“(1) A company not resident in the United Kingdom is within the charge to corporation tax if, and only if, it carries on a trade in the United Kingdom through a permanent establishment in the United Kingdom. (2) If it does so, it is chargeable to corporation tax, subject to any exceptions provided for by the Corporation Tax Acts, on all profits, wherever arising, that are attributable to its permanent establishment in the United Kingdom.”
“(1) The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. (2) Subject to the provisions of paragraph (3) of this Article, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm’s length with the enterprise of which it is a permanent establishment. (3) In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses of the enterprise which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere. (4) Nothing in the foregoing provisions of this Article shall affect any of the provisions of the law of a Contracting State relating specifically to the liability to tax of a life assurance company not having its head office in that Contracting State. (5) No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. (6) Where profits include items which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.”
“Before I examine the contrary submissions of the Crown, it is necessary to refer briefly to the approach to the interpretation of provisions, such as art XV, which have been agreed between sovereign states in a convention or treaty and have subsequently been given the force of law in the United Kingdom by reason of the implementing provisions of primary or secondary legislation. The parties are agreed that the correct approach is that laid down by the House of Lords in Fothergill v Monarch Airlines Ltd[1981] AC 251 . That case gave rise to problems of comparison with a foreign language text (that is, the French text of the Warsaw Convention) which are not present in these appeals. The House of Lords had to compare the English text and the French text because of a provision in the convention that the French text should prevail if there was any inconsistency between it and the text in English. Putting that special feature on one side, that decision makes clear the approach which should be adopted by the court. (1) It is necessary to look first for a clear meaning of the words used in the relevant article of the convention, bearing in mind that 'consideration of the purpose of an enactment is always a legitimate part of the process of interpretation': per Lord Wilberforce (at 272) and Lord Scarman (at 294). A strictly literal approach to interpretation is not appropriate in construing legislation which gives effect to or incorporates an international treaty: per Lord Fraser (at 285) and Lord Scarman (at 290). A literal interpretation may be obviously inconsistent with the purposes of the particular article or of the treaty as a whole. If the provisions of a particular article are ambiguous, it may be possible to resolve that ambiguity by giving a purposive construction to the convention looking at it as a whole by reference to its language[1990] STC 285 at 298 as set out in the relevant United Kingdom legislative instrument: per Lord Diplock (at 279). (2) The process of interpretation should take account of the fact that— 'The language of an international convention has not been chosen by an English parliamentary draftsman. It is neither couched in the conventional English legislative idiom nor designed to be construed exclusively by English judges. It is addressed to a much wider and more varied judicial audience than is an Act of Parliament which deals with purely domestic law. It should be interpreted, as Lord Wilberforce put it in James Buchanan & Co. Ltd v. Babco Forwarding & Shipping (UK) Limited[1978] AC 141 at 152], “unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation': per Lord Diplock (at 281–282) and Lord Scarman (at 293). (3) Among those principles is the general principle of international law, now embodied in art 31(1) of the Vienna Convention on the Law of Treaties, that 'a treaty should be interpreted in good faith and 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'. A similar principle is expressed in slightly different terms in McNair's The Law of Treaties (1961) p 365, where it is stated that the task of applying or construing or interpreting a treaty is 'the duty of giving effect to the expressed intention of the parties, that is, their intention as expressed in the words used by them in the light of the surrounding circumstances'. It is also stated in that work (p 366) that references to the primary necessity of giving effect to 'the plain terms' of a treaty or construing words according to their 'general and ordinary meaning' or their 'natural signification' are to be a starting point or prima facie guide and 'cannot be allowed to obstruct the essential quest in the application of treaties, namely the search for the real intention of the contracting parties in using the language employed by them'. (4) If the adoption of this approach to the article leaves the meaning of the relevant provision unclear or ambiguous or leads to a result which is manifestly absurd or unreasonable recourse may be had to 'supplementary means of interpretation' including travaux préparatoires: per Lord Diplock (at 282) referring to art 32 of the Vienna Convention, which came into force after the conclusion of this double taxation convention, but codified an already existing principle of public international law. See also Lord Fraser (at 287) and Lord Scarman (at 294). (5) Subsequent commentaries on a convention or treaty have persuasive value only, depending on the cogency of their reasoning. Similarly, decisions of foreign courts on the interpretation of a convention or treaty text depend for their authority on the reputation and status of the court in question: per Lord Diplock (at 283–284) and per Lord Scarman (at 295). (6) Aids to the interpretation of a treaty such as travaux préparatoires, international case law and the writings of jurists are not a substitute for study of the terms of the convention. Their use is discretionary, not mandatory, depending, for example, on the relevance of such material and the weight to be attached to it: per Lord Scarman (at 294).”
