UBS AG v Revenue and CustomS [2005] UKSPC SPC00480 (07 June 2005) 

SPC00480
DOUBLE TAXATION AGREEMENT – non-discrimination – whether UK permanent establishment of Swiss company entitled to payment of the tax credit on dividends under s 243 Taxes Act 1988 – yes, on the interpretation of the treaty – whether treaty incorporated into UK law by s 788 to give effect to the payment – no 

THE SPECIAL COMMISSIONERS

	UBS AG	Appellant

	- and -

	HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

		Special Commissioner: 	DR JOHN F. AVERY JONES CBE 
						JULIAN GHOSH

Sitting in public in London on 9 and 10 May 2005

John Gardiner QC and Jolyan Maugham, instructed by McDermott Will & Emery, for the Appellant

David Ewart, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

1.	This is an appeal by UBS AG, a Swiss bank, as successor to Swiss Bank Corporation in respect of its UK branch against refusal of a claim to relief under s 243 of the Taxes Act 1988.  We shall use the expression “the Appellant” to refer to the UK branch while recognising that it is not a legal entity itself, and the expression “UBS” to refer to the entity of which the Appellant is a branch.  The Appellant was represented by Mr John Gardiner QC and Mr Jolyon Maugham, and the Respondent was represented by Mr David Ewart.
2.	The issue in this appeal is whether the Appellant, as the UK permanent establishment of a Swiss company, is discriminated against contrary to the UK-Switzerland Double Taxation Convention of 8 December 1977 (“the Treaty”) incorporated into law in the UK by the Double Taxation Relief (Taxes on Income) (Switzerland) Order 1978 (SI 1978 No.1408) in relation to the treatment of losses under s 243 of the Taxes Act 1988 with the result that it is entitled to payment of the tax credit on dividends (and manufactured dividends) received.  The appeal concerns the years 1993 to 1996 when ACT was in force and has no application after 1997.
3.	There was an agreed statement of facts as follows (this is reproduced with minor editorial changes):
A.	UBS AG and Swiss Bank Corporation
(1)	UBS AG (“UBS”) is a bank resident in Switzerland, Swiss Bank Corporation (“SBC”) and Union Bank of Switzerland each having merged into UBS in 1998 by way of mergers under Swiss law.  UBS is therefore now the successor to the business of SBC.
(2)	SBC, at all material times, was a bank resident in Switzerland that owned a number of subsidiaries operating in many countries and otherwise conducted a banking business through branches located in many countries. 
(3)	SBC, at all material times, carried on a banking business in London through a branch (“the Appellant”). The agreed corporation tax computations show that, as at 1 January 1993, 1995 and 1996, the Appellant had accumulated substantial trading losses from the conduct of its banking business in London of the following cumulative amounts: £215,900,346, £515,978,719 and £595,220,041 respectively. 
B.	The Appellant’s activities as a market maker
(4)	The Appellant acted as a market maker on the London Stock Exchange. In other words, it held itself out in compliance with the rules of that exchange as willing to buy and sell securities at a price specified by it and was recognised as so doing by the Council of the Stock Exchange.
(5)	In the course of its activities as a market maker it (a) received dividends from United Kingdom resident companies and (b) received and paid “manufactured dividends” (as that term is used in section 737 of and Schedule 23A to the Taxes Act 1988). 
(6)	The dividends received arose in respect of securities held by the Appellant on the applicable dividend record date.
(7)	The manufactured dividends received arose primarily in consequence of stock lending transactions engaged in by the Appellant over dividend payment record dates or purchases which remained unsettled over such dates.  As a consequence of those transactions, the Appellant did not receive the dividends to which it would otherwise have been entitled and the borrower or the seller would make a payment to the Appellant to compensate it for the loss of the dividend.  The manufactured dividends paid arose primarily in the same circumstances save that the Appellant was the borrower or the seller rather than the lender. 
C.	Dividend income received
(8)	During the accounting periods comprising the calendar years 1993, 1995 and 1996 the surplus of UK dividends (and manufactured dividends) received by the Appellant over manufactured dividends paid amounted in value to £233,282,021 (the “Distributions”). Had the Appellant been a person resident in the United Kingdom, the Distributions would have carried with them tax credits, as provided by section 231 of the Taxes Act 1988, of £58,320,506.
(9)	The figures in respect of each of the accounting periods in question are as follows: 
Period	Surplus of UK dividends (and manufactured dividends) received by the Appellant over manufactured dividends paid 	Income tax credit claimed	
1993	£37,000,638	£9,250,160	
1995	£122,447,408	£30,611,852	
1996	£73,833,975	£18,458,494	
 D. The Claim and Appeal 
(10)	The Appellant (then a branch of SBC) claimed pursuant to section 788(6) of the Taxes Act 1988 for relief to be given under section 788(3)(a) for the accounting period ended 31 December 1993 on 24 December 1999. The basis of that claim was that Article 23 (the non-discrimination article) of the Treaty should have effect to provide for relief to be given to the Appellant so that it should be entitled to claim under section 243 for those years the same relief as would be available to a UK resident company carrying on the same activities as the Appellant.
(11)	Similar claims were made in respect of the accounting period ending 31 December 1995 and 31 December 1996 on 22 February 2000. The claims for the accounting periods ending 31 December 1993, 1995 and 1996 are referred to collectively as the Claim.
(12)	After correspondence between the parties, the Claim was refused by the Revenue by letter of 27 February 2003 (the “Decision”).
(13)	By letter of 6 March 2003, the Appellant appealed against the Decision.   
4.	We heard evidence from Mr Nicholas Anderson, Managing Director in the Financial Control Department of the Appellant.  We quote below part of his witness statement that expands on the activities of the Appellant (which we accept, except that we should make clear that his estimate of the split between dividends and manufactured dividends is not a finding of fact by us should it become relevant):
(1)	“The types of financial services business carried on by SBC and Union Bank of Switzerland (and now by UBS AG) include Swiss retail (high street) banking and, internationally, private banking (wealth management), investment banking and asset management.  For the purposes of this appeal, it is the investment banking activity carried on by the London Branch of SBC that is relevant.  Such activity encompasses a number of different facets, including lending and deposit-taking for corporate and institutional clients, corporate finance and capital markets activity, and both client facing and own account dealing in foreign exchange, fixed income and interest rate products and equities (i.e. shares and related products).  During the period in question, as paragraph 3 of the Statement of Agreed Facts records, SBC London Branch accumulated substantial trading losses from the conduct of its banking business.  As at 1 January 1993, 1995 and 1996, the accumulated losses were £215,900,346, £515,978,719 and £595,220,041 respectively.
(2)	It is the part of SBC London Branch’s business that comprised dealing in UK equities and, in particular, “market making”, that is relevant for the purposes of this appeal.
(3)	The nature of market making (so far as it relates to UK equities, which are the relevant instruments for the purposes of this appeal) can be described as follows, this description being based on my knowledge of the conduct of such business from my work at SBC and UBS AG.  The description is primarily relevant to the conduct of market making by SBC during the years relevant to this appeal (1993, 1995 and 1996), when the major stocks listed on the London Stock Exchange (LSE) were traded on a “quote driven system” relying on market makers, although it is still relevant today in relation to certain stocks not traded on the “order driven system” (SETS) which the LSE introduced in 1997. 
