The obligation to withhold tax at source can catch out unwary companies, giving rise to penalties. Once upon a time, not so long (about 15 years!) ago, there was a form called a CT61, which was very much part of a corporate tax adviser’s life. CT61s do still exist, but nowadays they are far less commonly seen. Consequently, they are also more easily forgotten, even when they should be used. This can cause problems in terms of compliance breaches, cash flow disadvantages and, in the worst cases, unexpected tax costs.
Form CT61 should be used by a company to report payments to HMRC, where it is required to withhold tax at source. Until its abolition CT61's were also used to report Advance Corporation Tax payments, and this, together with various other legislative simplifications, leaves far fewer scenarios where withholding tax now has to be deducted, and hence less need for CT61s. Strictly, there is no such tax as withholding tax; the payer is acting as a tax collector on behalf of HMRC. The tax withheld is the recipient's income tax, which explains the rate applicable; 20 per cent. To ensure you don’t get caught out, it is critical to understand the categories of payments to which withholding rules apply.
When to withhold
The most common situations where withholding tax is triggered are where a UK company pays annual interest to a non-UK resident, including group companies and overseas banks, and where a UK company pays annual interest to individuals or partnerships, but other annual payments may also be subject to withholding.
It is important to note that the interest rules only cover annual interest, so there can be circumstances where interest on short-term borrowings should be paid without withholding tax being deducted. Another complexity arises from what is meant by payment. Clearly, transferring cash must be payment, but what about situations where interest is rolled-up or capitalised, so is satisfied by a further principal amount?
Companies should examine each annual payment, as it is often possible to eliminate the withholding tax by perfectly legitimate means. One possibility is to apply for the benefits of the UK’s Double Tax Treaty with a lender’s territory of residence. Each Double Tax Treaty is different, but they work on similar principles; the withholding is UK income tax, and is suffered by the non-UK recipient who is also taxed in their own country. To prevent this income being taxed twice, the treaty may reduce the withholding tax to a lesser amount, or potentially to nil.
Within Europe and in the case of intra-group arrangements, the EU Interest and Royalties Directive might be available to remove the requirement to withhold. The purpose of this Directive is to enhance the operation of the single market, and as such, depending on the precise group structure, the withholding obligation is over-ridden. It is vital to appreciate that such Treaty or Directive benefits cannot be self-assessed and direct application to HMRC is required. Equally, withholding tax cannot be mitigated retrospectively – once a payment is made, the liability is crystallised and must be reported on the CT61, so a proactive approach is recommended.
For advice on withholding tax for your company or group, please contact Rebecca Reading or your usual RSM adviser