INTM505020 - Payment of interest overseas: deducting income tax

Obligation to deduct - legislation and definitions

Legislation

ICTA 88/S349(2)(c) provides that

'where any yearly interest of money chargeable to tax under Case III of Schedule D … is paid … by any person to another person whose usual place of abode is outside the United Kingdom, the person by or through whom the payment is made shall, on making the payment, deduct … income tax … (at the rate applicable) for the year in which the payment is made'.

Definitions

Interest

It is necessary to establish that the payment is interest. A full discussion of interest is outside the scope of this Manual. Detailed guidance on the nature of interest is to be found in the Inspector’s Manual at IM1500 and in the Company Taxation Manual, see CTM51705. The question of what constitutes interest has been the subject of much case law. The key decisions are summarised in CTM51760. Further technical advice in cases of difficulty can be obtained from CT & VAT, Specialist Financial.

Before 1st April 2004, where all or part of a payment was characterised as a distribution under ICTA88/S209, that amount could be interest for the purpose of ICTA88/S349(2)(c) and, therefore, was not subject to deduction.

Yearly interest

Yearly interest is interest calculated by reference to a debt which will be, or which is intended to be, outstanding for a period of a year or more. Short interest is calculated by reference to a debt which will be, or is intended to be, outstanding for a period of less than one year. The leading case law in this area explains that the intention of the parties to the debt is key in determining whether interest is yearly or short. Further guidance on these case law authorities can be found in the discussion of repo price differentials at IM4326.

Further technical advice in any case where the distinction between yearly and short interest is unclear or is disputed may be obtained from CT & VAT, Specialist Financial.

Chargeable to tax under Case III

Interest is chargeable to tax under Case III where the source of interest is in the United Kingdom. Guidance on whether or not an interest payment has a UK source can be found in the Savings and Investment Manual at SAIM9090.

Paid

It will usually be quite clear when interest has been paid.

However, there are a small number of special cases, for example:

• where interest is capitalised by being added to the principal sum, this will generally not constitute payment. Income tax should be deducted only when payment of the interest is actually made. The tax rate applicable is the rate of lower rate income tax which is in force at the time of actual payment. See IM3942 for a more detailed discussion of capitalised interest.
• where book entries are accepted as evidencing payment of interest (see CT12200), income tax should be accounted for, unless one of the exclusions or exemptions applies.

Further advice in any case where there is difficulty in determining whether interest has been paid may be obtained from CT & VAT, Business Profits & Relief BT1/3 (Interest).

Usual place of abode

Usual place of abode means principal place of business or the place where the person is normally to be found. It is not the same as tax residence. The term 'usual place of abode' is used in the legislation because the purpose of the legislation is to provide an effective way of collecting tax due from someone who is usually outside the UK and/or does not have a taxable presence in the UK.

United Kingdom

The United Kingdom comprises England, Wales, Scotland and Northern Ireland.