HMRC launches consultation on Simplifying Treaty Relief from WHT on interest payments paid overseas

Payments of UK-source yearly interest paid by a company, a local authority, or paid by any person to another person whose usual ‘place of abode’ is outside the UK are subject to UK withholding tax (WHT) at a rate of 20% (to be increased to 22% starting from April 2027). The obligation to deduct the WHT falls to those by or through whom payments of yearly interest are made.

This UK WHT obligation is subject to reliefs and exemptions, either (i) through the UK's large network of double taxation treaties (DTT) which reduces or removes the UK's taxing authority over the interest payment, or (ii) through non-treaty exemptions in UK law such as payments to UK banks, UK companies or under the 'qualifying private placement' exemption. It is the former which the consultation focuses on.

Even where a lender is entitled to the reduction or elimination of UK WHT under a relevant double tax treaty, the relief is not automatically applied. Instead, an overseas lender must apply for (through forms DT-Company or DT-individual, which involves providing an authorised certificate of tax residence) and obtain a direction from HMRC before it can be paid gross. Until such a direction and treaty clearance is obtained from HMRC, the UK borrower/payer is required  to apply UK WHT and account for this amount to HMRC.

In 2010, HMRC launched a voluntary mechanism to try to expedite this process: the Double Taxation Treaty Passport (DTTP) scheme. Rather than a lender having to make a separate treaty application for each loan that  it granted or acquired, an overseas lender can apply for a 'treaty passport' (valid for five years) which provides the lender with a unique scheme reference number and which can be provided to the UK borrower or payer, who uses this to notify HMRC of the terms of the loan (a DTTP2 Filing) and who would then be provided with a gross payment direction in turn. This process is intended to be more administratively straightforward for lenders, and quicker for borrowers to complete.

In its consultation, HMRC notes that it recognises that "the administration of treaty relief may create administrative and compliance challenges" as well as "unnecessary burdens".

Indeed, there are a number of unwelcome issues which may arise under the current system:

• Changes to terms of the loan: Even where a DTTP2 has validly been submitted on entry of a loan by a UK borrower/payer, any changes to loans (either by way of an upsize, or a change to the term of the loan) requires an additional DTTP2 to be filed. This can create issues where such amendments may not instinctively be considered by the parties as requiring an updated DTTP2 Filing, and which therefore may cause problems down the road where DTTPs have been invalidated.
  
  
• Renewal and expiration of lender passport: A DTTP passport must be renewed every five years by the lender, and so issues often arise where scheme reference numbers provided are out of date or a lender has forgotten to renew their lender passport. This delays transaction timetables or payments of interest until passports can be renewed and/or can invalidate DTTPs.
  
  
• Agents and/or borrowers: The application of the DTTP scheme is made more complex where payments of UK source interest are ultimately made by agents. This can create issues where ultimately both borrowers and agents may want to submit DTTPs for the same loan. This is on the basis that, whilst no UK WHT should arise to a borrower where an agent receives interest payments and pays these to overseas lenders and HMRC guidance states that the need to deduct tax will normally apply to the last UK-resident intermediary in the chain, HMRC still retains in law the right to assess the borrower as the person "through whom" interest is paid.
  
  
• Borrower risk: despite the DTTP scheme providing quicker directions from HMRC, a UK borrower/payer will not be able to pay the lender gross until it has received confirmation from HMRC that it can do so. HMRC's view stated in the terms, conditions and guidance of the DTTP scheme (DTTP30640) does however allow borrowers to provisionally withhold at the relevant treaty rate in advance of receiving a formal gross payment direction so long as the borrower/payer has submitted the form DTTP2; however this does mean the borrower  takes on risk for the tax if the DTTP is rejected.

All of these issues have been made more important as a result of HMRC's pausing of the concession whereby, in the event of a failure to properly file DTTP forms for a qualifying treaty lender, it will assess a UK borrower to  late-paid interest only rather than the underlying tax. The consultation has made clear that the operation and pausing of the concession is not an area which HMRC will be seeking views on.

