Restructured loans did not circumvent withholding tax obligations

The taxpayer company, Hargreaves Property Holding Limited, had borrowed money from a range of lenders to fund its property investments in the UK. Hargreaves and its lenders adjusted their loan arrangements with a view to ensuring that, when the company paid interest on the loans, no UK tax needed to be deducted from the payment.

The structure involved assigning the rights to receive the interest and principal from the existing lender to a Guernsey entity a few days before interest was payable. Interest was then paid to the Guernsey entity and principal also repaid to that entity. The original lender then used the proceeds of the assignment to the Guernsey entity to provide a new loan to Hargreaves. Later, there was a further restructuring of the loans, so that after the initial assignment to the Guernsey entity, the loans were assigned again to a UK tax resident entity called Houmet.

HM Revenue and Customs (HMRC) was unconvinced and pursued Hargreaves for the income tax that it should have withheld from the payments of interest. The Tribunal considered four questions that covered both international and domestic aspects, including:

• the meaning of beneficial entitlement under the relevant provision;
• the application of a double tax treaty;
• the meaning of yearly interest; and
• whether there was a UK source.

Both the first-tier tribunal (FTT) and upper tribunal (UT) agreed with HMRC on all four issues.

For the interest payments that were made to Houmet, the taxpayer argued that no UK withholding tax was due because they could rely on the “UK to UK” exemption in section 933 of the 2007 Income Tax Act (ITA). This was on the basis that Houmet was a UK-resident entity and was beneficially entitled to the interest payment. However, the FTT and UT found that Houmet was not beneficially entitled to the interest because it was contractually obliged to pay the vast majority of the sum back to the Guernsey entity under the assignment. The introduction of Houmet had no business purpose and could therefore be disregarded as an artificial step.

The UT has concluded on the meaning of “beneficially entitled” in the context of the s 933 exemption. The UT rejected adopting the meaning of “beneficial ownership” in a general legal sense. In accordance with the established approach to statutory interpretation it was necessary to look at the context and statutory purpose of section 933. Applying a purposive approach, the UT considered that purpose is derived by looking at the exception and the rule to which it provides an exception. Where a UK recipient receives and retains the income then HMRC can pursue them for any tax due, such that the withholding is not needed. The UT, however, considered that when the interest received by a UK company is then paid to an entity outside the UK, this is clearly excluded from section 933.

The UT also concluded that section 933 is a provision where the courts are permitted to look at the composite effect of transactions. Whilst there are tax provisions where the use to which the payment was put and its lack of business purpose did not matter, the tribunal found that section 933 was not one of those.

Hargreaves had also sought to rely on the provisions of the double tax treaty between the UK and Guernsey, specifically that the interest fell within the business profits article of the treaty. It was assumed that the interest income was entitled to the benefit of the business profits article in the UK/Guernsey treaty. HMRC instead relied on procedural arguments to challenge any relief. Whilst accepting the assumption for the purpose of the hearing, HMRC made no concession that the assumption on the application of the article was correct. This question therefore potentially remains open for another dispute.

The UT agreed with the FTT that the procedural requirements of making a claim to apply the treaty and needing a direction to be able to pay gross were necessary for Hargreaves to be able to rely on the assumed exemption. Since neither of those things had happened, Hargreaves could not rely on the treaty.

On the UK withholding regime, the question arose of whether the interest was “yearly interest”. Hargreaves had argued that where the loans were repaid within 12 months each should be viewed individually and the payments were of “short” interest and therefore not subject to the obligation to withhold. Applying established principles from the 2019 Supreme Court ruling against the joint administrators of Lehman Brothers International, the tribunal concluded that the provision of finance to Hargreaves was a long-term capital investment and that, while it was theoretically possible for a lender to decide not to provide a new loan, this never happened in practice. It is necessary to consider the question from a business-like perspective, not looking at each individual loan in isolation.

The tribunal also considered whether the interest had a UK source. Hargreaves argued that it did not and therefore the obligation to withhold did not apply. The UT found that the FTT had correctly applied the law to the facts in concluding that the interest had a UK source. That decision provides a further illustration of applying the principles laid down by the Court of Appeal in its 2018 decision in a case involving Ardmore Construction as to the question of whether a payment has a UK source. It is a multi-factorial evaluation looking at the underlying commercial reality, which involves considering factors such as where the interest was derived from, where the available assets to meet the liabilities to the lender were, and where enforcement in default would be.