The Ardmore ruling: Between a rock and a difficult place
It was perhaps unsurprising that in June the UK Court of Appeal ruled in favour of the UK tax authority (HMRC) in the Ardmore case.
Broadly speaking, the court confirmed the existing understanding of the law as it relates to UK withholding tax (UKWHT) on interest payments. Had the court done otherwise, the resulting upheaval could have led to UK taxpayers needing to re-examine a huge raft of debt arrangements.
But while being suitably grateful to Lady Justice Arden, who gave the leading judgment on June 21, some taxpayers and their advisers may feel that an opportunity has been missed to simplify and streamline the law in this area. Even worse, Ardmore may actually make life more complex.
Facts of the case
Ardmore, a UK-based, family-owned construction company borrowed money from trusts in Gibraltar. Ardmore did not deduct UKWHT from interest payments to the Gibraltan lenders.
In keeping with its long-standing position in such cases, HMRC determined that the interest payments had a “UK source” and so were subject to UKWHT. HMRC’s view was that, because Ardmore was a UK company, the “source” of the interest was the UK. As Ardmore had not accounted for the UK tax due, HMRC assessed Ardmore for that tax.
Ardmore and its advisers argued that, because the lenders were in Gibraltar, the debt arrangements were governed by Gibraltan law, and the loan documents included a Gibraltan jurisdiction clause, Gibraltar was the “source” of the interest and not the UK (and so no UKWHT was due). In short, Ardmore effectively thought it could justify this position by saying that the loan, rather than the debtor (and the funds from which the debtor serviced the interest), was the source of the interest.
The UK Court of Appeal upheld the previous lower tier tribunal decisions. Lady Justice Arden dismissed the idea that the origination of the loan from Gibraltar meant that the interest also originated there.
She said: “The immediate search is for the source of the interest rather than a search indirectly for the source of the loan. The funds paid over as interest derived from funds generated in the UK.”
“The activity of lending became passive once the loan was made, whereas the business of Ardmore was actively conducted to produce those funds.”
She added: “Furthermore, relative to the links with the UK, the links with Gibraltar were of an insubstantial kind: there was no evidence that they were backed up by any kind of other activity within Gibraltar, nor was it explained why it was necessary for the trusts to form companies in the British Virgin Islands or what commercial purpose those companies served.”
Gibraltan law, she went on, would, under the terms of the loan, govern the arrangement only in the event of a default by the borrower, and this had not happened.
However, the UK Court of Appeal did not endorse the hitherto-existing approach of HMRC, which is that a UK-resident debtor must, generally, deduct UKWHT from interest payments to overseas lenders (subject to the availability of any relief or exemption). Cases may be different, and HMRC should look at all the relevant factors in each case and weigh them accordingly. For instance, it may not be appropriate for HMRC simply to look to debtor residence where there is an “active” lender and a “passive” borrower.
The correct approach, she added, was “not merely multifactorial”, but should also be “acutely fact-sensitive”.
HMRC already considers a number of factors in such cases, but their position has for some time been that one of the most important factors is the residence of the debtor and the location of their assets. Other factors (upon which HMRC tends to place less weight) include the residence of any guarantor, the location of any security for the debt, the competent jurisdiction for any legal action and the relevant law of contract, and the method of payment of interest. Following Ardmore it may be prudent to reconsider how appropriate any such hierarchy is in light of the facts.
A “practical” and “substantive” approach should be taken to weighing the factors in each case. As Lady Justice Arden said, the key test was whether “a practical person would regard the source [of the interest] as in … [the UK] or elsewhere”.
All factors ought to be considered and each has some relevance. That may sound reasonable, but – in contrast to the existing HMRC priority given to a debtor’s residence and location of their assets – advisers and HMRC must now weigh them all.
An opportunity to simplify the rules in this area has been missed and the court declined to set out an objective test of universal application. If anything, the Ardmore judgment has made the job of hunting for a UK “source” more complex. However, the court’s approach of having regard to the facts in hand is reasonable – debt arrangements are increasingly complicated and very often more complicated than Ardmore’s arrangements – as applying a “one-size-fits-all” approach would carry its own significant challenges. The court’s action in broadly upholding the status quo, then, deserves two cheers.
This article was prepared by Oliver Walker, a tax partner, and Stuart Pibworth, a tax associate, of Weil, Gotshal and Manges (London).