Upper Tribunal find for HMRC in Hargreaves Property WHT case
HMRC win emphasises importance of commercial reality in assessing UK withholding tax obligations
Commercial reality matters for UK WHT
The Upper Tribunal’s (UT) recently published judgment in Hargreaves Property Holdings Limited v HMRC comprehensively rejects the taxpayer’s appeal against the First-tier Tribunal’s (FTT) conclusion that UK income tax should have been deducted from interest payments on debt financing provided to the group. Although not surprising, the judgment serves as a timely reminder of how to interpret various aspects of the UK’s withholding tax (WHT) rules and of the dangers of an overly mechanistic approach to these. It will therefore be important reading for all involved in considering the potential for UK WHT to apply to interest payable on funding ultimately used in the UK.
The case concerns a UK property investment group which had for many years partly financed its activities using interest-bearing loans from various related overseas lenders. During the relevant period the key loan agreements provided for these to be repayable on 30 days’ notice by either party, for payments to be made in Gibraltar from a source outside the UK, for there to be no security over UK assets and for the agreements to be governed by Gibraltar law under the exclusive jurisdiction of the Gibraltar courts.
The loans would periodically be refinanced, in some cases less than a year after being drawn down. Prior to being repaid the loans would be assigned by the lenders to a third party in Guernsey and in some cases that third party would further assign the right to accrued interest to a UK company. The repayments were then funded by fresh loans from the original lenders.
Unless benefitting from an exemption under UK domestic law or a relevant double tax treaty (DTT), companies are generally required to deduct UK WHT on payments ‘of yearly interest arising in the UK’. As it had before the FTT, the taxpayer company argued that no obligation arose here because:
- The interest should not be regarded as ‘arising in the UK’;
- The interest on the loans refinanced in less than a year was not ‘yearly’;
- The payment of the accrued interest assigned to the UK company benefitted from a domestic law exemption for income to which a UK resident company was ‘beneficially entitled’; and
- The payment of the remaining interest benefitted from an exemption under the UK-Jersey DTT.
The UT’s detailed rejection of these arguments (for essentially the same reasons as the FTT) warrants reading in full, but some key points emerging from the judgment include:
- In line with the Court of Appeal’s decision in Ardmore Construction v HMRC  EWCA Civ 1438, the test of whether the interest had a UK source was a fact-sensitive multifactorial one that looked at the commercial reality from the perspective of a practical person. In doing this, the FTT had been entitled to give more weight to the fact that the debtor was a UK resident which would fund the interest payments out of UK assets and activities (and any enforcement would necessarily need to be against these) than to the facts that payments were made outside the UK and the loans were governed (and if necessary enforced) under non-UK law;
- Determining whether interest was ‘yearly’ required a “business-like approach to the question of each loan’s permanence and investment nature”. That entailed taking account of the pattern of repayments and advances involving the same lenders, which meant that despite the short duration of individual loans, the commercial substance was that these were made to provide long-term funding and had the nature of investment – causing the interest to be correctly classified as ‘yearly’;
- The concept of ‘beneficial entitlement’ should be understood purposively, taking account of its statutory context. That meant that an exemption was only available for UK companies substantively entitled to receive and enjoy the income (which was not the scenario here), rather than simply where there was a beneficial entitlement in the narrower technical sense used to distinguish between legal and equitable interests in English common law; and
- The Tribunal agreed with HMRC that, regardless of whether the facts here fell within the relevant provisions of the treaty, the WHT obligation would only be disapplied if relief was formally claimed and directions issued by HMRC. This reminder of the need to follow proper procedure is particularly timely, given HMRC’s recent change to their guidance confirming that in light of Brexit they will now pursue late payment interest in all cases where the relevant paperwork is filed after interest payments have been made gross.
In summary, the judgment should act as a prompt to ensure that the exposure to UK WHT on any funding arrangements has been assessed with a proper regard to the underlying commercial reality and that treaty clearances and other compliance obligations have been dealt with in a timely fashion.
It is not yet known whether there will be a further appeal.