On 27th March HMRC released a consultation document entitled ‘Possible changes to Income Tax rules on interest’. This drearily-named paper proposes a series of anti-avoidance measures aimed at removing exemptions for withholding tax at source on interest payments. Whilst this may all seem rather insignificant, together they amount to a minor assault on common methods of company financing.
The three main proposals are:
- Quoted Eurobond exemption
- Funding bonds
- Yearly interest
Quoted Eurobond exemption
Eurobonds, not to be confused with the proposed Euro-area government bonds of the same name, are international bonds denominated in currencies other than that of their country of issue. In 1984 an exemption was introduced in the UK for quoted Eurobonds, allowing their interest to be paid gross. This was in response to similar exemptions in tax havens, and discouraged offshore tax avoidance whilst promoting the growth of the UK Eurobond market. However, in recent years groups have issued Eurobonds in territories such as the Channel Islands and Cayman Islands for intra-group financing to take advantage of this exemption. Despite being quoted these bonds are not actually traded, and “enable companies to make gross payments of interest out of the UK to fellow group companies, where otherwise deduction of tax would be required.”
HMRC wish to halt this avoidance of tax on the interest on inter-company debt, and therefore propose to remove the exemption “where the Eurobond is issued to a fellow group company, and listed on a stock exchange on which there is no substantial or regular trading in the Eurobond.” This shouldn’t affect third party financing arrangements, but groups using Eurobonds as part of their intra-group financing may find their existing arrangements will be hit as no mention is made of grandfathering.
Funding bonds are those where interest payments are made in kind, rather than cash. These payments may take the form of shares or loan notes, and are often used when a company has insufficient liquidity to pay in cash. Currently HMRC is obliged to accept such payments in kind when they collect 20% withholding tax on interest payments. The consultation document proposes that companies will have to pay the withholding tax to HMRC in cash. Whilst this will make HMRC’s job easier it could put undue strain on struggling companies, and may have knock-on effects in private equity where such bonds are sometimes used to take advantage of late interest rules.
Loans which pay ‘short’ rather than ‘yearly’ interest do not suffer withholding tax on interest; these are typically loans which are under one year in duration. HMRC considers this “somewhat archaic” and wishes to strike the term ‘yearly interest’ from the statutes, thereby disregarding loan duration. Whilst this may seem to them to be a reasonable simplification of the tax code, as Allen & Overy point out HMRC appear to have failed to consider the effect this would have on the colossal commercial paper market. It could also have a significant impact on private equity where short term bridging loans are common.
- For tax on interest to be withheld, the debt must have “arisen in the UK”. Some have argued that if the physical evidence for the debt resides offshore, then it cannot be said to have arisen in the UK. HMRC dispute this, and wish to have their interpretation written into law.
- HMRC are proposing that the interest element of compensation payments be subject to withholding tax in cases where this is currently disputed.
- The extending of ‘disguised interest’ anti-avoidance measures to cover individuals in addition to companies.
These proposals will likely have an adverse impact on corporate financing, especially private equity. However, the consultation is open until 22nd June so if you feel your company would be affected by the changes there is still time to make your voice heard.