1. 1 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Recent International Judicial Decisions Presented by Bijal Ajinkya ©Nishith Desai Associates

2. 2 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Case 1 National Westminster Bank, plc v. United States (December 2005) UK Bank B B B B B B UK USA Facts Taxpayer, a UK bank – had operations through 6 branches in the US, 3 located in one building in NY An NY branch bore overhead expenses for other co-located branches Each branch maintained separate books of record Taxpayer filed a single US tax return – for a single Permanent Establishment (“PE”) Revenue claimed that the assessee operations need to be treated as six different PE’s Revenue also claimed that each branch needed to be allocated capital by taxpayer to cover its economic risk and to cover losses made by the particular branch Assessee applied for summary judgment on these issues

3. 3 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Issues : 1.Whether the books and records of the US branches had been properly maintained? 2.How many PEs did the taxpayer have in the US? 3.Whether the amount of interest on free capital had been correctly excluded from computation of profits? Held: Books and records “Books and records” under the UK- US DTAA, necessary to determine the profits of a branch, which is a PE Argued by the revenue that the books of account were not properly maintained, hence the profits and capital were not distinguished clearly between the branches and anomalies existed in the books undermining their correctness Contended by assessee and held by court that the books and records were accurate and reliably maintained and that the Revenue could not prove anything on fact

4. 4 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates No of PEs Assessee argued that the question of number of PEs was a question of law, while the Revenue argued that it was a question of fact Assessee contended and it was held that the separate records for six branches were maintained for internal purposes There is no precedent, reference, no indication in the OECD commentary, the Revenue Manual or previous treatment given by the Government to hold that a foreign bank operating several offices in a host country is said to have more than one PE Further, it was held – based on opinions of the experts that filing of tax returns on an “aggregate” basis is a norm of a foreign corporation having operations in a host country As for the purposes of the tax liability of branches in a host country– there is a single PE, profits of which are determined on an aggregate basis Thus, there is only one PE and not six

5. 5 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Economic Risk Contended by Government that the taxpayer had failed to account for “economic capital” in calculating profits, failed to account for the losses sustained by the various branches in calculating profits and failed to follow the Manual with regard to “fixed assets” Court rejected the above contention and held that taxpayer was not obligated to identify an amount to be treated as allotted capital to account for economic risk posed by the activities conducted by the US branch Further, court rejected the contention on fixed assets and held that the taxpayers factual position did not need it to trace the assets, as no interest was paid on capital allocated for the assets

6. 6 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Held that it was not the task of the Inland Revenue to identify the amount of capital, which had in reality been given to the branch Further, that a UK bank with a branch in the US was under no regulatory requirement to provide capital to the US branch Accounting for Losses Taxpayer was entitled to treat six branches as a single PE for tax purposes, thus there was no requirement to account for losses in a single branch and transfer capital to that particular branch

7. 7 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Blanckaert v. Inspecteur van de Belastingdienst (ECJ) (September 2005) Facts: The taxpayer, a non resident of the Netherlands derived income from investments in the Netherlands Being a non resident, he was not required to make social security payments and consequently not entitled to deductions Case 2 Dutch Co No deduction allowed Netherlands

8. 8 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates He claimed that he should be entitled to the deductions and to set them against his tax and that the distinction between residents and non residents was in breach of the right to free movement of capital guaranteed under the EC treaty Issue: Whether the principal of free movement of capital under Community Law precludes a national rule under which tax credits in respect of social security contributions are denied to non residents if they do not have any income in that member state in respect of which social security contributions are payable.

