UK source of interest

In Ardmore Construction and Andrew Perrin v HMRC [2015] UKUT 633 (dual appeal), the Upper Tribunal (UT) dismissed the taxpayers appeals and confirmed that they had received UK source dividends on which UK income tax was deductible at source.

Background

Ardmore Construction Ltd (Ardmore) and Andrew Perrin (Mr Perrin) (together the Appellants) each appealed against separate decisions of the First-tier Tribunal (FTT) ([2014] UKFTT 453 (TC) and [2014] UKFTT 223 (TC)) that interest paid on loans arose in the UK and they were liable for tax that should have been deducted by the payer of the interest under section 874 Income Tax Act 2007 (ITA).

Mr Perrin was resident and domiciled in the UK. He was the managing director of a UK company which made contributions to a retirement benefits scheme via two trusts. One of the trusts made loans to Mr Perrin, payment of which was made from the trust's Isle of Man bank account to Mr Perrin's Isle of Man bank account. The underlying loan agreement was governed by Isle of Man law. Mr Perrin made two interest payments from funds in his Isle of Man account.

The FTT determined that Mr Perrin's obligations to pay would have been enforced or would have substantially originated from the UK. It found that the factors of Mr Perrin's residence in the UK and the source of funds for payment or enforcement in the UK outweighed that of the Isle of Man's jurisdiction and actual payments there, and therefore the interest payments arose in the UK for the purposes of section 874 ITA.

In the case of Ardmore, a UK company, two Gibraltar trusts lent funds to it pursuant to facility agreements. Ardmore also entered into loan agreements with companies registered in the British Virgin Islands which were owned by the trusts. Interest payments were made from Ardmore's bank account in the UK, funded by income from Ardmore's UK trading activities. In determining the source of the interest, the FTT referred to Ardmore's residence in the UK and found that the UK, as well as being the source or origin of the funds for payment, was the place of enforcement of the debt.

Relying on National Bank of Greece SA v Westminster Bank Executor & Trustee Co (Channel Islands) [1971] AC 945, the Appellants submitted that the source of the interest should properly be found by ascertaining the "nationality" or "residence" of the relevant loan instrument, or the place where the credit was provided, and the FTT had erred in applying a multi-factorial test.

Alternatively, if the multi-factorial test was the proper test, the FTT erred by affording too much weight to the Appellant's residence.

The UT's decision

The Appellants' appeals were dismissed by the UT.

The Appellants' relied upon three principal grounds of appeal, each of which were in the alternative.

Firstly, that the source of interest should be found by ascertaining the "nationality" of the loan instrument.

Secondly, the residence of the debtor is not a material factor in determining situs (ie the multi-factorial test).

Thirdly, that the place where credit is provided is the source of the interest.

In the view of the UT, the interest arose in the UK.

The UT gave weight to the residence of the payer and the source of the funds that the payer used to make the payments. Ardmore was repaying its loan using money derived from UK trading activities and Mr Perrin was not able to demonstrate that he could repay his loan from non-UK sources.

The place where the loan was provided and the residence of the lender were not relevant. The UT agreed with HMRC that the question of whether the interest had a UK source was not the same as whether the loan had a UK legal situs.

The UT considered that the FTT was right to have placed such significance on the residence of the debtor and the source of the payments. The National Bank of Greece case applied so that the source of the obligation to pay interest was pertinent and had to be determined by reference to all the relevant factors. The UT said that it was not possible to list an exhaustive set of relevant factors, since this would depend on the facts of each case. However, the residence of the debtor was material.

The UT therefore concluded that a multi-factorial test applied to determine whether interest arose in the UK for the purposes of UK withholding tax on interest. The UT's decision accords with HMRC's Savings and Investments Manual guidance that a number of factors must be considered, with the residence of the debtor being material. It is pertinent that section 874(6A) ITA now expressly provides that, with effect on and from 17 July 2013, the legal situs of a debt is irrelevant in determining whether interest arises in the UK.

Comment

This case is a reminder that it is important to determine whether payments of interest are from a “UK source” or “arise in the UK”, as such interest is subject to withholding tax unless specific exemptions apply, or the withholding obligation can be removed by a double tax treaty or the EU Interest & Royalties Directive.

It is also of importance to individuals who are resident but not domiciled in the UK who seek to rely on the remittance basis of taxation in respect of non-UK source income and gains.

In practice considerable reliance is placed on HMRC’s published guidance (SAIM9090) which states that whether or not interest has a UK source depends on all the facts and on exactly how the transactions are carried out. Some relevant factors include:

1.         the residence of the debtor and the location of his assets;

2.         the place of performance of the contract and the method of payment;

3.         the competent jurisdiction for legal action and the proper law of contract; and

4.         the residence of any guarantor and the location of any security for the debt.

In light of the above, it will be difficult to avoid the conclusion that interest paid by a UK resident is UK source if that interest, or the repayments of principal, are made (or will very likely be made) out of UK income and assets.