“Yearly” interest and witholding tax duty: Hargreaves Property Holdings v HMRC

22 November 2021

The UK has a system which requires any company paying “yearly” UK-source interest to a non-UK resident to withhold income tax from that interest at the basic rate (currently 20%) .

In the recent case of Hargreaves Property Holdings v HMRC, the First-tier Tribunal (FTT) (Tax Chamber) considered various interest-bearing loans from connected parties over a number of years, all of which were designed to be short term loans, and which were repaid within approximately one year of the advancement of the loan. HMRC argued that the borrowing company had a duty to deduct withholding tax on the interest payments.   

Reviewing these arrangements, the FTT held that:

  • the “underlying commercial reality” was that the interest payments did have a UK source since the interest was always going to be paid by a UK resident debtor out of its assets situated in, and the profits of activities conducted in, the UK (applying the decision of the court of appeal in Ardmore Construction Limited v the Commissioners for Her Majesty’s Revenue and Customs [2018]);
  • interest on short-term loans which are repaid within a year out of the proceeds of new loans from the same lenders are likely to be “yearly” in nature – particularly where the series of loans was, on the balance of probabilities, intended to provide long-term funding for the borrower (applying the Hay tests approved by the Supreme Court in The Commissioners for Her Majesty’s Revenue and Customs v Joint Administrators of Lehman Brothers International [2019] UKSC 12); and
  • the potential availability of treaty relief under the Guernsey/UK double tax treaty was irrelevant in this case as Hargreaves Property had not made a claim for relief.

It therefore concluded that the withholding obligation did apply to Hargreaves Property, which had a duty to account to HMRC for the tax which should have been withheld.

This is a useful reminder that it is not possible to circumvent the withholding obligation by using a series of short term loans: where the intention is to provide long-term funding for the borrower, the interest payments will likely be “yearly” in nature.  

The case also re-emphasises that where there is a UK resident borrower paying interest out of funds which derive from UK assets or profits, any interest payments will almost always be UK source – regardless of provisions in the loan agreement requiring that interest payments be made offshore. So, for example, loans by offshore trustees to UK resident beneficiaries may well give rise to a withholding obligation in respect of any interest paid by the beneficiary. If there is a tax treaty, relief may be available but only if it is claimed and HMRC give permission for the interest to be paid without any deduction of tax.

…the loans made by each Lender satisfied the Hay tests relating to a measure of permanence, a “tract of future time” and being in the nature of an investment…although each individual loan was short-term in nature, the loans provided by each Lender, when taken together, provided financing to the Appellant with a measure of permanence which had a “tract of future time