9. 9 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Analysis: Article 56 (1) EC – All restrictions on the movement of capital between members states and between member states and third countries shall be prohibited Article 58 (1) EC – the above provision shall be without prejudice to the member states: (a) to apply the relevant provisions of their tax law which distinguish between tax payers who are not in the same situation with regard to their place of residence or with regard to the place where their capital is invested; (b) to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation…

10. 10 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Article 58(3) - the measures and procedures adopted (in 58(1)EC) shall not constitute a mean of arbitrary discrimination or a disguised restriction on the free movement of capital and payments as defined in article 56 National Law : Natural persons are regarded as liable to tax if they either reside in the Netherlands (residents) or, although not residing in Netherlands, but receive income in the Netherlands (non residents) Under Netherlands law income tax was payable on income received from the Netherlands from employment and from other sources such as investment and rental income Social security contributions were payable by anyone resident in the Netherlands and by non resident who derived income from employment in the Netherlands Certain deductions from social security payments were permitted and if, after these reductions were applied, there was net amount due to the tax payer, the tax payer could deduct that from income tax payable

11. 11 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Held : The ECJ held in favour of the national tax administration “ Article 56 EC and 58 EC concerning the free movement of capital within the community do not preclude a national rule which, for income tax purposes, grants resident tax payers a tax credit in respect of expenditure connected with social security schemes but denies that tax credit to non resident tax payers, in so far as such differentiation is not based upon the place of residence of the tax payer but upon his status in that regard whether the person concerned is or is not required to pay contributions.”

12. 12 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Case 3 Bouanich V. Skatteverket, (European Union) (January 2006) Facts : Ms. Bouanich, a French national and resident, owned shares in a Swedish Company The Company repurchased those shares, resulting in a capital gain in the hands of the resident recipients, and dividend in the hands of non-residents, as per Swedish law She launched legal action after the Swedish local tax board treated taxed money received by her as dividend income and consequently refused to refund tax charged on her earnings, Swiss co. Distribution of capital - dividends Distribution of capital – capital gain Switzerland France 917,000 euros

13. 13 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates As per Swedish law - payments to resident shareholders upon repurchase of shares taxed as a capital gain and acquisition costs of such shares deducted and the gain taxed at 30%. For non-resident shareholders, such payment treated as dividend distribution subject to a 30% dividend tax, but acquisition costs may not be deducted in computing tax. Under the DTAA rate reduced to 15%. Issues : Whether Articles 56 and 58 of the EC Treaty (dealing with free movement of capital) permits differential tax treatment of share repurchase payments applicable under Swedish law?

14. 14 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Whether or not the Swedish system is compatible with the free of movement of capital especially where the DTAA with regard to a repurchase of shares provides for a lower rate for non- resident shareholders than that applying to resident shareholders and non-resident shareholders, based on the Commentary to the OECD Model Convention, may deduct an amount equal to the nominal value of the repurchased shares? Whether or not the Swedish system is compatible with Articles 43 and 48 of the EC Treaty?

15. 15 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates ECJ Held: Swedish legislation constituted arbitrary discrimination against non-resident shareholders as it taxed them more onerously than resident shareholders since, there was no objective difference between the situations of resident and non-resident taxpayers when receiving such income as the cost of acquisition of the shares was directly linked to the payments made in respect of their repurchase That the tax advantage to a resident of Sweden as compared to non-resident shareholders of being able to deduct the acquisition costs of the shares constituted a restriction on the free movement of capital within Article 56 EC

16. 16 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates In respect of the second question, the ECJ’s view was that the national legislation which derives from the DTAA would only be compatible with the free movement of capital if the treatment of the non-resident shareholder is not less favourable than the treatment of a resident shareholder That the Franco-Sweden DTAA must be taken into account when interpreting Community Law However, the determination of whether or not resident shareholders (who are taxed at the rate of 30% on share repurchase payments after the deduction of acquisition costs) are treated more favourably than non-residents shareholders (who are taxed at the rate of 15% after the deduction of nominal value of the shares) was left to the national court to decide That in light of the answers given to the first and second questions, it was not necessary to answer the third question

