The UK Court of Appeal has handed down a judgment on a financing structure which used several steps to try to take advantage of domestic exemptions from UK withholding tax. Contrary to the taxpayer’s arguments, the court applied a purposive interpretation to the relevant tests which the taxpayer ultimately failed to meet.
The case is interesting to an international audience as it shows that UK domestic tests are subject to a similar purposive interpretation as may arise in a treaty context. There are also practical takeaways for borrowers in a normal lending scenario.
Background
Hargreaves Property Holdings Limited (Hargreaves) was the holding company of a UK real estate group. Hargreaves restructured its loan financing (for tax reasons) so that its lenders repeatedly assigned their rights in the loans to third parties (first in Guernsey and then on to a UK resident company called Houmet). Each time, this assignment occurred shortly before the loans were repaid and then re-advanced by the original lenders.
The question before the Court of Appeal was whether the payments made by Hargreaves were subject to UK withholding tax. Hargreaves had previously argued (unsuccessfully) that the payments could benefit from double tax treaty relief and/or the payments were not “UK source” in nature.
At this level the two issues were whether:
(i) Houmet was beneficially entitled to the interest such that a domestic exemption for payments made to UK resident companies applied; and
(ii) Whether the payments were of “yearly interest” or of “short interest”, noting that the loans were repaid before the expiry of a year (the requirement to withhold only applying to payments of “yearly interest”).
“Beneficially entitled”
Hargreaves argued that in determining whether Houmet had “beneficial entitlement”, regard should be given to a line of cases (including the recent Court of Appeal case of Bostan Khan v HMRC [2021]) that suggested that a purposive approach to the legislation should not be applied.
The Court of Appeal disagreed. Lady Justice Falk stated that the relevant provisions were not immune from the requirement to apply the principles set out in WT Ramsay Ltd v Inland Revenue Commissioners [1982], namely that it was necessary to consider “whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”
Firstly, Falk confirmed that, when interpreting the concept of beneficial entitlement, little regard should be given to the “international fiscal meaning” as set out in Indofood International Finance v JP Morgan Chase Bank [2005], as the question was one of domestic law as opposed to treaty interpretation.
Falk examined relevant domestic case law on beneficial entitlement and noted that a legal owner of a property will not be its beneficial owner if they do not have any of the benefits of ownership (i.e. they hold only a “mere legal shell”), and that the burden of proof was on the taxpayer to show that the requirements had been met.
The Court of Appeal also assuaged concerns, raised by comments in the Upper Tribunal, that where a UK borrower makes payment to a non-resident, that, in and of itself, will mean that the withholding tax exception at section 933 of the Income Tax Act 2007 will not apply. The Court of Appeal did not endorse this view.
Hargreaves was though unable to provide evidence to discharge the evidential burden. The First Tier Tribunal (FTT) was provided with no explanation as to the role of Houmet in the structure or the reasons for the assignment of the interest to it.
The FTT accepted that Houmet was not acting in a role as trustee but the Court of Appeal considered that beneficial entitlement required more. Ultimately the decision was made, to apply Ramsay principles.
The court concluded that “Parliament cannot be taken to have intended that the exception in [section] 933 should extend to a company in the position of Houmet, which was involved on an ephemeral basis by way of steps that were entirely tax-motivated, and which has not been established as having benefited in any real sense from the interest that it paid away.”
The Court of Appeal also commented that whilst the framing of the legislative test is that the borrower needs to have a “reasonable belief” that the lender is a UK company that has beneficial entitlement, this reasonable belief element was not in point.
This is because if the reasonable belief is incorrect then the exemption is not available. Ultimately it is an additional requirement as opposed to a relaxation.
Considering the practical implications of this, the normal Loan Market Association construct is that UK non-bank lenders (covered by the relevant exception) give a tax confirmation of their status (including as to beneficial entitlement) on their accession to the agreement.
This though is usually stated as being for the agent’s benefit and without recourse against the lender if it is wrong. The borrower is therefore on risk if that tax confirmation is incorrect.
Considering the difficulties faced by Hargreaves in evidencing Houmet’s position, borrowers may want to consider seeking contractual protections to ensure that any tax confirmation is correctly given.
Having said that, Hargreaves was a case of clearly tax-motivated structuring and thus should be considered as very distinct from normal commercial lending (where usually a lender should be able to show that they retained more than a “mere legal shell”).
Yearly interest
The other ground in front of the Court of Appeal was whether the interest on the loans could be considered as “yearly” or whether it was short interest not subject to withholding.
The loans were repayable on demand with no automatic extension or re-advancement of monies. In reality though, whilst the loans were repaid within a year, they were repeatedly replaced by loans from the same lenders and new loans were not refused.
The Court of Appeal considered that the FTT and UT applied the correct test, namely set out in HMRC v the Joint Administrators of Lehman Brothers International [2019] that a “business-like” assessment should be taken of the loan’s likely duration. Applying this test, they were of the view that the loans were clearly long-term funding. They fulfilled a commercial need for the business and left the borrower’s assets free from security.
The Court of Appeal noted that “it makes no difference to this whether an individual loan happened to last for less than a year. On a business-like assessment, those loans could not be viewed in isolation as short-term advances.” Interest on them was therefore subject to UK withholding.
The author is indebted to Hobz De Caux, trainee solicitor at Norton Rose Fulbright, who assisted on the creation of this piece.