(4)	Market makers guarantee the liquidity of the LSE listed stocks in which they are registered as a market maker by ensuring that the investing public is able to trade in them at all times during normal market hours.  To be a market maker on the London Stock Exchange (the “LSE”), a particular bank or other securities dealer has to be a “member firm” of the LSE.  The member firm agrees with the LSE in which stocks it will act as a market maker.  By being registered as a market maker in a particular stock, the member firm is obliged to quote two-way prices in that stock (“bid/offer” prices, reflecting the prices at which it is willing to buy and sell shares respectively) during the times specified by the LSE (the “mandatory period”).
(5)	A market maker may trade in stock either on behalf of a client or for its own account.  When buying or selling stock, the market maker normally acts in a principal capacity rather than simply acting as agent between two other parties.  As a result, if the market maker buys shares, its inventory (“long position”) in that type of stock will be increased.  If it sells shares, this will result either in a reduced long position or, if the sale exceeds the amount of stock that the market maker holds, in a “short position”.  The latter typically results in the market maker having to borrow stock from another holder, in return for the payment of a fee, until such time as the market maker has sufficient stock to repay the stock loan.
(6)	A market maker’s long or short position in a stock may either represent an outright risk position or alternatively it may, in whole or part, offset (represent a hedge against) other risk positions.  For example, if the market maker has sold call options (rights to purchase shares) to its clients, then a holding of that type of share will act as a hedge to reduce the market maker’s risk from the options that it has granted.
(7)	Market makers can generate trading profits in a variety of ways.  First, for example, they will seek to make profits by offering to buy shares at a lower price than that at which they offer to sell shares. This is known as the bid/offer spread.  The margin will depend upon a number of factors, including the liquidity of the share.  For example, in the LSE’s “SETS market maker” (SETSmm) trading service, the market maker is generally allowed to quote a bid/offer spread of up to 5% or 10% of the stock price, depending on the type of stock concerned.  Secondly, market makers can make a profit by selling other types of equity-related instruments (e.g. options to buy or sell securities, or other derivative type instruments) and then hedging their risk by buying (or selling) the underlying shares to which those instruments relate, thus achieving an overall profit from the transactions whilst still adopting (so far as possible) a risk neutral position.  Thirdly, a market maker may hold a long (or short) position in a share if it thinks the price is likely to rise (or fall) with a view to generating profits from such future market movements.
(8)	UK equities which are listed and traded on the LSE generally pay dividends to their shareholders.  A market maker which is the holder of shares on the date by reference to which the entitlement to the dividend arises (the “record date”) is treated in the same way as any other registered shareholder, i.e. it is entitled to receive that dividend payment. Given the sometimes large size of market makers’ positions, the amounts of dividends received can be substantial.
(9)	As well as the receipt of actual dividend payments direct from the underlying company on the shares which it holds on a record date, a market maker may also receive or pay what are generally described as “manufactured dividends”:-
(a)	First, if a market maker has agreed (prior to an “ex dividend” date) to purchase shares from a counterparty, but this purchase does not settle in time for the market maker (or its bare nominee) to become the registered shareholder by the record date, the seller may be required to make a manufactured dividend payment to the market maker to compensate it for the dividend forgone.
(b)	Secondly, a market maker having a long position in a particular stock may have lent some or all of its shares to another market participant (to enable that person or a third market participant to satisfy a short position, as described above).  If a record date occurs for those shares whilst they are lent, the lending market maker will not receive a dividend from the underlying company on the shares because it is not the actual holder of the shares at that time.  In these circumstances, the market maker will instead receive a payment of a manufactured dividend from the borrower of the shares to compensate it for the dividend forgone.
(c)	Finally, if the market maker has itself borrowed stock to meet a short position, or has sold stock before an “ex dividend” date but this sale has not settled in time for the purchaser to receive the dividend, the market maker may in turn be required to pay a manufactured dividend to the lender or purchaser respectively. 
(10)	In practice, I believe that the large majority of SBC London Branch’s dividend receipts were actual dividends as opposed to manufactured dividends.  It is difficult, to express a precise percentage figure because our IT systems do not generate reports showing the ratio of actual to manufactured dividends.  However, I have conducted a small sampling exercise, looking at a number of SBC London Branch positions during the final quarter of 1996, which produced a figure of approximately 80% actual dividends and approximately 20% manufactured dividends (adjusting for one unrepresentative item).  It would be my expectation that these figures would be broadly representative of the ratios for the years in question. 
(11)	It will be appreciated from the description given above that the receipt of dividends (or manufactured dividends) by a market maker on the trading stock that it holds forms an integral part of the market maker’s overall revenues.  For example, in the context of the description given at paragraph 9 above, shortly before the stipulated record date for a particular dividend payment, the share will start trading on the LSE on an “ex dividend” basis, i.e. without the right to the forthcoming dividend payment.  If a market maker has bought shares before the ex dividend date and still owns them on that date then, all other things being equal (e.g. no underlying market movements), the market maker will incur a trading loss if it sells the shares on or after the ex dividend date, as the share price will fall on the ex dividend date by an amount equal to (approximately) the forthcoming dividend payment. However, the fact that the market maker receives the dividend compensates it for the fall in the value of the shares. The receipt of the dividend is therefore an integral part of the market maker’s revenues.  The same applies in the alternative situation described at paragraph 9 above, where the market maker has sold (for example) call options to a client and has then hedged its risk by buying the underlying shares to which the options relate, with a view to achieving an overall profit from the transactions whilst adopting (so far as possible) a risk neutral position.  When setting the price at which it is willing to sell the call options to the client, the market maker will have to make certain assumptions as to the amount of future dividends receivable on the shares to be held as its hedge.  If the expected dividends do not materialise (or do so but at a lower level than anticipated), then the market maker will suffer accordingly.  Contrarily, if the dividends paid on the underlying shares held as the hedge are greater than the market maker had expected, its resultant profit from the overall transactions will be increased.”
5.	We also find that:
(1)	With reference to paragraph 4(5) above, the Appellant, in common with most market makers in this position, generally (and in every case for the accounting periods in issue) adopted a long position.
(2)	The Appellant distributed the whole of its commercial profit to its head office.
(3)	In computing the profit of the Appellant interest paid to its head office was deducted.  The Appellant branch was funded entirely by debt but for tax purposes an adjustment for free capital was made to counteract this.  The Appellant was able to borrow from its head office at a “favourable rate,” which we take to be at a rate materially lower than that which the Appellant could have obtained had it borrowed from an arm’s length third party. 
6.	We shall approach this case in two stages, reflecting the different instruments being interpreted: first, whether on the true interpretation of the Treaty, the Appellant can claim that it has been discriminated against contrary to the Treaty; and secondly, whether on the true interpretation of s 788 of the Taxes Act 1988, the Treaty has been incorporated into law in the UK so as to give effect to our interpretation of the Treaty.
The interpretation of the Treaty
7.	We start by considering the correct approach to interpreting a treaty.  In IRC v Commerzbank [1990] STC 285, 297-8, in a passage approved by the Court of Appeal in Memec v IRC [1998] STC 754, 766g, Mummery J summarised the approach to treaty interpretation laid down by the House of Lords in Fothergill v Monarch Airlines Ltd [1981] AC 251: 
(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 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, [1987] 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).”