17. 17 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Case 4 Wood and Another V. Holden (Inspector of Taxes) (January 2006) Facts : Mr. And Mrs. Wood were settlers of a number of different trusts set up in the British Virgin Islands. These trusts owned all the shares in company, Copeswood Investments Limited (“CIL”), incorporated in the British Virgin Islands. CIL owned shares in Ron Wood Greeting Cards Holdings Limited (“Holdings”), a company in the United Kingdom (“UK”). CIL Eulalia Holdings SOLD BVI Netherlands UK MD

18. 18 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Subsequently, CIL acquired all of the share capital of Eulalia Holding BV (“Eulalia”), a company incorporated in Netherlands. Eulalia was, thereby, a wholly owned subsidiary of CIL. Thereafter, CIL sold to Eulalia all of CIL’s shareholdings in Holdings for substantial consideration and subsequent to this, Eulalia sold its shareholding in Holdings to another company. Eulalia’s managing director was a trust managed by ABN AMRO Bank (“Bank”) in the Netherlands and undertook responsibility for day-to-day management of the Netherlands company.

19. 19 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Issue : Whether the Commissioners were entitled to conclude that, under the common law of corporate residence, the Appellants had failed to establish that Eulalia, the Dutch subsidiary was not resident in the UK for tax purposes? Held : Court of Appeal held the High Court had been correct to hold that the only conclusion open to them was that Eulalia was resident in the Netherlands. Rejecting the Revenue’s appeal, the Court of Appeal held that on the basis of the “central management and control test” the Commissioners’ decision could not stand.

20. 20 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Rationale This case concerned an arrangement designed to defer the taxation of capital gains potentially arising on the disposal of shares by an individual in a U.K. company. The planning arrangements had been put in place at the request of an individual who had been the major shareholder of the U.K. company, and who had engaged an accountancy firm in the U.K. to act as corporate finance and tax advisers and who organized all of the arrangements for the share sales and planning.

21. 21 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Earlier, the Commissioners had noted that the only acts of management and control of the Netherlands company were the making of board resolutions and the signing or execution of documents and these were not sufficient for actual management. The Commissioners considered that effective decisions as to whether or not the resolution should be passed and the documents signed or executed were needed and that the Dutch trust company did not have sufficient information to make these key decisions relating to the company’s business. This current decision was based on the rationale that there was no evidence that the taxpayer’s UK-based accountant had dictated their decisions. A management decision did not cease to be such because it might have been taken on fuller information. Ill-informed decisions by directors remained management decisions.

22. 22 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Case 5 Yoon v R ( Tax Court of Canada) (July 2005) Facts : The tax payer was born in Korea She later returned to Korea and lived and worked there She along with her husband decided to retire in Canada but she continued to work in Korea and visited her husband in 2000- 2001 She had residences in both Korea and Canada but was working in Korea In the year 2002 she spent more time in Canada and eventually retired there Korea Canada

23. 23 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Issue : Whether she was a resident of Canada for tax purposes in 2001? Whether she was resident of Korea under Korean law, but no evidence was available as to Korean law and hence the question was whether the court could consider the matter according to lex fori? With which country the tax payer had had the closest connection under the terms of the Canada-Korea DTAA (which was identical to the OECD model DTAA)?

24. 24 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Held : Residency was a fundamental concept in the law of taxation and determination of residency was a question of the general law. It was not regulatory in nature. The foreign law could be assumed to be the same as the lex fori in the absence of evidence to the contrary Tie breaker rule – where doubt existed as to an individual’s ‘center of vital interests’ should tip the balance in favour of the country where the individual stays more frequently

25. 25 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates In this case, the first tie breaker did not resolve the issue as the taxpayer had a permanent home in both states. The second test involves the determination of the individual’s center of vital interests –involves an examination of the facts and circumstances of the tax payer’s life. In the instant case, this test pointed to Korea. The Court also noted that with regard to ‘habitual abode’ test, the tax payer spent the greater part of her time in Korea.

26. 26 Residential Refresher Course Mahabaleshwar, April 2006 ©Nishith Desai Associates Thank you