The recent First-Tier Tax Tribunal case of Hargreaves Property Holdings Limited v. HMRC [2021] provides a useful update, in light of other developments in this space, on the UK courts’ approach to various fundamental interest withholding tax issues. These include:

  • the source principle
  • the meaning of “yearly” interest
  • the twin procedural requirements to make a claim for treaty relief and receive a gross-payment direction
  • the exception for interest to which a UK resident company is beneficially entitled

The planning in Hargreaves, implemented in various forms over a decade until 2015, sought to remove interest on a UK-tax resident property investment group’s financings from the scope of UK withholding tax (while retaining corporation tax deductibility). The main elements of the refinancing involved:

  • removing the UK nexus from various contractual terms of the loans (place of payment, governing law and jurisdiction of enforcement). The intention here was to ensure that the interest was not UK-source; and
  • implementation of a (roughly annual) cycle of interest-stripping and loan-rolling under which coupon-payment rights were assigned for consideration to a Guernsey company (and, from 2012, to a UK resident company) shortly before pay date and, shortly afterwards, the loan was repaid out of the proceeds of a replacement loan. The intention here was to ensure that the interest was not yearly interest and – alternatively – that the recipients were entitled to gross payment by virtue of the Guernsey treaty and the UK corporate-to-corporate exception.

The outcome in relation to UK-source and yearly interest was surely unsurprising. On the former, the Court of Appeal judgment in Ardmore Construction [2018] had largely overtaken this planning. Applying the multi-factorial source test, and following the “underlying commercial reality”, the UK residence of the borrower and its (property investment) assets outweighed the other factors and the interest clearly arose from sources in the UK.

On the latter, although in most cases the duration of the loans was under a year, the interest was nonetheless found to be “yearly” as it formed part of a long-term financing. Here the FTT took pains to emphasise that this didn’t involve a recharacterization of the legal reality of the loans’ actual terms or, in findings which may be of comfort to taxpayers reliant on short-interest financings, call into question the “paramount importance” of the one-year threshold itself.

Touching on the (sometimes vexed) question of whose liability is the tax to be withheld, the FTT observes that, under the UK statutory scheme, the borrower has the obligation to withhold and account – and thus concludes that the WHT liability is the borrower’s. The contrary view expressed in Ardmore is described as an over-statement. This appears to be the basis for an unconventional finding that it was the borrower (rather than, as is typically assumed based on HMRC guidance and practice, the lender) who needed to claim treaty relief. In any event, what is beyond doubt is that an actual claim was required (and, in the event, wasn’t made) while the FTT also re-asserts the received wisdom that the borrower obtaining a direction from HMRC is a pre-requisite to the ability to pay gross interest (dismissing a suggestion by taxpayer counsel that the regime is effectively voluntary).

Another potentially significant point concerns the beneficial entitlement requirement in the UK corporate interest WHT exception. This is especially interesting following the 2019 “Danish cases” and increased focus on the interaction between beneficial ownership (and cognate concepts) and anti-avoidance regimes. The FTT first reasserts the conventional position that for domestic purposes a recipient of income will be beneficially entitled unless it is receiving it as a fiduciary (e.g., a nominee or trustee).

This remains the case even if the recipient has a contractual obligation to pay on the income to some other person; there is generally no need to interrogate the nature or significance of any such obligation (unlike under the OECD approach to the international fiscal meaning of beneficial ownership).

The absence of any business purpose for the assignment in Hargreaves then invited a purposive recharacterization on Ramsay [1982] grounds: the FTT found that the interest-assignee UK corporate was beneficially entitled to the interest only to the (de minimis) extent that the interest exceeded the consideration paid for the assignment. In UK terms, therefore, this presents a rare instance of circumstances where a non-fiduciary may lose beneficial entitlement – and a potentially even rarer instance of a participant in Ramsay arrangements nonetheless retaining some (residual) entitlement to a tax benefit from the arrangements.

Although not of precedent value, the finding on beneficial entitlement could at first blush be read as problematic for some common financing arrangements (sub-participations, for instance). But much more likely is that the fairly extreme fact pattern – connected parties, negligible risk/reward for the assignee, broader planning attempts, and some evidentiary failures – means this aspect of the case should be viewed in isolation without any read-across to genuinely commercial structures. Hargreaves arguably muddies some already muddy waters but doesn’t indicate that the UK is adopting the more aggressive position regarding availability of withholding tax exemptions taken in certain other jurisdictions.