The UK is generally thought to be a suitable jurisdiction in which to locate the holding or sub-holding company of an international group or sub-group in view of its reasonably generous and wide-ranging participation exemption in respect of inbound dividends, and its substantial shareholding exemption in respect of capital gains arising on share disposals. Additionally, the UK is one of the few jurisdictions in Europe which do not apply withholding taxes to dividends paid to non-residents whether such non-residents are corporates or individuals and whether or not the dividend recipients are resident in an onshore or offshore jurisdiction

However, under UK domestic law, a company may have a duty to withhold tax (WHT) in relation to the payment of interest.

Under Section 874 (1) (d) and Section 874 (2) of the Income Tax Act (‘ITA’) 2007 where ‘a payment of yearly interest’ that arises in the UK is made by any person to another person ‘whose usual place of abode’ is outside the UK, then the person by, or through whom, the payment is made must, on making the payment, deduct from it a sum equal to the basic rate of income tax in force for the year in which it is made. The current basic tax rate is 20%.

However, there are several exceptions to this general rule.
If none of them apply, a payment of interest must be made after the deduction of the applicable WHT until HMRC has given authorisation that the payment can be made gross, because of the applicability of treaty relief for the recipient.

The main exclusions are:

• Payments of interest by UK resident companies if the recipient of the interest is also a UK resident company, or a UK permanent establishment, provided the interest concerned will be taxed in the United Kingdom as part of the UK entity’s trading profits.
• Payments of interest on a quoted Eurobond.
• Payments of interest that qualify for exemption under the EU Interest and Royalties Directive.
• Payments of interest paid to or by a UK bank.
• Payments of ‘short’ interest, which is interest on loans that will not be outstanding for more than a year (i.e. parties had the intention that the relevant loan was to subsist for a period of less than one year)

Potential Solutions to reduce WHT

With careful planning it is often possible to overcome the basic UK domestic law position. Firstly, it is important to note that the obligation to deduct income tax only arises either where interest is paid or is treated as paid. It follows that there is no general obligation to deduct tax in respect of interest that has accrued but which has not actually been paid.
Below I examine two further solutions to the withholding tax issue.

Impact of Double Tax Treaty

Double Tax Treaty (DTT) is an agreement between two countries to prevent international double taxation. The UK has a double tax treaty with many countries (over 110 in total) to try to make sure that individuals and companies do not pay tax twice on the same income.
The DTT between the UK and Israel allows UK resident companies to withhold tax at 5% for interest payments for loans from banks and financial institutions and 10% in any other instances for interest payments to Israeli Resident companies and individuals.
It is important to note that HMRC do not regard the provisions of interest articles in the UK’s double taxation agreements as being applicable automatically. Each lender will be required to complete “Form DT Individual” which then needs to signed by their Tax office who sends it back to HMRC who will then issue a permission to UK company to pay interest at the reduced withholding tax rate. Each quarter the UK company needs to pay over to HMRC the withheld tax accompanied by “Form CT61”.

Follow this link to a concise table with the rates of WHT applicable to the most common payments of interest under UK domestic law where such a liability arises and the reduced rates that may be available under an applicable DTT.

Zero Coupon Bond

Another solution is structuring a loan in the form of a deeply discounted bond. In this case the borrower issues the debt in the form of a zero-coupon bond promising to repay the full amount of the loan. However, the amount advanced by the lender to the borrower is considerably less than the face value of the loan debt (the discount). Because no interest is being charged, no withholding tax can be applied although economically the return ultimately received by the investor is the same as if he had received interest.

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