New Treaty Passport Terms & Conditions

Update

For the Court of Appeal decision in Ardmore, see "Commercial and practical approach required to determining source of interest".

HMRC has published updated Terms & Conditions and Guidance for its Double Taxation Treaty Passport (DTTP) scheme. The updated rules apply to loans with a commencement date of 06 April 2017 or later, whilst the previous rules still apply to loans with an earlier commencement date. However, the updated scheme contains some indications that where a lender purchases a loan (or calls a guarantee) on or after 06 April 2017, the updated rules will apply as this is viewed as a new lender/borrower relationship (even though the loan was originally entered into before 06 April 2017). This is helpful as the changes to the Treaty Passport scheme are generally taxpayer-friendly.

The publication of the updated Terms & Conditions and Guidance follows on from the recent consultation response by HMRC setting out their plans to update the scheme, as to which see “Double Taxation Treaty Passport scheme consultation response published”.

Updated terms and conditions

For loans entered into from 06 April 2017:

• Expanded range of borrowers: The DTTP scheme will be available to all UK and non-UK borrowers that have an obligation to deduct withholding tax (whatever their legal form, including individuals) where they are facing passported lenders.  Previously the scheme was limited to UK and non-UK corporate borrowers.

• Tax-transparent lenders: Tax transparent non-UK lenders (such as partnerships or other forms of tax transparent fund) will be permitted to obtain passports where all partners/constituent beneficial owners of the interest are resident in the same jurisdiction and entitled to the same treaty benefits. Qualifying partnerships (and presumably other qualifying tax transparent lenders, though this is not explicit) must appoint a “designated” or “nominated” partner, responsible for making the initial application, corresponding with HMRC and notifying any relevant changes.

• Sovereign and pension fund investors: Sovereign investors and pension funds who are relying on a double tax treaty will be admitted into the scheme on the same grounds as other lenders, ie where the beneficial owners are entitled to the same treaty benefits under the same treaty. However, the passport scheme still will not apply to claims for sovereign immunity exemption from withholding tax - the only way to use the sovereign immunity exemption remains to receive interest net of withholding and claim repayment from HMRC of the tax withheld.

• Individuals: The DTTP scheme still does not appear to apply to individual lenders, although it does now appear to apply to a partnership whose partners include individuals as long as the partners are all resident in the same treaty jurisdiction and entitled to the same treaty benefits. This appears to be in contrast to the scheme now encompassing individual borrowers.

• Loan portfolios and block clearances: HMRC may accept use of a lender’s passport for a portfolio of loans to different borrowers (including individuals) acquired in a single transaction whose interest payments are collected under a single asset management or paying agent arrangement. This change is presumably intended to align with HMRC’s existing practice of permitting treaty exemption to apply to a whole portfolio of loans following a block treaty clearance application and issuance of a single block clearance to the manager/agent responsible for collecting in the interest and paying it on to the lender, without having to involve the underlying borrowers. Where a passport is used in this way, the manager or agent would presumably file Form DTTP2 on behalf of all of the borrowers.

• Omnibus clearance applications: Where borrowers are facing a syndicate comprising multiple passported lenders, the borrower may request that HMRC agree to arrangements under which it would file an “omnibus” Form DTTP2A instead of one Form DTTP2 for each such lender.

• Provisional application of treaty while HMRC processes clearance: Where a lender uses a treaty passport and the borrower submits Form DTTP2 online, once the borrower has received its online submission acknowledgement (which should be broadly immediate), it may provisionally apply withholding tax exemption without waiting for the application to be processed by HMRC and the treaty clearance issued. This is a substantial and welcome change - where it applies removes the traditional “slow tax authority risk” that a treaty exempt lender suffers UK withholding tax because clearance is not provided in time for the first interest payment. It further incentivises both the use of treaty passports and the online filing of Forms DTTP2. (It is not clear, however, if the online filing facility is available yet in practice).

