the Periods where the Election was in effect.
(76)	The US Tax liability of US Co for each of the part of the 2000 Period when HSIL was a partner and the 2001 Period as stated in paragraph 74 above would have been higher by US$10,054,000 and US$15,045,446 respectively, precisely the amount of the US Tax liability of US Partnership in each of the Periods where the Election was in effect.  See paragraphs 35 and 36 above. 
Chronology of Events
Date			
	Transaction A	Transaction B	
			
16 December 1998		US Partnership Established	
16 December 1998		Effective date of Election	
20 January 1999		Election made	
28 September 1999	US Partnership is established		
14 October 1999	Effective date of Election		
21 October 1999	Election made		
31 January 2000	HSIL invests in US Partnership		
2 May 2000		HSIL invests in US Partnership	
During 2000 and 2001	HSIL receives income from the US Partnership net of US Tax paid by the US Partnership	
4.	There was also a joint report by Mr Bruce Kayle of Milbank, Tweed, Hadley & McCloy LLP, expert witness instructed by the Appellant and Mr Michael Miller, Roberts & Holland LLP, expert witness instructed by HMRC, and in addition they each provided separate reports on one aspect that is no longer in issue.  We treat the whole of the joint report as a finding of fact whether or not we refer to any part of it.  The experts were asked to deal with the US tax consequences of a number of hypothetical alternative transactions but in the end HMRC relied on only one, that of a loan from the Appellant to US Company (a hypothetical alternative transaction which largely accorded with the US tax treatment of the action transactions).  On this the experts concluded:
“VIII. US TAX CONSEQUENCES IF, IN LIEU OF IMPLEMENTING THE TRANSACTIONS, HSIL HAD MADE LOANS OF £350 MILLION EACH TO US CO A AND US CO B, ASSUMING IN THE FIRST INSTANCE THAT THE ELECTIONS WERE MADE, AND ASSUMING IN THE ALTERNATIVE THAT THE ELECTIONS WERE NOT MADE
The analysis in this Part VIII considers US Tax consequences if HSIL had made loans of £350 million each to US Co A and US Co B, with fixed interest payable at the same rates determined under the Retirement and Acquisition Agreements (i.e., 5.74% per annum payable monthly in relation to Transaction A and 5.5205% per annum payable quarterly in relation to Transaction B), assuming in the first instance that the Elections were made, and assuming in the alternative that the Elections were not made. For convenience, this fact pattern is referred to as Hypothetical 5. 
The US Tax consequences of this Hypothetical 5 are the same as those set forth in Section B of the Statement of Facts (if it is assumed that the Elections were made) and Section C of the Statement of Facts (if it is assumed that the Elections were not made). If the loans in Hypothetical 5 were considered separately from the investments in the US Partnerships (or any other use of the loan proceeds or other capital by US Co A or US Co B), the only US Tax consequences would be as follows: (i) US Co A and US Co B would be entitled to deduct the interest payable to HSIL, and (ii) the interest income earned by HSIL would be exempt from US Tax pursuant to the Treaty.”
5.	In essence, this appeal is about the effect of the UK and the US analysing a transaction differently for tax purposes (for general law purposes, so far as we can tell, both the US and the UK are likely to respect the partnership character of the transactions).  Seen from the UK the Appellant has entered into a US partnership that has paid tax in the US (because it has elected to be taxed as a corporation for US tax purposes) and is claiming double taxation relief for that tax.  Seen from the US the Appellant is not a partner in the US partnership because of the agreement in place from the outset for the repurchase of the Appellant’s partnership interest by US Co A or B (as we make no distinction between the two transactions we shall hereafter just refer to “US Company”); US Company is the partner and is taxed as if it has borrowed the Appellant’s capital contribution to the partnership, with an amount equal to the partnership profits being paid to the Appellant in the form of interest.  In other words, seen from the US the US partnership (taxed as a corporation) has paid tax but US Company, treated as the partner, has paid interest of an equivalent amount of profits to the Appellant, so that taking the two together no US tax has been paid on the profits attributable to the Appellant.
6.	Section 795A provides as follows:
“Limits on credit: minimisation of the foreign tax
(1) The amount of credit for foreign tax which, under any arrangements, is to be allowed against tax in respect of any income or chargeable gain shall not exceed the credit which would be allowed had all reasonable steps been taken—
(a) under the law of the territory concerned, and
(b) under any arrangements made with the government of that territory,
to minimise the amount of tax payable in that territory.
(2) The steps mentioned in subsection (1) above include—
(a) claiming, or otherwise securing the benefit of, reliefs, deductions, reductions or allowances; and
(b) making elections for tax purposes.
(3) For the purposes of subsection (1) above, any question as to the steps which it would have been reasonable for a person to take shall be determined on the basis of what the person might reasonably be expected to have done in the absence of relief under this Part against tax in the United Kingdom.”
7.	Mr Ewart QC and Mr Vallat contend in outline:
