Inland Revenue 40
17 March 1998
______________________________________________________________
DOUBLE TAXATION RELIEF: ANTI-AVOIDANCE
The Chancellor has today announced action to prevent banks and
financial traders obtaining excessive double taxation relief
against United Kingdom tax for foreign tax payments.
The proposals extend the existing rules governing relief for
foreign tax in respect of interest income to cover certain
dividend income and, in specific circumstances, such income
and related expenditure of their associates. The changes will
also reflect developments in the way money is raised by
financial traders and their associates to fund their
activities.
The measures will apply immediately to payments in respect of
arrangements entered into on or after Budget day but will only
apply to payments in respect of pre-Budget day arrangements
from 1 January 1999.
DETAILS
1. The present rules expressly prevent banks and other
financial traders from getting excessive relief for foreign
tax in respect of interest received from abroad, but attempts
have been made to avoid these rules by arranging: for the
return from lending money to overseas borrowers to be in the
form of dividends and in circumstances which give rise to an
entitlement to claim relief for "underlying tax" (i.e., the
overseas tax paid by the payer of the dividend or one of its
subsidiaries); or for the income to be received, or the
related costs to be borne, by an associate.
2. To counter this, the scope of the current law will be
extended to include, in addition to interest, such dividends
received in the course of a trade. It will also apply to the
foreign interest and dividend income of associates of
financial traders where arrangements have been made to avoid
the restriction that would have applied had the income been
received by the trader and to any related costs borne by an
associate, whether the income is received by the trader or by
the associate. The amendments will take account of new ways in
which financial traders and their associates fund their
activities. To assist them and their advisers in establishing
whether and how the new measures will affect them, a draft of
the Finance Bill clauses has also been issued. [A copy is
annexed to this press release.]
3. In a separate Budget day announcement the Government has
indicated its intention to review the double taxation relief
system for companies with a view to possible changes in a
subsequent Finance Act. Although that review may in due
course lead to more extensive changes to the rules for
obtaining relief for foreign tax, the Chancellor considers it
right to act now to counter these particular avoidance
schemes.
NOTES FOR EDITORS
1. Double taxation arises when income is taxed both by the
taxpayer's country of residence and the country in which the
income arises. The United Kingdom approach to relieving double
taxation is to tax the foreign income of a United Kingdom
resident but to deduct the foreign tax paid on the item of
income from the corresponding United Kingdom tax. This is
known as double taxation relief (DTR) and the aim is to give
relief only against the actual United Kingdom tax payable on
the income.
2. A bank or similar financial institution is taxed in the
United Kingdom by reference to the net profit it makes on its
trading activities. In particular, it may set off interest
payable on funds acquired to make an advance against the
income from that advance. So, if foreign tax is paid on the
gross interest received, that may well exceed the United
Kingdom tax payable on the net profit made by the bank from a
loan. Special rules put it beyond doubt that relief for
foreign tax paid on interest does not extend beyond the United
Kingdom tax payable on the bank's net profit from the overseas
transaction to reduce the tax payable on its other profits,
including profits earned in the United Kingdom.
3. These rules are at section 798 Income and Corporation
Taxes Act 1988. They expressly limit the DTR available to a
bank or other financial institution to the United Kingdom tax
attributable to the net profit from any overseas loan which
forms part of its trading activities, but do not explicitly
restrict the DTR available in respect of income other than
interest. This has led to some financial institutions seeking
to get round the rules, for example, by making what are, in
economic substance, loans in a form which does not give rise
to interest - such as redeemable preference shares - and
arranging matters so that, in addition to the DTR in respect
of foreign tax payable directly on the dividends, a claim may
be made for relief of "underlying tax". Given the relatively
low rate of United Kingdom corporation tax, in some
circumstances, the combination of these two types of relief
might result in no United Kingdom tax being payable on
overseas dividends received by United Kingdom banks. Since the
effect of the ordinary DTR rules in these types of situation
has been disputed, section 798 will be amended to provide a
clear set of rules for a wider range of income of these
financial institutions.
