This is a tax refund action brought by taxpayer National Westminster Bank PLC (“NatWest”), a United Kingdom corporation, for the tax years 1981-1987. The Government appeals from the judgment of the United States Court of Federal Claims (“trial court” or “court”) that NatWest is entitled to a refund of $65,723,053 plus interest for the tax years at issue. Central to the trial court’s judgment is the issue of whether the application of Treasury Regulation § 1.882-5 is consistent with the United States’ obligations under Article 7 of the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains, U.S.-U.K., Dec. 31, 1975, 31 U.S.T. 5668 (the “1975 Treaty”). For the reasons stated below, we affirm.
BACKGROUND
The 1975 Treaty, which governs this dispute, was initially negotiated and signed by the United States and the United Kingdom in 1975. 1 31 U.S.T. at 5668. As may be surmised from its title, the 1975 Treaty states that its purpose is “the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains.” Id. at 5670. Of particular import to this case, Article 7 gоverns the taxing authority of the signatories with respect to the business profits of an enterprise operating in both countries. Id. at 5675-76.
NatWest is a United Kingdom corporation engaged in international banking activities. For the tax years 1981-1987, NatWest conducted wholesale banking operations in the United States through six permanently established branch locations (collectively “the U.S. Branch”). On its United States federal income tax returns for the years at issue, NatWest claimed deductions for accrued interest expenses as recorded on the books of the U.S. Branch. On audit, the Internal Revenue Service (“IRS”) recomputed the ihterest expense deduction according to the formula set forth in Treasury Regulation § 1.882-5. The formula excludes consideration of interbranch transactions for the determination of assets, liabilities, and interest expenses. Treas. Reg. § 1.882-5(a)(5) (1981).
2
The formula also imputes
NatWest concluded that the increased income would result in an additional tax liability of at least $37 million in the United States for which a foreign tax credit would not be available in the United Kingdom. NatWest thus requested, under Article 24 of the 1975 Treaty, that the United Kingdom enter competent authority proceedings with the United States to resolve the double taxation issue. Pursuant to the competent authority proceedings, the United Kingdom presented NatWest with a settlement offer, which NatWest concluded did not sufficiently address its double taxation concerns. NatWest rejected the settlement offer, paid the additional taxes, and filed suit in 1995, claiming that the IRS’s application of § 1.882-5 to an international bank such as NatWest violated the terms of the 1975 Treaty.
The 1975 Treaty
After the initial signing of the 1975 Treaty on December 31, 1975, certain рrovisions not at issue here were amended by three protocols signed between August 1976 and March 1979. 31 U.S.T. at 5668-69. The 1975 Treaty took effect on April 25, 1980. Id. at 5668. Article 7, entitled Business Profits, states as follows:
(1) The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in that other State but only so much of them as is attributable to that permanent establishment.
(2) Subject to the provisions of paragraph (3), where an enterprise carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar сonditions and dealing wholly independently with the enterprise of which it is a permanent establishment.
(3) In the determination of the profits of the permanent establishment, there shall be allowed as deductions those expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere.
Id. at 5675-76 (emphasis added). Relating the terms of the 1975 Treaty to the present appeal, “a Contracting State” is the United Kingdom, “the other Contracting State” is the United States, “an enterprise” is NatWest, and “a permanent establishment” is the U.S. Branch. The emphasized portion of paragraph 2 sets forth the “separate enterprise principle” and frames the dispute in this case.
Treasury Regulation § 1.882-5 was proposed on February 27, 1980, adopted on December 30, 1980, and took effect on February 6, 1981. 46 Fed.Reg. 1681 (Jan. 7, 1981). As described by the Government, the regulation sets forth a formula for apportioning the interest expense of foreign corporations. The formula applies to all foreign corporations with permanent establishments in the United States and makes no exception for banks or other financial institutions.
