Simplifying withholding tax treaty relief

The government has published a consultation on the possibility of allowing taxpayers to self-assess the availability of treaty relief for payments of interest to overseas recipients. The government notes that the current administrative rules which generally require businesses to obtain prior HMRC authorisation for payments of interest at zero or reduced treaty rates can be slow, difficult, costly and burdensome. The consultation is very much at an early stage and although self-assessment has been put forward as one option to be considered, the consultation also calls for responses on other ways in which the system might be simplified. “The intention is to identify options to meaningfully simplify the administration of the available relief, to make things simpler for taxpayers whilst maintaining robust safeguards against tax avoidance.”

Background

The UK tax regime charges income tax on interest and ITA 2007 Part 15 provides for an obligation to deduct withholding tax from payments of interest, subject to various exceptions. The UK has a wide network of Double Taxation Treaties (DTTs) which often reduce or remove the UK’s taxing rights over payments of interest to residents of the treaty partner. However, treaty relief from interest withholding is not automatic. The overseas recipient (or in some circumstances the UK payer) must apply for and obtain a direction from HMRC before the interest can be paid with a reduced (or zero) rate of withholding. Until HMRC grants this direction, the UK payer remains obliged to deduct at the basic rate of income tax and return the sums deducted to HMRC. The payee may then submit a claim for a refund of tax from HMRC if they are entitled to relief under the relevant treaty. While this eventually provides relief, it generally results in a cash-flow disadvantage, relies on a valid claim being made, and increases administration for both the lender and HMRC.

To ensure that treaty benefits are only conferred in appropriate circumstances, and that HMRC has an appropriate level of visibility over cross-border income flows, the processes to claim treaty relief on a payment of interest involve several steps by both parties to the payment involving:

• Relief is generally claimed using the DT-Company or DT-Individual forms. These require details of the payment, the payee, and the underlying Double Taxation Agreement.
• Once received, HMRC may issue a direction permitting future payments be made at the treaty rate (or gross) for a period of five years. These directions cease to have effect should events specified on the directions occur.
• These processes have been expedited by the operation of the Double Taxation Treaty Passport (DTTP) scheme, under which overseas corporate lenders can apply for a ‘treaty passport’. Once granted, the process to permit the UK payer to withhold at the treaty rate is streamlined – though importantly still requires an HMRC direction on a loan-by-loan basis.

Consultation

The consultation acknowledges that the current process can be costly and challenging to navigate and stakeholders have highlighted the administrative burden and risks for lenders and borrowers. Taxpayers have raised concerns that the current process can result in delays, administrative complexity, uncertainty and unnecessary cash-flow impacts. In many cases, initial withholding is required even where relief is ultimately available, resulting in complexity and administrative repayment processes with limited Exchequer benefit.

These challenges have led to calls for changes to the system, such as simplification of the processes under which directions are granted or allowing the payer of interest to self-assess treaty relief (as is the current position for payers of royalties) at their own risk. However, the government makes it clear that any simplification must balance reducing burdens with safeguards. The obligation to withhold is a key anti-avoidance measure and without it there is a risk that profits could be stripped out of the UK and avoid taxation entirely. Reforms that relax requirements would require appropriate safeguards to ensure that opportunities for avoidance or evasion do not arise.

The government is interested in exploring the details of such reform, leading to the publication of the consultation. The consultation notes that the government has not yet determined how best to reform the current regime and the purpose of this consultation is to “present a range of potential approaches and to invite views from stakeholders on their relative merits, risks, and practical impacts”. However, confusingly, the consultation in fact only puts forward one possible modified approach.

The option discussed in the consultation is to allow UK payers to apply treaty relief at source without prior HMRC direction where the payer believes the conditions for treaty relief are met. This could operate on a self-assessment basis, with the UK payer responsible for determining whether treaty relief applies. HMRC would retain the ability to review eligibility through compliance activity.

This approach would broadly align the treatment of interest with the approach currently taken for royalties, where treaty relief may be applied without advance clearance, at risk of penalties and interest if the payment was not eligible for relief. Potential advantages of this approach include reduced delays to commercial transactions where otherwise interest would have to be subject to deduction (and ultimately repayment claims) and reduced administrative costs for the payer, lender, and HMRC.

The approach might, in many ways, be similar to the ability of UK corporate payers of interest to make payments of interest without withholding tax where the person beneficially entitled to the interest is a UK resident company or subject to corporation tax on the interest.

The consultation notes that the government would need to consider appropriate safeguards, including exclusions from the entitlement to self-assess, reporting requirements, and penalties for misapplication or non-compliance with reporting obligations. Maintaining effective reporting requirements would be a crucial aspect of any simplification for the government, even where no UK tax is payable. As the consultation notes, reporting enables HMRC to understand the scale and nature of relieved transactions, assess whether relief is being applied appropriately, and target compliance activity proportionately, without relying solely on the withholding mechanism. Equally, however, the government is cognisant of balancing the need to ensure effective reporting against not duplicating obligations on businesses, including in light of proposals for the implementation of the International Controlled Transactions Schedule (ICTS).

Beyond the option to essentially self-assess treaty relief, the consultation merely asks if there any other options or ideas for simplifying the withholding process on interest which respondents believe the government should consider, for example based on any international examples or innovative uses of technology or data sharing.

Concessionary treatment

The consultation also notes that HMRC has operated concessionary treatment by which tax which otherwise would be assessed on the UK payer following a failure to operate the withholding process is not pursued to the extent that it is clear that any tax collected would be repaid to the lender under the terms of a DTA. Operation of this concession is currently paused whilst the underlying policy and conditions are reviewed. The operation of the concession, and its subsequent pause, are not within the scope of this consultation.

Comment

This consultation runs until 7 September and responses should be sent to simplifyingtreatyreliefconsultation@hmrc.gov.uk