Interest and beneficial entitlement

The Court of Appeal has confirmed the earlier decisions of the FTT and UT that interest on loans paid to a UK entity as part of entirely tax motivated arrangements did not benefit from the exemption from withholding tax in ITA 2007 s.933: Hargreaves Property Holding Ltd v HMRC [2024] EWCA Civ 365. The question whether the UK entity was "beneficially entitled" to the interest in the circumstances had to be judged by reference to a purposive construction of the legislation as applied to the facts viewed realistically. Parliament had not intended the exemption to benefit the involvement of a UK entity on an "ephemeral basis by way of steps that were entirely tax-motivated" where its involvement not only had no commercial purpose but had no practical or real effect.

The Court of Appeal's decision, applying a straightforward Ramsay approach to the question, comes as a welcome clarification. While the UT's decision was mostly expressed on this basis, some conflicting suggestions in the UT decision as to the potential relevance of an Indofoods style "international fiscal meaning" to domestic provisions relating to beneficial ownership had given some cause for concern. However, the Court of Appeal has expressly rejected any such approach.  

Background

The case concerns a UK group which acquired UK property for investment. Some of the group's loan funding came from a variety of sources including directors, founders, Gibraltar trusts and the group's FURBS (funded unapproved retirement benefit scheme). In 2004, the group entered into restructuring arrangements in respect of this debt which involved a number of steps:

• Shortly before interest was paid, the relevant lender assigned for consideration the right to interest to a third party. Initially this was a Guernsey resident company or trust and later a UK company (Houmet);
• At the same time, the relevant lender assigned the principal either to another company or the same entity;
• One or two days after the assignment, the group paid the interest and principal to the third party; and
• Arrangements were then made for the relevant lender to advance a similar amount to fund these payments. (These would later be subject to the same arrangements for assignment and repayment as above).

In addition, the loan documentation was changed to contain terms that (i) the loan was repayable on 30 days' notice by the lender or any time by the appellant; (ii) all payments were to be made in Gibraltar from a source outside the UK; (iii) no assets in the UK were secured; and (iv) Gibraltar law was the governing law and Gibraltar courts had exclusive jurisdiction.

HMRC assessed the group to income tax on the basis that it should have withheld income tax on interest payments pursuant to ITA 2007 section 874. This applies to payments of yearly interest arising in the UK by a company subject to a number of exceptions.

The taxpayer group appealed and led four arguments in favour of its case that income tax was not payable on the interest payments:

• As regards interest payments to the UK tax resident company (Houmet), these fell within the statutory exception to the withholding tax obligation (s. 933 ITA 2007). That applied where the company was "beneficially entitled" to the interest income.
• Payments to the Guernsey company were protected by the double taxation agreement between Guernsey and the UK.
• Some of the interest payments, which were for loans of less than a year or close to a year, were not payments of "yearly interest" and thus not caught by s.874.
• The source of the interest under the relevant case-law principles was outside the UK. The interest was not therefore interest "arising in the United Kingdom" under s.874.

The FTT rejected that appeal and that decision was upheld by the UT. For details of the decision of the UT on the four points see our earlier article.

The taxpayer appealed the decision of the UT on two grounds:

• That the UK company was beneficially entitled to the interest and so the statutory exception to withholding tax in s.933 applied, and
• Interest payment on loans for less than a year were not payments of "yearly interest".

Decision of the Court of Appeal: beneficial entitlement

In relation to the interest payments to Houmet, the FTT had found that Houmet was contractually obliged to pay on the sums it received to the Guernsey entities involved in the planning as consideration for the assignment to it to receive the interest payments. The FTT also found as a fact that there was no business purpose for the involvement of Houmet and the only reason it was included was to provide an argument that the s.933 exception applied and disregarded the artificial step comprising the involvement of Houmet. On this basis and in the context of purely tax-driven reasons for Houmet's receipt of the interest, the FTT held that Houmet was not "beneficially entitled" to interest which it received and paid on. The Upper Tribunal upheld that decision based on a purposive construction of s.933.

The taxpayer argued that the FTT and UT had erred in applying a purposive construction to "beneficial entitlement" and should simply have applied the clear existing authorities in cases such as Wood Preservations.

The Court of Appeal has undertaken an extensive review of the authorities on the meaning of beneficial ownership and derived a number of principles:

• Beneficial ownership essentially means ownership for the benefit of the person in question
• There is a significant degree of overlap between beneficial ownership and equitable ownership but the concepts are not entirely co-extensive
• The fact that the concept of beneficial ownership is well established does not mean the usual purposive approach to statutory construction is to be ignored
• A person who is the legal owner of property will not be the beneficial owner if they do not in fact have any of the benefits ownership, such that they hold a mere legal shell
• It is possible for a property owner not to possess or lose beneficial ownership without it vesting elsewhere
• The concept of "beneficial entitlement" should be construed with regard to the authorities that consider the concept of beneficial ownership ie in broad terms as "entitlement with benefits".

