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England and Wales Court of Appeal (Civil Division) Decisions


You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> MEMEC Plc v Inland Revenue [1998] EWCA Civ 941 (9 June 1998)
URL: http://www.bailii.org/ew/cases/EWCA/Civ/1998/941.html
Cite as: [1998] STC 754, 1 ITL Rep 3, [1998] EWCA Civ 941, 71 TC 77, [1998] BTC 251

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Case No: CHANF 96/1643/B

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE CHANCERY DIVISION
(REVENUE)
Mr. Justice Robert Walker
Royal Courts of Justice
Strand
London, WC2A 2LL

Tuesday, 9th June 1998

B e f o r e :

LORD JUSTICE PETER GIBSON
LORD JUSTICE HENRY
SIR CHRISTOPHER STAUGHTON

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MEMEC PLC
Appellants

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THE COMMISSIONERS OF INLAND REVENUE
Respondents
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(Transcript of the Handed-Down Judgment of
Smith Bernal Reporting Limited, 180 Fleet Streeet,
London EC4A 2HD
Official shorthand Writers to the Court)

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Mr. Robert Venables Q.C., Mr. Julian Ghosh and Mrs. Amanda Hardy (instructed by Finers, 179 Great Portland Street, London W1N 6LS for the Appellants)
Mr. Launcelot Henderson Q.C. (instructed by the Solicitor of Inland Revenue for the Respondents)

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J U D G M E N T
(As approved by the Court )

Crown Copyright
Peter Gibson L.J.: The taxpayer, Memec Plc ("Plc"), claimed relief from corporation tax in the accounting periods ended 31 December 1986, 1987 and 1988 respectively in respect of trade tax (Gewerbesteuer) levied in Germany on the profits of two German companies, which profits were the ultimate source of certain income received by Plc in those accounting periods. The claims were made pursuant to a double taxation convention of 28 November 1964 with Germany, as amended by a protocol of 23 March 1970, alternatively pursuant to Part XVIII of the Income and Corporation Taxes Act 1970 ("the 1970 Act") and/or Part XVIII of the Income and Corporation Taxes Act 1988 ("the 1988 Act"), and in the further alternative pursuant partly to the convention and partly to Part XVIII of the 1970 Act and/or Part XVIII of the 1988 Act. The Revenue refused those claims and on appeal by Plc a Special Commissioner dismissed the appeals. On an appeal by Plc from the Special Commissioner by way of Case Stated, Robert Walker J. on 24 October 1996 dismissed the appeal. Plc now appeals to this court.

The judge's full and careful judgment is now reported together with the decision of the Special Commissioner ([1996] S.T.C. 1336) and I can confine my recitation of the facts and of the fiscal provisions in point to the salient facts and the more important provisions, looking only, for convenience, at the 1988 Act, which reenacts provisions found in the 1970 Act, and at the convention.

Plc is an English company resident in England. It owns directly or indirectly the whole of the issued share capital of Memec GmbH ("GmbH"), a German holding company resident in Germany. GmbH owns the whole of the issued share capital of each of two subsidiary companies ("the Subsidiaries"), each of which is a German trading company resident in Germany. For every DM100 of profits each of the Subsidiaries paid approximately DM 20 trade tax, which is a local tax, and in addition German corporation tax (Körperschaftsteuer), which is a Federal tax, at the rate of 36% on the profits net of trade tax. On paying a dividend to GmbH, the Subsidiaries were obliged to deduct and account for dividend withholding tax at the rate of 25% of the gross dividend. GmbH had no further liability to trade tax on its dividend income and its profits for German corporation tax purposes consisted of the dividends received from the Subsidiaries grossed up to take account of the German corporation tax borne, and the dividend withholding tax paid, by the Subsidiaries. When GmbH paid a dividend to Plc, that was subject to withholding tax at the rate of 15% allowed under the convention. The net result was that only 43.52% of the Subsidiaries' pre-tax profits, assuming maximum distribution by the Subsidiaries to GmbH and by GmbH to Plc, was received by Plc.

It was with the primary intention of reducing the burden of German tax that Plc and GmbH on 14 February 1985 entered into an agreement ("the Agreement") for a silent partnership (stille gesellschaft). Such a partnership is one formed under ss. 230 ff. of the German Commercial Code and its characteristics were summarised by the judge (at p.1345) as follows:
"The essential points are that the silent partner (stille gesellschafter) makes a capital contribution to a commercial enterprise run by another person who is designated as the owner (inhaber). The owner remains the owner of the business assets, and of the income from those assets as it accrues. The silent partner has no proprietary interest in the assets but has a contractual right to payment of his share of the annual profits (if any) as shown by the partnership accounts, and can sue for damages in the event of any misappropriation. The owner runs the business, though the silent partner has access to information about it. The silent partner is not responsible for liabilities of the partnership beyond the amount of his contribution, but his share of any loss will be debited to his contribution, and must be made good out of his share of profits of later years before any share of profits is distributed to him. On termination of the partnership the silent partner gets a return of his capital contribution, so far as it has not been lost. A silent partnership has no separate legal personality under German law. Its existence is often unknown to customers dealing with the owner."

