The Court of Appeal has rejected HMRC’s argument that a taxpayer’s right to payments based on the volume and price of oil extracted from the Buchan oil field in the UK continental shelf amounted to income from immoveable property under Article 6 of the UK-Canada Double Taxation Treaty (the “Treaty”).

The court’s decision overturned the First-tier Tax Tribunal and Upper Tribunal decisions after a detailed analysis of the Treaty, which is based on the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention. The judgment is notable for the court’s willingness to look beyond a superficial reading of the Treaty and refusal to shoe-horn certain rights into different articles.

Matthew Greene and Krishna Mahajan examine the decision in Royal Bank of Canada v Commissioners for HMRC [2023] EWCA Civ 695.

Background

The taxpayer is tax resident in Canada, and although it had a branch in the UK, the activity at the centre of this dispute was not connected with that branch. In the early 1980s, the taxpayer lent $540m Canadian Dollars to Sulpetro, a Canadian oil company. A UK subsidiary of Sulpetro, SUKL, held a licence from the UK government to explore and exploit the Buchan oil field in the North Sea (on the UK Continental Shelf).

SUKL and Sulpetro agreed that Sulpetro would incur all the development and exploitation costs in relation to the Buchan oil field. In return, Sulpetro would receive the licence holder’s share of the oil extracted.

Sulpetro sold its interest in the Buchan oil field to BP in December 1986, and BP acquired the shares in SUKL and Sulpetro’s license interests. In addition, BP agreed to make a series of other payments, including the payment of what was described as a royalty to Sulpetro in respect of all production in the Buchan oil field (the “Payments”). The Payments were payable when the market price per barrel of oil exceeded $20 per barrel (subject to certain adjustments).

Sulpetro went into receivership in 1987, and the receivership ended in 1993. The taxpayer was a creditor of Sulpetro at this time. Under the court order ending the receivership, the right to the Payments from BP was assigned to the taxpayer for a nominal consideration.

Talisman Energy Inc. subsequently acquired BP’s interest in the Buchan oil field and assumed the legal obligation to make the Payments to the taxpayer from July 1996. It treated the Payments as deductible in computing its ring-fenced profits from its UK oil exploitation trade.

The arguments

HMRC argued that under Article 6 of the Treaty, the UK had the right to tax the Payments and that they were chargeable under section 1313 Corporation Tax Act 2009 (“CTA 2009”). Article 6 of the Treaty provides:

“Article 6 Income from immovable property

1. Income from immovable property, including income from agriculture or forestry, may be taxed in the Contracting State in which such property is situated.
2. For the purposes of this Convention, the term ‘immovable property’ shall be defined in accordance with the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships, boats and aircraft shall not be regarded as immovable property…” (The wording in bold is our emphasis.)

The taxpayer argued that HMRC (and the tribunals below) had misinterpreted the scope of Article 6(2). They relied in particular on the French text (the Treaty being a dual language document), which indicated that the relevant part of Article 6 “applied only to the rights of a grantor to receive payments from a grantee as consideration for the grant of a right to work mineral resources”. This was also consistent with the wider operation of the Treaty. If HMRC’s view was correct, large parts of the Treaty would be unnecessary given the breadth of HMRC’s interpretation of Article 6.

Decision and analysis

The Court of Appeal undertook a thorough analysis applying the well-established principles of treaty interpretation in the Vienna Convention. The court recognised that it would be surprising if an article dealing with immoveable property should extend to a purely contractual right to receive payments in exchange for a right to work land where a person holds that right to the payments with no interest in the land. However, that difficulty does not arise if the article is interpreted as referring to a right that has a legal rather than economic link to the land. The court considered the comparison with a mortgage debt and noted that debt claims secured by a mortgage are accepted as generally falling within the interest article (article 11) of the OECD model treaty rather than Article 6.

The court then examined the language in Article 12 concerning royalties, which contains a similarly worded provision referring to “payments of any kind received as consideration for the use of, or the right to use” intellectual property rights. The OECD commentary on article 12 states that it “does not, however, apply to payments that, whilst based on the number of times a right belonging to someone is used, are made to someone else who does not himself own the right or the right to use it”. Article 12 does not, therefore, apply to a person with no interest in the relevant intellectual property.

Turning to Article 13, which deals with capital gains arising from immoveable property, the court addressed the specific provisions contained in article 13(4) covering gains from the alienation of any right or licence to explore or drill for petroleum, natural gas and other hydrocarbons. The court considered it noteworthy that HMRC was relying on an interpretation of Article 6 that did not explicitly mention hydrocarbons, rather than Article 13, which contained wording specifically negotiated between the parties to the Treaty (as opposed to stemming from the model convention). As Lady Justice Falk said:

“The notion of the parties [to the Treaty] choosing to spell out in Article 13(4) that rights to explore, drill for and take hydrocarbons, and rights to assets produced from those activities, are within the scope of Article 13, no doubt on the basis that it at least might not otherwise be the case that they comprise immoveable property in any event, while being content to leave it to a rather obscure provision in Article 6(2) to catch rights to payments that relate in some way to those activities but are further removed from the land itself, seems to me to be rather extraordinary.”

The court considered the French text of the Treaty and agreed with the taxpayer that the French text uses the term “concession”, which connotes the creation rather than the transfer of a right and is more akin to a grant in English law.

The court therefore concluded that the Payments did not fall within Article 6. The court also agreed with the taxpayer’s alternative ground of appeal that the tribunal had wrongly proceeded on the basis that Sulpetro, rather than SUKL, had the right to extract oil. In other words, the Payments could not be consideration for a “right to work” within Article 6(2) because Sulpetro did not hold that right. HMRC had argued that Sulpetro’s right to direct the work and receive the benefit of it was sufficient. However, this would ignore the legal structure in place between Sulpetro and SUKL, a structure that was common (for regulatory reasons) and one the parties to the Treaty would have been aware of.

The Court of Appeal’s decision demonstrates a welcome willingness to look beyond a superficial reading of the Treaty. As the Vienna Convention principle makes clear, it is not appropriate to construe a bilateral Treaty as though it were a domestic statute. The agreement’s evolution, the purpose behind the model treaty provisions, the OECD commentary, how the articles fit together and (in some situations) the treaty’s different language versions are all highly relevant to understanding the rights and obligations arising under any double taxation treaty.

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