(1)	One starts with the assumption in sub-s (3) that double taxation relief does not exist in the UK, and asks what reasonable steps would have been taken in the US.  His answer is that instead of the partnership arrangements the Appellant would have made a loan to US Company, which is how the transaction is treated in the US.  Since the Appellant would then have received interest on which there is no US withholding tax under the US-UK tax treaty (1975) there would be no US tax to credit – in a situation where there was no double tax relief the Appellant would have optimised its position by avoiding a situation where there was double tax.
(2)	The Tribunal should find as a fact that in the absence of credit in the UK assumed by sub-s (3) the Appellant would have made a loan to US Company.
(3)	Subsection (2) is an inclusive definition of the steps that it would be reasonable for a taxpayer to take.  The steps listed relate to action that might be taken after the transaction in case there was doubt about whether they were included.
(4)	In substance the documents create a relationship that is close to being a loan.  For example, the repayment of the Appellant’s partnership capital and the re-purchase of its interest at a pre-determined price is guaranteed, as is the distribution of partnership income; the Appellant is prevented from taking part in the management of the partnership; the partnership income is at a fixed rate and equates to interest.
(5)	The person taking the steps need not be the person claiming the relief.  Relief can be claimed for income of another person, for example underlying tax and it must be in contemplation of the section that the other person has to take the steps.
8.	Mr Milne QC and Mr Baldry contend in outline:
(1)	The reasonable steps must be steps which were open to the taxpayer who is claiming relief.  Parliament can hardly have intended that a person should be deprived of relief under a double tax treaty by the actions, or inactions, of a third party over which he had no control.  The only person who might reasonably be expected to act differently in the absence of a relief by sub-s (3) is the person who is actually claiming the relief in question.
(2)	The list of steps included in sub-s (2) are all procedural steps which may be taken under the foreign tax regime or under the treaty after the transaction to reduce the amount of tax payable in the foreign territory.  Entering into a different transaction is not a “step” at all, and is wholly different from the steps mentioned in sub-s (2).  It would also not be reasonable to take a step that fundamentally changed the economics of the commercial deal.  Although sub-s (2) is an inclusive definition it is a possible meaning that it “means and includes” the listed items, see Dilworth v Commissioner of Stamps [1899] AC 99 at 105-6.  At the least the steps have to be the sort of steps that are listed in sub-s (2).
(3)	The steps must reduce the overall amount of foreign tax payable not simply the amount for which credit is available.  It cannot mean the creditable tax because the hypothesis in sub-s (3) assumes that there is no creditable tax.
(4)	There were no steps which the Appellant could have taken that would have reduced the amount of tax payable in the US on the transactions actually entered into.
9.	We are the same tribunal as considered s 795A in Bayfine v HMRC Spc 0719 (not yet reported), although our decision on the point in that case was obiter.  We have not substantially changed our view in the light of the arguments in this appeal.  
10.	The interpretation of s 795A involves the following issues: (1) what are “steps”? (2) when do they have to be taken? (3) who has to take the steps? and (4) are those steps reasonable steps for the Appellant to have taken?
11.	On the first two issues, sub-s (2) gives an inclusive definition of steps as claiming, or otherwise securing the benefit of, reliefs, deductions, reductions or allowances, and making elections for tax purposes.  All these have in common that they are actions to be taken after the transaction which are relevant to reducing the amount of foreign tax on the transaction.   We cannot accept Mr Ewart’s contention that they are listed because it might be thought that only steps taken before entering into the transaction were relevant and so a list of steps that might be taken after the transaction needed to be specified.  A far more natural reading is that these are a list of the type of steps that are relevant which leaves open the possibility of there being other steps that have the same effect, perhaps such as keeping one’s appeal rights open.  Entering into a completely different transaction is quite unlike the listed steps and not one that might be expected to be covered by the words in sub-s (2).  Taxation is based on the actual transaction entered into and not some economically similar transaction.  If Parliament had wanted to say that steps included entering into an economically similar transaction this would surely have been made clear in the section.  This is particularly the case with double taxation relief where tax treaties have different rules for different classes of income.  Here, while from the US tax point of view the Appellant has received interest, the Appellant is nevertheless as a matter of non-tax law a partner in a US partnership that has been taxed in the US as a corporation.  Accordingly in our view the steps relevant are those listed in sub-s (2) or similar steps that are to be taken after the actual transaction, and they certainly do not extend to entering into a completely different transaction.
