Ask an expert: Does interest have a UK source?

Question

My client is a Jersey resident company which has bought UK property with a loan secured on the property, and will rely on rents and eventual proceeds of sale to service and repay the debt. Is it required to withhold and pay income tax on the interest payments on the basis that the interest has a UK source?

Answer

Chapter 3 of Part 15 ITA 2007 imposes an obligation to deduct tax from interest that has a UK source. ITA 2007 s 874 specifies that the interest must be ‘yearly interest arising in the United Kingdom’. ITA 2007 s 884 excludes from this requirement ‘relevant foreign income’, being income arising outside the UK.

HMRC’s Savings and investment manual at SAIM9090 states:

‘Whether or not interest has a UK source depends on all the facts and on exactly how the transactions are carried out. HMRC considers the most important factor in deciding whether or not interest has a UK source to be the residence of the debtor and the location of his or her assets. Other factors to take into account are:

• the place of performance of the contract and the method of payment;
• the competent jurisdiction for legal action and the proper law of contract; and
• the residence of the guarantor and the location of the security for the debt.

‘HMRC considers the residence of the debtor to be most important because this, along with the location of the debtor’s assets, will influence where the creditor will sue for payment of the interest and repayment of the loan. “Residence” in these circumstances is not the same as tax residence. Residence of the debtor is residence for the purposes of jurisdiction.’

SAIM9095 states that where the debtor is a company, it may have more than one residence. Jurisdiction in relation to a corporation will in general depend upon where the corporation does business, so for these purposes it will be resident where it carries on business. The loan agreement will state where the interest and loan are payable and this, if the company is also resident in that place, will normally determine whether or not the interest has a UK source.

If the debtor is resident within the EU, the Council Regulation (EC) 44/2001 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters, and the 1968 ‘Brussels Convention’, may have an impact on the general rule. However, as the company in the query is stated to be resident in Jersey, this is not considered further here.

Accordingly, interest payable by a company that carries on business in Jersey under an agreement which states that the interest and the loan are payable outside the UK will not normally have a UK source. However, if the company does carry on business in the UK the interest may have a UK source, which would mean that tax should be deducted from yearly interest paid by it.

Perrin v HMRC

The principles were summarised in the recent First-tier Tribunal case of Perrin v HMRC [2014] UKFTT 223 (TC). The tribunal took account of the judgment of the House of Lords in Westminster Bank Executor and Trustee Co (Channel Islands) Ltd v The National Bank of Greece SA (1970) 46 TC 472, as well as a number of other relevant cases decided by the lower courts in recent years.

Mr Perrin, who was resident and domiciled in the UK, contended that the source of loan interest payable by him was the Isle of Man, and therefore that he was under no obligation to deduct tax. The tribunal agreed with HMRC that the interest had its source in the UK. The judge held that the case was to be decided by considering a number of factors:

• the ‘proper law’ of the loan agreement, which was that of the Isle of Man, was held to be ‘of very little weight’;
• the place in which payment was actually made, which was the Isle of Man, was also held to be ‘of little weight’;
• the jurisdiction in which judgment could be obtained, which was the Isle of Man;
• the country in which Mr Perrin was resident, which was the UK; and
• the country from or in which Mr Perrin’s obligations to pay would be contemplated to be enforced or would substantively originate, which was the UK.

The last of these factors would include the place where any security was situated, which was not relevant in this case. The residence of the lender was not relevant at all.

The judge pointed out that if judgment for the debt were given in favour of the creditor by an Isle of Man court, this would be registered and enforced in the UK against the debtor’s UK assets. Given that the debtor’s assets were in the UK, the likely place of enforcement was therefore in the UK; and this differed from the place of jurisdiction which was in the Isle of Man. It was held that the relevant questions were where judgment for the debt itself would be enforced, and where the funds to repay the debt would originate; not (if different) the place where the liability to pay the interest would be enforced or where the funds to pay the interest would originate.

Where does this leave us?

The country of the debtor’s residence and the place of enforcement and substantive origin were considered to be the most significant factors, and these outweighed jurisdiction and actual payment. The issues highlighted in this case should be considered by companies and individuals when determining whether interest has a UK source. In the query, the fact that the loan is secured on property in the UK, and that the debt is likely to be enforced in the UK, point strongly towards the interest having a UK source.