Taxation of Restitution Interest Payments

The UK Government has introduced a new 45% tax charge on awards of restitution interest paid by HMRC to companies in relation to claims for tax paid under a mistake of law or an unlawful collection of tax with effect from 21 October 2015.¹ The new tax charge is most likely to affect awards of interest on claims for repayment of taxes paid in breach of EU law.

The decision to introduce a tax charge on payments of restitution interest is controversial, and it is anticipated that it will face legal challenge.  It is arguable that the charge defeats the very purpose of a restitutionary award, namely to reverse the unjust enrichment of HMRC.

The tax charged is corporation tax rather than income tax and is to be withheld at source by HMRC.  Restitution interest is subject to the corporation tax charge on income, and all profits consisting of interest will be chargeable to tax as income regardless of whether they are income or capital in nature. However, the amount of restitution interest is not to be included in computing the company's total profits. This effectively "ring-fences" the item so that it cannot be reduced by losses, relief, allowances or set-offs available against the company's other profits. The territorial scope of the tax charge on restitution interest is restricted to UK resident companies and non-UK resident companies carrying on a trade through a UK permanent establishment.²

The legislation includes a general anti-avoidance provision as well as provisions tackling assignment of rights and company migration.

What is restitution interest?

Restitution interest falls within the 45% charge to corporation tax if the following three conditions are satisfied:

1. there has been a payment by HMRC of interest in respect of a claim by the company relating either to a payment of tax made under a mistake of law or an unlawful demand for or collection of tax;
2. the claim has been finally determined³ or settled by agreement between HMRC and the company; and
3. the interest due is not limited to simple interest at a statutory rate.⁴

Challenge

The new tax charge is vulnerable to legal challenge on the basis that it may deprive taxpayers of an effective remedy for breach of directly effective EU rights. If a taxpayer's rights are only fully vindicated with an award of compound interest, receiving only 55% of that amount may result in a less than effective remedy.

The counter argument the Government has outlined to justify the 45% tax rate is that the rate reflects the particular circumstances of the awards (i.e. the number of years over which the overpayments of tax were made, the fact that any such awards would be calculated on a compound basis and the historic rates of corporation tax rates that applied during the years to which the claims relate).  Rates of UK corporation tax in the 1970s and early 1980s were as high as 52%. The introduction of the 45% charge on restitution interest may, in respect of compound interest awards on claims dating back to this period, serve to more accurately reflect the lost benefit to the taxpayer.

However, the 45% tax charge will also impact on the interest payable for claims relating to overpayment tax in more recent years (when rates of corporation tax have been between 35% and 20%).   The imposition of the new tax charge on awards of interest on such claims will give rise to the argument that HMRC has not given up the whole benefit it received as a result of the overpayment of tax which is the objective of a restitutionary claim.

The anti-avoidance provisions

The legislation includes a targeted anti-avoidance provision as well as provisions dealing with assignment of rights and company migration.

Targeted anti-avoidance provision

Any restitution-related tax advantages arising from a relevant avoidance arrangement are to be counteracted by just and reasonable adjustments.

Relevant avoidance arrangements are defined to include any agreements, understandings, schemes or transactions for which the main purpose, or one of the main purposes, is to enable a company to obtain a tax advantage in relation to the application of the charge on restitution interest.

Relevant avoidance arrangements do not include arrangements for which the arising tax advantage can be regarded as consistent with wholly commercial arrangements.

Assignment of rights to a person not chargeable to corporation tax

Where a company transfers its right to restitution interest to a person who is not within the charge to corporation tax, and the main purpose, or one of the main purposes, of the transfer is to secure a tax advantage relating to the charge on restitution interest, the transferor remains liable for the corporation tax on the restitution interest.

For these purposes, a person is within the charge to corporation tax if they are a UK resident company and would not be exempt from corporation tax on restitution interest.

Migration of the company with a claim for restitution interest

Where a company ceases to be UK resident, and the company's main purpose, or one of its main purposes, in changing its residence is to secure a tax advantage relating to the charge on restitution interest, the company will be treated as UK resident for the purposes of the charge.

Mechanism of payment

HMRC will withhold the tax on restitution interest when making payments to companies.[v]  It is required to provide companies with a written notice stating the amount of the gross payment and the amount deducted from it. The withheld tax will be treated as having been paid by the company on account of its liability, or potential liability, to corporation tax on the restitution interest.

Appeals

Companies have a statutory right to appeal against the deduction by HMRC.  Appeals must be given in writing within 30 days of HMRC's notice advising the taxpayer of the withheld amount.

Subsequent repayments by the company/HMRC

If, after the payment in respect of interest had been made, it is determined that the payment was not restitution interest at the time that it was paid, and the company is not required to repay the net amount it has received, HMRC is required to repay the amount of the withheld tax.

If the amount withheld by HMRC exceeds the amount which should have been deducted, HMRC is liable to pay interest on the excess from the date on which the deduction was made at a statutory rate.

If, after the payment has been made, the company is required to repay the gross amount of the restitution interest received, the amount of tax withheld is treated as money repaid in partial satisfaction of the company's liability to repay the gross amount.

When does restitution interest arise to a company?

The amounts to be brought into account as restitution interest for any period are those that are recognised in determining the company's profit or loss in accordance with GAAP.

Adjustments must be made to tax returns (and any time limits for making those adjustments disregarded) if the interest is paid or becomes payable by HMRC after the end of the accounting period for which the amount is to be brought into account as restitution interest.

There are specific provisions to cover circumstances where a judgment is reversed on a late appeal in favour of HMRC.

Assessments

The legislation prescribes that HMRC may raise an assessment of the amounts chargeable as restitution interest, and that this will take into account any deductions made for withholding tax.

¹ The charge was introduced by the Finance (No. 2) Act 2015, which inserted a new Part 8C into the Corporation Tax Act 2010.  The charge applies to awards finally determined or settled on or after 21 October 2015.

² Section 5 of the Corporation Tax Act 2009 provides that a UK resident company is chargeable to corporation tax on all its profits wherever arising; and a non-UK resident company carrying on a trade through a UK permanent establishment is chargeable to corporation tax on its profits attributable to the permanent establishment.

³ Finally determined means a court (including a tribunal) has made a determination that cannot be varied on appeal (e.g. if there is an absence of a right of appeal or there has been a refusal of permission to appeal or no appeal has been made in time).

⁴ Interest is stated to include any amount that is equivalent to interest, that is an amount determined by reference to the time value of money. Interest paid as statutory interest before the date of the final judgment or settlement will not fall within the definition of restitution interest.  However, an award of interest including or calculated by reference to simple interest at a statutory rate may fall within the charge.

⁵ HMRC's withholding obligation arises on payments made on or after 26 October 2015.