12.	We analysed the purpose of sub-s (3) in Bayfine saying at [74]:
“The statutory purpose of that subsection is to determine what steps are reasonable to take.  If the UK gives credit for the full amount of foreign tax claimed, if subs (3) had not existed it could be argued that the person was not reasonably required to take steps which will make no difference to his tax position.  The purpose is clearly that the UK will not give credit for foreign tax that the person could by taking reasonable steps have reduced.  In order to determine what is reasonable subs (3) imposes the hypothesis that no credit is available and so any reduction in foreign tax benefits the person concerned (as opposed to the UK exchequer in the absence of the hypothesis), so that the issue becomes what steps are reasonable for the person to take in order to obtain the benefit to him of the saving of foreign tax.”
We have not changed our views.  On the third issue, we said that by implication from sub-s (3) the person who has to take the steps must be the person claiming credit.  Mr Ewart contends that the section must be wider than that because of the possibility that the steps have to be taken by the taxpayer in the other state, or an election may be required to be a joint election.  We agree with this but only insofar as the taxpayer is in a position to influence the taking of the steps by the other person.  One of HMRC’s examples given in the International Tax Manual at INTM 164140 where the section does not apply is “the case of underlying tax paid by a subsidiary company when the United Kingdom company, which claims the relief for that tax, is not in a position to influence the amount of tax paid.”  We agree with this approach.  A UK parent company is not without influence on its subsidiaries but legally the influence is that of a shareholder who can remove the directors but cannot dictate how the subsidiary will be run.  The UK parent company can lean on the directors to carry out its wishes in claiming tax reliefs but ultimately it is a matter for the directors of the subsidiary.  We therefore consider that while the person taking the steps may include persons other than the taxpayer claiming relief, the steps must be those that the taxpayer is in a position to influence.
13.	Applying that interpretation to the facts of this case, we decide that the steps that might reasonably be taken do not include the entering into a completely different transaction, whether or not it has a similar economic effect.  While the transaction entered into may have economic similarities to a loan it is not a loan but an investment in a US partnership, as it purports to be.  There are no other reasonable steps open to the Appellant that would reduce the amount of US tax.  Accordingly s 795A does not restrict the Appellant’s ability to claim relief.
14.	Mr Ewart invited us to make a finding of fact, regardless of our view of the law, that in the absence of credit in the UK the Appellant would have made a loan to the US Company.  Mr Milne contended that we should be cautious in making any finding in the absence of hearing witnesses, the parties having agreed all the necessary facts.  We consider that (on the assumption, contrary to our decision, that steps include the entering into different transactions) the likely outcome would have been that no transaction would have been entered into by the Appellant and the US Company.  The economic effect of the transaction is (to quote Mr Ewart’s skeleton, the figures in which the Appellant did not question):
“that the US Group could borrow from [the Appellant], in A, at a rate of 5.74% but because [the Appellant] received that interest tax-free (it was hoped), it was equivalent to a gross receipt of 8.2%.  The tax benefit of 2.46% was then shared between the two Groups by way of an interest rate swap that transferred 1.105% (45% of the benefit) back to US Co.  So the overall lending arrangement allowed the US Group to borrow at LIBOR minus 1.105%, and [the Appellant] to lend at LIBOR plus 1.355%, the sum total of these margins being the 2.46% tax benefit.  Transaction B also involved currency swaps but the net effect was similar; the share in that transaction was 50/50 of the tax benefit.”
If one makes the assumption that there is no credit in the UK so that there was no benefit to either party in making a loan we decline to find that they would have entered into a loan transaction at a higher rate of interest to the borrower and a lower receipt by the lender.  We consider that the US Company would have said to the Appellant that it was not interested in dealing with the Appellant, and the US Company would have instead approached, say, a Canadian bank to enter into substantially the same transaction as was entered into here.
15.	Accordingly we allow the appeal.
16.	In accordance with section 56A(2) of the Taxes Management Act 1970 we hereby certify that our decision involves a point of law relating wholly or mainly to the construction of an enactment that has been fully argued before us and fully considered by us.  This means that if both parties consent, and if the leave of the Court of Appeal is obtained, the Appellant may appeal from our decision directly to the Court of Appeal.

JOHN F. AVERY JONES

EDWARD SADLER
SPECIAL COMMISSIONERS
RELEASE DATE: 20 February 2009

SC 3102/06

Authorities referred to in skeletons and not referred to in the decision:
Bricom Holdings Ltd v IRC [1997] STC 1179
R v Warner [1969] 2 AC 256
Pepper v Hart [1993] AC 593
R v Environment Secretary, ex p. Spath Holme Ltd [2001] 2 AC 349