The Trials And Tribulations Of Interest Withholding Tax

Speed read

The requirement to deduct income tax from payments of UK source yearly interest is longstanding, and from a technical perspective it is reasonably well understood by UK practitioners. However, there are a number of administrative hazards that can cause even careful taxpayers to make inadvertent compliance errors. HMRC have historically applied a concessionary approach to rectifying errors, under which they collect only late payment interest where the underlying tax would be repayable. However, precisely how the concession applies is not always clear, and HMRC have recently indicated they have paused compliance work while they review their approach in this area. We hope that this review will lead to a more straightforward administrative process that will support the UK as an attractive place for investment and business.

UK domestic law requires payers of UK sourced yearly interest to deduct income tax at the basic rate of 20% – effectively a withholding tax (WHT) on interest. This is a longstanding requirement, and yet the administration of the UK interest WHT system is full of pitfalls for international businesses investing in the UK and their advisors, particularly given the specificity of available exceptions, and the interaction of the UK domestic rules with both the UK's extensive network of double tax treaties (DTTs) and, for relevant periods, EU law.

This article provides a high level overview of the UK interest WHT regime, outlines the historic practices for rectifying situations where interest has been paid gross in error, and then (drawing on recent experience) considers some challenges that the writers have encountered in practice.

When does an obligation to account for WHT arise?

The basic rule under ITA 2007 s 874(1) is that certain payers of ‘yearly interest arising in the United Kingdom' are required to deduct (and pay to HMRC) income tax at the basic rate of 20% from their payments. This definition is not a bright line test, and determining whether interest is yearly or has a UK source is not always straightforward. We have briefly reviewed the key considerations below

Yearly interest

There is no statutory definition of ‘yearly' interest, but both the relevant case law and HMRC (in their Savings and Investment Manual at SAIM9075) concur that the intention of the parties is the determining factor in assessing whether interest on a loan qualifies as yearly interest. Therefore, interest is likely to be yearly interest if both the borrower and lender anticipated when the loan was put in place that the debt in question would exist for more than a year. The parties' intentions for these purposes will be determined holistically by reference to all the facts, including any written agreements between them. A short-term lending arrangement repeatedly rolled over or renewed is likely to be viewed as a single loan intended to exceed 12 months yielding ‘yearly' interest on which withholding will be required.

Arising in the UK

There is likewise no definitive rule for determining whether an interest payment has a UK source, which depends on a multifactorial assessment set out in case law (notably, National Bank of Greece [1971] 1 All ER 233 and Ardmore Construction Ltd v HMRC [2018] EWCA 1438).

A common area of uncertainty is where a loan is made to a non-UK resident but either the loan is secured on UK real estate, or the interest on the loan is paid out of UK rental income receipts

In many situations the question of ‘source' should be relatively clear cut. For example, interest will usually have a UK source if it is payable by a UK tax resident or incorporated company, or if the obligation is expressed to be the obligation of a UK branch of a non-UK resident and non-UK incorporated company. However, some complex or cross-border structures may require a nuanced assessment with regards to the commercial substance of the arrangements, the flow of funds, and the practical realities of how the loan is operated and serviced. A common area of uncertainty is where a loan is made to a non-UK resident but either the loan is secured on UK real estate, or the interest on the loan is paid out of UK rental income receipts (or both). Although the interest could be considered UK source on the basis of the factors just described, where other factors (for example, governing law and enforcement jurisdiction) point to the interest having a non-UK source, the authors are aware that some non-resident landlord borrowers take the opposite view and HMRC have not challenged their approach.

Grossing up clauses

Many loan agreements contain ‘grossing up' clauses which broadly require the borrower to increase the amount of any interest payment from which tax must be withheld by law so that, after deduction of tax, the lender receives the same net sum as if no withholding had occurred. HMRC accept that any additional amount paid under a grossing up clause does not itself constitute an interest expense on which WHT could be applied (see International Manual at INTM413220). This is an important practice point, which may be particularly relevant where compliance failures have occurred.