8.	Article 31 of the Vienna Convention on the Law of Treaties referred to in this quotation provides as follows:
“1.  A treaty shall be interpreted in good faith 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.
2.  The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:
(a)	Any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty;
(b)	Any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty. 
3. There shall be taken into account together with the context:
(c)	any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;
(d)	any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;
(e)	any relevant rules of international law applicable in the relations between the parties.
4. A special meaning shall be given to a term if it is established that the parties so intended.”
9.	The Treaty is based on the OECD Model Tax Convention of 1977 which was issued shortly before the Treaty was signed, being adopted as a Recommendation of the Council of the OECD on 11 April 1977.  (The non-discrimination provision relating to permanent establishments was identical in the OECD 1963 Draft Model but the Commentary was considerably expanded in 1977.)  The issue in this appeal concerns the non-discrimination article of the Treaty which is as follows:
“Article 23.  Non-discrimination
 (1) Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.
 (2) The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.
 (3) Nothing contained in this Article shall be construed as obliging a Contracting State to grant to individuals not resident in that State any of the personal allowances and reliefs which are granted to individuals so resident.
 (4) Except where the provisions of paragraph (1) of Article 9, paragraph[s] (4) [and (6)] of Article 11, or paragraph (4) of Article 12 apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State.
 (5) Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.
 (6) The provisions of this Article shall apply to taxes of every kind and description.”
That article closely follows the OECD Model.  In particular article 23(2) of the Treaty which is the part in issue here is identical to the first sentence of article 24(4) of the 1977 Model (now article 24(3) of the current Model as the definition of national has been moved to article 3).  
10.	The OECD Model has a Commentary explaining the terms of the Model which is accordingly an important means of interpretation of the Model and treaties following the Model.  Although not the subject of argument in this appeal, there is academic literature discussing how the Commentary fits into articles 31 and 32 of the Vienna Convention.  Our view is that the negotiators on both sides could be expected to have the Commentary in front of them and can be expected to have intended that the meaning in the Commentary should be applied in interpreting the Treaty when it contains the identical wording and neither party had made an observation disagreeing with the Commentary.  Article 24(4) of the 1977 Model is a short general statement that taxation on the permanent establishment is not to be “less favourably levied” and how that phrase operates in practice is explained in 35 paragraphs of the Commentary.  It seems clear that the parties to the Treaty intended that such explanation should be more important than the ordinary meaning to be given to the terms of that phrase.  This is either on the basis that the existence of the Model and Commentaries demonstrate that the parties intended it as a special meaning within article 31(4) of the Vienna Convention, or that the Vienna Convention does not purport to be a comprehensive statement of the method of treaty interpretation.  Its own commentary states that “Accordingly the [International Law] Commission confined itself to trying to isolate and codify the comparatively few general principles which appear to constitute general rules for the interpretation of treaties” (Introduction para (5)).  We should add that it was common ground in Sun Life Assurance Co of Canada v Pearson [1986] STC 335, 347a.  
11.	The Commentary deals with the permanent establishment non-discrimination provision under various headings: A. Assessment of tax; B. Special treatment of dividends received in respect of holdings owned by permanent establishments; C. Structure and rate of tax; D. Withholding tax on dividends, interest and royalties received by a permanent establishment; E. credit for foreign tax; and F. Extension to permanent establishments of the benefit of double taxation conventions concluded with third states.  Relevant passages in the Commentary are:
22….In the negative form in which the provision concerned has been framed, it is the result alone which counts, it being permissible to adapt the mode of taxation to the particular circumstances in which the taxation is levied.
23….The purpose of this provision is to end all discrimination in the treatment of permanent establishments as compared with resident enterprises belonging to the same sector of activities, as regards taxes based on industrial and commercial activities, and especially taxes on business profits.
…
25. As regards the first sentence [of art 24(4)], experience has shown that it was difficult to define clearly and completely the substance of the principle of equal treatment and this has led to wide differences of opinion with regard to the many implications of this principle.  The main reason for difficulty seems to reside in the actual nature of the permanent establishment, which is not a separate legal entity but only a part of an enterprise that has its head office in another State.  The situation of the permanent establishment is different from that of a domestic enterprise, which constitutes a single entity all of whose activities, with their fiscal implications, can be fully brought with the purview of the State where it has its head office.  The implications of the equal treatment clause will be examined below under several aspects of the levying of tax.
26(c)  Permanent establishments should also have the option that is available in most countries to resident enterprises of carrying forward or backward a loss brought out at the close of an accounting period within a certain period of time (e.g. 5 years).”
It therefore recognises the problems of equating a permanent establishment with a company.  In a number of cases the Commentary is clear that particular reliefs, such as deduction of expenses, depreciation, losses (although it does not deal with the type of loss relief relevant to this appeal, no doubt because the Model is based on a classical system of corporation tax), capital gains, and tax incentives.  In other cases, such as inter-company dividends, it records disagreement and recommends that states made their interpretation clear in a protocol.  It states that the application of provisions dealing with progressive rates of tax and minimum rates of tax, give rise to especially difficult and delicate problems.  One of these relates to the split-rate system of company tax where it records (paragraph 42) that most OECD member states take the view that the reduced rate on distributed profits should not be applied to a permanent establishment the split-rate is only one element in a system of taxing company profits and dividends which must be considered as a whole and is therefore applicable to domestic companies only; other states disagree.  This is a related issue to the one in this appeal as it concerns a relief related to the payment of dividends which a permanent establishment cannot pay.  In relation to the imputation system, it deals (paragraph 44) only with dividends paid out of profits made by the permanent establishment.  There is no clear guidance from the Commentary on the issue in this appeal.
12.	Article 23(2) of the Treaty requires one to compare the taxation on the Appellant’s permanent establishment in the UK with a UK resident company carrying on the same activities to determine whether the taxation is less favourably levied on the permanent establishment.  The issue depends on identifying the exact comparator.  The same activities requirement means that the hypothetical UK resident company is a market maker.  It is common ground that it should have exactly the same tax losses and receive the same dividends and manufactured dividends as the Appellant and should pay the same manufactured dividends.  Beyond that there was disagreement between the parties.  Mr Ewart contended that one should also consider the profit distribution.  The Appellant distributed the profit to its head office and therefore, since the issue concerned tax credits which were part of the imputation system of dividends, he contended that the comparator UK company should have distributed its profit to its parent.  Mr Gardiner contended that profit distribution was irrelevant.  But if it were included one would need to consider whether a group election had been made by the hypothetical UK resident company, which raises the question of where the parent company was resident.  
13.	We do not consider that profit distributions should be included in the comparison.  It is the nature of a permanent establishment that it cannot pay dividends and so that is outside the comparison; indeed if it were, under a classical corporation tax system on which the Model is based, such a comparison would imply that a state could impose a branch profits tax as equivalent to the withholding tax on dividends without breaching the non-discrimination article, which cannot be right.  Mr Ewart did not go this far but he included the payment of dividends in the comparison in this case because the imputation system and tax credits were bound up with the payment of dividends.  We consider that it is inherent in any comparison between a permanent establishment and a resident company that one must ignore the distribution of profits.  The two entities are different in this respect and no meaningful comparison can be made.
