The fact that a non-resident recipient of UK interest suffers UK income tax, by deduction, does not guarantee deductibility to the payer: the loan could, for example, be a loan relationship for an unallowable purpose. See INTM510050 for further guidance on loan relationships for unallowable purposes.
In cases where it is asserted that the obligation to deduct income tax from cross-border interest does not apply, the terms of the facility should be reviewed to ensure that, for example, interest is indeed short interest. See INTM505020 for the relevant definitions.
The precise terms of the relevant double taxation agreement
should be inspected to ensure that the conditions for a reduced
rate of withholding are satisfied.
For example, certain agreements do not permit a reduced rate
of withholding tax, where the loan has been entered into in order
to benefit from the treaty and not for bona fide commercial
reasons.
Where the OECD Model Tax Convention has been followed, the
agreement will normally include the following provision at Article
11(6):
Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.
Where this provision applies, the excess interest will be subject to deduction of income tax without reduction.
Also see the chapter on avoidance and arbitrage at INTM509000.
