Royal Bank of Canada – Canadian bank liable to pay UK tax on assigned oil royalties

In Royal Bank of Canada v HMRC [2020] UKFTT 267 (TC) the First-tier Tribunal (FTT) held that a Canadian bank was subject to UK tax on royalties assigned to it following its oil company creditor entering receivership.

Background

Royal Bank of Canada (RBC) loaned $540 million in the early 1980s to Sulpetro Ltd (Sulpetro), a Canadian oil company, to fund exploration in the UK continental shelf. In 1986, Sulpetro sold its interest in the oil field to BP Petroleum Development Ltd (BP) in exchange for sums, including an entitlement to contingent royalty payments on production from the oil field (the payments). 

Sulpetro entered receivership in 1993 and its rights to all future payments were formally assigned to RBC for nominal consideration. BP subsequently sold its interest in the oil field to Talisman Energy (UK) Ltd (Talisman). Talisman assumed the obligation to make the payments and accounted for these as a deduction from its ringfenced profits of its UK oil exploitation trade. 

RBC treated the loan to Sulpetro as a bad debt and the payments received as recovery of the bad debt and income of its banking business in Canada. The payments were not reported in any UK tax returns.

HMRC became aware of the payments being made by Talisman to RBC when reviewing Talisman's tax affairs.  HMRC claimed that RBC ought to account for UK corporation tax on the payments it received as part of a ring-fence activity carried on through a deemed UK permanent establishment. It raised discovery assessments against RBC for the years 2008–2012, between 2014 and 2017 (the assessments). 

RBC appealed the assessments.

FTT decision

The appeal was dismissed. 

There were three main issues for determination by the FTT:

1. whether the UK/Canada double tax treaty allocates taxing rights to the UK in respect of the payments;
2. if it does, whether the payments fell within the scope of the UK taxing provisions; and
3. whether the assessments were stale and therefore invalid. 
   

Issue 1 

The key issue for the FTT to consider was whether, for the purposes of Article 6(2) of the Double Taxation Relief (Taxes on Income) (Canada) Order 1980, the payments received by RBC amounted to income from "immovable property". Under Article 6(2), "immovable property" includes "rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources". 

The FTT noted that the purpose of Article 6 (2) is to focus on profit derived from the exploration for, or exploitation of, mineral resources, whether that profit is derived directly by working the resources or indirectly by letting out the right to do so. In the view of the FTT, there was no reason to limit the scope of Article 6(2) to cover only payments made directly to the owner of the rights in exchange for the grant of a right to exploit them. Such a limitation would be inconsistent with the purpose of Article 6(2), as it would be possible to avoid local taxation by interposing an assignment of the royalty rights after they had been granted.  

The FTT concluded that the payments fell due as part of the consideration paid by Talisman for the assignment to it of the right to work the field. The royalty rights were immovable property, for the purposes of Article 6(2), as they were rights to variable payments as consideration for the right to work mineral deposits. The UK was therefore entitled to tax the payments under Article 6(2). 

Issue 2 

It was common ground that the oil field formed part of the UK sector of the continental shelf. The question for the FTT to determine was whether the UK had exercised its taxing rights. 

The FTT referred to section 1313(2), Corporation Tax Act 2009 (CTA), which provides as follows:

"(2) Any profits arising to a non-UK resident company—

(a) from exploration or exploitation activities, or

(b) from exploration or exploitation rights,

are treated for corporation tax purposes as profits of a trade carried on by the company in the United Kingdom through a permanent establishment in the United Kingdom."

Although the FTT recognised that Talisman was conducting the exploitation activities referred to in section 1313(2)(a), this section is only intended to apply where there is a direct link between the taxpayer and the activities themselves. Section 1313(2)(a) was not therefore applicable to the payments as the connection between RBC and Talisman's activities was not sufficiently proximate. 

Turning to section 1313(2)(b), the FTT said that the question to be answered was whether any profits arose to RBC "from rights to assets to be produced by exploration or exploitation activities or to interests in or to the benefit of such assets".

The FTT noted that the payments did not arise from rights to the oil to be extracted from the oil field nor did RBC have an underlying legal interest in the oil itself. The main issue for the FTT to consider was whether the payments received by RBC amounted to rights "to the benefit" of the oil to be extracted, where the totality of the benefit was shared between RBC and Talisman (the company making the payments). As it could not have been the intention of section 1313 that rights in respect of part of the benefit of the oil would fall outside the scope of the provision, the FTT concluded that RBC did have rights to the benefit of the oil extracted from the field by virtue of the payments from Talisman. The payments were therefore taxable ring-fence profits of a deemed permanent establishment of RBC in the UK. 

Issue 3  

With regard to the third issue, the FTT concluded that the assessments were  not stale. In particular, the fact that much of the information had been available to HMRC for many years before the years under assessment, did not preclude the officer in question from making a discovery. It held that the list of information on the desk of the hypothetical officer is an exhaustive list and "any attempt to include other information, however ingeniously the argument is repackaged, must be rejected", based on the principles enunciated in Langham v Veltema [2004] EWCA Civ 93.

For 2008 and 2009, HMRC also had to rely on the longer time limit for discovery assessments that are available where the loss of tax has been brought about carelessly. RBC argued that, given the complexity of the issues, there were reasonable grounds for concluding that the payments were not taxable and therefore that it was reasonable not to include them in its tax returns.

The FTT considered that the existence of a 1991 letter from BP (who had been paying the payments at that time) to RBC that stated that BP had spoken to HMRC  and they had concluded that RBC should contact HMRC to determine RBC’s tax liability, which was not acted upon, indicated that RBC had been careless. The FTT concluded that RBC had ignored the letter, left the payments out of its tax returns and provided no explanation to HMRC. In the viewof the FTT, such an approach was not the approach of a reasonably diligent taxpayer.  

Comment 

While the decision regarding the cross-border taxation of oil royalties that have been assigned to a non-oil company are likely to be of limited relevance to other taxpayers, the FTT's decision in relation to the carelessness of RBC will be of wider interest. It is surprising that the FTT concluded that RBC had been careless simply because it had not acted on a letter it had received from a third party. 

Taxpayers should retain all documents recording any advice received from their professional advisors in relation to complex tax issues, as such evidence may assist them in defeating a claim that they have acted carelessly. 

The decision can be viewed here.