14.	We now turn to the statutory provision in issue which are as follows:
208. U.K. company distributions not generally chargeable to corporation tax 
Except as otherwise provided by the Corporation Tax Acts, corporation tax shall not be chargeable on dividends and other distributions of a company resident in the United Kingdom, nor shall any such dividends or distributions be taken into account in computing income for corporation tax.
238. Interpretation of terms and collection of ACT 
(1) In this Chapter—
“franked investment income” means income of a company resident in the United Kingdom which consists of a distribution in respect of which the company is entitled to a tax credit (and which accordingly represents income equal to the aggregate of the amount or value of the distribution and the amount of that credit), but subject to section 247(2);
“franked payment” means the sum of the amount or value of a qualifying distribution and such proportion of that amount or value as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made, but subject to section 247(2); 
“surplus advance corporation tax” has the meaning given by section 239(3); 
“surplus of franked investment income” means any such excess as is mentioned in subsection (3) of section 241 (calculated without regard to franked investment income which by virtue of subsection (5) of that section cannot be used to frank distributions); 
“tax credit” means a tax credit under section 231;…
231. Tax credits for certain recipients of qualifying distributions 
(1) Subject to sections 95(1)(b)[, 247 and 441A], where a company resident in the United Kingdom makes a qualifying distribution and the person receiving the distribution is another such company or a person resident in the United Kingdom, not being a company the recipient of the distribution shall be entitled to a tax credit equal to such proportion of the amount or value of the distribution as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made….
242. Set-off of losses etc. against surplus of franked investment income 
 (1) Where a company has a surplus of franked investment income for any accounting period—
 (a) the company may, on making a claim for the purpose, require that the amount of the surplus shall for all or any of the purposes mentioned in subsection (2) below be treated as if it were a like amount of profits chargeable to corporation tax; and 
(b) subject to subsection (4) below, the provisions mentioned in subsection (2) below shall apply in accordance with this section to reduce the amount of the surplus for purposes of section 241(3); and 
(c) the company shall be entitled to have paid to it the amount of the tax credit comprised in the amount of franked investment income by which the surplus is so reduced.
 (2) The purposes for which a claim may be made under subsection (1) above are those of—
 (a) the setting of trading losses against total profits under section [393A(1)];…
(5) Where—
 (a) on a claim made under this section for any accounting period relief is given in respect of the whole or part of any loss incurred in a trade, or of any amount which could be treated as a loss under section 393(9); and 
(b) in a later accounting period the franked payments made by the company exceed its franked investment income; 
then (unless the company has ceased to carry on the trade or to be within the charge to corporation tax in respect of it) the company shall, for the purposes of section 393(1), be treated as having, in the accounting period ending immediately before the beginning of the later accounting period mentioned in paragraph (b) above, incurred a loss equal to whichever is the lesser of—
(i) the excess referred to in paragraph (b) above; and 
(ii) the amount in respect of which relief was given as mentioned in paragraph (a) above or so much of that amount as remains after deduction of any part of it dealt with under this subsection in relation to an earlier accounting period.
243. Set-off of loss brought forward … 
 (1) Where a company has a surplus of franked investment income for any accounting period, the company, instead of or in addition to making a claim under section 242, may on making a claim for the purpose require that the surplus shall be taken into account for relief under section 393(1)…1, up to the amount of ranked investment income for the accounting period which, if chargeable to corporation tax, would have been so taken into account by virtue of section 393(8); and (subject to the restriction to that amount of franked investment income) the following subsections shall have effect where the company makes a claim under this section for any accounting period.
 (2) The amount to which the claim relates shall for the purposes of the claim be treated as trading income of the accounting period.
 (3) The reduction falling to be made in trading income of an accounting period shall be made as far as possible in trading income chargeable to corporation tax rather than in the amount treated as trading income so chargeable under this section.
 (4) If the claim relates to section 393(1), section 242(5) shall apply in relation to it.
 (5)… 
 (6) The time limits for claims under this section shall be as follows—
 (a) if and so far as the purpose for which the claim is made is the allowance of relief under section 393(1), six years from the end of the accounting period for which the claim is made, 
(b)…  
 (7) For the purposes of a claim under this section for any accounting period the surplus of franked investment income for that period shall be calculated without regard to the part, if any, carried forward from an earlier accounting period.
244. Further provisions relating to claims is under section 242 or 243 
 (1) Without prejudice to section 242(9) or 243(7), the surplus of franked investment income for an accounting period for which a claim is made under either of those sections shall be calculated without regard to any part of that surplus which, when the claim is made, has been used to frank distributions (2) Where in consequence of a claim under either section 242 or section 243 for any accounting period a company is entitled to payment of a sum in respect of tax credit—
(a) an amount equal to that sum shall be deducted from any advance corporation tax which apart from this subsection would fall, under section 239, to be set against the company’s liability to corporation tax for the next accounting period or the benefit of which could be surrendered under section 240; and 
(b) if that amount exceeds that advance corporation tax or there is no such advance corporation tax, that excess or that amount (as the case may be) shall be carried forward and similarly deducted in relation to the following accounting period and so on….” 
15.	We summarise the effect of a claim under s 243 (which is the claim made by the Appellant) in relation to a UK resident company as follows.  One starts from the position that dividends received by a financial trader are not part of its trading income; they are taxable under a different Schedule, Schedule F, and in any case they are not chargeable to corporation tax (s 208).  (We ignore the application of s 95 of the Taxes Act 1988 which was introduced for distributions made to dealers after 25 November 1996, which is not material in this appeal.)  A company with surplus franked investment income (i.e. broadly the excess of dividends plus the associated tax credit received over dividends plus the advance corporation tax on them paid) for an accounting period may claim that the surplus be taken into account for effective loss relief under s 393(1) (trading losses brought forward and set against profits of the same trade) (s 243(1)).  The amount of the surplus is “for the purposes of the claim” treated as trading income of the accounting period (s 243(2), thereby cancelling the effect of the exclusion of franked investment income from trading profits and enabling it to be set against the loss.  The consequence is not expressly stated in s 243 but it is common ground that s 243 activates, in turn, s 242.  Section 242 provides that the company is “entitled to have paid to it the amount of the tax credit comprised in the amount of franked investment income by which the surplus is reduced.”  Accordingly the company receives from the Revenue what s 244 describes as the “payment of a sum in respect of tax credit.” However, the Appellant cannot, under the Taxes Act, receive payment of the amount of the tax credit under s 243 because only a resident company can have franked investment income, the definition of which is limited to “income of a company resident in the United Kingdom.”  It is convenient to note at this stage that although the application of ss 242 and 243 entitles a UK resident company to a payment of a sum of money (equal to the “tax credit”) which is self-evidently calculated to give relief for losses sustained by that UK resident company while within the charge to corporation tax, the payment is not itself expressed to be a payment or repayment of corporation tax.
16.	Next, if in a later accounting period franked payments exceed franked investment income, effectively the claim is reversed.  The company will have paid ACT on the excess of franked payments.  So long as it still caries on the same trade, it is treated as having incurred a loss immediately before the beginning of the later period of the amount previously claimed up to that excess (s 242(5)).  Whether or not the company still carries on the same trade, the amount originally claimed reduces the ACT which can be set against mainstream corporation tax in the next (or subsequent) accounting periods (s 244(2)(a)).  The effect is that the loss which was originally used to obtain a payment of the tax credit the company is reinstated in the later period and can instead be set against profits, with the result that the loss reduces profits taxable at the full corporation tax rate, which is more favourable than the tax credit at the ACT rate.  The same amount that was paid under the s 243 claim has now been paid as ACT but cannot then be used to set against mainstream corporation tax, and so the position is the same as if the claim had been repaid.  It is common ground that a non-resident, such as the Appellant, can never obtain the benefit of the relief described in this paragraph because it cannot make franked payments.