At the outset, “[ijnter-branch loans, assets, liabilities, and interest expense amounts resulting from loan or credit transactions of any type between the separate offices or branches of the same foreign corporation are disregarded.” § 1.882-5(a)(5). The deductible interest expense is then calculated according to a three-step formula. In step one, the permanent establishment’s U.S.-connected assets—“total value of all assets of the corporation thаt generate, have generated, or could reasonably have been or be expected to generate income, gain, or loss effectively connected with the conduct of a trade or business in the United States”—are determined according to the books of the permanent establishment, exclusive of the intracorporate transactions disregarded under § 1.882-5(a)(5). § 1.882-5(b)(l). In step two, the permanent establishment’s U.S.-connected liabilities are estimated either by multiplying the U.S.-connected assets by a capital ratio of 0.95 or by the ratio of the average total amount of corporate worldwide liabilities to the average total value of corporate worldwide assets. § 1.882-5(b)(2). In step three, the interest deduction is computed under either the “branch book/dollar pool method” or the “separate currency pools method.” § 1.882-5(b)(3). The IRS used the branch book/dollar pool method to audit the U.S. Branch. Under this method, the permanent establishment is allowed an interеst deduction on the larger of the U.S.-connected liabilities or the average total amount of liabilities, again exclusive of transactions disregarded under § 1.882-5(a)(5), shown on the books of the permanent establishment. § 1.882-5(b)(3)(i)(A), (B). The branch book/dollar pool method further specifies which interest rate(s) will be used to determine the total amount of the interest expense deduction. Id.
Proceedings in the Court of Federal Claims
The parties agree, both before the trial court and on appeal, that the 1975 Treaty requires that the U.S. Branch be taxed as if it were a separate enterprise from Nat-West—the “separate enterprise principle.” The parties differ with respect to the manner in which the separate enterprise principle treats (1) interest expenses on intracorporate loans (i.e., interbranch loans between the U.S. Branch and Nat-West’s other branches) and (2) the allocation of capital to the U.S. Branch. The trial court decided these issues in three separate summary judgment opinions and orders.
On cross-motions for partial summary judgment, the trial court concluded that the application of § 1.882-5 to a bank such as NatWest violated the terms of the 1975 Treaty.
Nat’l Westminster Bank, PLC v. United States,
The parties then filed cross-motions for partial summary judgment regarding the manner in which the IRS should determine or estimate the amount of “adequate” capital held by the U.S. Branch.
Nat’l Westminster Bank, PLC v. United States,
After the decision in NatWest II, the U.S. moved to reopen discovery regarding the amount of capital that the books of NatWest’s home office show as being allotted to the U.S. branch. The government put forth a new theory that capital held by other branches should be imputed to the U.S. Branch, but the court found that the Government waived this theory by failing to present it during the briefing stage of NatWest II. Nat’l Westminster Bank, PLC v. United States, No. 95-758T (Fed.Cl. Jan. 18, 2005) (hereinafter “Order Denying Reconsideration ”).
In the third summary judgment opinion, the trial court considered whether uncontroverted facts supported NatWest’s assertion that, consistent with the holdings of
NatWest I
and
NatWest II,
the U.S. Branch was entitled to a refund of $65,808,076 plus interest.
Nat’l Westminster Bank PLC v. United States,
DISCUSSION
The Government presents three issues on appeal. First, the Government appeals thе ruling of NatWest I and argues that the application of Treasury Regulation § 1.882-5 to NatWest is consistent with the expectations of the United States and the United Kingdom at the time the 1975 Treaty was negotiated, signed, and entered into force. Second, the Government appeals the ruling of NatWest II and submits that as an alternative to § 1.882-5, the proposed corporate yardstick method is a permissible means for imputing capital to the U.S. Branch. Last, the Government appeals the ruling of the Order Denying Reconsideration and requests that it be allowed to take discovery of NatWest’s home office books to determine the capital actually allotted to the U.S. Branch. Should we uphold NatWest I, NatWest II, and the Order Denying Reconsideration, the Government does not appeal the trial court’s ruling in NatWest III.
A grant of summary judgment by the Court of Federal Claims is reviewed de novo, drawing justifiable factual inferences in favor of the party opposing the judgment.
SmithKline Beecham Corp. v. Apotex Corp.,
When construing a treaty, “[t]he clear import of treaty language controls unless ‘application of the words of the treaty according to their obvious meaning effects a result inconsistent with the intent or expеctations of its signatories.’ ”
Sumitomo Shoji America, Inc. v. Avagliano,
The “entire context” of the 1975 Treaty is informed by, and is based on, the Office of Economic Cooperation and Development’s (“OECD”) 1963 Draft Double Taxation Convention on Income and Capital (“1963 Draft Convention”).