Unlike many other major economies, the UK requires a prior direction from HMRC before interest can be paid gross to an overseas lender, rather than permitting borrowers/payers to self-assess and apply treaty relief on the basis of lender documentation. This may be placing the UK at increasing competitive risk, particularly in light of the formal adoption of the EU's Faster and Safer Tax Excess Refund (FASTER) Directive, which is to be adopted by EU Member States by 1 January 2027. FASTER is designed to make WHT relief faster and less "lengthy, costly and cumbersome", removing a barrier to cross-border investment, by introducing a common EU digital tax residence certificate (to be issued within one working day), two fast-track treaty relief procedures, and standardised reporting obligations for certified financial intermediaries, with estimated savings to investors of around €5.17 billion per year. As EU Member States move to streamline their WHT relief administration procedures, the UK risks becoming a comparatively less attractive destination for cross-border financing if these administrative systems remain unreformed.

Interactions with tax provisions in facility agreements

The administration of seeking treaty relief, either through direct applications to HMRC or via the DTTP scheme, can be made more complex by its interactions with tax provisions within cross-border financing agreements.

 For example, typically under a Facility Agreement, a UK borrower will agree to gross-up 'Qualifying Lenders' for any UK WHT, in the event that a lender ceases to be a 'qualifying lender' as a result of a change of law. A treaty lender (i.e. the lender which satisfies the conditions for treaty relief for a reduction or elimination of WHT) is usually a 'Qualifying Lender' for the purposes of such loan agreements, and it is typically assumed for the purposes of the definition of Treaty Lender that "all procedural formalities" (in order to benefit from treaty relief) will be completed. This means in practice that the risk of DTTP filings not being properly made sits with the borrower.

Increasingly on loan agreements for borrowers with stronger negotiating positions, the requirement is for all procedural formalities actually to be completed (as opposed to assumed to be completed). This can create tension in respect of lenders relying on the HMRC DT Treaty Passport scheme, since it is for the borrower to make the applicable DTTP2 Filing with HMRC; and so an overseas lender may find itself in a position where it is  not considered a Treaty Lender and therefore not entitled to the benefit of the gross-up, until a borrower makes such the relevant DTTP2 Filing. Wherever the risk in this area ultimately sits, many borrowers and lenders will consider that it is unsatisfactory that they should be required to bear the financial risk that can arise from comparatively minor and inadvertent administrative mistakes under the current system.

HMRC has put forward a range of potential approaches for reform of the rules as part of the consultation, noting though that the government has not determined "how best to reform the current regime" and therefore that views of stakeholders and advisers provided through the consultation will be particularly helpful in steering and identifying which solutions should be taken forward.

Of particular note, HMRC puts forward an option that treaty relief could apply without prior HMRC direction and instead on a self-assessment basis, with the UK borrower responsible for determining whether treaty relief applies. From HMRC's questions as part of the consultation, it appears  that additional guardrails may be imposed in respect of this process for 'self-assessment' to work in practice:

• Limiting the use of self-assessment: HMRC asks whether self-assessment option should only be available where the risk of erosion of the tax base is low, and asks what a good basis for a threshold might be (for example the payer/borrower is subject to transfer pricing rules, the corporate interest restriction, or Pillar 2).
  
  
• Facility to confirm treaty relief: The consultation considers whether it would be "necessary or helpful" to introduce a facility for interest payers to obtain certainty in advance of paying interest, so that it could be confirmed that HMRC agrees treaty relief is available. This would be helpful for borrowers or payers where the availability of n treaty relief is not clear under the relevant DTT provisions. It would be helpful, though perhaps unworkable in practice, if such a facility could also provide confirmation of treaty relief where the UK payer needs to confirm that the person being paid the interest is "beneficially entitled" to the payment (in order to benefit from treaty relief). It is also possible under this proposal that it will fall to the UK payer to request and review certificates of residence itself, so as to get comfortable that the lender is tax resident in the relevant treaty state.
  
  
• Reporting: HMRC asks whether it would be overly burdensome for payments made with complete relief to be reported as part of the borrower/payer's regular withholding tax compliance cycle, noting that HMRC will need some oversight and visibility on the application of the self-assessed treaty reliefs.