4. Since section 798 only applies to interest received and
expenditure incurred in the course of a trade, it can also be
side-stepped by arranging for the interest to be received, or
the expenditure incurred, by an associated company in whose
hands it is regarded as income from, or an expense of, an
investment, rather than a trade. In either case, the bank
continues economically and commercially, to make the loan or,
as the case may be, incur the related costs but, by routing
one or the other through such an associate, it avoids the
current specific limitation to trading income.
5. Section 803 ICTA 1988, which prevents banks and financial
traders from avoiding these rules by arranging for the income
to be received by an associate resident outside the United
Kingdom, is being similarly amended.
6. The cost to companies of complying with the changes is
expected to be negligible for all save aggressive tax
avoiders.
7. The revenue yield arising from the measure is estimated
at 10 million pounds for 1999-2000 and 50 million pounds for
2000-2001.
INLAND REVENUE PRESS OFFICE
Double taxation relief
Restriction of relief on certain interest and dividends.
[j4571]
.-(1) For section 798 of the Taxes Act there shall be
substituted the following section-
"Restriction of relief on certain interest and dividends.
798.-(1) This section applies where-
(a) in any chargeable period the profits of a trade
carried on by a qualifying taxpayer include
an amount computed in accordance with
section 795 in respect of foreign interest
or foreign dividends;
(b) the taxpayer is entitled in accordance with this
Chapter to credit for foreign tax on the
foreign interest or foreign dividends; and
(c) in the case of foreign dividends, the foreign
tax mentioned in paragraph (b) above is or
includes underlying tax.
(2) The amount of the credit for foreign tax referred to
in subsection (1)(b) above which, in accordance with this
Chapter, is to be allowed against income tax or
corporation tax-
(a) shall be limited by treating the amount of the
foreign interest or foreign dividends (as
increased or reduced under section 798A) as
reduced (or further reduced) for the
purposes of this Chapter by an amount equal
to the taxpayer's financial expenditure in
relation to the interest or dividends (as
determined in accordance with section
798B); and
(b) so far as the credit relates to foreign tax on
interest or foreign tax on dividends which
is not underlying tax, shall not exceed 15
per cent of the interest or dividends,
computed without regard to paragraph (a)
above or to any increase or reduction under
section 798A.
(3) In this section and sections 798A and 798B-
"interest", in relation to a loan, includes any
introductory or other fee or charge which
is payable in accordance with the terms on
which the loan is made or is otherwise
payable in connection with the making of
the loan;
"foreign dividends" means dividends payable out of
or in respect of the stocks, funds, shares
or securities of a body of persons not
resident in the United Kingdom;
"foreign interest" means interest payable by a
person not resident in the United Kingdom
or by a government or public or local
authority in a country outside the United
Kingdom.
(4) In this section and section 798B "qualifying
taxpayer" means, subject to subsection (5) below, a
person carrying on a trade which includes the receipt of
interest or dividends and is not an insurance business.
(5) Where a company which is connected or associated with
a qualifying taxpayer is acting in accordance with a
scheme or arrangement the purpose, or one of the main
purposes, of which is to prevent or restrict the
application of this section to the taxpayer-
(a) the company shall be treated for the purposes of
this section as a qualifying taxpayer; and
(b) any foreign interest or foreign dividends
received in pursuance of the scheme or
arrangement shall be treated for those
purposes as profits of a trade carried on
by the company.
(6) For the purposes of this section and section 798B-
(a) section 839 applies; and
(b) subsection (10) of section 783 applies as it
applies for the purposes of that section."
(2) This section and sections {j4572} and {j4573} do not
have effect in relation to foreign interest or foreign
dividends paid before 1st January 1999 in pursuance of
arrangements which were entered into before, and are not
altered on or after, 17th March 1998.
(3) Subject to subsection (2) above, this section and
sections {j4572} and {j4573} have effect in relation to
foreign interest or foreign dividends paid on or after 17th
March 1998.
