Withholding tax: claims for treaty relief where tax was not deducted

HMRC has withdrawn the concession previously contained in its International Manual at INTM413230 under which, in certain circumstances, it would collect only late payment interest where a borrower had failed to deduct tax from interest paid to an overseas lender. The withdrawal takes effect from 2 November 2026 and applies to disclosures received on or after that date, including those concerning failures in earlier periods. However, new guidance at INTM413232 recognises that the payer may itself claim treaty relief in respect of its liability and provides a new process for ensuring that only late payment interest is due in appropriate cases.

Background

ITA 2007 s.874 requires a UK borrower paying UK source yearly interest to an overseas lender to deduct income tax at the basic rate and account for it to HMRC. A double taxation agreement may reduce or eliminate that withholding tax requirement. However, it is necessary to obtain HMRC clearance in order to benefit from treaty provisions which provide for payment gross or at a reduced rate.

The concession addressed the situation where interest had been paid gross without clearance, but the overseas lender subsequently obtained clearance for future payments and would have been entitled to repayment of the tax on the earlier payments. Where the tax was both collectible and repayable, HMRC would set aside its right to collect the underlying tax and seek only late payment interest under TMA 1970 s.87. This avoided the circular process of collecting tax from the borrower and repaying it to the lender.

In December 2025, HMRC paused the processing of disclosures of failures to deduct, including associated repayment claims and applications for interest only treatment, while it reviewed the processes and relevant legislation. As explained in INTM413205, borrowers remained obliged to disclose failures without delay, and applications for clearance for future payments were unaffected.

Withdrawal and new guidance

Following that review, HMRC has withdrawn the concession and published new guidance at INTM413232 to INTM413236. Importantly, where the payer failed to deduct, HMRC will now recognise a claim by the payer for relief under the relevant treaty. It will not accept a claim from the lender where no deduction was made, because the lender has suffered no tax capable of repayment.

The payer must use HMRC’s prescribed form and verify treaty entitlement. Claims are generally subject to a four-year time limit running from the end of the tax year in which the obligation to deduct arose. Where relief is due, HMRC will discharge the corresponding unpaid tax or repay tax already paid. Late payment interest runs from the original due date until the earlier of payment and submission of a valid claim. Where the payer has suffered tax as a result of a failure to deduct in years of assessment that ended more than four years earlier, the guidance notes that relief might be obtained under the treaty’s mutual agreement procedure (MAP) instead.

The new procedure depends on there having been a “failure to deduct”. The guidance notes that whether or not there has been a deduction from a payment is a matter of fact. A contractual requirement to compensate for any deduction (a “gross-up” clause) does not, by itself, mean that a deduction was made. What matters is whether an amount was actually deducted from the gross interest liability before payment. The guidance suggests that where the gross-up and net interest are paid together, it may be difficult to distinguish the situation from a payment of the gross interest where no deduction was made. Contemporaneous records relating to the payment may assist in establishing what occurred.

The position for disclosures received before 2 November 2026 and caught by the pause is not yet fully resolved. HMRC is still considering cases where a claim is not made or is out of time and suggest that affected taxpayers do not need to contact HMRC at this stage. Further guidance will be published once the approach has been finalised.

Comment

Although the former concession has been withdrawn, the new guidance provides a largely equivalent route for a payer who has failed to withhold tax to avoid payment of the withholding tax formally due, where treaty relief would have been available, subject to payment of late paid interest. However, borrowers should ensure they follow the new HMRC procedure in order to avoid exposure to withholding tax and potential penalties for inaccurate returns.