Domestic exemptions

As a general rule, no withholding obligation should arise in respect of interest paid to UK resident lenders. On the one hand, individuals under ITA 2007 s 874(1) are only required to account for WHT on interest payments made to other legal persons (including other individuals, companies and trustees) whose ‘usual place of abode' is outside the UK; on the other hand, specific statutory exemptions (the ‘UK corporate exemption' at ITA 2007 s 938 and the exemption for bank lending at ITA 2007 s 879) should cover all payments of yearly interest to UK corporation tax payers.

Further statutory exemptions mean that, in practice, a wide range of yearly interest payments by UK borrowers to overseas lenders can also be made free of WHT. The most used exemptions are:

the exemption for interest paid by banks in the ordinary course of business (ITA 2007 s 878); and
the ‘quoted Eurobond' (QEB) exemption (ITA 2007 s 882).

The QEB exemption is the clearest and least qualified of all exemptions from UK interest WHT. It removes the obligation to deduct tax from any payment of interest on a QEB, which is defined for these purposes (in section 987 ITA 2007) as an interest-bearing security that is issued by a company and is either listed on a recognised stock exchange (which should be designated as such by HMRC), or admitted to trading on a multilateral trading facility operated by a recognised stock exchange regulated by the EEA, the UK or Gibraltar. There are a large number of recognised exchanges (in the UK and abroad) on which a QEB can be listed and there is no requirement that the security be actively traded on the relevant exchange. The QEB exemption is therefore an important structuring option for overseas lending into the UK.

A less frequently used exemption, the ‘qualifying private placement' (QPP) exemption (ITA 2007 s 888A), was introduced in 2016 in order to simplify lending into the UK from jurisdictions within the UK DTT network. In practice, its use has been more limited than expected, and in our experience it is used either where the relevant DTT does not reduce WHT to 0% or as a fallback (particularly when DTT relief cannot be secured within a tight time frame), rather than as a preferred route.

DTT relief

Where no domestic exception is available, taxpayers may still be able to secure relief through a suitable DTT. The UK has a wide DTT network that ensures that many overseas lenders can benefit from no or a reduced rate of interest WHT. However, DTT relief is not always a straightforward remedy, including because taxpayers must satisfy procedural requirements before paying interest gross or at the reduced rate.

A standard application for a direction from HMRC that interest can be paid gross of WHT (or with WHT applied at a lower rate) can be made using HMRC's ‘DT Company' form (for companies) or ‘DT individual' form (for individuals). Borrowers may also apply for relief under the Double Taxation Treaty Passport (DTTP) scheme, which allows accredited non-UK lenders to expedite the clearance process and simplify applications in respect of new loans from the same lender. Under the DTTP scheme, once a lender holds a valid ‘passport' confirming HMRC's acceptance of their entitlement to treaty benefits, a UK corporate borrower need only file an online ‘DTTP2' form in respect of its specific loan.

Timing can often be a bar to taxpayers seeking to rely on DTT relief. HMRC's typical processing times for both lender ‘passport' applications and standard (non-DTTP) clearance applications can vary from a few days to a number of weeks, with even longer wait times (sometimes several months) having been the norm in the recent past. Some recent clearance applications involving lenders who were individuals (rather than companies) have taken over a year to process.

Moreover, both the obligation to deduct interest WHT, as well as the procedural requirements to give effect to DTT relief (where relevant), can be poorly understood by international investors. Foreign investors are also often caught unaware by the highly specific nature of directions which, for example, typically lapse if the lending entity undergoes a name change or if the loan principal is increased, and mistakes are not easily picked up by their outsourced service providers because interest WHT is neither reported nor collected through the annual company tax return process. These factors can lead to inadvertent compliance failures and substantial rectification costs for both lenders and borrowers in circumstances where relief would otherwise have been available under the relevant DTT.