Adjustments of interest and dividends for spared tax etc.
[j4572]
. After section 798 of the Taxes Act 1988 there shall be
inserted the following section-
"Adjustments of interest and dividends for spared tax etc
798A.-(1) In a case where section 798 applies-
(a) subsection (2) below applies if the foreign tax
referred to in subsection (1)(b) of that
section is or includes an amount of spared
tax; and
(b) subsection (3) below applies if the foreign tax
so referred to is or includes an amount of
tax which is not spared tax.
(2) For the purposes of income tax or corporation tax,
the amount which apart from this subsection would be the
amount of the foreign interest or foreign dividends shall be
treated as increased by so much of the spared tax as
does not exceed-
(a) the amount of the spared tax for which, in
accordance with any arrangements applicable
to the case in question, credit falls to be
given as mentioned in section 798(1)(b); or
(b) if it is less, 15 per cent of the interest or
dividends, computed without regard to any
increase under this subsection.
(3) If the amount of tax which is not spared tax exceeds-
(a) the amount of the credit which, by virtue
of this Chapter (but disregarding subsection
(2) of section 798),is allowed for that tax
against income tax or corporation tax;
or
(b) if it is less in the case of tax on foreign
interest, 15 per cent of the interest,
computed without regard to any increase or
reduction under this section or that
subsection,
then, for the purposes of income tax or corporation tax,
the amount which, apart from this subsection, would be the
amount of the foreign interest or foreign dividends shall be
treated as reduced by a sum equal to the excess.
(4) Subsection (2) above has effect for the purposes of
corporation tax notwithstanding anything in section 80(5) of
the Finance Act 1996 (matters to be brought into
account in the case of loan relationships only under
Chapter II of Part IV of that Act).
(5) Nothing in subsection (2) above prejudices the
operation of section 795 in relation to foreign tax which is
not spared tax.
(6) In this section "spared tax" means foreign tax which
although not payable falls to be taken into account for
the purposes of credit by virtue of section 788(5)."
Meaning of "financial expenditure". [j4573]
. After section 798A of the Taxes Act 1988 there shall be
inserted the following section-
"Meaning of "financial expenditure".
798B.-(1) For the purposes of section 798 "financial
expenditure", in relation to a qualifying taxpayer and any
interest or dividends is, subject to the provisions of
this section, the aggregate of-
(a) so much of the financial expenses (consisting of
interest, discounts or similar sums or
qualifying losses) incurred by the taxpayer
or a person connected or associated with
him as-
(i) is properly attributable to the
earning of the interest or dividends;
and
(ii) falls to be taken into account in
computing the taxpayer's or
person's liability to income tax or
corporation tax; and
(b) so much of any other sum paid by the taxpayer or
a person connected or associated with him
which-
(i) falls to be taken into account as
mentioned in paragraph (a) above;
and
(ii) would not, apart from this
paragraph, be taken into account in
determining the amount of the
interest or dividends,
as it is reasonable to regard as
attributable to the earning of the interest
or dividends (whether or not it would fall,
in accordance with normal accountancy
practice, to be so treated).
(2) There shall be deducted from the aggregate given by
subsection (1) above so much of the qualifying gains and
profits accruing to the qualifying taxpayer or a person
connected or associated with him as-
(a) is properly attributable to the earning of the
interest or dividends; and
(b) falls to be taken into account in computing the
taxpayer's or person's liability to income
tax or corporation tax.
(3) In a case where the amount of a qualifying taxpayer's
financial expenditure in relation to the earning of the
interest or dividends is not readily ascertainable-
(a) that amount shall be taken, subject to
subsection (4) below, to be such sum as it
is just and reasonable to attribute to the
earning of the interest or dividends; and
(b) in the case of interest, regard shall be had in
particular to any market rates of interest
by reference to which the rate of the
interest is determined.