Manufactured dividends
17.	Manufactured dividends were also received and paid by the Appellant in the circumstances described in Mr Anderson’s statement quoted in paragraph 4(9) above.  The relevant statutory provisions affecting UK resident companies with which the permanent establishment is to be compared, are straightforward:
Schedule 23A
2.—(1) This paragraph applies in any case where, under a contract or other arrangements for the transfer of United Kingdom equities, one of the parties (the “dividend manufacturer”) is required to pay to the other (“the recipient”) an amount representative of a dividend on the equities; and in this Schedule the “manufactured dividend” means any payment which the dividend manufacturer makes in discharge of that requirement.
 (2) If, in a case where this paragraph applies, the dividend manufacturer is a company resident in the United Kingdom, then, for all purposes of the Tax Acts, the manufactured dividend shall be treated as if it were a dividend of, and paid by, the dividend manufacturer (and shall accordingly be a distribution of the dividend manufacturer for those purposes).
Manufactured dividends are treated in exactly the same way as real dividends received from the paying company or paid on its own shares by the company concerned.  The tax credit and ACT consequences are exactly the same as for real dividends.  
18.	The position of the UK branch of a non-resident company is more complex.  We shall limit our consideration to the circumstances existing in this case where dividends plus manufactured dividends received exceed manufactured dividends paid.  The following provisions are relevant:
737. Manufactured dividends: treatment of tax deducted 
(1) Subject to the provisions of this section and of Schedule 23A, where, under a contract or other arrangements for the transfer of securities, one of the parties (the “dividend manufacturer”) is required to pay to the other an amount representative of a periodical payment of interest on the securities, section 350(1) and Schedule 16 shall apply as if the payment by the dividend manufacturer (the “manufactured dividend”) were an annual payment made, after due deduction of tax, wholly out of a source other than profits or gains brought into charge to income tax.]…
…
(5A) Where this section applies in relation to a manufactured dividend, relief shall not be given to any person under any provision of the Tax Acts in respect of any amount which he is required to deduct from the manufactured dividend on account of income tax; and in this subsection “relief” means relief by way of—
 (a) deduction in computing profits or gains; or 
(b) deduction or set off against income or total profits. 
 …
 (7A) Where the dividend manufacturer—
 (a) is not resident in the United Kingdom but carries on a trade through a branch or agency in the United Kingdom, or 
(b) is a member, of a prescribed class or description, of a prescribed recognised investment exchange, 
dividend manufacturing regulations may make provision for this section and such other provisions of the Tax Acts as may be prescribed to apply with prescribed modifications in connection with the manufactured dividend or any tax required to be deducted or accounted for in respect of it.
The Income Tax (Dividend Manufacturing) Regulations 1992
13.—(1) Paragraph (2) prescribes, for the purposes of subsections (7A) and (7B), the modifications with which subsection (1) of section 737 shall apply in the cases specified in paragraphs (3) and (4). 
(2) The prescribed modifications to subsection (1) of section 737 are that— 
(a) the charge to tax under subsection (1) of section 737 shall only apply to the extent that the manufactured dividends (other than manufactured overseas dividends) paid exceed dividends (other than overseas dividends) and manufactured dividends (other than manufactured overseas dividends) received;
(b) the dividends (other than overseas dividends) and manufactured dividends (other than manufactured overseas dividends) received shall not be treated as the income of the dividend manufacturer to the extent that they do not exceed dividends (other than overseas dividends) and manufactured dividends (other than manufactured overseas dividends) paid; 
(c) to the extent that manufactured dividends (other than manufactured overseas dividends) paid do not exceed dividends (other than overseas dividends) and manufactured dividends (other than manufactured overseas dividends) received, they shall not qualify for relief in the hands of the dividend manufacturer; and 
(d) section 350(1) of, and Schedule 16 to, the Taxes Act, shall not apply.” 
Schedule 23A paragraph 2 (continued from the part quoted in paragraph 17 above)
 (3) If, in a case where this paragraph applies, the dividend manufacturer is not such a company as is mentioned in sub-paragraph (2) above [which applies to UK resident companies] (so that section 737 applies in relation to the dividend manufacturer) the manufactured dividend shall for all purposes of the Tax Acts be treated in relation to the recipient and all persons claiming title through or under him—
 (a) as if the manufactured dividend were a dividend on the United Kingdom equities, 
(b) as if any amount required in consequence of section 737 to be deducted by the dividend manufacturer on account of income tax in respect of the gross amount of the manufactured dividend were required to be accounted for by him as advance corporation tax in respect of the dividend, and 
(c) as if any certificate of deduction of tax required in consequence of that section to be issued in connection with the manufactured dividend were the tax credit certificate that would have been issued had the manufactured dividend in fact been a dividend on the United Kingdom equities…”.
19.	We can summarise the effect of these provisions as follows.  So far as the Appellant is concerned the receipt of a manufactured dividend is not taxable and there is no further or other relief available to it (as there is for the tax credit available to a UK resident company) (s 737 as modified by regulation 13(2)(b)).  No relief is available for manufactured dividends paid (regulation 13(2)(c)), which is exactly the same as for a UK resident company.  Accordingly, we shall not make any further reference to manufactured dividends as the difference in the position of the tax credit is the same as for actual dividends, and for other purposes there is no difference in treatment between the Appellant and a UK resident company.
Whether the comparison can include payment of the tax credit
20.	Mr Ewart contends that one must look at the provisions described in paragraphs 15 and 16 as a whole.  The provisions described in the second of those paragraphs cannot apply to the Appellant because it can never have an excess of franked payments over franked investment income, and so he contends that none of the provisions can apply.  He characterises the difference between the Appellant and the hypothetical UK resident company that the latter receives a conditional payment in respect of the tax credit.  But if the Appellant is accorded the payment by virtue of the non-discrimination article of the Treaty it would be an absolute payment (because the provisions summarised in paragraph 16 can never apply to it), which is not a fair comparison to lead to the result that the taxation on the Appellant permanent establishment is less favourably levied.  Mr Gardiner contends that the only time that the payment in respect of the tax credit was reversed for the UK resident was where it had instead received the more favourable relief for its loss by using it against profits otherwise taxable at the higher corporation tax rate.  The fact that the Appellant can never do this should not disentitle it to the first relief.
21.	Mr Ewart also contends that s 243 is not part of the process of levying tax but a mechanism whereby a company can secure the payment of a tax credit from the Revenue.  Mr Gardiner contends otherwise.
Reasons for our decision on the comparison
22.	We see no difficulty in making the comparison so that only the provisions summarised in paragraph 15 apply to the Appellant.  That is a provision related only to losses and the receipt of franked investment income.  The fact that there are other related provisions summarised in paragraph 16 that can give a UK resident company a greater benefit but which are inapplicable to the Appellant does not prevent the comparison from being made in relation to the paragraph 15 provisions.  We consider that this is part of levying tax.  While in one sense it is a mechanism for securing payment of the tax credit, the circumstance in which this occurs is by way of a relief for losses.  In this respect it is not different in nature from carrying losses forwards or backwards, which the Commentary states must be applied to a permanent establishment.  The discussion in the Commentary about the applicability of the reduced rate of corporation tax under a split-rate system of corporation tax is much closer to the issue in paragraph 16.
