Technical Spotlight: New UK withholding tax exemptions

HMRC has been consulting on the new UK interest withholding tax exemption for qualifying private placements. This was initially announced in the Autumn Statement 2014 as a means “to help unlock new finance for businesses and infrastructure projects” and some details were contained in the Finance Act 2015.

However, the key remaining details are to be included in secondary legislation, a further draft of which has been doing the rounds. Many of the more restrictive conditions previously included in earlier draft provisions have now helpfully been dropped and the exemption will now be available to all loans meeting the criteria, including those entered into before the exemption comes into effect.

Critically though, it seems increasingly clear that the benefit of the exemption is, in practice, likely to be limited to lenders resident in countries which have double tax treaties with the UK. Perhaps the biggest impact is that many lenders in China, Japan, Korea, Italy and Indonesia will now be able to lend direct to the UK without suffering any withholding. That could open up some new sources of capital.

It is now clear that this new qualifying private placement exemption will not be as seminal a change as had originally been hoped. However, there is a second ongoing consultation which could lead to further relaxation of the UK withholding regime in the Finance Act 2016.

This article deals with the qualifying private placement exemption now that its outline is reasonably clear. Final details will be released by HMRC towards the end of 2015.

Background

Private placements are much more common in the US than has hitherto been the case in Europe. There is a widely held view that the depth and resilience of the US private placement market helped speed economic recovery, as lenders – other than the traditional banks – stepped in to fill the funding gap as banks shrunk their balance sheets. This has led to a well-publicised effort to develop a pan-European private placement market.

A typical private placement involves direct lending by non-bank investors, such as pension funds, insurers and fund managers.

What you need to know

• Benefits to lenders resident in countries which have double tax treaties with the UK. Many lenders in China, Japan, Korea, Italy and Indonesia are now able to lend direct to the UK without suffering any withholding.
• Final details of the qualifying private placement exemption will be released by HMRC towards the end of 2015.
• There will be a possible further relaxation of UK WHT rules some time in 2016.

Current withholding tax position

By way of background, the UK generally imposes a 20 per cent withholding on payments of interest by UK incorporated companies (and some foreign companies with a UK connection) on loans or debt securities, but only where the loan or debt is intended to last more than a year.

The UK’s quoted Eurobond exemption disapplies withholding tax (WHT) from most listed bonds. However, that quoted Eurobond WHT exemption does not generally apply to private placements of debt securities issued by UK incorporated companies since such issuances are usually, by their very nature, unlisted. Most UK lenders that are either incorporated as a company or are registered as a pension fund with HMRC can avail themselves of a WHT exemption. But the position for non-bank lenders – the category of lenders the new exemption is designed to stimulate – is more difficult where they are incorporated outside the UK.

Even where they cannot use the above exemptions, though, that is not necessarily fatal. That is because those lenders, resident in other jurisdictions that have a UK tax treaty which reduces the WHT to nil, can generally still apply to HMRC for exemption from withholding. Historically, this was a somewhat painful and time-consuming process involving a formal tax treaty clearance application to HMRC. Since 2010, HMRC has offered an alternative, more streamlined, process known as the double tax treaty passport (DTTP). In our view, that works well, though it also takes a little time and paperwork.

“Qualifying private placement exemption”

This new “qualifying private placement exemption” is designed to simplify matters for many such lenders in treaty jurisdictions. It will not assist lenders incorporated in tax havens such as, for example, many hedge funds. This new exemption is an alternative; as a matter of law, lenders can continue to claim treaty relief, or other available exemptions if they prefer, subject to whatever contractual provisions are contained in the underlying debt documentation. Following an initial consultation, both the primary legislation and the draft regulations impose fewer conditions than the original December drafting. Our thoughts on the currently proposed conditions are set out below.

What are the conditions for the exemption?

Two sets of conditions need to be met. The first set of three conditions was included in the Finance Act 2015 and provides that the WHT exemption is, subject to the further conditions under discussion below, available for:

• interest paid on a security;
• which represents a loan to which a company is a party as debtor; and
• which is not listed on a recognised stock exchange.

It is worth noting that:

a. HMRC’s clearly stated guidance is that the exemption will be available for debt taking the form of loans, facility agreements, etc., as well as that structured as a note or bond;

b. the exemption applies whether the debt is in bearer or registered form; and

c. in theory, the exemption applies whether the debt is cleared or not or, if cleared, where it is cleared (as long as the debt is not also listed on a recognised stock exchange where the quoted Eurobond exemption might be expected to apply). However, the practicalities of the certification requirements set out below means that the exemption may be less useful for cleared instruments.

Additional conditions in the draft secondary legislation

The draft secondary legislation specifies that the following further conditions must be met:

1. Securities

The securities may not have a term exceeding 50 years

There is no minimum term specified. As noted above, though, where the term is less than a year (i.e. commercial paper), there is generally no UK WHT in any event so the exemption will not generally be relevant for such paper.

The security or the placement as a whole must have a minimum value of £10m

But subject to that, there is no upper limit for the availability of the exemption.