Under the Agreement Plc was the silent partner making a capital contribution of DM2.05 million and GmbH was the owner of what was called "the GmbH business", which was not defined but appears to be the whole business of GmbH, and Plc was to share in the profits and losses of the GmbH business, Plc being entitled to 87.4% of the profits of the GmbH business. The establishment of Plc's share of the profits was to take place at the end of each business year, and that share was to be payable immediately after the shareholders of GmbH had approved the financial statements of GmbH. The effect of the Agreement was that GmbH was not liable to German corporation tax on Plc's share of the profits and as a result (on the assumption, for the sake of simplicity, that all of GmbH's profits were paid to Plc) Plc received (after deduction of 15% withholding tax) 68% of the pre-tax profits of the Subsidiaries, instead of only 43.52% before the Agreement.

When prior to the Agreement U.K. corporation tax was charged at a rate not exceeding 36.48% the availability of a credit for trade tax paid by the Subsidiaries was academic, as the credit for German corporation tax and withholding tax (suffered by GmbH and Plc) was sufficient to cover the U.K. corporation tax. But, as the judge pointed out (at p.1355), as soon as the German corporation tax was largely avoided by the formation of the silent partnership, the availability of a credit for the Subsidiaries' trade tax became a matter of practical importance. That is the issue in the present case. Plc submits that unless it is entitled to credit for the trade tax paid by the Subsidiaries, it will have suffered economic double taxation. It points out that the Agreement was not made to avoid U.K. tax. In so far as Plc is claiming that it has the merits on its side, I do not think that these points carry much weight. Prior to the Agreement, Plc accepts, economic double taxation was suffered through the group structure it had chosen to adopt. It is common ground that the new structure has achieved its intended purpose of reducing the burden of German tax by eliminating German corporation tax in respect of Plc's share of the profits of the silent partnership. Whether the new structure has achieved the further benefit for Plc of a credit against U.K. corporation tax for the trade tax paid by the Subsidiaries seems to me to be a dry question of law unencumbered by the merits. The question turns on the applicability of provisions of the U.K. tax legislation and of the convention, as amended, which was incorporated into U.K. law by the combined effect of s.788 of the 1988 Act and the Double Taxation Relief (Taxes on Income) (Federal Republic of Germany) Orders of 1967 and 1971 respectively.

By Article I(1) the convention is expressed to apply to (amongst other taxes) German corporation tax and trade tax and U.K. corporation tax. Article II contains a number of general definitions applicable throughout the convention, unless the context otherwise requires, but para. (3) is a sweeping-up provision:
"In the application of the provisions of the present Convention by one of the Contracting Parties any term not otherwise defined in the present Convention shall, unless the context otherwise requires, have the meaning which it has under the laws in force in the territory of that Party relating to the taxes which are the subject of the present Convention."

There are then 13 distributive Articles which indicate in which country different types of profits or income are to be taxed. Article VI relates to dividends. Para. (1) provides that dividends paid by a company resident in one of the territories to a resident of the other territory may also be taxed in the former territory but not at a rate in excess of 15% of the gross amount of such dividends. Para.(4), which was substituted by the 1970 protocol, contains an important definition:
"The term "dividends" as used in this Article means income from shares, jouissance shares or jouissance rights, mining shares, founders' shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights assimilated to income from shares by the taxation law of the territory of which the company making the distribution is a resident; in the case of the United Kingdom the term includes any item (other than interest or royalties exempt from United Kingdom tax under the provisions of Article VII of this Convention) which under the law of the United Kingdom is treated as a distribution of a company; in the case of the Federal Republic the term includes income arising from participation in the capital and profits of a company resident in the Federal Republic, and the income derived by a sleeping partner from his participation as such."
It is not in dispute that "sleeping partner" includes a silent partner. Article VII relates to interest and royalties.

Article XVIII is headed "Elimination of double taxation" and is in this form:
"(1) Subject to the provisions of the law of the United Kingdom regarding the allowance as a credit against United Kingdom tax of tax payable in a territory outside the United Kingdom (which shall not affect the general principle hereof):
(a) Federal Republic tax payable under the laws of the Federal Republic and in accordance with this Convention, whether directly or by deduction, on profits, income or chargeable gains from sources within the Federal Republic (excluding in the case of a dividend, tax payable in respect of the profits out of which the dividend is paid) shall be allowed as a credit against any United Kingdom tax computed by reference to the same profits, income or chargeable gains by reference to which the Federal Republic tax is computed;
(b) in the case of a dividend paid by a company which is a resident of the Federal Republic to a company which is a resident of the United Kingdom and which controls directly or indirectly at least 25 per cent of the voting power in the Federal Republic company, the credit shall take into account (in addition to any Federal Republic tax creditable under the provisions of sub paragraph (a) of this paragraph) the Federal Republic tax payable by the company in respect of the profits out of which such dividend is paid."
Thus para. (1)(a) allows credit for withholding tax but excludes, in relation to a dividend, underlying tax (I use that term in the sense of s.792(1) of the 1988 Act: "tax which is not chargeable in respect of that dividend directly or by deduction"). But para.(1)(b) allows, in relation to a dividend paid by a German resident company to a U.K. resident company owning at least a quarter of the German company's shares, credit for underlying tax payable by the German company in respect of the profits out of which the dividend is paid. Para. (2) contains provisions relating to residents in Germany. Article XVIII, which was substituted by the 1970 protocol, refers to dividends paid by U.K. companies and by German companies, but contains no definition of "dividends".

