Withholding tax

Posted on
Ardmore Construction Ltd v HMRC [2014] UKFTT 453 (TC)

A withholding tax is not, in itself, a discrete category of tax but is rather a term used to describe a tax on a payment that is collected by the payer. A withholding tax arises whenever a person is required both to:

  • Deduct an amount from a payment that it makes to another person representing the payee's tax liability on that payment; and
  • Account for the amount withheld to the relevant taxing authority.

By ensuring that the payer calculates how much tax is due on a payment, and accounts for that tax, a taxing authority may be able to save money and time. Withholding taxes may also offer taxing authorities a cash flow advantage by obliging a payer to withhold monies at source, funnelling them directly into authority's coffers more promptly than might otherwise be the case.

An example of a withholding tax is the UK system for requiring tax to be withheld from payments of interest which obliges UK companies paying interest on loans to deduct 20% tax from that interest. For the withholding obligation to apply, the interest must arise in the UK; that is, the interest must have a "UK source".

Many loan documents will include a "gross-up" obligation requiring a borrower to pay an additional amount to a lender to ensure that the lender receives the same amount as it would have done if no tax had to be withheld by the borrower from the payment.

In a recent tax chamber tribunal case (Ardmore Construction Ltd v HMRC [2014] UKFTT 453 (TC)), it was held that interest arising on unsecured loans made by a Gibraltar trust to a UK resident company, which was paid by a UK resident company from UK trading profits "arose", for withholding tax purposes, in the UK and UK withholding tax rules applied.

The tribunal accepted that HMRC's multi-factorial approach to determining the source of interest was supported by the case law authorities, where courts had weighed a variety of different factors including, e.g:

  • Residence of the debtor,
  • Place of enforcement of the debt against the debtor,
  • Residence of any guarantor,
  • Location of any security,
  • Situs of the debt,
  • Proper law of the contract; and
  • Place of payment of interest.

Applying the multi-factorial approach approach to the facts of this matter, the tribunal concluded that the interest arose in the UK because the payer was resident in the UK and both its assets and the debt were situated in the UK. Further, the UK would be the place of enforcement of the debt and the interest was serviced from profits generated in the UK.

These facts held more weight than the contractual terms included by the parties in the loan agreements which stated that the laws of Gibraltar governed the contract and that the parties agreed to submit to the exclusive jurisdiction of the Gibraltar courts in the event of a dispute. The parties had also agreed to pay interest from a non-UK source.