Whether taxation is less favourably levied: preliminary points
23.	Mr Ewart made two preliminary points relating to whether the taxation on the Appellant was less favourably levied.  First that the Appellant paid interest to its head office which was allowed in the computation of its profits as it is a financial institution.  In that respect the Appellant permanent establishment was treated more favourably than a company as it was entirely funded by debt.  Mr Gardiner made the point that the Appellant was able to borrow from its head office at a favourable rate of interest (which we accept: see above).   Secondly, Mr Ewart contended that for 1993 foreign interest received was excluded from the taxation of the Appellant by virtue of article 11 of the Treaty and in that respect the Appellant was treated more favourably than a hypothetical UK resident company (the Treaty was changed in 1993 and so this did not apply to later years).  
24.	We do not consider that either of these points should be taken into account.  The computation for 1993 (and we infer other years) adds back a figure for “free capital” which we take to be an adjustment to deal with the first point.  The second point goes to the nature of the comparison.  Here the Treaty gives a more favourable treatment to a permanent establishment and the question is whether in determining whether taxation is less favourably levied it is possible to take this into account.  Nowhere in the Commentary is there any suggestion that a global approach should be taken so as to take account of each and every tax provision in either the domestic tax law of the Contracting State or the Treaty.  It refers to numerous items to be included in the comparison without making any statement about making an overall comparison.  This is inherent in the approach that taxation must not be less favourably levied; there is no prohibition on its being more favourably levied.  While we agree with Mr Ewart that an item by item approach cannot be made mechanically (his example was a higher nominal rate of tax on the permanent establishment, but the lower rate on a resident company was based on the grossed-up amount), nevertheless we consider that the Commentary requires an item by item approach when making the comparison.  We consider that the effect of the substantive provision under scrutiny on the permanent establishment on the one hand and the resident comparator on the other should be made without regard to the effect on either of other provisions which are not under scrutiny.  The application of each and every tax provision is the subject of scrutiny of article 23 of the Treaty: see the reference to “any taxation or any requirement connected therewith” in article 23(1).  The scope of the non-discrimination article in the Treaty extends to every application of the domestic tax provision under scrutiny, irrespective of any particular factual circumstances.  Thus, in applying the non-discrimination article, it is not permissible to have regard to the potential application of domestic tax provisions other than that under scrutiny, if the application of those other domestic provisions depend on the facts of a particular case.  In other words the reference to “the same circumstances” in article 23(1) merely ensures that the comparison is made on the basis of the actual application of the provisions scrutinised. The contrary global view would either make a comparison impossible (because it is always possible to point to some differences between a permanent establishment and a UK resident company which arguably put them in different circumstances or suggest that tax is not levied “less favourably” on the present establishment) or draw arbitrary lines to determine which provisions other than the provision under scrutiny could or could not be considered.  Here the Treaty expressly treats the permanent establishment more favourably in one respect but the non-discrimination article must in the context of the Treaty as a whole ignore this and intend that the less-favourably-levied test should be applied to other aspects of taxation.  It is only less-favourably-levied taxation that is prevented, not more-favourably-levied taxation.
Reasons for our decision on whether taxation is less favourably levied
25.	We consider that payment of the tax credit is part of the levying of taxation and that the taxation on the Appellant is less favourably levied.  The UK resident company in exactly the same circumstances can claim from the Revenue a payment in respect of the tax credit; the Appellant cannot.  In a later accounting period the UK resident company which pays more dividends than it receives will automatically receive a greater benefit at the cost of the claim being reversed and being repaid in the form of ACT that cannot be set against mainstream corporation tax, which the Appellant cannot.  We do not describe this as a comparison between a conditional and (if the Appellant succeeds) an absolute one.  Rather, it is payment to the hypothetical UK resident of at least the sum in respect of the tax credit, and possibly more; and (if the Appellant succeeds) a payment to the Appellant equal to that sum, but never a greater sum.  In the words of the Commentary “it is the result alone which counts.”  Nothing can obscure the difference that before the application of the non-discrimination article the UK resident can on making a claim receive cash from the Revenue in respect of the tax credit, while the Appellant cannot.  That, in our view, is clearly taxation less favourably levied on the Appellant.
26.	It is convenient to note here that Mr Ewart contended that article 10(5) of the Treaty (which disapplies the tax credit provisions for dividends paid to a permanent establishment) was consistent with his submission that the Appellant was not entitled to a payment of a tax credit under ss 243 and 242.  As we understand it, his contention was that Article 10(5) demonstrated an intention on the part of the draftsman of the Treaty not to give any relief to a permanent establishment based on a tax credit.  We reject this contention as oversubtle and irrelevant.  Article 10(5) merely disapplies the tax credit provisions in that article and applies the Business Profits Article (article 7), which in turn brings into play the permanent establishment non-discrimination provision.  That is all.  
27.	Accordingly, our interpretation of the Treaty is that the Appellant is entitled to succeed in its claim that it is discriminatory to deny it the benefit of a claim under s 243.
Section 788 of the Taxes Act 1988
28.	We turn next to the internal law question of whether the Treaty has been incorporated into UK law in such a way as to entitle the Appellant to succeed in its claim.  Section 788 provides: 
788. Relief by agreement with other countries 
 (1) If Her Majesty by Order in Council declares that arrangements specified in the Order have been made with the government of any territory outside the United Kingdom with a view to affording relief from double taxation in 
(a) income tax, 
(b) corporation tax in respect of income or chargeable gains, and
(c) any taxes of a similar character to those taxes imposed by the laws of that territory, 
and that it is expedient that those arrangements should have effect, then those arrangements shall have effect in accordance with subsection (3) below.
 (2) Without prejudice to the generality of subsection (1) above, if it appears to Her Majesty to be appropriate, the arrangements specified in an Order in Council under this section may include provisions with respect to the exchange of information necessary for carrying out the domestic laws of the United Kingdom and the laws of the territory to which the arrangements relate concerning taxes covered by the arrangements including, in particular; provisions about the prevention of fiscal evasion with respect to those taxes; and where arrangements do include any such provisions, the declaration in the Order in Council shall state that fact.
 (3) Subject to the provisions of this Part, the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide—
 (a) for relief from income tax, or from corporation tax in respect of income or chargeable gains; or
(b) for charging the income arising from sources, or chargeable gains accruing on the disposal of assets, in the United Kingdom to persons not resident in the United Kingdom; or
(c) for determining the income or chargeable gains to be attributed— 
 (i) to persons not resident in the United Kingdom and their agencies, branches or establishments in the United Kingdom; or 
(ii) to persons resident in the United Kingdom who have special relationships with persons not so resident; or 
(d) for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident.” 
29.	Mr Gardiner relied on subs (3)(a) and did not rely on subs (3)(d).
Approach
30.	Mr Gardiner contends that we should approach the issue by leaning in favour of the Treaty being properly incorporated.  He relies on the following passage by Diplock LJ in Salomon v Customs and Excise commissioners  [1967] 2QB 116 at 143F:
“If the terms of the legislation are not clear but are reasonably capable of more than one meaning, the treaty itself becomes relevant, for thee is a prima facie presumption that Parliament does not intend to act in breach of international law, including therein specific treaty obligations; and in one of the meanings which can reasonably be ascribed to the legislation is consonant with the treaty obligations and another or others are not, the meaning which is consonant is to be preferred.”
