Income tax deduction from interest paid overseas

The First Tier Tribunal (FTT) has ruled again that a UK borrower had to deduct income tax from interest paid to a non-resident lender because thesource of interest was in the UK. The case of Ardmore Construction Ltd addressed the same issue, where interest arises, as the earlier case of Perrin and came to a similar conclusion but by a different route. It is clear from these cases that where a debt is owed by a UK-resident person (company or individual) to a non-resident HMRC will press for income tax to be deducted from the interest.

The case also demonstrated the limitations on HMRC’s power to refer to unreported past decisions.

Location of a debt / place where interest arises

Ardmore is a trading company owned by two UK resident individuals. It subscribed for “A” shares in each of two companies incorporated in the British Virgin Islands. Trusts resident in Gibraltar owned the ordinary shares of each company. Each BVI company lent the subscription proceeds to their shareholder trust and each of the two Gibraltar trusts made loans to Ardmore.

The reasoning in Ardmore is similar to that in Perrin. The source of interest cannot be shifted from the UK by paperwork – such as having the loan agreement signed offshore and the place of payment offshore. All aspects need to be considered before paying interest gross to a non-UK resident lender. Ardmore is a company and Mr. Perrin an individual but that made no difference to the decision because the same legislation applies.

Ardmore paid the interest to the trusts gross, asserting that the interest arose where the loan was provided, Gibraltar. The FTT rejected this narrow approach to determination of the place interest arose. Unlike Perrin where the Tribunal had a tick box approach listing each factor, in Ardmore the FTT took a narrative, “multi-factorial” approach, saying that source is determined by reference to “a variety of, albeit different, factors including, e.g.

  • the residence of the debtor,
  • the place of enforcement of the debt against the debtor,
  • the residence of any guarantor,
  • the location of any security,
  • the situs of the debt,
  • the proper law of the contract, and
  • the place of payment of the interest.” (para 41 of the decision)

The FTT decision goes on to state:

“Applying such a multi-factorial approach to the facts of this case, in particular given that Ardmore was resident for all purposes in the United Kingdom, the situs of the debt, although not a determinative factor, is also located where Ardmore is resident. The United Kingdom, in addition to being the source or origin of the funds for payment, would be the place of enforcement of the debt. We therefore conclude that the interest arose in the United Kingdom.” (para 42)

Ardmore had to pay the tax it should have deducted from payment of the interest (there is no DTA with Gibraltar).

Ardmore judge rejected Perrin because it was partly based on an unreported decision

In Ardmore the FTT judge ruled that the judge in Perrin had been wrong to rely “at least to some extent” on an unreported decision of the Special Commissioners (SPC), the predecessors of the FTT whose decisions were not automatically reported until the 1990s. The Tribunal in Ardmore had to consider afresh the place interest arises because it regarded the Perrin decision as unreliable due to reliance on an inadmissible precedent. Neither SPC nor FTT decisions set binding precedents but they are usually seen as highly persuasive and so are likely to be followed.

Ardmore shows that whilst HMRC may base policy on unreported Special Commissioners’ decisions they cannot rely on them in Court.