“as an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm’s length with its Head Office. It is considered that this conception necessarily includes the assumption that the London branch commands sufficient free working capital to operate as an independent enterprise”
“gives no authority to write into the branch accounts a level of capital which the branch does not have. To do this is to go against the scheme of Article III and the requirements of the paragraph (2) hypothesis that the United Kingdom branch is trading under ‘…the same or similar conditions…’. This directs that the actual conditions under which the United Kingdom branch trades are taken into account. It is those conditions which dictate the expenses in question. Accordingly the ‘notional interest formula’, under which interest is disallowed to the extent that the (actual) capital account of the branch falls short of an amount (estimated by the Revenue) which would be required as ‘free working capital’ by an independent banking enterprise is in our opinion unwarranted. The notional interest formula may very well result in the disallowance of actual expenditure which is attributable to the branch and that is something which Article III plainly does not authorise. … the formula may offer a convenient method of avoiding the difficulties involved in the allocation [of] actual receipts and expenses, but in our opinion it is not sound in law.”
“29. There is also a further – and in our judgment altogether more fundamental reason, which we put to the parties in argument – why this material is inadmissible. That is because this material is irrelevant to the question of construction that we have to answer. The unilateral practice of a taxing authority – no matter how well-advised – is not material that can support or contradict a particular interpretation of a treaty. 30. It is permissible to look to the subsequent conduct of the parties to a treaty to see if there is a subsequent agreement or practice that goes to the meaning of the treaty. Such agreement or practice would have to be evidenced, and would have to demonstrate a bilateral agreement or practice involving both parties to the treaty. No such agreement or practice was alleged here; and we consider the point to be a factual one, that could only properly be raised before the FTT. 31. We do not consider that the unilateral practice of a contracting party – even if that practice shows a careful attempt by that party to abide by a treaty – can affect the meaning of that treaty or constitute material going to its construction.”
“2. It should perhaps be said at this point that neither Article is strikingly novel or particularly detailed. The question of what criteria should be used in attributing profits to a permanent establishment, and of how to allocate profits from transactions between enterprises under common control, has had to be dealt with in a large number of European double taxation Conventions concluded since the war, and it is fair to say that the solutions adopted have generally conformed to a standard pattern. It is generally recognised that the essential principles on which this standard pattern is based are well founded, and it has been thought sufficient to restate them with some slight amendments and modifications primarily aimed at producing greater clarity. The two Articles incorporate a number of directives. They do not, nor in the nature of things could they be expected to, lay down a series of precise rules for dealing with every kind of problem that may arise when an enterprise of one State makes profits in another. Modern commerce organises itself in an infinite variety of ways, and it would be quite impossible within the fairly narrow limits of an Article in a double taxation Convention to specify an exhaustive set of rules for dealing with every kind of problem that may arise. This, however, is a matter of relatively minor importance. If there is agreement on general lines. Special cases may require special consideration, but it should not be difficult to find an appropriate solution if the problem is approached within the framework of satisfactory rules based on agreed principles. … Paragraph 2 10. This paragraph contains the central directive on which the allocation of profits to a permanent establishment is intended to be based. The paragraph incorporates the view, which is generally contained in bilateral Conventions that have been concluded since the war, that the profits to be attributed to a permanent establishment are those which that permanent establishment would have made if, instead of dealing with its head office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market. Normally, this would be the same profit that one would expect to be reached by the ordinary processes of good business accountancy. In the great majority of cases, therefore, trading accounts of the permanent establishment – which are commonly available if only because a well-run business organisation is normally concerned to know what is the profitability of its various branches – will be used by the taxation authorities concerned to ascertain the profit properly attributable to that establishment. Exceptionally, there may be no separate accounts…But where there are such accounts they will naturally form the starting point for any processes of adjustment in case adjustment is required to produce the amount of properly attributable profits. It should perhaps be emphasized that the directive contained in paragraph 2 is no justification for tax administrations to construct hypothetical profit figures in vacuo; it is always necessary to start with the real facts of the situation as they appear from the business records of the permanent establishment and to adjust as may be shown to be necessary the profit figures which those facts produce. 