Mr Ewart contended that the passage related to the situation where the legislation gave effect to a particular treaty obligation not in the words of the treaty but in the draftsman’s own words, as Park J explained in NEC Semi-Conductors Ltd v IRC [2004] STC 489 at [51] where he described Diplock LJ’s remarks are not relevant to the interpretation of s 788 which is an enabling provision applicable to treaties that are to be made.  Mr Ewart contended that this was a case where:
“If the terms of the legislation are clear and unambiguous, they must be given effect to, whether or not they carry out Her Majesty’s treaty obligations, because the sovereign power of the Queen in Parliament extends to breaking treaties…. (Salomon  at p.143)
31.	Mr Gardiner also made the point that the OECD Model gave states the opportunity of entering a reservation where it disagreed with a provision of the Model (paragraph 31 of the Introduction to the Model) or an observation if it disagreed with the Commentary (paragraph 30 of the Introduction).  It was relevant that no reservation or observation had been entered in elation to article 24(3) of the Model (the equivalent of article 23(2) of the Treaty).  If the effect of s 788 is such that the Treaty is not properly incorporated in respect of the relief claimed, the same must apply to all other treaties based on the Model.  In this respect we observe that the UK entered a reservation in 1992 that it reserved the right to restrict the scope of the non-discrimination article to the taxes covered by the Convention (paragraph 72 of the Commentary to article 24 of the Model), which must be because s 788 is limited to income tax and corporation tax (and, by reference, capital gains tax: s 277 Taxation of Chargeable Gains Act 1992), but even that reservation was not there when the Treaty was made and the Treaty is not restricted in this way in its terms.  
Whether payment of the tax credit is a relief
32.	On whether payment of the tax credit is a relief Mr Gardiner relied on IRC v Trustees of SEMA Group Pension Scheme [2003] STC 95 in which one issue considered by the Court of Appeal was whether payment of the tax credit on dividends to trustees of a pension scheme was within the definition of tax advantage in s 709:
“(1) In this Chapter “tax advantage” means a relief or increased relief from, or repayment or increased repayment of, tax, or the avoidance or reduction of a charge to tax or an assessment to tax or the avoidance of a possible assessment thereto, whether the avoidance or reduction is effected by receipts accruing in such a way that the recipient does not pay or bear tax on them, or by a deduction in computing profits or gains.”
There he was arguing for the taxpayer that exemption was conceptually different from relief, and receipt of the tax credit was not a relief.  The decision of the Court of Appeal was that there was no conceptual difference between relief and repayment:
“[109] In my judgment, what the draftsman was manifestly trying to do when defining ‘tax advantage’ in s 709(1) was to cover every situation in which the position of the taxpayer vis-à-vis the Revenue is improved in consequence of the particular transaction of transactions….In my judgment, ‘relief’ in s 709(1) is intended to cover situations where the taxpayer‘s liability is reduced, leaving a smaller sum to be paid, and ‘repayment’ is intended to cover situations in which a payment is due from the Revenue.”
33.	Mr Ewart pointed out that this part of the decision was obiter as the trustees won on whether the dividend was an abnormal one, and also that the issue in the case was whether exemption from tax was a relief.  The Revenue did not argue that payment of the tax credit was a repayment of tax.  They were arguing [at 69] that “it is the exemption of the scheme from tax, and not the consequential entitlement of the trustees to a tax credit, which is the relevant ‘relief’” (which is essentially Mr Gardiner’s argument in this appeal).  The Court of Appeal were rejecting any conceptual difference between exemption and relief:
“[108]  In the first place, I reject Mr Gardiner’s submissions based on the conceptual difference between exemption and relief.  Such submissions seem to me to involve a degree of sophistication which runs entirely counter to the general approach to be adopted to the construction of the relevant statutory provisions, as finally laid down by the House of Lords in IRC v Joiner [1975] STC 657.”  [This is a reference to “…we must continue to give ‘transactions in securities’…the widest meaning: we can neither confine these expressions to the instances given in [the definition section], nor can we deduct from that enumeration any limitation on their scope.” Per Lord Wilberforce]
Whether payment of the tax credit is a relief from corporation tax
34.	On the question whether the claim is a relief from corporation tax Mr Gardiner contends that relief is given for a loss in circumstances where a profit is liable to corporation tax.  It is merely the mechanics of the relief that the Appellant is (in view of our decision on the Treaty) entitled to a payment of sum in respect of the tax credit.  In SEMA it was held that payment of the tax credit was a relief from income tax.  If Mr Ewart’s argument that here the payment of the tax credit is not corporation tax is correct, that would have been a complete argument in SEMA.
35.	Mr Ewart contends that the Appellant has losses that are not liable to corporation tax and has received dividends that are not chargeable to corporation tax (s 208).  What the Appellant is entitled to receive is not corporation tax.  It is a payment created by s 243.
Reasons for our decision on s 788
36.	On this aspect we agree with Mr Ewart.  So far as the approach is concerned, while we appreciate that Diplock LJ in Salomon was dealing with a very different situation, we see not reason in principle why, if two interpretations are equal, we should not prefer the one that is consistent with treaty obligations.  But that is extremely difficult to apply to s 788 which deals with future treaties whose provisions are unknown.  It certainly goes too far to assume that s 788 will give effect to a treaty in the form of the OECD Model.  An obvious example is the one to which we have referred of article 23(6) of the Treaty, corresponding to article 24(7) of the Model, that the non-discrimination article applies to taxes of every kind and description; this clearly goes beyond what is authorised by s 788 (i.e. “income tax” and “corporation tax” and capital gains tax by reference).  In any event, we do not consider that this is a case of ambiguity which needs to be resolved by virtue of a presumption.  
37.	On whether the claim can be described as a relief, we consider SEMA to be a different case.  The distinction between exemption and relief is irrelevant here.  And unlike s 709 no distinction is being made in s 788 between relief and repayment, and so the Court of Appeal’s distinction between them is not relevant.  Indeed much of the relief under the Treaty will be by way of repayment of taxes deducted at source and so relief in s 788 must encompass repayment.  The term “relief” is not a term of art: Taylor v MEPC Holdings Ltd [2004] STC 123, 126 per Lord Hoffmann at [10].  In the broad sense a repayment could be a relief.  On the ordinary meaning of language the payment of the tax credit in the circumstances of s 243 is a relief from tax for similar reasons to our decision that it is part of the levying of taxation in relation to the Treaty.  We reach our conclusion without reference to s 709(2A) of the Taxes Act 1988 [definition of “relief” expressly extended to a tax credit] which was introduced by s 73 of the Finance Act 1997.  No argument was presented by either party in relation to s 709(2A).  In any event, we do not consider s 709(2A), being legislation enacted subsequent to s 788, to be a legitimate aid to the construction of s 788(3)(a).
