INTM573121 - Thin capitalisation: filling in form 4450/1

Treaty shopping - an example

Consider the following facts:

• UKCo is a UK holding company with interest income only, amounting to £100,000, which is taxed at 30%.
• It has a 100% property-owning subsidiary, OzCo, in Australia.
• OzCo wants to borrow Eurodollars equivalent to £5m to buy a new property.
• A Dutch lender, DyCo, is prepared to lend to OzCo.
• Australia charges 10% withholding tax on interest flowing to the Netherlands.
• There is also a 10% withholding tax on interest flowing between Australia and the UK.
• There is no withholding tax between the UK and the Netherlands.
• DyCo wants a return of 8% free of all tax.
• The UK/Netherlands treaty contains an anti-treaty shopping clause.

If DyCo lends directly to Australia the calculations are:

Before entering into any arrangement involving treaty shopping UKCo has a tax liability of £30,000. It agrees to take part in an arrangement whereby the loan is made from DyCo to UKCo, which then passes the loan on to OzCo under the same terms. UKCo will receive interest of £40,000 from OzCo, less £4,000 withholding tax. It will pay £40,000 interest to DyCo with no withholding tax.

The position of UKCo after entering into the arrangement is:

Before the arrangement the CT liability of UKCo was £30,000; after it the liability is £26,000. The UK is £4,000 worse off, effectively paying the Australian withholding tax.

In a case such as this the main purpose of the loan from the Netherlands to the UK was to avoid tax. Treaty benefits will not therefore be given, and tax should be deducted from the interest payments at the full domestic rate.