The double tax treaty passport (DTTP) scheme was introduced in 2010 as a mechanism to simplify the process by which non-UK lenders could receive interest payments from UK borrowers without deduction for withholding tax under the terms of applicable double tax treaties. However, until April 2017, the DTTP scheme only applied to loans where both the borrower and lender were corporates. From April 2017, HMRC has extended the DTTP scheme to all types of borrower and certain lenders (including partnerships and pension funds), provided that the requisite conditions are met.
How are payments of interests to non-UK lenders taxed in the UK?
Where a borrower pays interest to a non-UK lender, they are required to deduct and pay over to HMRC 20% of the payment (referred to as "withholding tax") if the payment arises in the UK.
When does a payment arise in the UK (ie when is it subject to withholding tax)?
Various factors are taken into account in determining if payments arise in the UK, including whether:
- The borrower is UK resident
- The borrower's assets are located in the UK
- Interest payments are made from or to a UK bank account
- The loan agreement is governed by UK law
- The security for the loan is located in the UK
What effect does withholding tax have on the parties to the loan agreement?
Depending on the provisions of the loan agreement, either:
- The borrower may have to increase its interest payments so that the lender receives the full amount of interest
- The lender may only receive the net amount of the interest payment from the borrower, with the remainder paid to HMRC
Can withholding tax be reduced or eliminated?
The UK is party to numerous double tax treaties with other countries, under which interest can be paid by a UK borrower to a lender situated in the other jurisdiction without withholding or at a lower rate than 20%. In order to benefit from the lower (or zero) rate of withholding under a double tax treaty, the borrower must first receive a direction (or clearance) from HMRC. The lender is required to apply for this clearance.
How did lenders apply for clearance under a double tax treaty before the DTTP scheme?
Lenders applied for clearance under a relevant tax treaty by submitting a claim form to their local tax authority, which certified the lender's tax residence and passed the form to HMRC. This was known as the "certified claim" method. HMRC would then issue a clearance to the borrower enabling interest payments to be made without withholding (or with deduction at the reduced rate specified in the relevant double tax treaty).
What were the problems with the certified claim process?
The certified claim process is often time-consuming (with the IRS currently taking around three months to certify a US lender's place of residence) and also needs to be carried out for every loan. Lenders could therefore be put off lending into the UK, given the additional cost and time required to obtain the direction.
How did the government reduce this deterrent?
In 2010, HMRC instituted a simplified process for lenders to apply for clearance, known as the DTTP scheme.
How does the DTTP scheme apply to lenders?
Lenders apply for a "passport", valid for a five-year period, confirming their eligibility to benefit from the provisions of the double tax treaty between the UK and the lender's country of tax residence. HMRC allocates a unique treaty passport number to the lender.
How does the DTTP scheme apply to borrowers?
Borrowers notify HMRC of the details of the loan and the lender's treaty passport number when a loan is entered into utilising the scheme. HMRC then issue a clearance (usually within 30 days) to the UK borrower enabling interest payments to be made without withholding.
What were the limitations of the DTTP scheme?
Until April this year, the DTTP scheme was limited to loans between corporate borrowers and corporate lenders, whilst non-corporates had to rely on the more onerous and slower certified claim procedure to obtain clearance.
What changes have been made?
HMRC has extended the DTTP scheme to the following entities:
- Borrowers - all borrowers, including individuals, partnerships and unit trusts
- Lenders - tax transparent or look through entities, for example partnerships will be able to apply for a treaty passport, provided that all of the beneficial owners of the interest payments are resident in the same jurisdiction and entitled to the same benefits under the relevant double tax treaty. Pension funds and sovereign wealth funds may also qualify
What limitations still exist?
The DTTP scheme has not been extended to tax transparent entities where the beneficial owners are resident in different jurisdictions. Non-corporate lenders must also notify HMRC if there are any changes in either the identity or country of residence of its members or partners. The extension of the DTTP scheme to non-corporate lenders is therefore likely to be most advantageous for entities whose memberships are relatively stable.
When did the changes come into effect?
The changes came into effect for loans entered into on or after 6 April 2017. Lenders who made loans to non-corporate borrowers prior to this date will be subject to the previous rules, so will need to use the "certified claim" procedure to obtain clearance from HMRC to receive interest payments without withholding.
What about syndications and assignments?
Loans entered into before 6 April 2017, but sold or assigned on or after this date, will be treated as being entered into on the date the loan is transferred, so the new provisions of the DTTP scheme can apply to the transferred loan.
Are the changes wholly positive?
Yes. They should simplify compliance and costs for borrowers and lenders alike and therefore make the UK a more attractive place to lend.