Last March HMRC launched a consultation on the income tax treatment of interest, including proposals to restrict withholding tax exemptions for quoted Eurobonds and interest on short term loans. We reported on these proposals in an Update dated 29 March 2012. HMRC has now published a Summary of Responses plus its proposals for legislative change and this Update gives an overview of the key proposals.
Under current law there is no obligation to withhold tax from interest on quoted Eurobonds. It was proposed to prevent the application of this exemption to securities issued between group companies where there was no substantial or regular trading. There was a lot of opposition to this in the responses to consultation and the Government has confirmed that it will not be proceeding with its proposal to restrict the exemption.
The Government has also backtracked on its proposal to abolish the concept of yearly interest, so there will continue to be no withholding tax on “short” interest (interest on loans expected to be outstanding for less than a year).
HMRC states that it will make changes to its guidance in the Savings and Investment Manual to set out more clearly its view of “short” loans that are repeatedly rolled over. The implication here is that they regard these as giving rise to yearly interest.
“Interest arising in the UK”
UK withholding tax applies to interest “arising” in the UK, commonly referred to as “UK source” interest. Several factors are taken into account in determining the source of interest and the position is not always as clear as it might be. The Government will legislate to make clear that, in the case of “specialty debt” or “debts under seal”, the location of the agreement or deed evidencing the debt will not be taken into account as a factor, so the physical holding of such documents offshore will not suffice to prevent interest having a UK source.
Several respondents commented on the lack of clarity of the term “arising” in the UK but the document states that there was no consensus as to the approach to be taken so further change seems unlikely in the short term.
Cross border payments of interest – possible re-think on withholding tax?
Part of the stated rationale for agreeing not to scrap the concept of yearly interest and to retain the Eurobonds exemption was representations that a large proportion of the payments would actually be exempt from withholding under double tax treaties so the proposed changes would result in additional administrative inconvenience but not much additional tax revenue. The document states: “the Government has noted the representations made on the wider question of the extent to which tax is withheld from interest in a cross-border context, and will consider this further.” Several other major jurisdictions do not impose withholding tax on interest paid to non-residents so it will be interesting to see whether the Government considers emulating them as part of its strategy of making the UK internationally competitive
Interest in kind and funding bonds
The Government will proceed with modified proposals to determine the value of interest paid in the form of goods and services. Broadly this will be the retail or market price or, in the case of vouchers, the face value or the cash equivalent of the goods or services for which the voucher can be exchanged. Witholding tax will be calculated on the grossed up amount of these values and payable in cash.
However the current treatment of funding bonds will be retained. The issuer will still be able to issue bonds to HMRC in payment of withholding tax on interest satisfied by issue of funding bonds.
Disguised interest and deeply discounted securities
The Government also proposes to introduce “disguised interest” rules for income tax, similar to those already in place for corporation tax, to treat as interest returns which are economically equivalent to interest. It will repeal some existing legislation which will become redundant, namely chapter 12 of Part 4 ITTOIA (disposals of futures and options involving guaranteed returns) and sections 597 to 606 of ITA and Chapters 5 and 6 of Part 7 ITA (income tax rules on repos and quasi-stock lending arrangements).
The deep discount security and accrued income scheme rules will remain in place, at least initially, but the Government will consult on the possible “simplification” of these regimes following introduction of the new disguised interest regime with a view to legislation in Finance Act 2014. It is possible that this “simplification” may result in discount being taxed in the same way as interest and becoming subject to withholding tax which would make deep discount bonds a less attractive funding option. There is no indication yet as to whether existing bonds might be “grandfathered”.
The Government proposes legislation in Finance Bill 2013 to make it clear that the general requirement to deduct income tax from yearly interest applies to the interest element of compensation payments made to individuals, including payments made by banks in the ordinary course of their business. The legislation would not re-characterise as interest amounts that are not interest on first principles.
Click here for the full text of the response document.