Our team of friendly experts are here to answer your questions
For many international groups this potential withholding tax liability is overridden by the interest article of a UK double tax treaty, if the UK company’s lender is resident in a Contracting State. However, this note assumes there is no possibility of treaty or EU Directive reliefs. The most common reason for this is that the lending company is often an offshore company i.e. not registered and resident in an EU Member State (or EEA State) and not party to a suitable tax treaty with the UK. Examples of offshore companies lacking a tax treaty with the UK include the British Virgin Islands and the Cayman Islands; examples of offshore jurisdictions with tax treaties with the UK but whose provisions are unlikely to override UK taxing rights include Jersey, Guernsey, and the Isle of Man.
The duty to deduct: Example
In the above scenario, HMRC’s policy has almost always been to regard the interest income paid by the UK company as liable to a deduction (made by the payer of the interest) of basic rate income tax. The rate of tax is therefore 20% of the gross interest paid. HMRC reason that the income must be regarded as having a UK source, on account of the debtor being UK resident. If this reasoning is not challenged (and unfortunately some advisors often accept HMRC’s interpretation of the law as correct) the offshore lender will be liable to the basic rate income tax charge on its gross interest, as s 368(2) Income Tax (Trading and Other Income) Act (ITTOIA) 2005 states:
“Income arising to a non-UK resident is chargeable to tax under this Part only if it is from a source in the UK.”
HMRC say in their Savings and Investment Manual (SAIM 9000):
”…whether or not tax should be deducted from interest paid on an overseas loan depends on the source of the interest. If the interest has a UK source tax must be deducted, if it does not then tax should not be deducted.”
This is clearly correct. HMRC then go on to say:
”Whether or not interest has a UK source depends on all the facts and on exactly how the transactions are carried out. HMRC consider the most important factor in deciding whether or not interest has a UK source to be the residence of the debtor and the location of the debtor’s assets.”
The first sentence of the paragraph immediately above is consistent with authority on the source of interest, but the second sentence is not.
The “Greek Bank" case
Until the case of Ardmore, the common law authority for the source of interest was the so-called Greek Bank case (Westminster Bank Executor and Trustee Co v National Bank of Greece (1970) 46 TC 472). A bank in Greece had issued bearer bonds denominated in sterling. The bank defaulted on the loan, and the Greek guarantor paid the interest. HMRC argued that the interest had a UK source because although the original guarantor had no branch in the UK, the successor guarantor resulting from a corporate amalgamation, acquired a UK branch on its universal succession in London so that the bonds were enforceable in the UK. The House of Lords held that the interest had a non-UK source based on various factors including the non-UK residence of the debtor and the guarantor, and the fact that the loan was secured on lands and public revenues in Greece. Payment of interest was to be made in sterling, either by remittance from Greece to the paying agents specified in the bond or, at the option of the holder, by cheque issued in Greece but drawn on London payable out of funds remitted from abroad. Lord Hailsham also made an opaque reference to the bond being “a foreign document”.
Pursuant to the Greek bank case, HMRC has adopted a multi-factorial approach to determine the source of interest, with greatest weight being attributed to the residence of the debtor.
Until the Court of Appeal judgement in Ardmore, it had not been clear what respective weight should be given to the various possible factors that fell to be considered in the Greek Bank case. Following Ardmore, the issue of weighting is clearer, although as underlined by the Court of Appeal, each case is “acutely fact sensitive“.
Ardmore Construction Ltd v HMRC (2018) (EWCA Civ 1438)
Ardmore Construction Limited was and is a UK resident company owned and managed by two brothers, also UK resident. The activities of the company were essentially confined to the UK, where a trade was carried on. Using its working capital, Ardmore subscribed for shares in two British Virgin Islands companies owned by two Gibraltar trusts settled by the two brothers respectively. The sums subscribed by Ardmore in the two BVI companies were then loaned by the BVI companies to the two offshore trusts. The trusts then lent the sums received to Ardmore. The loans were not secured on the UK assets of Ardmore, and the loan documents were governed by the laws of Gibraltar. The borrower (Ardmore) and the lenders (the Gibraltar trusts) submitted to the exclusive jurisdiction of the Gibraltar courts. Interest was paid from Ardmore’s bank account in the UK to the lenders’ bank accounts in Gibraltar.
Counsel for Ardmore argued that the source of interest was to be found by ascertaining the “nationality” or “residence“ of the loan document (echoing Lord Hailsham’s reference to the bond in Greek Bank being a foreign document). This was an argument against a multi-factorial approach, which ultimately failed before the Court of Appeal. In the alternative Ardmore argued that if a multi-factorial test was the proper test, the FTT had erred in affording too much weight to the residence of the debtor (the FTT judgement concluded that the factors of residence and the source of funds outweighed that of jurisdiction and actual payment). The third ground of Ardmore’s appeal was that the place where credit is provided is the source of interest.
The Court of Appeal rejected Ardmore’s arguments, and fully endorsed the reasoning of the Upper Tribunal (UT) which had itself endorsed the findings of the FTT. The following passages from the UT are instructive: