The TMI Tax Doctor: Withholding Tax
In this issue of Tax Doctor we look at two questions around Withholding Tax. Firstly, a practical solution to reducing the administrative burden of making double tax treaty claims to reduce/relieve the need to withhold tax on cross-border lending, and secondly the duty to withhold tax on interest payments in the context of a notional cash pooling arrangement.
Q1: We’re a non-UK lender and make loans to UK borrowers. Historically, we’ve relied on the certified claim method to benefit from reduced treaty withholding tax rates on interest and completed this on a loan by loan basis. We’ve recently seen a large increase in the number of loans entered into and the certified claim method is becoming an administrative burden. Is there another way?
The UK operates a Double Tax Treaty Passport (DTTP) Scheme which streamlines and simplifies the process of the making of Directions by HM Revenue & Customs (HMRC) to borrowers to pay interest at a reduced or zero rate of withholding tax.
To be eligible to enter the scheme, the overseas lender must be a corporate (or an entity treated by its country of residence as a corporation for tax purposes) in a country with which the UK has a double taxation treaty that includes an interest Article. As of April 2013, HMRC now also, in certain circumstances, will consider issuing a treaty passport to a US disregarded LLC or US S-Corporation.
The application for a Treaty Passport is made to HMRC using a specific form which can be completed by a responsible person for the company or its tax agent. It must also be certified by the tax authority in the company’s country of residence.
If HMRC grant a Treaty Passport, the corporate lender then becomes a passport holder with its details entered onto a publicly available register with a unique identification number. Following this, each time a UK borrower enters into a loan agreement with the passport holder, the lender simply notifies the borrower of its passport holder status.
The UK borrower must then use those details to notify HMRC and obtain a ‘Direction’ to pay the interest with UK withholding tax deducted at the rate set out in the relevant Double Taxation Treaty.
Use of the DTTP scheme is dependent on the lender undertaking to comply with certain terms including confirmation that the scheme will not be used for any income which is not within the company’s beneficial ownership (within the international fiscal meaning of the term where this is relevant to the purpose of obtaining relief).
Q2: Our group operates a single currency notional cash pool with a bank. Does the bank have a duty to withhold interest payments made by it to pool participants? Equally, do the pool participants have a duty to withhold interest payments made by it to the bank?
Typically, the starting point in identifying the tax implications associated with a cash pooling arrangement is to determine the legal characterisation of that arrangement. Generally under a notional cash pool, the bank will be paying interest to each of the pool participants (and vice versa), although interest may be paid to the pool leader in the first instance who effectively acts as a collecting agent.
In respect of interest payments made by the bank, the bank managing the arrangement may be required by domestic law to withhold tax payments on interest. The same may also be true of payments made to the bank.
However, in practice specific domestic bank legislation will often remove any obligation to withhold tax on payments made to and from banks. For example, under UK tax law, the duty to withhold tax does not apply to a bank within the charge to UK tax, if the payment is made in its ordinary course of business. Equally, under UK tax law, the duty to withhold tax does not apply to a payment by a UK company on an advance from a bank, if the person ‘beneficially entitled’ to the interest is within the charge to UK tax at the time the payment is made.
Care will need to be taken however to understand the exact nature of the notional cash pool arrangement including identification of the person beneficially entitled to interest (broadly meaning the recipient enjoys the full privilege to directly benefit from the income). How the pooling arrangements is viewed in the local jurisdiction of both the bank and each pool participant will also be important. In particular, in some jurisdictions (e.g. the United States) the use of cross guarantees under a notional cash pool can have the effect of re-characterising the interest payment resulting in an alternative withholding tax analysis.