Part XVIII of the 1988 Act relates to double taxation relief. Two types of relief are provided for: relief under double taxation conventions (s.788) and unilateral relief (s.790). The latter is relief against U.K. income and corporation tax in respect of tax payable under the law of a non-U.K. territory where there is no double taxation convention providing for such relief. Chapter II of Part XVIII contains the rules governing both types of relief. S.790(4) lays down the general rule that credit for tax paid under the law of the non-U.K. territory and computed by reference to income arising in that territory shall be allowed against any U.K. income or corporation tax computed by reference to that income. By s.790(5) that provision is to have effect subject to the modification that (inter alia) credit is not to be allowed for that overseas tax on a dividend paid by a company resident in that territory unless the dividend is paid to a company within subs.(6). That, so far as material, provides:
"Where a dividend paid by a company resident in the territory is paid to a company resident in the United Kingdom which either directly or indirectly controls....
(a) not less than 10 per cent. of the voting power in the company paying the dividend....
any tax in respect of its profits paid under the law of the territory by the company paying the dividend shall be taken into account in considering whether any, and if so what, credit is to be allowed in respect of the dividend."
By s.790(12) tax levied by a municipality or other local body is included in references to tax paid under the law of a territory outside the U.K. Thus trade tax is comprehended within the references to a non-U.K. tax.

In Chapter II ss.800 and 801 are material to the argument before us. By s.800:
"Where-
(a) arrangements provide, in relation to dividends of some classes but not in relation to dividends of other classes, that underlying tax is to be taken into account in considering whether any, and if so what, credit is to be allowed against the United Kingdom taxes in respect of dividends; and
(b) a dividend is paid which is not of a class in relation to which the arrangements so provide;
then, if the dividend is paid to a company which controls directly or indirectly, or is a subsidiary of a company which controls directly or indirectly, not less than 10 per cent. of the voting power in the company paying the dividend, credit shall be allowed as if the dividend were a dividend of a class in relation to which the arrangements so provide."

S.801 provides:
"(1) Where a company resident outside the United Kingdom ("the overseas company") pays a dividend to a company resident in the United Kingdom ("the United Kingdom company") and the overseas company is related to the United Kingdom company, then for the purpose of allowing credit under any arrangements against corporation tax in respect of the dividend, there shall be taken into account, as if it were tax payable under the law of the territory in which the overseas company is resident -
(a) any United Kingdom income tax or corporation tax payable by the overseas company in respect of its profits; and
(b) any tax which, under the law of any other territory, is payable by the overseas company in respect of its profits."

A partnership is not a company (s.832) and it is an agreed fact that a silent partnership is not a body corporate under German law. By subss. (2), (4) and (5) of s.801, for the purposes of subs. (1) tax paid by a subsidiary of the overseas company in respect of its profits can be treated as tax payable by the overseas company in respect of its profits if the subsidiary has paid the overseas company a dividend. Thus credit against U.K. corporation tax for the trade tax borne by the Subsidiaries which paid dividends to GmbH may be obtainable by Plc if either the dividends paid by the Subsidiaries can be treated as paid to Plc or the share of the profits of the silent partnership paid to Plc can be treated as a dividend paid by GmbH.

It was contended by Plc before the Special Commissioner that Plc's share of the profits of the silent partnership was a dividend as understood in English law or within the meaning of Article XVIII. Both limbs of that contention were rejected as was the submission that the share which Plc received of the profits from GmbH was a share of the same profits as those of the Subsidiaries in respect of which trade tax had been paid. The Special Commissioner also rejected arguments based on ss.790, 801 and 800.

On appeal the judge categorised the arguments as raising 3 issues. (1) Was the silent partnership transparent (in the sense that dividends paid by the Subsidiaries were paid to Plc, to the extent specified in the Agreement)? (2) Did "dividends" in Article XVIII have the wide meaning given to the term in Article VI? (3) Did "dividends" in Part XVIII of the 1988 Act comprehend the share of the profits of the silent partnership paid to Plc? The judge decided against Plc on the first issue but in favour of Plc on the second issue. However that was not enough to enable Plc to succeed on the appeal, Article XVIII (1)(b) allowing a credit only for German tax payable by GmbH and so not assisting in relation to the trade tax paid by the Subsidiaries. Plc needed to succeed on the third issue as well, but the judge decided against Plc on that issue. He rejected arguments based on ss. 790(6), 801 and (by implication) 800.