See NatWest I,
In
NatWest I,
the trial court concluded that the application of § 1.882-5 to the U.S. Branch of NatWest violated the separate enterprise principle of the 1975 Treaty.
the U.S. Branch is to be regarded as an independent, separate entity dealing at arm’s length with other units of Nat-West as if they were wholly unrelated, except that the U.S. Branch may deduct, in addition to its “own” expenses, a reasonable allocation of home office expense. Words such as “distinct” and “separate” and the phrase “dealing wholly independently” (emphasis added) would appear to permit no other interpretation.
On appeal, the Government criticizes the trial court’s conclusion in NatWest I on the following grounds: (1) the court ignored the 1975 Treaty’s plain language; (2) the court misapplied the 1963 Commentaries that support the Government’s position; (3) the court ignored the parties’ shared expectations; and (4) the court did not accord proper deference to the “Treasury’s consistent determination that the regulation is consistent with Article 7.”
We agree with the trial court’s analysis of the plain language of the 1975 Treaty. On a fundamental level, we do not rеad the separate enterprise language of Article 7, 112—requiring that the U.S. Branch’s business profits be determined as “if it were a distinct and separate enterprise engaged
To the extent that the Government submits that the “reasonable allocation” language of Article 7, If 3 is relevant to whether § 1.882-5 is permissible under the 1975 Treaty, the Government misreads the treaty. With regard to allowable deductions for a determination of the profits of a permanent establishment, the 1963 Model Convention, which differs slightly from the 1975 Treaty, reads as follows:
In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are' incurred for the purposes of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere.
1963 Draft Convention 46. The 1975 Treaty modifies this language by including a nonexclusive list of executive and general administrative expenses that are incurred on behalf of the enterprise as a whole (e.g., NatWest’s worldwide enterрrise including the U.S. Branch) and that may be partially allocated to the permanent establishment (e.g., NatWest’s U.S. Branch).
In the determination of the profits of a permanent establishment, there shall be allowed as deductions those expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere.
31 U.S.T. at 5675-76 (emphasis added). Importantly, the “reasonable allocation” language refers to expenses, such as interest, that are “incurred for the purposes of the enterprise as a whole.” Furthermore, a comparison of the Treaty to the 1963 Model Convention indicates that no reasonable allocation is necessary for expenses, such as interest, that are directly “incurred for the purposes of the permanent establishment.”
As previously noted, the 1963 Draft Convention was published as part of a document that included the 1963 Commentaries, the purpose of which is “ ‘to illustrate or interpret the provisions’ ” and to “ ‘be of great assistance ... in the settlement of eventual disputes.’”
NatWest I,
On the separate enterprise рrinciple specifically, the 1963 Commentary to Article 7, U 2 states, “[T]he profits to be attributed to a permanent establishment are those which that permanent establishment would have made if, instead of dealing with its head office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market.” 1963 Draft Convention 82, 1110. To determine these profits, “it is always necessary to start with the real facts of the situation as they appear from [t]he business records of the permanent establishment and to adjust as may be shown to be necessary the profit figures which those facts produce.” Id. Exceptions to this rule, however, may exist where no separate accounts exist. Id. (allowing for formulaic allocation in the absence of separate accounts). The 1963 Commentary goes on to explain that adjustment to the accounts of the permanent establishment may be necessary in situations such as when the transactions between a pеrmanent establishment and a head office do not reflect market pricing (i.e., market interest rates for financial enterprises). Id. at II11.
Consistent with the 1963 Commentary to Article 7, H 2, the commentary to Article 7, 113 focuses on whether an expense is incurred by a permanent establishment, rather than whether the expense is paid to a foreign branch of the same worldwide enterprise. “[F]or the sake of removing doubts,” the 1963 Commentary states that Article 7, 113 “specifically recognizes that in calculating the profits of a permanent establishment allowance is to be made for expenses, wherever incurred, that were incurred for the purposes of the permanent establishment.” Id. at 83,1113. The commentary explicitly includes as a deductible expense “payments of interest made by different parts of a financial enterprise (e.g. a bank) to each other on advances, etc., (as distinct from capital allotted to them), in view of the fact that making and receiving advances is narrowly related to the ordinary business of such enterprises.” Id. at 83-84,1115.
The Government argues that the use of formulaic allocations for taxing purposes by both parties during the period between the signing of the 1975 Treaty and its entry into force is evidence that the parties did not intend for the Treaty to prohibit the use of allocation formulas. The Government’s position is undermined in two important respects. First, in 1978 the United Kingdom abandoned its formula then in use after concluding that the formula was inconsistent with the separate enterprise principle. Second, the interest expense allocation formula used by the United States was significantly different than that prescribed by § 1.882-5.