The Court also agreed that the FTT had been correct to reject the argument that the concept of beneficial entitlement should be construed in accordance with the Court of Appeal decision in Indofood as the case was concerned with domestic legislation not an international fiscal meaning.

The Court also rejected the argument that the reference to "beneficial entitlement" in s.933 was in any sense immune to the requirement that legislation be construed purposively as formulated in Ramsay and subsequent cases.

How did these principles apply to the specific facts under consideration?

Firstly, the Court noted that in most cases, a UK resident company that is legally (or equitably) entitled to interest income and does not receive it on behalf of anyone else would be expected to be able to benefit from the exception in s.933. In particular, the Court did not endorse the suggestion of the UT's that mere payment on by the recipient company to an entity outside the UK may be enough to disapply s.933 because "there is the same underlying concern that tax on the income will not in practice be able to be collected".

Secondly, however, it was the interest payments in the context of the scheme of which they formed part that made the difference in this case. Section 933 needed to be construed purposively to the transaction viewed realistically. Under that scheme, the taxpayer was unable to demonstrate that Houmet had any of the benefits that might be derived from any entitlement to, or receipt of, the interest.

"The fact that Houmet no doubt used (or was treated by the parties as using) the interest to pay for the assignment is, in the circumstances of its entirely tax-motivated and artificial involvement which was not demonstrated to give rise to any risk or meaningful reward, not sufficient to answer the statutory description in s.933. Parliament cannot be taken to have intended that the exception in s.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. Houmet's involvement not only had no commercial purpose but had no practical or real effect."

The Court also rejected the argument that the fact that Houmet may have been required to bring the interest receipts into account for corporation tax purposes was sufficient to avoid the need to focus on whether it did, in fact, obtain any benefit from its entitlement to the interest. The requirement for the interest to fall within the charge to corporation tax in the hands of the recipient does not negate the need to determine whether the test of beneficial entitlement is met.

Yearly interest

The FTT held that the interest on the loans was yearly interest, despite repayment at or around the one year mark. In particular, the loans were regularly renewed by the relevant lender and formed part of a sequence of loans which represented the provision of fixed capital of the business. The FTT found that each lender made a continuous provision of finance over a lengthy period. The UT upheld that determination.

The Court of Appeal agreed that the FTT and UT had applied the correct approach. There was no legal error in concluding that the interest was yearly interest because the loans were in the nature of long-term funding, were regarded by the lenders as an investment and formed part of the capital of the business, with a permanency that belied their apparent short-term nature. It made 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. In reality, the lenders provided attractive long-term funding in the nature of an investment.

Comment

The decision covers many of the grounds that arise in relation to the question whether withholding tax should be deducted on payments of interest. As such it is a very useful source of authority in an area that is generally short of authority.

In relation to the meaning of whether a recipient of interest is "beneficially entitled" for the purpose of s.933 ITA 2007 or similar, the Hargreaves case is a stern reminder that if such a receipt of interest is tax motivated rather than having a business purpose, "beneficial entitled" will be narrowly construed by the courts to exclude scenarios where the interest is received and passed on. The explicit endorsement of the Court of Appeal that this is on the basis of the application of the Ramsay principle is welcome and should mean that the decision should not, in practice, trouble the very large number of capital markets and securitisation transactions in which UK source interest is received by a UK SPV which pays it on to noteholders or other secured creditors under the terms of notes and other contractual documents in accordance with a pre-determined "waterfall" of payment priorities for genuine commercial reasons as a means of raising finance secured over the incoming streams of interest rather than a tax avoidance purpose.

In particular, the confirmation by the Court of Appeal that the Indofoods approach is not appropriate in a domestic legislative context and its refusal to endorse potential suggestions by the UT that the principle might treat any situation in which interest received by a UK company is paid on under back-to-back obligations as not amounting to the UK company being "beneficially entitled" (regardless of purpose) is very welcome. This is in line with published HMRC guidance indicating that HMRC views the narrower "international fiscal meaning" of beneficial ownership which requires the beneficial owner to have full use and enjoyment of the interest as applicable only to beneficial ownership for treaty purposes and not for UK domestic tax law purposes. This guidance is relied upon by a great many securitisation and structured finance transactions in which interest is received and paid on by an SPV for commercial rather than tax avoidance reasons.

The finding that the interest on the loans was annual interest not short interest was entirely unsurprising. It has long been understood that interest on a series of loans which, while each less than one year individually, are part of a wider debtor-creditor relationship extending over a longer period is annual interest rather than short interest.