Canadian financial interest in UK oil field not subject to UK tax

Royal Bank of Canada (RBC) had lent money from its Canadian operations to another Canadian company, Sulpetro, to fund its oil exploration in the UK continental shelf. Although there was a complex chain of acquisitions and disposals that followed, ultimately, following Sulpetro getting into financial difficulties, the receiver assigned Sulpetro’s rights to receive payments in respect of oil extracted from a UK continental shelf oil field (the Buchan field) to RBC.

RBC wrote off the original loan to Sulpetro as a bad debt and treated the payments received from the Buchan field as recoveries of that bad debt, which were treated as taxable income in Canada.

HM Revenue and Customs (HMRC) argued, however, that the payments were taxable in the UK as profits of a deemed separate ring-fence trade applicable to oil-related activities. HMRC succeeded with that argument in both the first-tier and upper tax tribunals. However, RBC appealed to the Court of Appeal.

As a general rule, non-UK resident companies are only subject to corporation tax on trading profits if the trade is carried on through a UK permanent establishment. However, certain closely defined oil-related activities have their own special rules so that any such activities that are carried on as part of a UK trade are deemed to be their own separate trade, with the relevant profits then being within the oil ring-fence – with a resultant higher tax charge.

The core of the matter appealed to the Court of Appeal was the interpretation of the Double Tax Treaty between Canada and the UK. There was also a question of UK tax law, but the treaty points were dealt with first because if the treaty did not permit the UK to tax the payments to RBC, the UK tax law point did not need to be considered. 

Under Article 6 of that Canada/UK Double Tax Treaty, income from “immovable property” may be taxed by the contracting state in which the property is situated. The dispute centred on a part of the definition of “immovable property”, namely “rights to variable or fixed payments as consideration for the working of, or the right to work mineral deposits, sources and other natural resources”.

The view of Lady Justice Falk, with whom the other two sitting judges agreed, was that this limb of the definition of immoveable property is limited to “rights to payments held by a person who has some form of continuing interest in the land in question to which the rights can be attributed”. Since RBC did not, at the time of the payments, or indeed at any stage, hold an interest in the Buchan field, it did not have rights that fell within the definition of immoveable property. This conclusion was not altered by the fact that RBC was stepping into the shoes of Sulpetro.

In reaching that conclusion, the Court of Appeal made a number of observations that have potentially wider application.

Firstly, tax symmetry is not a determinative factor. The fact that tax deductions had been given in the UK for the payment of the amounts paid to RBC could not determine the tax treatment of RBC.

The other provisions of the Double Tax Treaty should be considered when interpreting a definition that applies across the whole treaty. The court found assistance in similar wording regarding intellectual property and, particularly, in the whole scheme of taxation applied to extractive activities, including the taxation of chargeable gains and offshore extraction within the treaty.

A UK court also can and should take into account the non-English version of a Double Tax Treaty. In this case, the court considered the French text on the basis that it is stated to be equally authoritative as the English one. The court found that the French text supported the narrower interpretation.

The second issue appealed by RBC was that the tribunals had proceeded on the basis that Sulpetro had the right to extract oil, rather than its UK subsidiary which held the licence. RBC argued that this failed to take account of the true contractual and regulatory position.

The Court of Appeal found that Sulpetro had the right to direct the work and had the right to receive the financial benefits from it but did not have the right to carry out that work. This was because UK regulatory rules at the time required the licence to be held by a UK resident entity, which Sulpetro was not. The contractual and regulatory structure was very clear that the right to work was held by the UK subsidiary and that “simply cannot be ignored on the basis of some broader concept of commercial or economic reality”, the court said. Lady Justice Falk noted in support that the capital gains article within the UK/Canada Double Tax Treaty expressly contemplated this structure but that Article 6 of the treaty did not. She inferred that the contracting states catered for these structures where they needed to, but that did not include Article 6.

While the Court of Appeal did not need to decide the appeal on the further ground relating to the interpretation of section 1313 of Corporation Tax Act 2009 – i.e. whether the payments would actually be taxed under the UK regime in any event – the court did express some doubt about whether an interest in some of the sale proceeds from oil could be properly described as “the benefit of” the oil.

Given the earlier wins at the tribunal stage, it may be that HMRC will seek permission to appeal this decision.

Co-written by Sukhbir Binning of Pinsent Masons.