The record demonstrates that during the negotiation period of the 1975 Treaty, the United Kingdom did employ a formulaic allocation when determining the interest expense deduction of a U.K. branch of a foreign (e.g., incorporated in the United States) bank. The Government’s reliance on this use in furtherance of its appeal is misplaced. Referred to in the reсord as the “Price Waterhouse formula” (“PW formula”), the United Kingdom used the ratio of the bank’s worldwide total free capital to total liabilities and compared the liabilities of the U.K. branch to the bank’s total liabilities to allocate free capital to the U.K. branch for taxation purposes.
Nat-West II,
Nor is the Government’s position supported by its own conduct contemporaneous to the negotiations of the 1975 Treaty. The Government points to Revenue Ruling 78-423, 1978-
The Government is correct to assert that it has unwaveringly interpreted § 1.882-5 as being consistent with the 1975 Treaty and other similar treaties based on the 1963 Draft Convention.
See, e.g.,
Rev. Rui. 89-115,1989-
The record, therefore, contains no evidence prior to the 1984 OECD report that
In sum, we find that the plain language of the 1975 Treaty—the separate enterprise principle—mandates that expenses incurred for the benefit of the U.S. Branch be deductible, including interest expenses paid to foreign branches of NatWest. Our reading of the plain language finds direct support in the 1963 Commentary and the contemporaneous understanding of the United Kingdom. Moreover, there is very little evidence that the contemporaneous understanding of the United States differed in any way from that of the United Kingdom. Lastly, the Government’s current interpretation of the 1975 Treaty is entitled to minimal deference where it contravenes the treaty’s language and negotiation history, as well as the contemporaneous expectations of the United Kingdom. For these reasons, we conclude that Treasury Regulation § 1.882-5 is inconsistent with the 1975 Treaty as applied to a permanent establishment of an international financial enterprise, e.g., the U.S. Branch of NatWest during the tax years at issue.
After rejecting the application of § 1.882-5 to the U.S. Branch in
NatWest I,
the court considered in
NatWest II
the method by which the books of the U.S. Branch should be adjusted for the “imputation of adequate capital to the branch and to insure use of market rates in computing interest expenses.”
NatWest I,
At issue is whether the separate enterprise principle was intendеd by the parties to require a permanent establishment to be taxed as a separately incorporated institution or to be taxed according to the reality of its situation and accounts as adjusted to reflect market pricing in its dealings with the home office.
Id.
at 497.
On appeal, the Government maintains that the separate enterprise principle allows the IRS to tax the U.S. Branch as if it were subject to the same regulatory and market capital requirements as a separately incorporated U.S. subsidiary. As before, our analysis begins with the language of the 1975 Treaty as informed by the 1963 Draft Convention and the expectations of the parties.
Turning again to the separate enterprise principle set forth in Article 7, K 2,
there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.
31 U.S.T. at 5675. Under this language, the Government’s position seems to focus on the “dealing wholly independently with” phrasе as indicating that for tax purposes, the U.S. Branch should be taxed as if it possesses enough interest free capital to support its own operations, rather than rely on the capital of the worldwide Nat-West enterprise. Conversely, the “same or similar conditions” language seems to support NatWest’s position that the U.S. Branch should be taxed in a manner consistent with the actual conditions of its operation—a branch with operations that are funded with little or no interest free capital.
To the extent the parties’ conflicting positions evidence ambiguity in the 1975 Treaty’s language, we agree with the trial court that NatWest has espoused the better reading. The “same or similar” language of the separate enterprise principle refers to the activities and conditions in which the U.S. Branch conducted its business. That is, the U.S. Branch should be taxed as if it were a separate enterprise engaged in activities that are the “same or similar” to those activities in which the U.S. Branch engаged and as if it were operating in conditions that are the “same or similar” to the conditions in which the U.S. Branch conducted its activities. By way of contrast, the Government’s reading of the separate enterprise principle requires that the “same or similar” language describe the activities of the hypothetical separate enterprise. That is, the U.S. Branch should be taxed as if it were engaged in activities that are the same or similar to those in which a separate enterprise would engage and as if it were operating in conditions that are the same or similar to those in which a separate enterprise would operate.
