1. Introduction

Recently, the UK First-Tier Tribunal (Tax Chamber) (hereafter referred to as “the Court”) pronounced a decision involving applicability of Art. 8(2) of tax treaty between the United Kingdom and Ireland [that provision was similar to Art. 7(2) in a pre-2010 OECD Model Convention.

In the above-mentioned decision, the Court concurred with the UK tax authorities that it was necessary to notionally attribute certain level of free capital to the UK permanent establishment of an Irish bank. The Court reached that conclusion on the basis of a specific provision in the UK tax law, and opined that it did not conflict with a tax treaty provision similar to Art. 7(2) in pre-2010 OECD Model Convention. 

This is not the solitary incident of a Source State’s attempt to attribute notional capital to a permanent establishment. As pointed out in this article, even the tax authorities from other jurisdictions (including the United States, France, and Spain) have made similar attempts.

With due respect to the Court, the approach and the conclusion in the UK Court’s decision – analyzed in detail in this article – seem difficult to reconcile with the scheme of ‘independent enterprise’ (or separate enterprise) hypothesis embodied in tax treaty provisions similar to Art. 7(2) of the OECD Model Convention. Though the French Conseil d’Etat and the Spanish equivalent of the Court of Appeal have recently rejected similar attempts, the UK decision may ‘refuel’ the dispute on this highly complex issue and it could have serious ramifications even beyond the financial services industry.