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INTM584030 - Thin capitalisation: third-party loan agreements: The grossing up clause for withholding tax

It is common for a loan agreement to contain a ‘grossing up clause’ with respect to withholding tax. Of itself, it is neither good nor bad, just an agreement that if for any reason the borrower is obliged to withhold tax from an interest payment, they will nevertheless pay to the lender a sum equal to the gross interest. As long as the obligation to withhold is respected and the appropriate treaty clearance applied for in a timely way, a grossing up clause is not of concern. However, a number of points arise from this requirement if it is put into effect:

  • the correct amount of tax should be withheld and must still be paid over to HM Revenue & Customs.
  • only the lender is entitled to apply for repayment of the tax withheld, and HMRC will repay it to them unless the lender specifically mandates HMRC to do otherwise. This will mean that the borrower has paid the gross amount to the lender, the tax to HMRC, and has in effect paid the amount of the tax twice.
  • the additional amount paid to the lender to make up the withheld tax is not additional interest and must not be deducted in the Corporation Tax computations.
  • unfortunately, if a grossing up clause is enforced, it reduces the likelihood of the lender making the treaty clearance application, since they will not be prompted by receipt of the net amount.
  • the existence of a grossing up clause in a loan agreement is not a reason for entering into an agreement to allow informal treaty clearance while the enquiry continues - see INTM574020 onwards.