Under the proper reading of the “same or similar” clauses, it becomes clear that the “dealing wholly independently with” language requires taxing authorities to scrutinize intracorporate transactions involving a permanent establishment to ensure that the transactions are accurately
Our analysis of the 1975 Treaty’s plain language is supported by the 1963 Draft Convention. The 1963 Commentary to Article 7, If 2 states that the analysis of taxable business profits is to begin with the “trading accounts of the permanent establishment,” but allows for a formulaic allocation of profits in circumstances where the permanent establishment does not maintain separate accounts from the home office. 1963 Draft Convention 82, 1110. The commentary goes on to state:
It should perhaps be emphasized that the directive contained in paragraph 2 is no justification for tax administrations to construct hypothetical profit figures in vacuo; it is always necessary to start with the real facts of the situation as they appear from the business records of the permanent establishment and to adjust as may be shown to be necessary the profit figures which those facts produce.
Id.
(emphasis added). In the instant case, the real facts of the situation are that the U.S. Branch is not required to maintain any minimal amount of capital. Therefore, because the corporate yardstick would essentially recharacterize loans that bear an interest expense as equity capital infusions based on regulatory and domestic market requirements that do not apply to the U.S. Branch, the corporate yardstick ignores the real facts of the U.S. Branch’s situation and violates the 1975 Treaty as informed by the 1963 Draft Convention. As stated by the trial court in
NatWest II,
“The Commentary confirms that the purpose of any adjustment should be to reflect the real facts of the branch’s transactions with the entity of which it is a part.”
The Government argues that because both parties used capital allocation formu-lae during the period of the 1975 Treaty’s negotiation, the parties expected that the use of similar formulas, e.g., the corporate yardstick, would be permissible under the treaty. Specifically, the Government identifies the adoption of Treasury Regulation § 1.861-8 in 1977, see 49 Fed.Reg. 1195 (Jan. 6, 1977), and the United Kingdom’s use of the PW Formula in support of its position. The record reveals, however, that the implementation or abandonment of these formulae provide little, if any, support for the Government’s use of the corporate yardstick.
As discussed previously, § 1.861-8 used worldwide information of an international financial enterprise to allocate an interest expense to a permanent establishment doing business in the United States. Section 1.861-8, however, contained language expressly stating that applicable treaty provisions would take precedence over the regulation. Treas. Reg. § 1.861-8(f)(l)(iv) (1977). Thus, to the extent that § 1.861-8 conflicts with our reading of the 1975 Treaty and analysis of the signatories’ expectations, the treaty governs.
More importantly, the analysis of the Queen’s Counsel opinion when the United Kingdom abandoned the PW Formula in 1978 is particularly instructive. The opinion explicitly considered the appropriateness of treating a permanent establishment as “a company with independent
[I]n our view the Convention gives no authority to write into the branch accounts a level of capital which the branch does not have. To do this is to go against the scheme of Article III and the requirement of the paragraph (2) hypothesis that the United Kingdom branch is trading under “... the same or similar conditions ... This directs that the actual conditions under which the United Kingdom branch trades are taken into account. It is those conditions which dictate the expenses in question.
Accordingly the “notional interest formula”, under which interest is disallowed to the extent that the (actual) capital account of the branch falls short of an amount (estimated by the Revenue) which would be required as “free working capital” by an independent banking enterprise is in our opinion unwarranted. The notional interest formula may very well result in the disal-lowance of actual expenditure which is attributable to the branch and that is something which Article III plainly does not authorise. Like the global apportionment referred to in paragraph 5 above the formula may offer a convenient method of avoiding the difficulties involved in the allocation of actual receipts and expenses, but in our opinion it is not sound in law.
Id. at 3 (alterations in original). This analysis of the separate enterprise principle (as similarly set forth in Article III of the previous U.S.-U.K. double taxation treaty, see supra note 4) led the United Kingdom to abandon the PW formula. U.K. Amicus Br. at 24-25. We are persuaded by the clarity of the Queen’s Counsel’s analysis thаt when the 1975 Treaty was negotiated, the parties did not understand the separate enterprise principle to allow for imputation of capital to the U.S. Branch according to estimates generated by the IRS’s use of the corporate yardstick.
Having concluded that the corporate yardstick violates the 1975 Treaty as applied to the U.S. Branch, we uphold the trial court’s decision in
NatWest II.
