Income Tax Conventions

HMRC increased the UK branch profits of the Irish taxpayers’ branch banking, or home mortgages, businesses by attributing to their UK permanent establishments notional additional free capital on the basis that if they had operated as distinct and separate enterprises, they would have had a higher amount of free capital and therefore a correspondingly lower amount of borrowed capital – with the result that HMRC disallowed interest which was actually paid to third parties. Patten LJ was fortified in his conclusion that these adjustments accorded with the “comparator provisions” of the permanent establishment Article in the UK-Ireland Treaty (Art. 8(2), which was similar to Art. 7(2) of the OECD Model) by passages in the 2008 OECD Commentaries, notwithstanding that he was dealing with a 1976 Treaty. He stated (at para. 31):

Although [43]-[47] of the 2008 Commentary are new, it is clear from [7] of the Commentary that they were considered appropriate for inclusion by the OECD because they were not in conflict with earlier versions of the Commentary. … On that basis, the 2008 Commentary, although new, would be admissible as an aid to the construction of Article 8(2) of the 1976 Convention which, as I have explained, adopted the wording of Article 7(2). It would only be inadmissible if the new material made substantive changes which are inconsistent with the commentaries in existence at the time of the 1976 Convention.

The Indian taxpayer (Satyam) argued unsuccessfully before the Full Federal Court of Australia “that tax treaties are, and can only be, exclusively relieving: that is, they are only ever ‘shields not swords’ and not the grant of a standalone taxing power and independent imposition of taxation.”

Art. 23(1) of the Australia-India Treaty provided:

Income, profits or gains derived by a resident of one of the Contracting States which, under any one or more of Articles 6 to 8, Articles 10 to 20 and Article 22 may be taxed in the other Contracting State, shall for the purposes of the law of that other State relating to its tax be deemed to be income from sources in that other State.

The bolded language had the effect of indicating that a technical-services royalty, which Australia was permitted to tax under the Australian royalties article of the Treaty, was deemed to arise in Australia not only for the purposes of the Article of the Treaty dealing with the elimination of double taxation, but also for the purposes of the Australian domestic taxation provisions. Consequently, technical services fees (which were deemed royalties) earned by Satyam, which in the absence of the Treaty would have been considered to not arise in Australia so that they would not have been subject to Australian income tax under the approximate Australian equivalent of ITA s. 115, were now deemed for the purposes of that provision to arise in Australia and to therefore be subject to Australian income tax.