When a company takes out a loan it is important that they are clear on who the lender is to avoid any tax traps further down the line when making interest payments.
The default position for any payments of interest by a company is to deduct 20% withholding tax from the payment. There are some exemptions to this including:
- Interest paid to another UK resident company or UK bank.
- Interest paid on a short-term loan (typically a loan with a repayment term of less than 12 months).
- Interest paid on a quoted Eurobond.
Most other payments of interest will be subject to withholding tax.
Trap 1 - overseas lenders
One common trap is that a company may borrow from what initially appears to be a UK lender. However, on closer inspection it becomes clear that the loan may have actually been syndicated to a number of overseas lenders. In this case, withholding tax must be deducted on the interest payments unless treaty relief can be obtained.
Where the UK has a double tax treaty with the lenders respective jurisdiction, it may be possible to reduce the withholding tax rate down from 20% to, often nil. However, this relief is not automatic and the borrower will need to file certain forms before making any interest payments.
This process can be cumbersome but can be simplified where the overseas lender has applied to HMRC for a double tax treaty passport. In this case, the borrower will simply need to file a form (DTTP2) with HMRC 30 days before making any interest payments on the loan, rather than having to wait to receive agreement from HMRC. Where there are multiple lenders, the borrowing company will need to file one form for each lender.
Trap 2 - loans from individuals
Another trap to be aware of is where an individual has made a loan to a company. In such cases, the UK corporate must again deduct 20% withholding tax on any payments, regardless of whether the individual is UK resident or not. Again, where the payment is made to a non-UK resident it may be possible for the withholding tax rate to be reduced under a relevant double tax treaty.
The recipient will normally be able to claim relief for any tax withheld against their UK or overseas tax liability.
Trap 3 – what constitutes payment of interest?
A final trap is that the interest does not necessarily need to be physically paid in cash for the withholding tax rules to apply. A book entry will constitute payment providing the company has sufficient funds to pay the interest and the lender can draw on those funds as they wish (for example by crediting an inter-company loan account).
Interest is also treated as paid where funding bonds are issued. This includes the issue of shares or securities, a common example of which is ‘payment in kind’ (PIK) loan notes. These are often used to settle interest payments where the company has insufficient cash funds to do so.
Compliance obligations
The company will need to file a quarterly form, known as a CT61, with HMRC reporting and paying any tax withheld on interest payments. This form should also be used to report any withholding tax suffered on receipts. A net payment will then need to be made to HMRC for that quarter, or alternatively a refund can be requested if the tax suffered exceeds the tax withheld in that period.