This month’s Chartered Accountants Tax Case digest looks at a case where a company argued that it had relied on HMRC guidance on double tax relief set out in HMRC’s International Manual. That guidance was later proven to be incorrect.

The company sought to argue that HMRC’s interpretation of the law as set out in the guidance was binding and that it had a legitimate expectation to rely on the guidance.

Background

The Appellant, Aozora UK, appealed against the decision of the High Court dismissing its application for judicial review of the decision of HMRC to issue closure notices following inquiries into Aozora UK’s tax returns for the accounting periods ending 31 March 2007–2009 inclusive. The total amount of additional corporation tax due as a result of the closure notices was over £3.6 million.

Aozora UK is a member of a group of companies and is a wholly-owned subsidiary of its Japanese parent company, Aozora Bank Limited (Aozora Japan). Aozora UK was set-up by Aozora Japan in 2006 as a vehicle for investments to be made outside Japan. In order to make such an investment, Aozora UK in turn established a wholly-owned subsidiary in the USA, Aozora GMAC Investments LLC (Aozora USA), which was resident in the US for tax purposes.

During the accounting periods ended 31 March 2007 to 31 March 2009, Aozora UK made loans to Aozora US and received interest payments in respect of the funds advanced. The issue in this appeal related to the taxation of those interest payments in the hands of Aozora UK. The interest payments were potentially liable to tax in both the UK and the US. The US imposed withholding tax at the rate of 30% on the interest paid by Aozora US. Aozora UK was liable to corporation tax in the UK on the amount of interest received from Aozora US.

When Aozora UK filed its tax returns for the three years in dispute, it accounted for tax on those interest payments as if it were entitled, by way of unilateral relief under Section 790 ICTA 1988, to set that 30% withheld tax against its own liability to corporation tax on the interest payments. HMRC opened enquiries into those tax returns and recalculated the tax on the basis that there was no entitlement to unilateral relief, issuing closure notices to that effect.

During the three relevant accounting periods, HMRC had published a manual to assist its staff to understand and apply the law. The relevant manual was HMRC’s international tax manual (the Manual), which was also made available to the general public for the information of taxpayers and their advisers. Paragraph 151,060 of the Manual at the relevant time stated:

UK legislation – unilateral relief

ICTA88/s790 together with TCGA92/s277 for Capital Gains Tax, allows unilateral tax credit relief to be given against United Kingdom taxes for foreign taxes imposed in a country with which the United Kingdom has no double taxation agreement. The legislation provides that Section 792–806M (rules for giving foreign tax credit relief) are to apply as if there was an agreement in force with the country concerned which contained the provisions in Sections 790(3) and (4).

Unilateral relief under S790 can only be given by way of credit for foreign tax. Part of the income cannot be taken out for assessment. In broad terms, credit is limited to the amount that would be due if a treaty were in existence.

ICTA88/s793A provides a restriction to credit relief under S790. It provides that, where a double taxation treaty contains an express provision to the effect that relief by way of credit shall not be given in particular cases or circumstances specified or described in the agreement, then neither shall credit by way of unilateral relief be allowed in those cases or circumstances. The provision has effect for arrangements made after 20 March 2000. At 1 April 2003, the only provisions to which S793A applies is Article 24(4)(c) of the new UK/US DTA” (italics added for emphasis).

By 3 February 2011, the Manual had been amended specifically to exclude the sentence emphasised above.

The effect of each closure notice was to deny Aozora UK unilateral credit relief under Section 790 of the Income and Corporation Taxes Act 1988 (ICTA 1988) so that Aozora UK was not allowed to use the tax already withheld by the US tax authorities to offset its liability to UK corporation tax on the interest. Instead, it was allowed to deduct the US withheld tax from the gross amount of interest payable and to pay corporation tax on the net interest received, otherwise known as deduction relief.

The appeal therefore turned on the question of when unilateral tax relief under Section 790 ICTA 1988 is available in circumstances where there is a double taxation arrangement in place between the UK and the relevant overseas jurisdiction, but where that arrangement does not by its terms provide double taxation relief in the particular circumstances of the taxpayer’s case.

Arguments and decision

By its judicial review claim, Aozora UK contended that the terms of HMRC’s international tax manual as published at the relevant times contained a representation by HMRC that the scope of Section 793A was limited to precluding the availability of credit relief only in one particular circumstance which, it is common ground, did not apply to Aozora UK.

Aozora UK argued that the representation was binding on HMRC because it gave rise to a legitimate expectation that Aozora UK would be taxed in accordance with that interpretation of Section 793A, whether or not the terms of the Manual were accurate as a matter of law. HMRC subsequently changed the statement in the manual, which it said was incorrect and tried to deny Aozora the relief. The closure notices were issued by HMRC on the basis that the provisions of Section 793A ICTA 1988 operated to prevent the availability of unilateral credit relief under Section 790 ICTA 1988.

The High Court had held that the statement in the Manual as to the proper construction of Section 793A did amount to a representation on the part of HMRC on which it was reasonable for taxpayers to rely. However, Aozora UK had not relied on that representation when making the decision to arrange the loans to Aozora US through Aozora UK. Further, it was held that it would not be conspicuously unjust for HMRC to resile from the representation in the circumstances of the case.

The High Court therefore dismissed the application. However, permission to appeal was granted in November 2018. Aozora UK’s appeal was based on the following five points:

• The Judge erred in holding that it was necessary for Aozora UK to have itself relied on the representations in Paragraph 151,060 of the Manual. They argued that it is sufficient that Aozora UK’s tax advisers relied on the representation in advising Aozora UK;
• The Judge erred in holding that the Deloitte UK partner did not rely upon the representation in concluding that Section 793A(3) of ICTA 1988 only applied to Article 24(4)(c) of the Treaty. The Judge misread and misinterpreted the written evidence, which was that he did rely on the representation in taking the view that there was no risk that unilateral relief would be denied by Section 793A(3);
• The Judge erred in holding that Aozora UK had to prove what advice would have been given if the representation had not been made or if HMRC had correctly stated the law in the Manual. That is not a burden placed on a taxpayer where there was actual reliance on a representation which might reasonably have led the representee to conclude as it did;
• The Judge erred in holding that Aozora UK had to prove what it would have done if the representation had not been made. The burden of proof on that issue was on the representor, that is HMRC; and
• The Judge erred in holding that it was not conspicuously unfair for HMRC to resile from their representation and collect so much additional tax which they had represented would not be due. That was plainly conspicuously unfair.

The Court considered that the High Court was right to hold that the degree of unfairness arising for Aozora UK if HMRC is now allowed to collect tax on the basis that Article 23 of the Treaty precludes the grant of unilateral relief is not sufficient to prevent HMRC from applying that interpretation of the law if their earlier, different interpretation is incorrect. The kind of representation relied on by Aozora UK, although clear, unambiguous and unqualified, is weak in the sense that it is only a representation as to HMRC’s opinion as to the law.

The factors that are relevant to an assessment of whether Aozora UK has shown that it would be unfair to a high degree if HMRC was permitted to impose a charge on the basis of the correct interpretation of the law do not establish any unfairness here approaching an abuse of power.

Aozora Japan obtained advice from specialist tax advisers who were not at any great disadvantage compared to HMRC when coming to their own view of the law and it is that view on which Aozora Japan relied. The appellant had not therefore shown it had suffered a serious detriment as a result of any reliance on the representation.

The Court of Appeal emphasised the high threshold before the court would intervene to prevent HMRC from resiling from previously given guidance.

The full judgment in this case is available from https://www.bailii.org/