INTM574030 - Thin capitalisation: treaty clearances: The law for treaty claims where interested has been paid gross without clearance
It is important to be clear about the law as it relates to treaty clearance applications and the following points are relevant:
- Yearly interest arising in the UK is subject to UK tax Schedule D Case III (ICTA88/S18(3)).
- If it is paid by a UK resident to a non-resident, then ITA07/S874 (previously ICTA88/S349(2)(c)) requires that tax be withheld at the prescribed rate from amounts paid to the overseas lender, and paid to HM Revenue & Customs.
- This requirement may be overridden by the terms of the double taxation agreement between the UK and the country of residence of the recipient of the interest, if the UK agrees to give up its taxing rights over some or all of the interest.
- Only the DT Treaty Team at LBS Nottingham, formerly at Charity, Assets & Residence (CAR), has the authority to give a formal notice of clearance under the treaty for the interest to be paid gross or at the treaty rate. The taxpayer relationship is between that team and the overseas claimant, since the clearance application is a claim under ITSA.
- Until the DT Treaty Team grants treaty clearance, no payer is entitled to assume that the treaty rate will apply and that it need not withhold tax.
- Tax that is withheld and paid to HMRC will, upon application for repayment, be refunded (to the extent that the withholding tax is no longer due) to the recipient of the interest, if it subsequently transpires that the treaty rate was applicable at the time of payment.
- If interest is paid to the lender gross even though there is no treaty clearance giving permission to do so, an assessment may be made under ICTA88/SCH16 on the company which paid the interest. The purpose of the assessment may be to recover the lost tax, or, if the withholding obligation has been lifted by a clearance agreement, the assessment may be to recover interest due on the unpaid tax for the period the tax was outstanding. The interest falls due under TMA70/S87, as commercial restitution for the period when the withholding tax should have been in the hands of HMRC.
- If interest is paid gross which should have been paid under deduction of tax and included in an ICTA88/SCH16 return then the payer will either have failed to make a return or will have made an incorrect return. Penalties for the failure (or incorrect return) are chargeable under TMA70/S98. Where a company has failed to make a return of the tax that should have been deducted the tribunal can impose a penalty of up to £3,000 instead of the normal £300 where the company could not reasonably believe that one of the conditions in ICTA88/S349B allowing gross payment is satisfied. Both the lower or higher level penalty may be sought even where there is no net tax due because treaty clearance for gross payment is subsequently given. Approval from Tax Administration Advice is needed before the higher-level penalty can be sought.
See INTM574040 onwards for the practice which may be adopted in cases where the treaty clearance application was held up pending resolution of thin cap problems (applications received by CAR on or before 21st April 2007).