PIM2110 - Deductions: interest: paid abroad

Business deduction and deduction of tax

The residence status of the lender does not affect the taxpayer’s right to an interest deduction in computing the profits or losses of their rental business. But where they pay interest to a lender whose usual place of abode is outside the UK, they should normally deduct IT at the basic rate from the payments they make and account for it to HMRC, (ICTA88/S349 (2) and ITA07/S874 (1)). But see the paragraph below for more about double tax agreements.

Double taxation agreements

Where there is a double taxation agreement between the UK and the country of residence of the lender, it may be possible for the lender to obtain authority from HMRC to have the interest paid without deduction of tax, or under a reduced rate of withholding tax. This will depend on the terms of the double taxation agreement with the country of the lender.

Applications by lenders who are not resident in the UK to receive interest abroad without deduction of tax, or under a reduced rate of withholding tax, should be made to CAR Residency, Fitzroy House, PO Box 46, Nottingham NG2 1BD.

The borrower can’t apply to pay the interest without deducting tax - it must be the lender. Borrowers must deduct (and pay over to HMRC) the full amount of the basic rate tax unless they have authority from HMRC to deduct less than the full amount. If they pay the gross interest to the non-resident lender without deducting tax, they will still have to pay HMRC the tax they ought to have deducted.

Interest paid at uncommercial rates

Interest paid to a lender not resident in the UK over and above a commercial rate isn’t allowable as a deduction even if it would otherwise qualify (perhaps because the loan was used to buy a rental business property). Generally, HMRC will accept the interest charged by the lender as an allowable deduction where it is paid on an arm’s length loan made on a normal commercial basis.

To summarise:

• interest paid abroad may have to be paid under deduction of tax,
• lenders may be able to get interest paid gross or at a reduced rate of tax, under double taxation agreements,
• interest paid abroad is not allowable as a deduction to the extent that it is paid at an uncommercially high rate.

Take a broad view of what is a reasonable commercial rate. You should not normally seek an adjustment where the payer and recipient are at arm's length. If interest is payable in the UK on an advance from a foreign bank carrying on a bona fide banking business in the UK through a branch, treat it as if it were interest payable to a UK bank.

If an adjustment is required because the interest is at more than a normal commercial rate, the adjustment is the excess over a reasonable rate, not the whole of the interest.

Non-resident companies

ICTA88/S337A was introduced by FA96 as part of the new provisions relating to corporate debt. Section 337A states that, in computing a company's income, no deduction is available for interest except in accordance with the loan relationship rules in Chapter II of Part IV, FA96. However, Section 337A does not preclude a deduction for interest for companies chargeable to IT such as non-resident companies with income from UK property.