Locations
This article was included in issue 1 of the Finance Brief.
Does interest paid under this loan agreement have a UK source? – this is one of the most common questions asked of tax lawyers by their finance colleagues. In many cases, this simple question will have a simple answer, but in other cases there can be a difficult and uncertain analysis.
Why does it matter? – if interest has a UK source, UK withholding tax applies unless an exemption or relief is available. Generally, where interest which has a UK source is paid to a UK bank, interest can be paid gross. If this is not the case, the question becomes a key financial issue for borrower and lender alike: no one wants to enter into a loan where there will be withholding tax or a real risk of it, whether UK or non-UK. If interest has a non-UK source, a different set of withholding tax rules will be in point, so, even though interest is paid to a UK bank the exemption is not available if interest is paid from a non-UK source.
The UK source analysis is a delicate balancing act. Originating from a 1969 House of Lords case (Westminster Bank Executor and Trustee Co and Channel Islands Ltd v National Bank of Greece SA [1969] 3 All ER 504), there are a number of factors to consider which must be weighed up against each other to provide the answer – yes or no. The case considered when interest paid by a UK company has a non-UK source. Conversely, HMRC’s interpretation of the case law considers when interest paid by a non-UK company has a UK source and so should be approached with caution. HMRC places particular emphasis on the following factors: (a) the residence of the borrower and the location of their assets; (b) the place of performance of the contract and the method of payment; (c) the competent jurisdiction for legal action and the proper law of the contract; and (d) the residence of any guarantor and the location of the security for the debt.
HMRC considers that it is for the taxpayer to prove whether interest has a UK source and therefore whether UK withholding tax is in point. It is unfortunate that “HMRC should effectively treat the question of UK source as something to be put in the ‘too difficult to handle box’ and then dump that box firmly on the taxpayer’s doorstep” ! The uncertainty in this area of law emphasises the need to examine the facts and circumstances of each arrangement on its own merits. Whilst in many cases, the source of interest is clear, the analysis is not always clear cut and there can be unexpected results.