Before this court Mr. Venables Q.C. for Plc redeployed the arguments which he had advanced to the judge. He contends that Plc is entitled to succeed on any one of six different arguments. Each of the arguments depends on Plc having received "dividends" and rests of one or two bases: either the dividends were the conventional dividends paid by the Subsidiaries and received as profits of the silent partnership, or the share of the profits of the silent partnership which was paid by GmbH to Plc was a dividend.

I The first basis : transparency
To succeed on the first basis Plc must establish that the silent partnership is properly to be regarded as transparent, so that Plc as the silent partner is to be treated for U.K. corporation tax purposes as entitled to a share of the dividends paid by the Subsidiaries. Mr. Venables had three separate arguments on the first basis, relying on Article XVIII, s.790 and s.800 respectively, but each argument depends on the transparency point. If Plc succeeds on that point and dividends paid by the Subsidiaries to GmbH are also to be treated as dividends paid to Plc, the Crown accepts that Article XVIII (1) applies, and it would be unnecessary to consider unilateral relief under s.790 or the further route provided by s.800.

Mr. Venables submits that the reality of the situation must be looked at and that in reality the share of the profits of the silent partnership received by Plc in this country is the same as the profits earned by the Subsidiaries. He says that the Agreement giving Plc a contractual right to the share of the profits of GmbH made no difference in substance and that Plc as a silent partner was in the same position as a partner in an ordinary partnership or a limited partner in a limited partnership under English or Scottish law. It is not in dispute that an English or Scottish partnership is transparent for tax purposes, and as Fox L.J. said in Padmore v C.I.R. (1989) 62 T.C. 352 at p.380:
"The source of the income of an individual partner is the same as the source of income for all the partners, namely the trading operations of the partnership".
Mr. Henderson Q.C. for the Crown accepts that the fact that a partner is entitled only to his share and not to the whole of the partnership income makes no difference. The partnership is regarded as mere machinery through which each partner receives what is his due.

Both Mr. Venables and Mr. Henderson accepted that there was no direct authority on how a silent partnership should be treated for corporation tax purposes, and that is hardly surprising given that it is not a form of partnership known in English or Scottish law. We were taken to a number of authorities for assistance by way of analogy. They are fully discussed by the judge (pp. 1349-1351) and I intend no discourtesy to Counsel in not discussing them anew. They relate to other situations, for example post-cessation receipts of a deceased author ( Carson v Cheyney's Executor [1959] AC 412) and income from a foreign trust ( Baker v Archer-Shee [1927] AC 844 and Archer-Shee v Garland [1931] AC 212) and I agree with the judge that they do not go far to showing how to solve the problem posed in the present case of a commercial arrangement for intra-group division of corporate profits. The judge made a comment (at p.1351) on the distinction between a life tenant under an English trust and a beneficiary under an English discretionary trust, there being transparency in the case of the former but, the judge said, not in the case of the latter. I merely note that this distinction is supported by the Crown but disputed by Mr. Venables (by reference to Drummond v Collins [1915] A.C. 1011), but it is not necessary for the purposes of this appeal to resolve the dispute.

What in my judgment we have to do in the present case is to consider the characteristics of an English or Scottish partnership which make it transparent and then to see to what extent those characteristics are shared or not by the silent partnership in order to determine whether the silent partnership should be treated for corporation tax purposes in the same way. The judge aptly cited the remark of Rowlatt J. in Garland v Archer-Shee (1929) 15 T.C. 693 at p.711 in relation to an American trust:
"The question of the American law is, what are exactly the rights and duties of the parties under an American trust, and when you find what those rights and duties are, you see what category they come in, and the place they fill in the scheme of the English Income Tax Acts which the Courts here must construe."
The relevant characteristics of an ordinary English partnership are these:
(1) the partnership is not a legal entity;
(2) the partners carry on the business of the partnership in common with a view to profit (s.1(1) Partnership Act 1890);
(3) each does so both as principal and (s.5 ibid.) as agent for each other, binding the firm and his partners in all matters within his authority;
(4) every partner is liable jointly with the other partners for all debts and obligations of the firm (s.9 ibid.); and
(5) the partners own the business, having a beneficial interest, in the form of an undivided share, in the partnership assets ( MacKinlay v Arthur Young & Co. [1990] 2 AC 239 at p.249 per Lord Oliver), including any profits of the business.
A limited partnership differs relevantly only in the following respects:
(a) (2) and (3) above are modified in that the limited partner takes no part in the management of the partnership business (s.6(1) Limited Partnership Act 1907), the ordinary partners acting on his behalf as well as on their own behalf;
(b) the limited partner on entering the partnership is obliged to make a contribution of a sum or sums as capital or property of a stated amount and (4) above is modified in that the limited partner is only liable up to, but not beyond, the amount so contributed.

