16 September 2010

UK’s new administrative regime for treaty relief in respect of corporate interest payments

Many cross-border payments of UK-source interest are subject to deduction of tax at source under UK domestic tax laws, although many non-UK recipients of such interest are eligible to have their potential UK tax liabilities removed or reduced under the terms of one of the UK’s numerous double tax treaties.

In principle, it is necessary for a formal application for treaty relief to be made before any UK-source interest can legitimately be paid to a non-UK party without deduction of tax at source by the paying party, and the same general administrative regime applies to both companies and individuals seeking treaty relief for cross-border interest payments. However, in the case of corporate lenders and borrowers the basic administrative system has been subjected to various modifications over time, and some significant changes to this modified system have been introduced with effect from 1 September 2010.

The new aspects of the UK’s administrative system for treaty relief for cross-border corporate loans are summarised briefly below. Please note that these new approaches to tax administration only apply to withholding tax on interest and not to any withholding tax that might be applicable to cross-border payments of UK-source rent, royalties or (in those rare situations in which this is still a live issue in a UK context) dividends.

Please also bear in mind that, although a borrower has the primary administrative responsibility to deduct any UK tax that is properly deductible at source, it is the primary responsibility of the lender to seek any tax relief that may be available under the terms of an applicable double tax treaty. This is because it is the lender that is the taxpayer in respect of interest receivable, even though the borrower may be saddled with most of the accounting and reporting obligations of a taxpayer in a case involving a lender based outside the jurisdiction.

The new ‘passport’ scheme for foreign corporate lenders

It was already possible before September 2010 to obtain a form of provisional treaty relief for UK-source interest payments arising under certain types of cross-border corporate loan. But the aim of the UK’s new passport scheme is to provide a more streamlined form of general pre-clearance for particular parties to lending arrangements, rather than particular loans.

Under the new administrative system (which formally commences as from 1 September 2010 but which has in fact already been operating informally for several months, so as to enable interested parties to seek relevant approval from the UK tax authorities) foreign corporate lenders may seek general advance approval from the UK tax authorities as bodies that are entitled to make applications for future UK-source interest on loans to be paid on a gross basis under the terms of an applicable double tax treaty.

The general idea is that an eligible body should submit to a single advance screening process as a result of which that body obtains a registration number that is included in a publicly available register maintained by the UK tax authorities. Any foreign corporate lender that is able to quote such a registration number to a UK-based corporate borrower is thereby entitled to make a streamlined application for the UK tax authorities to issue a formal direction to an affected borrower, enabling that borrower to make interest payments without deduction of UK tax at source.

Such a registration thus operates as a kind of general ‘passport’ to relevant tax treaty benefits for a defined period that is determined by the UK tax authorities. It seems that the usual period of validity will be five years, which is already the usual length of time for the validity of any formal directions issued by the tax authorities to a borrower in any particular case of treaty-based applications for relief from deduction of tax at source. However, it should be noted that the duration of validity of either a passport or a specific direction to pay gross interest is a matter which wholly lies within the general administrative discretion of the tax authorities; there is no specific legal right to claim the benefit of such facilities for any particular length of time.

Since the new passport regime only provides a streamlined administrative means of accessing the traditional system of obtaining double tax under tax treaties it is still necessary to ensure in any particular case, that a borrower is in fact properly authorised by the tax authorities to dispense with the basic requirement to deduct tax from cross-border interest payments.

This means that, once a particular passported loan has been entered into, both the lender and the borrower must submit prescribed application forms to the UK tax authorities within specified time limits, so as to notify the authorities that a particular cross-border loan has been entered into under the terms of the lender’s passport. Formal approval of gross payment of interest is then granted (or, as the case may be, refused) in relation to each particular loan that has been notified to the tax authorities under the passport scheme.

Various conditions attach to the issue of a registration number under this new regime and various sanctions are available to the tax authorities in respect of non-compliance with relevant conditions. The ultimate sanction is expulsion of a foreign lender from the scheme, which would mean that an affected party then had to make wholly separate formal applications for tax relief under any applicable tax treaties in relation to any future interest payments due from UK-based borrowers. 