Both the obligation to deduct interest WHT, as well as the procedural requirements to give effect to DTT relief (where relevant), can be poorly understood by international investors

Administrative hazards of the UK interest WHT system

Failure to obtain clearance

UK domestic legislation imposes an obligation to deduct income tax in respect of interest payments at source, which continues to apply until HMRC formally directs the payer that they may pay gross or withhold at a reduced rate. HMRC's view (stated at INTM413230) is that, where a company pays yearly interest before obtaining clearance, HMRC retains the right to assess the payer for the unpaid income tax and HMRC late payment interest (under TMA 1970 s 87), regardless of whether the borrower would have been entitled to pay gross (or with a reduced rate of withholding) had it made an application. With HMRC late payment interest charged at 8.25% since 28 May 2025, it is therefore important for borrowers to rectify any compliance failure promptly upon discovery.

HMRC concession where clearance later obtained

While HMRC consider that UK taxing rights do not simply disappear following a successful DTT clearance application, INTM413230 outlines a concessionary approach whereby HMRC can forgo collecting the underlying tax and limit its assessment to the TMA 1970 s 87 late payment interest charge if the overseas lender would be entitled to full repayment under the relevant DTT. Borrowers may request the benefit of this concession by making a disclosure to HMRC regarding their failure to account for interest WHT.

This concession is stated to apply only where both of the following conditions are satisfied:

firstly, the overseas recipient of the interest must have applied for, and been granted, clearance to receive future interest payments from the source in question without deduction of income tax; and
secondly, HMRC must be satisfied that the lender would be entitled to repayment of the tax for the period for which income tax should have been withheld. It is unclear whether HMRC believe that the first

condition described above should be applied literally in all cases. Under that approach, the concession could never apply in situations where the loan in respect of which a compliance failure happened has been fully repaid (and it is not therefore possible to make a clearance application for the future). If, however, the aim of the concession is to relieve the administrative burden for lenders in circumstances where there is an established entitlement to repayment, while maintaining an incentive (in the form of late payment interest) for taxpayers to obtain clearance, then there is no obvious policy reason why such loans should be excluded.

It is unclear whether HMRC believe that the first condition described above should be applied literally in all cases. Under that approach, the concession could never apply in situations where the loan in respect of which a compliance failure happened has been fully repaid

The issue outlined above is far from academic: in our experience, it is a recurring feature in cases where taxpayers have identified a historical compliance failure that they are seeking to regularise with HMRC. In such cases, absent a pragmatic approach from HMRC, taxpayers could be left in the unsatisfactory position of having to pay an amount of tax that HMRC would inevitably be required to repay following a claim from the lender

Another layer of practical difficulty in some cases arises from the need to get the lender to make a refund claim. The lender will have received its interest gross of withholding tax (potentially over many years) and in situations where the lender and borrower do not have an enduring relationship (because they are not in the same group of companies and the commercial relationship between them has been terminated), may not be willing to assist the borrower, or may only be willing to assist in return for a fee. Moreover, the lender may have been liquidated, and in that scenario it may not be possible to make a refund claim.

Interaction with EU law

For a time, the position described above was further complicated by EU law. In 2018, the CJEU ruled in TTL EOOD (Case C-553/16) that imposing irrecoverable late payment interest on WHT where the application of a DTT resulted in no or a reduced rate of source taxation was contrary to the freedom to provide services (article 56 of the Treaty on the Functioning of the European Union (TFEU)). Following TTL EOOD HMRC accepted that late payment interest should not apply where the payment of interest was to a person taxable in another EU member state and DTT relief would have been available (but for a compliance failure).

Article 56 ceased to apply to the UK when it left the EU on 1 January 2021. HMRC is no longer therefore bound by the decision in TTL EOOD; however, we understand that in practice HMRC accept that no late payment interest should accrue in respect of interest payments made to lenders before 1 January 2021. This can provide significant practical relief for taxpayers affected by compliance failures during that period.

HMRC's guidance on TTL EOOD did not change until 4 May 2023 and some therefore consider that late payment interest only applies to interest payments made from that date. However, given the guidance stated that it was based on TTL EOOD and Article 56, which ceased to apply from 1 January 2021, we consider the better view is that HMRC can apply late payment interest from that earlier date.