No findings of fact were made by the Special Commissioner or agreed as agreed facts in relation to Scottish partnerships and the judge commented, at p.1352, that there was, strictly speaking, no evidence before him as to Scottish law. There should of course have been such evidence if it was sought to be relied on by Plc. But the judge rightly said that it would be unrealistic to pretend to be unaware of s.4(2) of the 1890 Act or of the fact that in practice a Scottish partnership is taxed in the same way as an English partnership. Mr. Venables and Mr. Ghosh have taken us to statements in the leading Scottish textbooks. They and the provisions of the 1890 Act, most of which apply indifferently to English and Scottish partnerships, show that a Scottish partnership differs in the following respects:
(a) (1) above does not apply: the partnership is a legal entity distinct from the partners of whom it is composed, but an individual partner may be charged on a decree of diligence directed against the firm, and on payment of the firm's debts is entitled to relief pro rata from the firm and his other partners (s.4(2) of the 1890 Act);
(b) (3) above is also modified in that the partner is not a principal but is an agent of the firm and his partners;
(c) (4) above is modified in that the partner is not only jointly but also severally liable;
(d) (5) above is modified in that the assets of the partnership are vested in the partnership legally and beneficially, the interest of each partner in the partnership property being described by Bell as "a pro indivso right in the stock or common fund vested in the partners, firstly for payment of the company debts and then for the partners themselves" (Bell Commentaries II, 501); one of the consequences of this, as described by Bell, is "the peculiarity that heritable subjects belonging to and held by a company are considered not as heritable in succession but as moveable, consisting of jus crediti only" (Stair (1995) Vol.16 para.1073). However the partner has an interest which may be arrested (or seized) by his separate creditors, but only in the hands of the firm, and specific property of the partnership cannot be arrested by such creditors (Gloag & Henderson : Law of Scotland 10th ed. (1995) para.50.18).

It is not difficult to see why an English partnership (including a limited partnership) is treated as transparent, the partners carrying on business (whether by themselves or by the other partners as their agents) in common and owning the business and having a beneficial interest in the partnership assets and profits. The justification for treating a Scottish partnership as transparent, though it may be less obvious because of the interposition of the partnership as a legal entity between the partners and the profits of the partnership, can be perceived in that in substance the position of the partners in relation to the profits is the same as in an English partnership: those profits are earned by the partners carrying on business in common together and are shared in the same way and the partners, whilst not directly owning the business and assets, indirectly do so and have an indirect interest in them which is capable of being arrested by the creditor of a partner.

A silent partnership, whilst being similar to an English partnership in not being a separate legal entity, differs from both English and Scottish partnerships in a number of respects. The judge considered the decisive point to be the absence of any proprietary right, legal or equitable, enjoyed by Plc in the shares of the Subsidiaries or in the dividends accruing on those shares. That is certainly a strong point of distinction from an English partnership, though it is less obviously so in the case of a Scottish partnership. But even a Scottish partner has an (indirect) interest in the profits of the partnership as they accrue as well as in the assets of the partnership. In a real sense the profits and assets are the profits and assets of the partners, the firm, their collective alter ego, merely receiving those profits and holding those assets for the partners who are the firm. They are jointly and severally liable for the firm's debts. In contrast, though a silent partner is indirectly interested in those profits, in that his entitlement to a share of the profits (or his obligation in respect of the losses) will be computed by reference to the profits of the owner at the end of the year, his interest is purely contractual. A clearer distinction is the point advanced by Mr. Henderson that unlike in an English or Scottish partnership in the silent partnership no business is carried on by Plc and GmbH in common with a view to profit. The business is that of GmbH as sole owner. Plc is not jointly liable with GmbH to creditors of GmbH for the debts and obligations of GmbH. The liabilities of the business are those of GmbH alone, though Plc can be called on by GmbH to bear its share of losses computed at the end of the year to the extent of its capital contribution. To a third party, Plc's role in the silent partnership is irrelevant and may not be known.

The position of Plc seems to me to be that of a purchaser who, for a consideration consisting of the contribution of a capital sum and an undertaking to contribute to losses of the owner of a business up to the amount of the contribution, purchases a right to income of a fluctuating amount calculated as a share of the annual profits of the business. Neither in English or Scottish law would that leave Plc a partner with GmbH. That in itself is not determinative of transparency, and I of course accept Mr. Venables' submission that technical differences in the nature of rights should not cause cases which are in substance identical to receive different U.K. tax treatment. But I see insufficient justification present in the circumstances of the silent partnership for treating the share of the profits of the GmbH business received by Plc as the same as the profits of the Subsidiaries or the dividends which were paid to GmbH alone as shareholder and not to Plc. The judge said (at p.1353):
"Metaphorical language is not a substitute for analysis, but it may help to explain the conclusion: adopting Lord Asquith's phrases [in Stainer's Executors v Purchase [1952] A.C. 280 at p.291], I conclude that Plc's rights under the [Agreement] did have independent vitality and were not mere incidental machinery. Without those rights under the [Agreement] Plc would continue to receive dividends from GmbH, and nothing from the [Subsidiaries]."
I respectfully agree. The Agreement was in my judgment the source of Plc's share of the profits of the GmbH business, not the trading operations of the Subsidiaries or the shares owned by GmbH in the Subsidiaries producing the dividends paid to GmbH. Accordingly I would reject the first basis advanced on behalf of Plc.