The new administrative system is entirely optional and it still remains open to foreign corporate lenders from September 2010 onwards to seek specific approval of particular loans under the formal tax treaty mechanisms, either generally (i.e. without seeking any clearance at all under the new passport regime) or in relation to particular loans (i.e. after the lender has successfully obtained a passport but has decided, for some reason, not make use of that passport in a particular case, such as in relation to a loan which the lender had been advised to discuss with the tax authorities in views of doubts about its fundamental eligibility for treaty relief).

Nothing in the new regime removes or reduces the desirability of ensuring, from a lender’s perspective, that a loan agreement contains comprehensive contractual protection against the possibility of deduction of tax by or on behalf of a borrower. Therefore, a general grossing-up clause should still always be included in any loan agreement that is drafted on behalf of a foreign corporate lender, whether or not passport eligibility is in issue. However, a borrower might wish to consider inserting a contractual requirement to the effect that a lender must use all reasonable endeavours to obtain and utilise a registration number under the new passport scheme, if there is any material risk that the failure to do so would increase the borrower’s total exposure to the lender under the loan.

Syndicated corporate loans

A form of provisional treaty relief was originally introduced into UK tax administration in 1999 but that scheme has now been amended so as to take account of the introduction of the new passport scheme with effect from 1 September 2010.

The earlier form of provisional relief applied (although in different ways) to both syndicated corporate loans and one-to-one corporate loans but the latter element of the original scheme is now considered unnecessary in view of the introduction of the new passport scheme. Therefore, no new applications for provisional treaty relief for interest payments arising from one-to-one loans may be made after 31 August 2010.

The remainder of the original provisional relief scheme is now rebranded as ‘the syndicated loan scheme’. Broadly speaking, this enables complex multi-party and/or multi-jurisdictional lending arrangements to be made subject to a single application for treaty relief on behalf of the all eligible foreign lenders participating in the lending arrangements, with that single application for tax relief being channelled through an appropriate body that undertakes to act as syndicate manager for this purpose.

Changes in the membership of a syndicate will not necessarily need to be reported to the tax authorities on an individual basis, provided that the overall UK tax profile of a syndicate is not altered as a result (for example, no specific reporting of syndicate changes would usually be required if one lender that was eligible for a 10% rate of tax under a double tax treaty was replaced by another lender that was also eligible for such a 10% treaty rate). 

Foreign lenders are eligible in principle for inclusion in the SLS regime if, from a UK perspective, they have the character of companies. In this respect, one of the key characteristics of a lender is a lack of tax-transparency, so that participation in the SLS regime will not generally be available to lenders that are partnerships nor will participation be open to certain other types of legal body (such as US LLCs) that are regarded by the UK tax authorities as transparent for tax purposes.

However, this does not necessarily mean that a loan involving partnerships or other tax-transparent bodies will be incapable of being covered by the SLS regime. This is because it will still be possible under certain conditions (for example, where no more than 20% of total indebtedness is held by ineligible bodies) for a syndicate manager to seek permission to pay interest without deduction of tax in respect of any lenders that are companies based in suitable treaty-protected foreign jurisdictions. One of the syndicate manager’s responsibilities will be to identify different taxable categories of lender, so that the tax authorities are able to authorise payments on a ‘block’ basis to sub-groups of syndicated lenders who are entitled either to full exemption from UK tax or reduced treaty rates of taxation.    

There are various conditions which must be satisfied before a particular loan will be considered eligible, such as the requirements for the loan to be on fully commercial terms and for the lenders to be unrelated to the borrower.

The UK tax authorities must also be satisfied that the proposed syndicate manager (which could potentially be the borrower) is a suitable person to co-ordinate applications for tax relief on behalf of a number of foreign parties. Both the membership of a syndicate and the syndicate manager’s administrative practices are liable to periodic scrutiny by the UK tax authorities, in order to ensure that the SLS regime is being implemented properly by the parties involved in relevant syndicated loans.

The tax authorities expect syndicate members to demonstrate a serious long-term commitment to the SLS regime and the SLS facility will not be made available in any particular case if it appears to the authorities that there is a lack of such commitment for the full anticipated life of a syndicated loan. 

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