2. Creditor

The creditor will generally be the beneficial owner of the relevant securities. That is straightforward when a lender holds a loan directly or via a nominee and has not sought to reduce its economic exposure through, for example, a sub-participation or hedge. What is less clear to us, under the current drafting, is who the “creditor” is where there is a sub-participation or similar risk transfer mechanism involved.

The debtor reasonably believes that it is not connected with the creditor

This requirement has presumably been included to prevent intra-group shareholder debt availing itself of this new exemption. That is not surprising given all the historic discussions around shareholder debts structured as quoted Eurobonds.

The “creditor” also needs to certify that it meets the following conditions:

The creditor is “resident” in a “qualifying territory”

This is a key condition regarding the width of this new exemption.

A “qualifying territory” is, broadly, the UK or a territory with which the UK has a double tax treaty with a nondiscrimination provision. The fact that the UK does have tax treaties with a number of tax havens – generally to exchange information, etc. – sometimes causes confusion. However, those treaties with tax havens do not generally have a “non-discrimination provision” (effectively a clause providing that the UK will not discriminate against nationals of the tax haven as compared to UK nationals). That is why this exemption will not directly assist lenders incorporated in tax havens (for example, many hedge funds).^[1]

The requirement is that the creditor be “resident” in a qualifying territory. In this draft legislation, “resident” means “liable to tax” in that territory. Note that this condition means that such a lender would, subject to what is covered below, often already be able to avail itself of relief under the relevant double tax treaty (assuming the relevant filings were made).

The term “resident” does, perhaps surprisingly, generally cover a foreign pension fund or charity even if it is taxexempt in its home jurisdiction.^[2]

However, the requirement that the lender be “resident” means that this new exemption will not directly help those private equity, mezzanine or infrastructure funds set up as partnerships, whether established in the UK or elsewhere. Again, that is because to qualify as “resident”, the lender effectively needs to be a taxpayer in the relevant jurisdiction. Partnerships are, on the whole, tax transparent and so will generally not qualify. Theoretically, it may be that one could look through to the partners and whether the partners themselves satisfy this condition but the practicalities involved in most investment funds mean that that is of little practical use as drafted.

The current drafting is far more likely to assist where a fund partnership has incorporated a subsidiary entity, such as a taxable Luxembourg company. Indeed, this new exemption could conceivably be very useful, in this context, if work under Action 6 of the OECD Base Erosion and Profit Shifting Plan restricts the ability of such subsidiaries to access treaty relief.

Interestingly, it is not relevant for these purposes whether the treaty actually reduces the rate of UK withholding to nil (as it does under most of the UK treaties) or to, for example, ten per cent (as it does under the current UK treaties with China, Japan, Korea, Italy and Indonesia). Thus, this is a really positive development in terms of attracting inbound investment from those countries as, historically, they would generally have suffered ten per cent withholding if they had originated or acquired loans to UK borrowers which were not in the form of quoted Eurobonds.

This exemption will, where the other conditions are met, remove that cost for them.

The creditor holds the security for genuine commercial reasons and not as part of a tax advantage scheme

This sort of provision is now fairly standard in new UK tax legislation. What will be interesting to understand is its application to some commonly seen arrangements. The creditor will be required to certify that it meets these conditions. The borrower is able to rely on that certification and, absent inappropriate behaviour, should therefore not be at risk if the creditor’s certification turns out to have been incorrect. This does place additional burdens on investors, but these will be less onerous than under a full treaty claim, although the difference may be minimal as compared to the filings required where a lender already has a DTTP number.

As with the other UK exemptions, the exemption is looked at on a lender-by-lender basis. It is therefore possible that some lenders will qualify for the exemption and some will not, but the existence of the latter camp does not, of itself, prejudice the availability of the exemption for the former camp.

Outstanding issues

There are a couple of aspects that Ashurst is still discussing with HMRC, in particular, whether the following will be able to benefit from the exemption:

a. UK lenders lending through partnerships; and

b. offshore incorporated borrowers.

The wider HMRC consultation

HMRC is currently undertaking a full review of options in relation to withholding on interest, including considering its abolition. That review was started as a result of the decision to abolish certain withholding on interest paid on bank accounts. While that limited change is only going to apply to bank accounts, it has triggered this wider review of withholding on interest more generally. ^[3]

It is too soon to tell where that is going to end up, but a number of groups are pushing for further relaxations of the regime, especially for partnerships which cause particular issues at the moment.

Change is not expected, though, under this wider review until mid-2016.

This article is part of Issue 5 of our Credit Funds Insight for 2015. To see the full publication, please click here.

_Notes

_{^[1] There is a (slightly historic) list of the treaties that HMRC considers qualify in the HMRC International Manual at INTM412090, hmrc.gov.uk.}

_{^[2] See INTM162040 on hmrc.gov.uk and the principles in Weiser -v- Revenue and Customs Commissioners [2012] SFTD 1381.}

_{^[3] See “Deduction of income tax from savings income: implementation of the Personal Savings Allowance”, HMRC consultation document, gov.uk website, July 2015}