II The second basis : the share of profits as a dividend
(1) Article XVIII and s.801
Mr. Venables submitted that in Article XVIII "dividends" had the same meaning as in Article VI, which the Crown accepts covers a share of the profits paid to a silent partner. Even if that submission is correct, the convention would not suffice to enable Plc to obtain a credit for the trade tax on the Subsidiaries' profits. He relied on s.801(2) to deem that tax to have been paid by GmbH.

Mr. Venables rightly cautioned us against interpreting the convention as though it had been drafted in Lincoln's Inn. He and Mr. Henderson were at one in regarding the statement by Mummery J. in C.I.R. v Commerzbank A.G. (1990) 63 T.C. 218 at pp. 234-236 as correctly summarising the approach to be adopted. That judge warned against a literal interpretation, particularly where it would be inconsistent with the purposes of the provision or treaty in question. He said that interpretation should take account of the fact that a convention is not designed to be construed exclusively by English judges but is addressed to a wider judicial audience. I would add to that comment that in the case of a double taxation agreement the judicial audience is in addition to the judges found in the constituent parts of the United Kingdom only the judges to be found in the courts of the other contracting party. It is not to be assumed that the convention is addressed to a wider international audience than that. Mummery J. also referred to the general principle of international law now embodied in Article 31(1) of the Vienna Convention on the Law of Treaties that a treaty should be interpreted in good faith and in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

The question in the present case is whether the absence of a definition of dividends in Article XVIII signifies that it is to be construed in that Article as having the same meaning as in Article VI(4) or as having the meaning indicated by Article II(3), which allows U.K. law to determine its meaning. In posing the latter alternative in that way, I accept Mr. Henderson's submission, which Mr. Venables did not challenge, that the words of Article II(3), "any term not otherwise defined", mean "any term not otherwise relevantly defined." Article VI(4) commences with the words "The term "dividends" as used in this article means ..." The fact that the definition is not included in Article II as a general definition supports the view that the draftsman did not intend the Article VI(4) definition to apply whenever "dividends" is found in the Convention. That view is strengthened by the fact that Article VI(4) was substituted by the 1970 Convention at the very same time that Article XVIII was substituted, and it would be very surprising if the draftsman had intended the Article VI(4) definition to apply to Article XVIII not merely without saying so but whilst qualifying the scope of the application of Article VI(4) in the way I have indicated. Moreover where a term defined only in a distributive article is to have the same meaning in another but not every article, the draftsman has taken care to say so (see Articles XII(2), VIII(1) (substituted by the 1970 protocol) and XVI(1)). Mr. Venables sought to derive significance from the French text of Article 10.3 of the OECD 1963 Model Convention on which Article VI(4) was plainly based: "Le terme "dividends" employé dans le présent article". He suggested that this was more neutral language which should be taken to be the meaning in Article VI(4). For my part, I am unimpressed by that over-subtle point.

It is far from obvious that the U.K. would have wanted or intended, or that Germany would have insisted, that the share of profits of a German silent partnership should be treated as a dividend for U.K. tax purposes. True it is that Article XVIII is headed "Elimination of double taxation", but it is clear from the Article that only if its specific conditions are satisfied is credit to be allowed. Thus under the convention it is not enough that the German company paying the dividends to the U.K. company does so out of dividends from a wholly owned subsidiary the profits of which bore trade tax. Mr. Venables submitted, and Mr. Henderson did not dispute, that in two other Articles of the Convention (Articles III(5) and XX III(3)(b)) references to dividends are to be construed as having the Article VI(4) meaning; but that is because both relate to tax withheld from a dividend and so implicitly cross-refer to Article VI. By contrast in Article XVIII(1) "dividends" only appears in connection with relief for German underlying tax. Relief for German withholding tax levied pursuant to Article VI(1) is afforded by Article XVIII(1)(a) whether or not the payment is a dividend as understood in the U.K.

The judge found of some help a decision of the Bundesfinanzhof (1982) BFH 22 HFR 301. That included the comment: "What was meant by dividends was explained at other places in the Treaty (for dividends in Art. 10(6) DTT). It is true that income from the holding as a typically sleeping partner was not explicitly mentioned in Art. 28(1) DTT; but it fell within the provision of the concept of dividend contained in Art. 10(6)DTT, whereby the expression "dividends" comprised not only income from shares in limited companies, but continued to encompass holdings in a trade as a sleeping partner within the meaning of German law." That was a decision on a differently worded article in a different context in a different double taxation convention (between Germany and Switzerland) and it is open to question how much assistance can be obtained from other conventions, the more so when they are conventions to which the U.K. was not a party (see Padmore v C.I.R. , supra, at p.377). It is not apparent whether the applicability of Article 10(6) of the German-Swiss convention was in issue, but Article 28 of that convention appears to have been concerned to preserve the right to apply withholding tax on dividends in the country of source. In that context a wide meaning for "dividends" was natural.

