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HMRC has recently made several significant updates to the process that non-UK entities must follow to claim double tax treaty relief from income tax deductible at source by UK entities (withholding tax) on cross-border payments of interest and royalties. Alongside those changes, there are also several practical matters that businesses should regularly review to help manage their withholding tax obligations, as well as staying up to date with the rates of withholding tax that apply to them.

Administrative updates

Historically, non-UK entities were required to submit a standard HMRC form to request clearance for the UK payer to apply the treaty rate of withholding tax, when in point. There was a generic Form DT-Company which covered payments made to most jurisdictions, together with a few variants of the form that were specific to certain jurisdictions (eg Form US-Company).  

Clearance applications were typically completed manually and were, in the first instance, submitted to the tax authority of the foreign payee entity for confirmation of its tax residence status. The form would then be passed on by the foreign tax authority to HMRC to complete the processing and issue the appropriate direction to the UK payer.   

What has changed?

The standard forms have been consolidated into a single online Form DT-Company. The new online form requires broadly the same information that was common to all the original variants, but a key feature is that jurisdiction-specific questions are prompted as the user completes the form.

The completed Form DT-Company can be sent direct to HMRC if an up-to-date certificate of residence of the payee can be attached. This bypasses the previous requirement for the form to be submitted to the overseas tax authority as a first step.

Practical implications

The historical process could be slow and cumbersome. The absence of a single submission process led to clearance applications often being delayed owing to the use of an incorrect form, and it was also not uncommon for applications to go astray when moving between the foreign tax authority and HMRC.  

When to apply for clearance regarding withholding tax?

In relevant circumstances, UK entities are required to withhold income tax at source on certain interest payments (or deemed payments), and must be in receipt of a direction issued by HMRC before a rate of withholding tax other than the standard statutory rate of 20% can be applied on those payments. If commercially possible, businesses may wish to consider deferring relevant payments until the payer holds such a direction from HMRC. Clearance applications must be made on a loan-by-loan basis.

There are, of course, exceptions to this general rule - clearance applications are not required, for example, if the interest arises on loans that will not be in place for more than one year (’short’ interest), where the interest payable is in respect of a Quoted Eurobond, or where the payee holds a passport issued under the double taxation treaty passport scheme and clearance has been granted to the payer under the more streamlined process that applies under that regime.  

By contrast, UK businesses are free to self-assess the availability of treaty relief on royalty payments or other qualifying annual payments, such that clearance from HMRC is not required before applying the relevant treaty rate of withholding tax. This can provide for a more straightforward process for businesses, but support for the treatment adopted should be prepared, to mitigate the risk of penalties should HMRC challenge the position.

Many businesses nonetheless choose to apply for clearance in advance from HMRC on payments of royalties and/or other qualifying annual payments as the direction issued by HMRC provides for certainty of treatment. This can be particularly important in the context of a potential sale of the paying entity, as a direction can provide assurance to a prospective purchaser regarding the withholding tax status of its relevant payments.

If withholding tax is in point, affected businesses should also ensure that the appropriate CT61 reporting is done and payments made.  

Common pitfalls regarding withholding tax

A direction issued by HMRC in response to a clearance application typically has a term of five years, assuming that there are no material changes to the facts and circumstances as detailed on Form DT-Company. Where there are significant changes (eg a receivable is assigned to a different lender), the direction may lapse, and the payer would, as a result, be obliged to withhold tax and comply with CT61 reporting as if no treaty relief is available, until an updated direction is obtained.  

Similarly, a new direction is required once the term of an earlier direction has elapsed. This point is frequently overlooked in respect of, for example, loans with a term of more than five years, and can expose the UK payer to additional liabilities for withholding tax and any resulting interest on late payment, together with penalties for non-filing of quarterly CT61 returns.

What else is new?

The UK already has an extensive double tax treaty network, but the government is continually working to make existing treaties more competitive, to promote bi-lateral investment. For example, the new UK-Luxembourg treaty has reduced the rate of withholding tax on royalties that qualify for relief under the treaty, from 5% to 0%, effective from 1 January 2024. 

Elsewhere, stakeholders have been lobbying the government to renegotiate the UK-Singapore treaty, as that currently provides for a relatively high treaty withholding tax rate of 8% on royalties, placing the UK at a competitive disadvantage when compared to the new Netherlands-Singapore treaty, for example, which provides for a 0% rate on royalties. 

For more information, please get in touch with Suze McDonald or your usual 91̽»¨contact.