11. Even where a permanent establishment is able to produce proper accounts which purport to show the profits arising from its activities, it may still be necessary for the taxation authorities of the country concerned to rectify those accounts, in accordance with the general directive laid down in paragraph 2. Adjustment of this kind may be necessary; for example, because goods have been invoiced at prices which are not consistent with this directive, and profits have thus been diverted from the permanent establishment to the head office or vice versa. 12. In such cases, it will usually be appropriate to substitute for the prices used ordinary market prices for the same or similar goods supplied on the same or similar conditions… Paragraph 3 13. This paragraph clarifies, in relation to the expenses of a permanent establishment, the general directive laid down in paragraph 2. It is valuable to include paragraph 3, if only for the sake of removing doubts. The paragraph specifically recognizes that in calculating the profits of a permanent establishment allowance is to be made for expenses, wherever incurred, that were incurred for the purposes of the permanent establishment. Clearly in some cases it will be necessary to estimate or to calculate by conventional means the amount of expenses to be taken into account. In the case, for example, of general administrative expenses incurred at the head office of the enterprise it may be appropriate to take into account a proportionate part based on the ratio that the permanent establishment’s turnover (or perhaps gross profits) bears to that of the enterprise as a whole. Subject to this, it is considered that the amount of expenses to be taken into account as incurred for the purposes of the permanent establishment should be the actual amount so incurred. 14. Apart from what may be regarded as ordinary expenses, there are some classes of payment between permanent establishments and head offices which give rise to special problems, and it is convenient to deal with them at this point. The next five paragraphs discuss three specific cases of this kind and give solutions for them. It should not, of course, be inferred that it is only in relation to the three classes of payments mentioned in these paragraphs that problems may arise; there may well be payments of other kinds to which similar considerations apply. 15. The first of these cases relates to interest, royalties and other similar payments made by a permanent establishment to its head office in return for money loaned, or patent rights conceded, by the latter to the permanent establishment. In such a case, it is considered that the payments should not be allowed as deductions in computing the permanent establishment’s taxable profits. (Equally, such payments made to a permanent establishment by the head office should be excluded from the computation of the permanent establishment’s taxable profits.) It is, however, recognised that special considerations apply to payments of interest made by different parts of a financial enterprise (e.g. a bank) to each other on advances, etc (as distinct from capital allotted to them), in view of the fact that making and receiving advances is narrowly related to the ordinary business of such enterprises. Furthermore, if an enterprise makes payments of interest, etc, to a third party and these payments in part relate to the activities of the permanent establishment, then a proportionate part of them should naturally be taken into account in calculating the permanent establishment’s profits insofar as they can properly be regarded as expenses incurred for the purposes of the permanent establishment.”
“The foregoing examination of Article 7 of the Treaty, preratification reports of the Treasury Department and the Senate, and Commentaries intended to assist in interpretation leads to the conclusion that the Treaty contemplates that a foreign banking corporation in the position of plaintiff will be subjected to U.S. taxation only on the profits of its U.S. branch and that such profits should be based on the books of account of such branch maintained as if the branch were a distinct and separate enterprise dealing wholly independently with the remainder of the foreign corporation, provided that the financial records of the branch, especially those reflecting intracorporate lending transactions, are subject to adjustment as may be necessary for imputation of adequate capital to the branch and to insure use of market rates in computing interest expenses. In addition to normal deductible expenses reflected on the books of the branch, as adjusted, there shall be allowed in the determination of the profits of the U.S. Branch a reasonable allocation of general and administrative expenses incurred for the purposes of the foreign enterprise as a whole.”