“[B]ranch profits must be based on the properly maintained books of the branch,” subject to examination and adjustment where: “(1) an interest expense was deducted for advances to the branch that were not used in the ordinary course of its banking business; (2) an interest expense was deducted on amounts designated as capital on its books or on amounts that were in fact allotted to it for capital purposes, such as funding capital infrastructure; and (3) interest paid on inter-branch borrowing [that] was not at arms’ length.”
NatWest II,
Having upheld the trial court’s decision in
NatWest I
and
NatWest II,
we turn now to the Government’s appeal from the
Order Denying Reconsideration.
Following its ruling in
NatWest II,
the trial court issued a Scheduling Order that limited the scope of discovery regarding the “capital issue.”
Order Denying Recons.
1. In the Scheduling Order, the court stated that “the ‘capital issue’ does not include attributing capital to the U.S. branches from other National Westminster branches or its home office.”
Id.
Thereafter, the Government filed Defendant’s Motion for Reconsideration of Court’s July 16, 2004, Order, Limiting Scope of Capital Issue (hereinafter “Motion for Reconsideration”). The Government argued that United Kingdom banking regulations required Nat-West to hold sufficient capital to support the operations of the U.S. Branch and that this capital should be attributed to the U.S. Branch for tax purposes. Mot. for Recons. 2. As evidence supporting its motion, the Government offered the expert
We review the denial of a motion for reconsideration by the Court of Federal Claims for an abuse of discretion.
Mass. Bay Transp. Auth. v. United States,
The trial court’s denial of the Motion for Reconsideration was not an abuse of discretion. The Government identifies no allegedly clearly erroneous finding of fact. In addition, having concluded that Nat-West II was correctly decided, we find no misapplication of the relevant law. Discovery of NatWest’s home office books was not necessary because the interest expense deduction for the U.S. Branch is to be determined according to the properly maintained books of the branch. We further find that the trial court did not abuse its discretion by finding that the Government had waived its argument that capital held by the NatWest home office should be imputed to the U.S. Branch for tax purposes.
CONCLUSION
We are persuaded that the signatories to the 1975 Treaty expected that the interest expenses incurred by a permanent establishment of an international financial enterprise, e.g., the U.S. Branch of Nat-West, would be deductible to the extent the expenses were related to the permanent establishment’s ordinary course of business. Accordingly, we conclude that Treasury Regulation § 1.882-5 and the corporate yardstick as applied to the U.S. Branch violate the 1975 Treaty. We further conclude that the Court of Federal Claims did not abuse its discretion by denying the Government’s Motion fоr Reconsideration. The judgment of the Court of Federal Claims is therefore affirmed.
AFFIRMED
COSTS
No costs.
Notes
. The United States and the United Kingdom negotiated a new treaty that entered into force in 2003. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains, U.S.-U.K., July 24, 2001, S. Treaty Doc. No. 107-19 (2002).
. Section 1.882-5 remained unchanged for the tax years at issue but was amended in 1996. 61 Fed.Reg. 9329 (Mar. 8, 1996); 61 Fed.Reg. 15891 (Apr. 10, 1996). Section 1.882-5 was amended again in 2006 to comply with the renegotiation of the U.S.-U.K. treaty, as well as a renegotiated U.S.-Japan
. The court also concluded that U.S.-connected liabilities under § 1.882-5 were impermis-sibly computed by reference to the worldwide assets and liabilities of NatWest rather than the operations of the U.S. Branch,
NatWest I,
. The business profits and separate enterprise language of the earlier trеaty states,
[TJhere shall be attributed to such permanent establishment the industrial or commercial profits which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm’s length with the enterprise of which it is a permanent establishment.
Supplementary Protocol Amending the Convention of April 16, 1945, as modified by the supplementary protocols of June 6, 1946, May 25, 1954, and August 19, 1957, U.S.-U.K., March 17, 1966, 17 U.S.T. 1254.
. The Government’s reliance on Revenue Ruling 78-423 may also be mistaken in its assumption that the U.S.-Japan treaty considered therein is sufficiently similar to the U.S.U.K. treaty at issue here. Rather than mandating deductions for "those expenses which are incurred for the purposes of the permanent establishment,” 1975 Treaty, art. 7 H 3, the U.S.-Japan treaty requires deduction for "expenses which are reasonably connected
. The OECD issued a new draft convention in 1977 that did not materially alter Article 7 of the 1963 Draft Convention.
See NatWest II,