The judge also found of some help the views expressed in Vogel on Double Taxation Conventions 2nd ed. (1990) p. 1064. The author minimises the importance of provisions like Article II(3), and refers to the 1982 Bundesfinanzhof case as an example of the proposition that case law has never been known to reject application of a definition contained in a distributive rule. The views of an acknowledged expert in this field, as Professor Vogel undoubtedly is, deserve respect, but they are very generalised comments, and the reason expressed for his view that Article II(3) should not apply where there is a definition in a distributive article, viz. that otherwise "the amount of tax allowed by the treaty to be withheld at the source, and the extent to which credit should be given for such withholding tax, might not be in line", is inapplicable in this case. Here credit is allowed by Article XVIII(1)(a) for German withholding tax on the share of the profits paid to Plc.

The judge rightly said that those two matters which he found of some help were not determinative. What he found decisive was "the purposive argument for construing the convention in as symmetrical a way as possible, unless the language is clearly against such a construction" (p.1357). He sought "as much symmetry as can reasonably be achieved between the distributive provisions of Art VI and the relieving provisions of Art XVIII". The scope of Article VI is quite different from that of Article XVIII. The wide definition of "dividends" in Article VI recognises Germany's right to impose withholding tax on such distributions and to ensure that they do not come with Article III, relating to business profits, or Article VII, relating to interest. It is entirely appropriate that credit should be given against U.K. corporation tax for such withholding tax and that is achieved by Article XVIII (1)(a). But different considerations apply to the giving of credit for underlying tax which in some way is related to what is distributed to a U.K. resident. Whether such credit is afforded depends on the satisfaction of the conditions specified in Article XVIII. In truth to achieve the symmetry which the judge sought requires treating a term defined in a distributive article for the purposes of that article as though it were a general definition in Article II. But that does not do justice to the coherent and careful drafting of the Convention and the 1990 protocol, which to my mind indicates that the absence of a definition in Article XVIII and the consequent application of Article II(3) were intended.

For these reasons, therefore, and in agreement with the Special Commissioner on this point, I accept the Crown's argument that "dividends" in Article XVIII does not include the share of the profits from the silent partnership.

The judge, however, found against the taxpayer on the meaning of "dividend" in Part XVIII of the 1988 Act. There is no definition of the term in that Part. Mr. Venables submitted that in s.801(1), dividend should have the meaning which it has under the double taxation arrangements referred to in the subsection and applicable in relation to the dividend in question. I am not able to agree. The form of the subsection is to state as a condition precedent, "where [the overseas company] pays a dividend to [the United Kingdom company]". That presupposes that "dividend" has its ordinary meaning in U.K. law. Unless the condition is satisfied the subsection cannot have effect. The subsequent reference to the arrangements is not worded in such a way as would require "dividend" to have the meaning, if any, given to the term in the arrangements. In my judgment express wording would have been needed to extend the meaning of "dividend" beyond its ordinary significance in U.K. law.

The ordinary meaning of "dividend" is that it is a payment of a part of the profits for a period in respect of a share in a company ( Esso Petroleum Co. Ltd v Ministry of Defence [1990] Ch.163 at p.165). In s.209(2) of the 1988 Act, "distribution" in relation to any company, means:
"(a) any dividend paid by the company, including a capital dividend;
(b) .... any other distribution out of assets of the company (whether in cash or otherwise) in respect of shares in the company ...."
As the judge said, that is consistent with, and tends to confirm, the proposition that the meaning of dividend in the 1988 Act (with one immaterial exception) is the ordinary meaning as stated in the Esso case. Further the usage of the term throughout Part XVIII is consistent with that ordinary meaning. To treat Plc's entitlement to a share of the profits of GmbH under the silent partnership as a dividend, when that payment was unrelated to shares in GmbH and the partnership is not a company, would be inconsistent with the ordinary meaning of "dividend". On this ground too, therefore, I would reject the argument of Plc.

(2) s.790(6)
Mr. Venables argued that a right enforceable by a silent partner against the owner to receive a share of profits and payment of such share can properly be described as a dividend. In my judgment this argument is hopeless for the reasons just given and because of the language of s.790(6) itself, referring as it does to a "dividend paid by [the overseas company] to a [U.K.] company .... which .... controls .... not less than 10 per cent. of the voting power in the company paying the dividend". The language is consistent only with conventional dividends paid by a company to an English company holding shares in the paying company.

(3) s.800
Mr. Venables submitted that if the dividends were not of a class which fell within Article XVIII, relief was available under s.800, as the convention would then have provided in relation to dividends of some classes (those falling within Article XVIII) but not in relation to dividends of other classes (those falling within Article VI but not Article XVIII) that underlying tax is to be taken into account. S.800 would secure that relief would be given as if the latter did not fall within Article XVIII. "Dividends", he said, in s.800 must be interpreted in accordance with the applicable convention. Mr. Venables wisely did not press this argument which again seems to me impossible. The language of s.800 must be given its ordinary and natural meaning, the reference to dividends of some classes and dividends of other classes obviously referring to dividends on shares of a particular class such as ordinary or preference shares. S.800 has no application to the present case where no dividend was paid to Plc in respect of any class of shares held by it, but merely a share of GmbH's profits under the silent partnership.