• Guarantee payments: In relation to payments by guarantors, the updated DTTP scheme indicates that if a guarantee is called, HMRC treats interest paid under the guarantee as if it is paid under a new debt relationship. This appears to suggest HMRC believes the guarantee payments of interest should be viewed as separate interest payments whose UK withholding tax treatment should be considered afresh, rather than viewing the guarantee payments as payments of the underlying loan interest by the guarantor and hence inheriting the withholding tax status of the underlying interest payment obligation. Accordingly, the new DTTP scheme indicates that where a non-UK lender calls on a guarantee for payment of interest, a new treaty clearance process will need to be undertaken and a new treaty clearance obtained from HMRC addressed to the guarantor, and the updated DTTP scheme will apply to this. The UK tax status of guarantee payments (and whether they are viewed as a payment of the underlying obligation or a separate payment of a different character) is an area of uncertainty in UK tax law, so it is perhaps surprising to see HMRC take such a definitive position.

The updated terms confirm some points which were unclear from the previous Government response (published on 20 March 2017) to last year’s consultation on the operation of DTTP scheme; and in particular the confirmation that all UK and non-UK borrowers paying UK source interest may access the scheme and the provisional application of treaty exemption while HMRC processes an online passported treaty clearance application are very welcome.

Non-UK borrowers and UK withholding tax on UK source interest

Lenders and borrowers should remember that the DTTP scheme and changes to it are purely an administrative simplification, with no effect on the underlying UK rules on interest withholding tax and whether interest has a “UK source”. UK withholding tax rules apply even to interest paid by non-UK borrowers if the interest has a “UK source”. Whether interest has a UK source is determined applying a multi-factoral test first laid down in the case of Westminster Bank Executor and Trustee Company (Channel Islands) Ltd v National Bank of Greece SA (46 TC 472):

(A) the residence of the debtor

(B) the source of income used by the debtor to pay the interest

(C) the location of the debtor’s assets and/or any security for the debt and the location of any guarantor of the debt

(D) the place of enforcement of the debt (both by reference to the above factors and the choice of jurisdiction and law governing the relevant debt)

(E) the place in which the interest is physically paid (less significant factor).

The Upper Tribunal confirmed in the combined appeal of [Ardmore Construction and Perrin v HMRC_](http://www.elexica.com/en/legal-topics/tax/11-withholding-tax-on-uk-source-interest)_ [2015] UKUT 633 that UK source is judged by reference to a multi-factoral test in which no one factor is individually conclusive. This decision is being appealed, which could potentially cause a change in the UK withholding tax rules (albeit this is not anticipated). In the meantime, non-UK borrowers should certainly not assume that they are not paying UK source interest without also considering whether the other factors could be in point.

The updated Treaty Passport scheme makes clear that treaty relief, treaty clearances and treaty passports all apply to UK source interest paid by non-UK resident borrowers in the same way that they apply to interest paid by UK resident borrowers. One additional requirement for treaty relief in such circumstances is that it is necessary to evidence to HMRC that the borrower has concluded the interest is UK source and would apply UK withholding tax in the absence of a treaty clearance. One common means of providing such evidence is to include a statement to that effect in the relevant loan facility. Alternatively a copy of correspondence between lender and borrower indicating this could be provided, or HMRC will accept evidence that the borrower has already paid interest under deduction of UK withholding tax on the relevant loan. This requirement is intended to limit HMRC’s administrative burden of providing clearances to non-UK borrowers to cases where the clearance is necessary to enable interest to be paid free of UK withholding tax - ie HMRC does not want to have to process protective clearance applications submitted “just in case”. However, this can create practical concerns for lenders and borrowers, as the multi-factoral nature of the “UK source” test means it is often not 100% clear cut whether interest is UK source. Parties who consider interest is likely not to be UK source but wish to mitigate the risk that HMRC proves not to agree with their judgment are not able to apply for treaty clearance even if they are entitled to treaty relief from UK withholding tax in the event the interest is UK source.