(4) The Board may by regulations supplement subsection(3)
above-
(a) by specifying matters to be taken into account
in determining such a just and reasonable
attribution as is referred to in paragraph
(a); and
(b) by making provision with respect to the
determination of market rates of interest
for the purposes of paragraph (b);
and any such regulations may make different
provision for different cases.
(5) In this section "qualifying losses" means-
(a) losses falling to be brought into account for
the purposes of Chapter II of Part II of
the Finance Act 1993 (exchange gains and
losses) in accordance with sections 125 to
127 of that Act; and
(b) losses falling to be brought into account for
the purposes of Chapter II of Part IV of
the Finance Act 1994 (interest rate and
currency contracts) in accordance with
sections 155 to 158 of that Act;
and "qualifying gains" and "qualifying profits" shall be
construed accordingly."
Underlying tax reflecting interest or dividends. [j4574]
.-(1) Section 803 of the Taxes Act 1988 (underlying tax
reflecting interest on loans) shall be amended as follows.
(2) In subsection (1)-
(a) in paragraph (b), after the words "a dividend"
there shall be inserted the words "("the
overseas dividend")";
(b) in paragraph (c), for the words "interest on a
loan made" there shall be substituted the words
"interest or dividends earned or received"; and
(c) for paragraph (d) there shall be substituted the
following paragraph-
"(d) if the company which received the interest or
dividends ("the company") had been resident
in the United Kingdom, section 798 would
apply in relation to that company."
(3) In subsection (3), for the words from "on so much" to
the end there shall be substituted the words "on so much of
the interest or dividends as exceeds the amount of the
company's relevant expenditure which is properly attributable
to the earning of the interest or dividends".
(4) In subsection (4)-
(a) in paragraph (a), for the words "section 798(2)"
there shall be substituted the words "section
798(3)";
(b) for paragraph (b) there shall be substituted the
following paragraph-
"(b) "the company's relevant expenditure" means the
amount which, if the company referred to in
subsection (1)(d) above were resident in the
United Kingdom and were a qualifying taxpayer
for the purposes of section 798, would be its
financial expenditure in relation to the
earning of the interest or dividends, as
determined in accordance with section 798B."
(5) In subsection (5)-
(a) for the words "the dividend", in both places
where they occur, there shall be substituted
the words "the overseas dividend"; and
(b) for the words "the interest" there shall be
substituted the words "the interest or
dividends".
(6) In subsection (6)-
(a) for the words "the dividend" there shall be
substituted the words "the overseas dividend";
and
(b) for the words "the permitted amount" there shall
be substituted the following paragraphs-
"(a) the amount of the spared tax which under any
arrangements is to be taken into account for
the purpose of allowing credit against
corporation tax in respect of the overseas
dividend; or
(b) if it is less, 15 per cent of the interest or
dividends;".
(7) For subsection (7) there shall be substituted the
following subsection-
"(7) In this section "spared tax" has the same meaning as
in section 798A."
(8) In subsection (8)-
(a) after the words "amount of tax which" there
shall be inserted the words "is referable to
interest and"; and
(b) for the words "the dividend" there shall be
substituted the words "the overseas dividend".
(9) In subsection (9)-
(a) for the words "the interest", in both places
where they occur, there shall be substituted
the words "the interest or dividends"; and
(b) for the words "the dividend" there shall be
substituted the words "the overseas dividend".
(10) For subsections (10) and (11) there shall be
substituted the following subsection-
"(10) In subsection (1) above "bank" means a company
carrying on, in the United Kingdom or elsewhere, any trade
which includes the receipt of interest or dividends, and
section 839 applies for the purposes of that subsection."
(11) This section does not apply where the overseas
dividend is paid before 1st January 1999 in pursuance of
arrangements which were entered into before, and are not
altered on or after, 17th March 1998.
(12) Subject to subsection (11) above, this section
applies where the overseas dividend is paid on or after 17th
March 1998.
i.1996 c. 8.
ii.1993 c. 34.
iii.1994 c. 9.