38.	Finally, is it a relief from corporation tax?  In SEMA, in general, because of the exemption of dividends received by trustees of a pension fund from income tax they had an automatic entitlement to payment of the tax credit if it exceeded their liability to income tax, which was presumably nil.   Section 231(3) provides:
“A person, not being a company resident in the United Kingdom, who is entitled to a tax credit in respect of a distribution may claim to have the credit set against the income tax chargeable on his income under section 3 or on his total income for the year of assessment in which the distribution is made and…where the credit exceeds that income tax, to have the excess paid to him.
It was reasonable to describe the trustees’ exemption from “income tax” and the consequent automatic right to payment of the tax credit on dividends as a relief from income tax.  The trustees could theoretically (we say nothing about how realistic this prospect is) have been liable to income tax on, say, trading income.  In that case the tax credit would have reduced this income tax liability.  So the right to payment of the tax credit, being a right to a payment of the difference between an income tax liability and the tax credit is a relief from income tax.  The nil liability to income tax on the trustees, in SEMA, depended on the facts (i.e. whether the trustees had taxable income).  The position of the Appellant is different here.  In the year in question the Appellant was potentially liable to corporation tax but had trading losses and received dividends that were exempt from corporation tax, and so did not pay any corporation tax.  Unlike s 231(3), there was no question of that exemption giving an automatic right to a payment of the tax credit if the amount of the tax credit exceeded the Appellant’s liability to corporation tax.  The Appellant’s corporation tax liability was the same whether or not it received the payment of the tax credit.  The trustees’ liability to income tax in SEMA was dependent on the facts, which might have been (at least in theory) adjusted by the tax credit; the Appellant’s liability to corporation tax in this case could never have been adjusted by the payment of the tax credit.  This is a matter of principle, independent of the facts.  Put another way, the right to the payment of the tax credit under ss 242 and 243 is not a payment which “reduces the [corporation] tax which would otherwise be payable” (Taylor v MEPC Holdings Ltd [2004] STC 123, 126 per Lord Hoffmann at [10]).  The payment arises once the final corporation tax has been agreed and does not adjust it.  
39.	Finally, on this issue, that the calculation of the right to a payment of the tax credit is clearly intended to give loss relief for corporation tax purposes does not, we consider, make the right to the payment itself a relief from corporation tax.  Accordingly whereas in SEMA the relief was the exemption of pension trustees from tax (“income tax”), here the relief is solely the entitlement to receive payment of a sum in respect of the tax credit.  As a matter of mechanics (“for the purposes of the claim”: s 243(2)) the franked investment income is treated as trading income but it remains exempt from corporation tax under s 208 and so such treatment does not entitle the company to any relief from corporation tax for the trading loss set against it (as does the relief summarised in paragraph 16 above).  When the Treaty provided, as we have decided, for payment of the tax credit, it did not provide for any relief from corporation tax; it merely provided that s 243 should operate in the particular circumstances so as to entitle the Appellant to receive payment of a sum in respect of a tax credit.  That sum has no connection with corporation tax, other than someone else paid an equivalent sum as ACT.  One may contrast the situation with that applying before 1973 when income tax was deducted from dividends.  The equivalent relief to ss 242 to 244, contained in s 62 of the Finance Act 1965, gave rise to an express repayment of income tax (that is an express reduction of the paying company’s income tax liability) and so effect was given to it by s 788(3)(a) as being a relief from income tax.  The introduction of the imputation system and the notion of tax credits in 1972 meant that a right to a tax credit became conceptually very different to the reduction of the tax liability of the holder of that right.  Contrast the right to the repayment of basic rate tax withheld at source under s 349 of the Taxes Act 1988, which is treated as a income tax or corporation tax liability of the payer (although the obligation to withhold represents a collection of a flat rate of tax from the payee of the interest where s 349 applies) (see s 350 and Sch 16).  Thus any right to a payment for the payer of such interest, who had withheld tax at source, in respect of the amount withheld, is clearly a right to relief from the income tax or corporation tax liability of the payer.   
40.	Accordingly our decision on this aspect is that the right under the Treaty to receive a payment in respect of the tax credit under s 243 is not something incorporated into UK law.  It follows that the Appellant cannot succeed in its claim.  
41.	We reach this part of our decision with considerable reluctance.  The position is wholly unsatisfactory.  It means that the UK has made a treaty but has not given effect to it in domestic law and is therefore in breach of the Treaty in the sphere of international law.  We cannot tell whether this failure is deliberate or whether it was an oversight that s 788(3)(d) refers only to s 231 and not to ss 242 to 244; our interpretation that the equivalent relief was covered before 1973 suggests that it might not have been deliberate.  Indeed, it is difficult to see what s 788(3)(d) does achieve if it really is confined to a “right” to a tax credit since that “right” is useless without the parasitic right to a payment under each ss 231(2), 231(3), 242 or 243.  Whether or not s 788(3)(d) was intended, as a matter of construction, to extend to these parasitic rights was not argued before us and accordingly we do not consider this issue any further.  We note that, in other respects, the non-incorporation of the non-discrimination article in relation to particular taxes is clearly deliberate, as in the case we have given of article 23(6) of the Treaty stating that the non-discrimination article applies to “taxes of every kind and description,” which clearly goes beyond s 788.  One might guess that the Swiss were told of the limited effect of s 788 and that they accepted that they would make a lopsided agreement in this respect, to the advantage of the UK national or resident who may be able to invoke the non-discrimination article in Switzerland in respect of taxes not covered by the treaty.  But it is far more probable that the UK negotiators would not have told the Swiss that they could not give effect to the Treaty in the case dealt with in this appeal.  We also observe that this is not the first time that s 788 has been found not to have incorporated a tax treaty fully, see Sun Life of Canada v Pearson [1984] STC 461, 516b (credit for foreign tax not available to a permanent establishment since s 788(3) gave relief “subject to the provisions of this Part” [of the Taxes Act 1988], one of which was that only residents qualified for relief; the law has since been changed); R v IRC ex p. Commerzbank [1991] STC 271, 277f (repayment supplement not within s 788(3), although the discrimination was not within the nationality provision of the non-discrimination article); NEC Semi-Conductors Ltd v IRC [2004] STC 489 at [34] onwards (ACT not corporation tax in respect of income or chargeable gains within s 788(3), although there is no finding that the discrimination was contrary to the treaty); and possibly the Special Commissioners’ decision in Bricom Holdings Ltd v IRC [1996] STC (SCD) 228, 236-7 (tax on controlled foreign companies is not corporation tax (a matter left open by the Court of Appeal [1977] STC 1179, 1196) and if it is a tax “substantially similar to” corporation tax it is not within s 788, although the charge was not contrary to the treaty).  We put forward the suggestion that Parliament should reconsider s 788.
42.	In summary our decision is that 
(1)	On the true construction of the Treaty the Appellant is entitled to claim payment of the tax credit on dividends under s 243 of the Taxes Act 1988
(2)	But that s 788 of the Taxes Act has not incorporated such a right into UK law and accordingly the appeal is dismissed.

JOHN F. AVERY JONES

JULIAN GHOSH
SPECIAL COMMISSIONERS
RELEASE DATE: 7 June 2005

SC 3134/04

Authorities referred to in skeletons and not referred to in the decision:
F.S. Securities Ltd v IRC (1964) 41 TC 666
Pirelli Cable Holdings v IRC [2004] STC 130
Padmore v IRC (No.2)  [2001] STC 280
Attorney-General v Wilts United Dairies Ltd (1921) TLR 884