OT22105 - Interest and Financing

Timing of Review.

Where an interest deduction has to be considered all the issues must be reviewed on the basis of the most up to date information. Put another way, in considering the application of DTA's and FICO clearance applications, and/or in considering any requests for letters of comfort from companies themselves under general clearance procedures, OTO needs to see the spreadsheets and projection information that an independent bank would want to see. For example, in considering a loan clearance in March 2002 OTO would expect to see copy audited and approved accounts to at least December 2000 together with un-audited accounts and management accounts to December 2001. Another requirement would be cash flow projections from say January 2000 over the anticipated lifetime of the loan.

If interest is payable by one company to another within a group, whether both companies are in the same country or not, there is no net income and no net expense to the consolidated group taken as a whole. If however one tax authority taxes the receipt of the interest whilst another denies relief for the payment the group suffers a tax cost where there is no net income. This is termed "economic double taxation". The OECD nations have agreed to try to avoid the incidence of economic double taxation. By extension of this policy, if interest is payable by one UK resident company within the ring fence to another outside the ring fence then if OTO refuses relief for the interest payment it would usually agree not to tax the interest receipt, and for CTSA periods this corresponding adjustment would be required by statute. However, if the interest is paid by a UK resident ring fence company to an overseas parent the overseas fisc may well have taxed the receipt of the interest before OTO even considers the allowability of the deduction. If OTO then denies relief for the payment (or accrual after FA96) it would create a situation in which economic double taxation will arise if a corresponding adjustment cannot be negotiated with the overseas fisc.

Potential problems on the deduction of interest should therefore be challenged at the earliest possible opportunity.

An exception to the problem of economic double taxation arises when the payer of the interest is a UK/US dual resident paying interest to a US company that is not UK resident. There is a net deduction for UK tax purposes but, as both companies are part of the US consolidated tax group, the deduction and the receipt will be self cancelling in the USA irrespective of the UK tax treatment. Therefore apart from any issue of US tax credit for UK tax paid the payment of interest in these particular circumstances becomes a matter solely of UK tax relief.

The first indication of new borrowing from an overseas associate will often be an application to FICO by the non resident for interest to be paid gross under treaty. This will become apparent in OTO when form 4450/1/FD is received for completion by the accounts Inspector. When this happens is the best available time to consider thin capitalisation and open discussions with the group. If there is prima facie concern enquiries will be raised, and liaison made with other colleagues in International as appropriate. If the company submits its return and accounts for the period during your enquiries, they will have to be carried out under the formal CTSA enquiry procedures and co-ordinated with any other enquiries. Once it is known that a challenge is to be made to interest deductions companies will be very reluctant to go ahead and pay intra-group interest until they can get our agreement that it will be deductible.

In the absence of an exemption notice issued by FICO (International) (formerly IFD) there is, of course, a statutory obligation to deduct tax at the appropriate rate from the interest payments made overseas. Retrospective relief for consent to pay interest gross under treaty may be allowed but retrospection will not go back to a date earlier than the date of the receipt by FICO (International) of the claim by the non-resident.