Withholding tax - the importance of commercial reality

19 February 2022

The recent HMRC victory in the First-tier Tribunal (FTT) case of Hargreaves Property Holdings Limited v HMRC serves as a reminder for taxpayers of the potential pitfalls that may lie in wait for those who focus on the strict legal form of a transaction whilst overlooking its commercial reality, when assessing whether a relevant payment may be subject to the requirement to deduct UK income tax at source (withholding tax).

Whilst Hargreaves is ostensibly concerned with whether tax should be withheld on payments of interest, many of the principles discussed in the decision are equally relevant to the payment of royalties.

The facts

Hargreaves is a property business that was, for the years under appeal, wholly UK based. The business required ready access to funding to grow its property portfolio, so funding was initially obtained from third party lenders, its UK based shareholders and other parties connected with the shareholders. However, as part of tax planning arrangements intending to ensure UK corporation tax deductions for the interest with no UK tax on the lenders:

  • the terms of the related party loans were amended to ensure that the interest payments would be made in and governed by law of a jurisdiction (Jersey) other than the UK; and
  • shortly before interest was due to be paid, the loans would be assigned to an unrelated non-UK resident (Guernsey) company, and the interest and full principal amount of the loans would be paid by Hargreaves to that company annually, a few days after assignment and funded from new loans advanced by the related parties.

At a later date, it was agreed that the loans assigned to the Guernsey company would instead be acquired by unrelated Guernsey trusts and the right to receive interest assigned by them to an unconnected UK company.

The FTT focussed on four key concepts, which businesses need to consider when determining whether withholding tax is in point:

  1. Did the payments have a UK source?
    The claimant argued that, given the loan terms were no longer governed by UK law and following the initial assignment, the interest did not have a UK source and hence was excluded from the requirement to withhold tax. Whilst acknowledging the legal agreements, the FTT reviewed the underlying commercial reality of the arrangements and determined the interest to have a UK source on the basis that the payments were funded out of assets and profits of activities situated in the UK.

  2. Was the interest yearly interest?
    The claimant next argued that the interest was ‘short interest’ (ie on loans not capable of exceeding one year’s duration) and, therefore, not subject to the requirement to withhold tax. This argument was made on the basis that the loans were repayable on demand, had a lending term of less than 12 months, and were always repaid within 12 months.

    The FTT, however, concluded that the interest was in fact yearly in nature, and therefore subject to withholding, as the continuous presence of the underlying funding (albeit represented by a series of separate loan instruments) indicated the commercial reality was that the loans were intended to form part of the long-term financing requirements of Hargreaves’ business, regardless of how this was presented in the legal documentation.

  3. How did the relevant double tax treaty apply?
    The relevant double tax treaty following the initial assignment was the UK:Guernsey treaty. The claimant argued that the treaty provides that a Guernsey resident company is not subject to UK tax unless its profits are connected with a UK permanent establishment and hence that there is no basis for UK tax to be withheld. Although not concluding on whether interest income was covered by the treaty, the FTT instead determined that relief under the treaty would not be available as the taxpayer did not submit the required claim or receive the required direction from HMRC before seeking to rely on it.

    This highlights the importance of not only understanding whether the relevant double tax treaty may afford relief, but also of ensuring that the administrative steps required to benefit from that relief are followed.

  4. Who was the beneficial owner of the interest income?
    The claimant argued that, following the assignment of the right to receive interest to an unrelated UK company, the interest payment was not subject to the requirement to withhold tax as interest payments made to UK companies are excepted.

    However, the legislation is clear that the exception only applies to the extent the recipient is beneficially entitled to the interest. In the absence of evidence to the contrary, the FTT found that the unrelated UK company had no business purpose other than to ensure that the interest income was received by a UK resident company and thereby to secure a tax advantage. The FTT concluded that, save for the interest accruing in the days between assignment and payment, the unrelated UK company was not beneficially entitled to the interest and, therefore, it was subject to withholding.


The concepts discussed in Hargreaves may be familiar to many businesses, but the case underlines the importance of taking an objective and balanced review of both the legal documents and the commercial fact pattern when determining whether withholding tax is in point.

For more information, please get in touch with Suze McDonaldPeter Coe, or your usual RSM contact.