Trevor L James and Sonia Girgis
Taxation | Europe and Federal Tax
The UK Double Tax Treaty Passport (“DTTP”) scheme has recently been extended by HM Revenue & Customs (“HMRC”) to allow both non-corporate borrowers and lenders to enjoy the benefits of the scheme. The aim of the amendments is to further encourage overseas lending into the UK and to ensure that UK businesses are not unduly restricted by the withholding tax levied on interest payments made to overseas lenders.
What is the purpose of the DTTP scheme?
The UK imposes a 20% withholding tax on interest payments made by a UK borrower to an overseas lender. Lenders are able to avoid such withholding tax through the use of the UK’s wide network of tax treaties, which either reduce or eliminate the withholding tax.
Prior to the introduction of the scheme in 2010, an overseas lender was required to obtain treaty clearance under the relevant tax treaty via the certified claim method. This involved the overseas lender submitting a claim form on a loan-by-loan basis to its local tax authority, which would then certify the lender’s tax residence and submit the form to HMRC – a process that typically took several months. This was problematic for the UK borrower as market practice typically requires a borrower to gross up any payment so that the lender receives the full amount of the interest due, net of any withholding tax deduction, forcing the borrower to gross up any such payments until treaty clearance is provided. Equally, the overseas lender had the administrative burden of regularly filing claim forms with its local tax authority.
The DTTP scheme was introduced to simplify the procedure and largely reduce the waiting time involved for obtaining treaty clearance. Overseas lenders are able to apply for a treaty passport, valid for five years, which attests that the lender is eligible to benefit from the double tax treaty between the lender’s country of tax residence and the UK. Once the lender has obtained such a passport, it is able to provide its passport details to the UK borrower when making a loan. The UK borrower subsequently notifies HMRC, and treaty clearance typically follows within 30 days.
What were the issues with the DTTP scheme?
The DTTP scheme historically only applied to loans entered into between corporates. This was problematic for both UK borrowers and overseas lenders that were not structured as corporates. Certain sectors were particularly affected by such restrictions; particularly those sectors where borrowers are typically structured as partnerships (for example, real estate). This made it more difficult for entities operating within these industries to raise funds from outside of the UK.
Equally, it was onerous for non-corporate overseas lenders (such as pension funds and sovereign wealth funds) to lend to UK borrowers, reducing the pool of entities willing to invest in the UK.
What has changed?
The restriction on the applicability of the DTTP scheme to corporate borrowers has been relaxed to allow any borrower making UK source payments to utilise the scheme. As such, partnerships, unit trusts, pension funds, sovereign wealth funds, charities, universities and individuals all qualify for the DTTP scheme.
Also, the restriction on the applicability of the DTTP scheme to corporate lenders has been relaxed to allow pension funds, sovereign wealth funds and tax transparent entities to obtain treaty passports, so long as all members beneficially entitled to the interest are resident in the same jurisdiction and entitled to the same benefits under the treaty.
Do any restrictions remain in place?
Although the restrictions on the DTTP scheme have largely been relaxed, tax transparent entities whose beneficial owners are resident in different jurisdictions are unable to apply for a passport, even if each relevant double tax treaty reduces the rate of withholding tax to zero. As a result, only funds and partnerships with relatively narrow memberships are eligible to apply for a treaty passport, with larger or more complex tax transparent entities still having to rely on the arduous certified claim method.
When did these changes take effect?
The updated DTTP scheme came into effect on 6 April 2017.
A loan entered into between the time when the scheme was originally introduced in 2010 and 5 April 2017 is subject to the previous restrictive DTTP scheme terms and conditions. If the loan in question is sold or transferred on or after 6 April 2017, the new, relaxed, DTTP rules will apply. However, care must be taken, as a loan entered into prior to 6 April 2017 may not have made allowances in its documentation for the DTTP scheme to apply, especially if the parties were not eligible for a passport at the time that the loan was entered into. This means that, although the new DTTP rules could apply on a transfer, the parties might be at a risk if they agree to use the DTTP scheme but are not governed by appropriate terms within their agreed loan documentation.
The extension of the DTTP scheme is a welcome reform that will result in the UK becoming a more attractive location for inward debt investment. Although there has been further reform with the introduction of the qualifying private placement withholding tax exemption, the UK still slightly lags behind other European jurisdictions that do not impose withholding tax on interest payments, completely eliminating any time lag between submitting the request and obtaining approval from the relevant local tax authority.
If you have any questions on the DTTP scheme or changes to the UK loan market, please contact Trevor James, Sonia Girgis, or Dom Rothbarth of Morrison & Foerster LLP.
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