Timing considerations

Prompt rectification is crucial to minimise the late payment interest that may accrue as a result of any compliance failures. The published guidance on the concession does not explain when HMRC consider that late payment interest should stop accruing. The authors take the view that this should be the point at which the taxpayer has made a full disclosure to HMRC which establishes their right to relief (ideally accompanied by payment of the late payment interest accrued to date). However, we are aware of some instances in which HMRC have charged interest up to the point at which they have reviewed and agreed a disclosure. That process can in practice take several months and so result in a higher late payment interest liability due to factors outside the taxpayer's control.

For some taxpayers, timing is critical beyond the increased interest cost. This is because it is not clear how far back HMRC consider they can assess for unpaid WHT, and it is similarly unclear what the time limit is for making refund claims

This problem is compounded by the fact that, since at least January 2025, HMRC have notified several taxpayers of a pause in the processing of voluntary WHT disclosures pending an internal review of ‘the application of the mechanisms associated with the deduction of income tax on making payments of UK source yearly interest to foreign recipients', which is stated to include the correct operation of the concession described above. It is unclear what has prompted this review, and whether it is being undertaken with a view to withdrawing the concession, or because HMRC are reconsidering their view that late payment interest is due at all in situations where a right to DTT relief can be established. For the time being taxpayers are likely to face delays in the processing of their disclosures. In the meantime, the only certain way to stop late payment interest from accruing further is for borrowers to account for the overdue WHT to HMRC – although we are aware of HMRC offering in some cases to stop further interest accruing in respect of ongoing disclosure processes.

Moreover, for some taxpayers timing is critical beyond the increased interest cost. This is because it is not clear how far back HMRC consider they can assess for unpaid WHT, and it is similarly unclear what the time limit is for making refund claims.

The usual time limit for discovery assessments relating to income tax is four years from the end of the taxable period to which the assessment relates. However, this can be extended to six years in cases involving a ‘loss of income tax' brought about carelessly, and to 12 years if in addition it involves an ‘offshore matter'. Under domestic law, WHT refund claims are also subject to a four-year time limit from the end of the taxable period to which they relate (TMA 1970 s 42). This is arguably capable of being extended to six years if the lender requests a ‘mutual agreement procedure' under the relevant DTT (TIOPA 2010 s 125(3)). However, there remains a potential mismatch between the periods for which HMRC can issue assessments and the periods for which lenders can make a refund claim. This means that if the lender's claim is not submitted before the end of the relevant time limit, the borrower may be left in the unsatisfactory position where it is required to pay WHT to HMRC that the lender would no longer be able to recover.

It may be possible to argue that where a DTT is clear that the UK is not permitted to tax interest payable to a resident in a treaty state, there is no ‘loss of tax' for HMRC where a borrower has failed to comply with domestic procedural requirements, such that the extended time limits to issue discovery assessments cannot apply. This would have the result that the domestic law time limits for issuing discovery assessments and making refund claims would match, which does have some logic to it. However, HMRC may well be unwilling to accept such an argument, given it restricts their assessment powers.

We hope that HMRC's review of their administrative approach to interest WHT cases will lead to a clearer and more straightforward process for rectifying compliance issues. Arguably, however, the time is ripe for a more fundamental look at policy in this area

Conclusion

While the UK imposes a broad default requirement to withhold tax, lenders can rely on DTT relief and a host of statutory exemptions to reduce or eliminate their exposure. Where required, however, obtaining advance directions from HMRC permitting gross payment is time consuming (as is the mechanism for reclaiming tax that has already been withheld). Added to that, the process-heavy administrative approach means this is an area where it is relatively common for even careful taxpayers to make minor inadvertent compliance errors. As explained above, rectifying those errors can be complicated, even where there is ultimately no tax at stake. The result is a system that is burdensome for taxpayers and generates limited Exchequer revenues

Originally Published by Tax Journal

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