Hargreaves Property Holdings: withholding on yearly interest

Hargreaves Property Holdings Ltd v Revenue and Customs [2024] EWCA Civ 365 is a significant case on withholding tax. It is a good reminder of the basic principle that any payment of 'yearly interest' with a UK source is generally subject to withholding tax, and of the key exceptions to that obligation.

The case involved short-term recurring loans, with interest paid to a UK resident company. The taxpayer argued that withholding was not due as the interest was not 'yearly interest' and a UK resident company was beneficially entitled to it. Following a thorough analysis of the relevant authorities, in particular those concerning the meaning of beneficial entitlement, both grounds were dismissed by the Court of Appeal.

Facts

Hargreaves Property Holdings Ltd (Hargreaves), the UK resident parent company of a UK property investment group, funded the group's commercial activities through interest-bearing loans from connected overseas lenders.

Hargreaves restructured its loan agreements in 2004, with the intention that loan interest would not be subject to UK withholding tax, whilst still obtaining relief for its interest expense. The loan arrangements were structured so that:

• shortly before interest was paid, the relevant non-UK lender assigned its right to interest (and to the principal) to a Guernsey resident entity. From 2012, the Guernsey entity would further assign the interest to a UK tax resident company (Houmet).
• In consideration for the interest assignment, the assignee paid the assignor a similar sum to the interest that had been assigned to it.
• One or two days after the assignment, Hargreaves paid the interest, without withholding tax, and principal to the assignee (Houmet or the Guernsey entity, as relevant).
• The original lender then advanced a new loan to Hargreaves, the new loan being funded by the proceeds from the loan assignment.

This cycle of assignment, repayment and further advance repeated and was regularly renewed by Hargreaves and the lenders.

HMRC asserted that Hargreaves should have withheld tax from the interest payments. As a general rule, any payment of 'yearly interest' with a UK source is subject to withholding tax (s874 Income Tax Act 2007).

Issues

At the Court of Appeal, Hargreaves argued that two exceptions to the withholding obligation applied:

1. interest paid in respect of loans which were repaid in less than a year was not 'yearly interest', and therefore not subject to the obligation to withhold.
2. Interest paid to Houmet (the UK assignee company) fell within the exception to the withholding tax obligation for income to which a UK resident company is ‘beneficially entitled’ (s933 Income Tax Act 2007).

Court of Appeal decision

The Court of Appeal, upholding the decisions of the First-tier and Upper Tribunals, dismissed both grounds of appeal put forward by Hargreaves.

Beneficial entitlement to interest

Following a thorough analysis of the relevant authorities on the meaning of beneficial entitlement and beneficial ownership, the Court determined that Houmet was not beneficially entitled to the interest it received for the purposes of s933, and therefore this exception to the obligation to withhold did not apply.

The Court applied a Ramsay purposive analysis to s933 and considered whether the facts in this case fell within its intended scope. It considered Houmet's inclusion in the structure to be "entirely ephemeral" as well as "tax-motivated and artificial" with no commercial purpose for its involvement. Houmet did not benefit in any real sense from its entitlement to the interest it received, which it was obliged to pay away, nor was it at risk as to the amount that might be paid to it. The Court therefore considered that the s933 exception to the withholding obligation did not apply to payments of interest to Houmet, and could not have been intended by Parliament to do so.

Other key points made by the Court in relation to beneficial entitlement included:

• the fact that Houmet was required to bring the interest receipts into account for corporation tax purposes did not negate the requirement to consider whether, in fact, it obtained any benefit from its entitlement to the interest.
• The Court did not endorse the Upper Tribunal's suggestion that mere payment onwards by a recipient of interest to an entity outside the UK is enough of itself to cause beneficial entitlement to be lost and for the s933 exemption to be disapplied.
• The Court confirmed that the narrower Indofood approach to beneficial ownership, which requires the beneficial owner to have full use and enjoyment of the interest, is not appropriate in a domestic legislative context, and is reserved, rather, for treaty purposes.

Yearly interest

Interest paid on the loans was determined by the Court to be 'yearly interest' and therefore subject to withholding.

Although many of the loans were repaid in less than a year, they were regularly renewed by the lenders and formed part of a sequence of loans which could not be viewed in isolation. The Court considered the loans to have a "permanency that belied their apparent short-term nature", taking the form of "long-term funding". Hargreaves' argument that withholding was not due as interest was not 'yearly interest' was therefore rejected.

Reflections

In relation to the s933 exception from withholding, the case is a notable reminder that the concept of 'beneficial entitlement' will be narrowly construed in the context of a tax-motivated receipt of interest, excluding scenarios where interest is received and passed on by an entity with no commercial purpose. However, the Court's move away from the Upper Tribunal's worrying suggestion that on-payment of interest alone could be enough to lose beneficial entitlement is to be welcomed, as is its confirmation that Indofood's narrow interpretation of beneficial ownership is irrelevant for domestic purposes.

On yearly interest, it is not uncommon for financing structures to involve a 'rollover' of short-term loans. The withholding tax position should be considered carefully in these circumstances, and any risk of withholding allocated in accordance with the commercial agreement between the parties.