“The court agrees with NatWest. There is nothing in the language of Article 7 to suggest that the government is allowed to impose capital requirements on a branch that are the same as those imposed on separately-incorporated banks in order to give meaning to the phrase "separate and distinct." The phrase "separate and distinct" does not mean the branch should be treated as if it were "separately-incorporated," but instead "separate and distinct," means separate and distinct from the rest of the bank of which it is a part. Thus, Article 7 of the Treaty simply allows the taxing authorities to adjust the books and records of the branch to ensure that transactions between the branch and other portions of the foreign bank are properly identified and characterized for tax purposes. For example, if equity capital infusions are in fact made to the branch and are not properly identified as equity infusions, the taxing authority cannot allow interest payments on those amounts. Similarly, Article 7 allows the books and records of the branch to be adjusted to ensure that interest payments between the branch and other parts of the entity reflect an armslength [sic] relationship. There is nothing in the plain words of the Treaty that allows the government to adjust the books and records of the branch to reflect "hypothetical" infusions of capital based upon banking and market requirements that do not apply to the branch. In short, the government's reading of Article 7 goes too far. Moreover, as discussed below, the government's reading does not reflect the shared expectations of the parties, as evidenced by the legislative history surrounding the Treaty.”
“Under the proper reading of the "same or similar" clauses, it becomes clear that the "dealing wholly independently with" language requires taxing authorities to scrutinize intracorporate transactions involving a permanent establishment to ensure that the transactions are accurately characterized and reflect arm's length terms and pricing. Conversely, the Government's reliance on "dealing wholly independently with" is at odds with a proper reading of the "same or similar" clauses. To conclude that ''wholly independently" requires that the U.S. Branch be taxed as if it were subject to regulatory and market capital requirements is to ignore the fact that the U.S. Branch does not operate under conditions in which it is subject to these requirements. In essence, the Government would read the "same or similar conditions" language out of the 1975 Treaty. … In the instant case, the real facts of the situation are that the U.S. Branch is not required to maintain any minimal amount of capital. Therefore, because the corporate yardstick would essentially recharacterize loans that bear an interest expense as equity capital infusions based on regulatory and domestic market requirements that do not apply to the U.S. Branch, the corporate yardstick ignores the real facts of the U.S. Branch's situation and violates the 1975 Treaty as informed by the 1963 Draft Convention. As stated by the trial court in NatWest II, "The Commentary confirms that the purpose of any adjustment should be to reflect the real facts of the branch's transactions with the entity of which it is a part."”
“5. On the one hand, the provisions of art 4(1) cited above have as theirobject and effect to restrict the right of the French authorities arising from art 209(1) of the General Taxation Code to tax profits resulting from the exploitation in France of a branch of a foreign company, by limiting that right to the taxation only of profits attributable to that branch. The provisions of para (6) of the same article have as their object and effect to impose on the same authorities that, in determining the latter profits, the deduction is permitted for all expenses incurred, whether in France or abroad, for the purposes of the branch. 6. On the other hand, it is not appropriate, in interpreting the provisions of art 4(2) cited above, to refer to the Commentaries drafted by the Fiscal Committee of the Organisation for Economic Co-operation and Development on art 7 of the Model Convention published by that organisation, since those Commentaries are subsequent to the adoption of the provisions at issue. In the version applicable to the facts in this case, these provisions must be understood as authorising the state of the branch to attribute to the latter the profits that would have been realised if, instead of dealing with the other parts of the enterprise, it had been dealing with separate enterprises under normal conditions and at market prices. On the contrary, these provisions do not have as their object nor, consequently, their effect of permitting that state to attribute to the branch the profits which would have been earned if the taxpayer had been provided with its own funds in an amount different from that which, being inscribed in the written accounts produced by the taxpayer, accurately reflects the charges and capital-provisions made between the different parts of the enterprise. In particular, the tax administration may not substitute for the latter amount the capital which the branch would have had to be granted, by virtue of the applicable regulations and having regard, specifically, to the risks to which it is exposed, if it had been a separate legal person. 7. It follows from this that the terms of art 209(1) of the General Taxation Code which subject to corporation tax 'profits ... the taxation of which is attributed to France by an international convention relating to double taxation' cannot, any more than the rules mentioned in para 3, have the effect of granting to the French tax authorities the right to tax the profits determined in accordance with the contested reassessments.”