Residence under the US / UK Double Tax Treaty: The case of GE financial investments

The case of GE Financial Investments v. HMRC contains a detailed analysis of the approach to treaty interpretation and the meaning of ‘residence’ in the context of the US / UK Double Taxation Agreement (and other tax treaties). The case concerned corporate tax residence, but the Upper Tribunal’s analysis is equally applicable to individuals.

The First Tier Tax Tribunal (FTT) denied GE Financial Investments Ltd tax relief of nearly £125 million, but the Upper Tribunal reached the sensible and practical conclusion that a UK company which, through its connection with the US, was liable to US tax was entitled to credit for the US tax paid.

The facts are complex, but in summary:

• GE Financial Investments Ltd. (GEFI Ltd.) was a UK private company incorporated under the Companies Act 1985.
• It was a subsidiary of a US company and part of the General Electric group, the holding company of which is US-incorporated.
• GEFI Inc, a Delaware corporation, was a sister company of GEFI Ltd.
• In 2003, the shares in GEFI Ltd were ‘stapled’ to the stock of GEFI Inc and vice versa. Effectively, it meant that the shares / stock (I will refer just to shares below) in each company could not be transferred separately, but if shares in one company were transferred, shares in the other company had to be transferred also.
• GEFI Ltd and GEFI Inc formed a Delaware limited partnership funded by other group members.
• The limited partnership made loans, running into hundreds of millions of dollars, to members of the General Electric group.
• The partnership and, accordingly, its members received interest on the loans.

GEFI Ltd paid US Federal income tax on the interest it received in the accounting periods ending in December 2003 to 2008. GEFI Ltd also filed corporation tax returns in that period and claimed a credit for the US tax paid on the same interest against its corporation tax liability.

HMRC refused the claim for double tax relief.

The relief denied amounted to £124,913,161.86.

The main question was whether GEFI Ltd was a ‘resident’ of the US for the purposes of Article 4 of the US / UK Double Tax Agreement (the DTA). If it was, it was entitled to the tax credit it had claimed.

One effect of the stapling of the GEFI Ltd shares to the stock of GEFI Inc was that GEFI Ltd was treated as a ‘domestic corporation’ for US Federal income tax purposes and, as a result, was liable to tax on its worldwide income in the US.

The First Tier Tax Tribunal found that, despite this, GEFI Ltd was not US resident for DTA purposes, and the company appealed to the Upper Tribunal.

Article 4(1) of the DTA provides:

‘…the term “resident of a Contracting State” means, for the purposes of this Convention, any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or of profits attributable to a permanent establishment in that State.’

This is closely based on the OECD model convention, with the addition of ‘citizenship’ and ‘place of incorporation’ to the connecting criteria.

HMRC sought to argue that being a ‘domestic corporation’ was not a ‘criterion of a similar nature’ and that some territorial or personal connection to a state, beyond being fully taxed in it, was required for residence.

The Upper Tribunal’s approach to interpreting the DTA was to consider the context, object, and purpose of the treaty. This required a consideration of the UK and US tax rules applicable to companies at the time the DTA was entered into. A state is deemed to be aware of the law of the other state when entering into a treaty. The Tribunal also considered the model OECD treaty and the commentary on it.

The relevant US and UK laws

Under UK law, a company, wherever incorporated, is resident ‘where the central management and control actually abides’. If that is in the UK, the company is UK resident.

In addition, since 1988, a company that is incorporated in the UK is deemed to be resident in the UK, irrespective of where it is centrally managed and controlled.

A UK resident company is liable to corporation tax on its worldwide income.

UK resident individuals are subject to tax on their worldwide income.

Non-residents, whether corporate or individual, are taxable in the UK, if at all, on UK source income only.

Worldwide taxation depends solely on residence.

Under US Federal income tax law, the distinction is between ‘domestic’ and ‘foreign’ corporations. A domestic corporation is liable to tax on worldwide income; a foreign corporation is liable to US tax only on certain US connected income.

The sole test for being a domestic corporation is incorporation in the US. A company that is not domestic is foreign.

The US tax Code provides that where a domestic corporation and foreign corporation are stapled entities, the foreign company ‘shall be treated as’ a domestic corporation but only if more than 50% of the votes and value are owned, directly or indirectly, by US persons.

These rules were in place before the DTA was negotiated.

There are other situations where a foreign company is treated as a domestic corporation, for example, where the company elects for this treatment.

GEFI Ltd was treated as a domestic corporation because of its direct and indirect links to other companies incorporated in the US.

There is no difference in tax treatment between a ‘real’ domestic corporation and a corporation deemed to be domestic under the stapling rules.

The OECD model convention and its commentary

The points the Tribunal took from Article 4 of the model treaty and the OECD Commentary on it are:

1. Article 4(1) is concerned with full taxation of the person (as opposed to taxation only on sources within the territory), and full taxation is linked to ‘residence’ in the territory.
2. Whether a person is resident in a state is to be determined solely by reference to domestic law.
3. Residence can include deemed residence, whether of an individual or a company.
4. Purely formal criteria (such as the place of registration / incorporation of a company) are relevant in determining residence if that is the approach taken by a particular state. There is no need for any substantive territorial connection.
5. The purpose of Article 4 is to provide a solution where there is double taxation as a result of double residence. Some states resolve the issue in favour of the ‘place of effective management’, but many of the newer treaties, including that with the US resolve double residence by ‘mutual agreement’ between the respective tax authorities.

The US / UK Double Tax Agreement

The references in Article 4 to ‘citizenship’ and ‘place of incorporation’ do not appear in the OECD model. This reflects the fact that the US imposes worldwide taxation by reference to the citizenship of individuals and the place of incorporation of companies.

The consequence of the mutual agreement procedure is that if HMRC and the IRS do not agree, a dual resident company remains taxable in both countries and is entitled to a tax credit only for US tax against its UK tax liability.

The Tribunal considered it ‘apparent’ that the US regards its rules for taxing companies via the concept of a domestic corporation as an example of corporate residence. In other words, the status of domestic corporation is functionally equivalent to residence.

Considered in the light of the purpose and contextual background of the DTA, the concept of a domestic corporation is a ‘criterion of a similar nature’ to ‘domicile, residence, citizenship, place of management [and] place of incorporation’. What is important is that the criterion establishes full tax liability in the territory, whether it is a formal criterion, such as place of incorporation, or a factual one, such as place of effective management. As the relevant concept takes its meaning from domestic law, there is significant room for a state to determine the basis on which it takes ‘full’ taxing rights.

The Tribunal endorsed the OECD commentary, which states that a person who is deemed to be resident under domestic law is also resident for the purposes of the Convention and stated that this applies to companies just as much as to individuals.

On the basis that ‘stapling’ caused GEFI Ltd to be deemed a domestic corporation in the US and thereby liable to full taxation in the US, the Tribunal held it was resident in the US for the purposes of the DTA. Accordingly, it was entitled to double tax relief.

Comments

The case highlights some interesting points on the applications of double tax treaties generally:

1. The meaning of terms like ‘residence’ or any other term not expressly defined must be determined by reference solely to the domestic law of each state.
2. It is intended that a state should have a wide scope to determine its own criteria for taxation.
3. The only requirement is that the chosen criterion should impose ‘full’ ie worldwide taxation, on the person who falls within it.
4. It is not necessary for there to be some factual territorial connection between a person and a state for the person to be resident there. A purely legal or formal connection is sufficient if it carries with it a liability to full taxation.
5. A person who is ‘deemed’ to fall within the criterion is treated in the same way as those who actually satisfy the criterion.
6. Residence under domestic law means the person is resident for the purposes of the DTA.

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