For these reasons I would reject all the contentions of the taxpayer, despite the well-sustained arguments of Mr. Venables by which he demonstrated his great expertise in this field. I would dismiss this appeal.

Lord Justice Henry: For the reasons set out in the judgment of my Lord, Lord Justice Peter Gibson, I too would dismiss this appeal.
Sir Christopher Staughton:
(1) Transparency
The first argument on behalf of Memec plc is that it did indeed receive dividends from companies which were resident in the Federal Republic of Germany, that is to say from the trading subsidiaries of Memec GmbH; and that in consequence the English company is entitled to credit, under Article XVIII (1)(b), for the tax paid by the subsidiaries in respect of the profits out of which the dividends were paid.

At first sight this argument meets the obstacle that Memec plc did not receive the dividends from the subsidiaries, but from Memec GmbH itself. But it is said that the intervention of GmbH can be disregarded. There is authority that, for tax purposes, an intermediary can in certain circumstances be disregarded. Indeed that must be the case where the intermediary is a mere agent or messenger, such as the post office or a bank. A wider application of the doctrine can be seen in the contrasted cases of Baker v.Archer-Shee (1927) AC 844 and Archer-Shee v. Garland (1931) AC 212.

It is said, correctly, that if the agreement between PLC and GmbH had been an English partnership or an agreement to the same effect, it would have been regarded as transparent. As George Herbert wrote:
A man that looks on glass,
On it may stay his eye;
Or if he pleaseth, through it pass,
And then the heaven espy.
The question is whether one should treat Memec GmbH as having paid the moneys to Memec plc. Or was it the subsidiaries who paid the moneys?

An English partnership is not a separate legal entity from the partners; income paid to the firm is paid to the partners. If that were the situation in this case, the dividends paid to the partnership of GmbH and PLC would be paid to them as partners. But the stille gesellschaft is different. A silent partner in such an organisation (in this case PLC) does not carry on the business, and does not incur the rights and liabilities of the business. It is interested only in its share of the net profits. Section 230(2) of the German Commercial Code provides:
The owner alone has the rights and obligations with respect to transactions concluded within the operation of the business.
The owner, in that section, is the one who runs the enterprise, in contrast to the silent partner. I therefore conclude that the German subsidiaries in the present case cannot be treated, for tax purposes, as having paid dividends to PLC.

It does not necessarily follow that the result would be the same with a Scottish partnership, although it is a legal person distinct from the partners (section 4(2) of the Partnership Act 1890). Scottish partners are jointly and severally liable for the debts and obligations of the firm (section 9), and therefore can be said to participate in the transactions of the business. But if I am wrong about that, then we must tolerate as best we can a difference between the tax law for English and Scottish partnerships. (In parenthesis, I do not think that it is necessary to have evidence of Scottish or foreign law when it is only relied on to show what English law is, or should be. Evidence is required when foreign law is relied on as the lex causae , the law which is relevant to determining the rights of the parties.)
(2) Dividends
The second argument for Memec plc is (i) that dividends in Article XVIII(1)(b) include payments made by a silent partnership to the silent partner, and (ii) that credit against English tax can be claimed by the recipient of such dividends in respect not only of the tax paid in respect of the profits out of which the dividends were paid, but also (by virtue of section 790 and section 801 of the Taxes Act 1988) in respect of the underlying tax paid by the trading subsidiaries.

As to point (i), I agree with the view of Robert Walker J that the word "dividend" in Article XVIII should be given the same meaning as it is defined to have in Article VI(4). In other words it includes -
the income derived by a sleeping partner from his participation as such.
I appreciate that Article VI(4) says "as used in this Article" (in French, le terme ´dividende' employé dans le present article). But Professor Klaus Vogel cites a decision of the highest German tax court for the proposition that the word should bear the same meaning elsewhere in the treaty.

A decision by the courts of one state which is party to a bilateral treaty is not, in my judgment, as compelling on the courts of the other party as in the case of a multilateral treaty. But there is in effect a multilateral aspect here. At least one other treaty (between Germany and Switzerland) has to our knowledge similar wording; and it is very probable that a great many others do, since some such wording is to be found in the Model Income Tax Treaties of the OECD of 1963 and 1977.

It seems to me very likely that continental courts generally, like the German court already mentioned, would reject the semantic restriction attributed to the words "as used in this Article", and would hold that the definition could be relied on elsewhere in the Convention. In the interest of uniformity, I would do the same.

It is still necessary for Memec plc to rely on the Taxes Act 1988 if it is to get credit for tax borne by the subsidiaries of Memec GmbH, as opposed to tax borne by GmbH itself. For that purpose PLC relies on sections 790 and 801. But each of those sections refers to "dividends"; and there is no definition of dividends in English domestic law which would include distributions made by a body such as a German silent partnership. Article VI(4) of the Convention cannot in my judgment be treated as governing the Taxes Act 1988. It follows that the second argument must likewise fail, and this appeal be dismissed.

ORDER: Appeal dismissed with costs; leave to appeal to the House of Lords refused.
(Order not part of approved judgment)


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