Under UK domestic law there is a general rule that companies paying interest are required to deduct withholding tax (WHT) at the rate of 20%. There are many exceptions, one of which is when the interest does not arise in the UK i.e. it is not UK sourced.
Whether interest is UK sourced is not always a straightforward matter and is dependent on the facts and circumstances. HMRC sets out in its guidance the approach it takes to determining the issue. This approach has been adopted from case law and a recent decision from the Upper Tribunal (UT) further endorses this.
The UT in the case of Ardmore Construction held that a multi-factorial test must be adopted to determine the source of interest on a loan and whether, therefore, UK tax must be deducted from interest payments. The First Tier Tribunal (FTT) originally held, in 2014, that interest on unsecured loans from an offshore trust paid by a UK resident company from UK trading profits arose in the UK. Accordingly, the UK company should have deducted income tax at the basic rate.
The UT concluded that the interest arose in the UK because the payer was resident, and the debt situated, in the UK. Further, the UK would be the place of enforcement of the debt and the interest was serviced from profits generated in the UK. The tribunal was untroubled by the parties’ contractual agreement to submit to the exclusive jurisdiction of the Gibraltar courts and to pay interest from a non-UK source.
The multi-factorial approach essentially assesses the connection of the debt and associated interest to the UK. It is vital for the paying company to understand whether the interest is sourced in the UK as a failure to deduct the right amount of income tax can lead to tax-geared penalties and interest. The paying company may also bear the amount of tax that should have been withheld which becomes an additional cost on top of the interest payment itself. It is also important to determine the county of source in order to review the correct double tax treaty and assess the availability of treaty relief.
The UK sourcing rules are just one area that must be considered in determining whether an obligation to deduct WHT exists. If you are concerned about your company’s potential obligation to deduct WHT then please contact or Tax Accounting Specialists here at PKF Francis Clark.