Taxing interest: the hidden cost for UK property investors
TaxTalk - Autumn 2024
Overseas financing when buying a UK property may not be as simple as you think.
Cross-border financing arrangements used to acquire UK property can carry a hidden cost of up to 20% if investors fail to consider the UK withholding tax (WHT) rules carefully. These rules are complex, and a common but risky assumption is that they only apply to UK incorporated companies. But in reality, non-UK corporate investors are just as likely to be affected. Overlooking the detail of the WHT rules can be costly.
Real estate investments are typically highly geared due to the capital-intensive nature of the sector. They often require significant upfront funding.
When overseas investors want to acquire UK property, they may rely on cross-border funding through intra-group loans or external sources like banks. In such cases, where interest payments (or interest equivalents) are deemed to ‘arise’ in the UK, borrowers must consider the application of UK WHT rules.
What to expect from HMRC
There’s a risk that HMRC may argue the overseas financing is deemed to have a UK source and is therefore considered to arise in the UK. This is because often the corporate borrower’s sole income generating asset is its UK property, for which it receives UK rental income.
The WHT mechanism aims to secure tax revenue for HMRC earlier and mitigate the risk of non-declaration by recipients. The standard UK WHT rate is 20%, but in certain scenarios it can be reduced right down to 0%. The borrower is responsible for ensuring compliance, so any failure to withhold tax may mean HMRC charges interest and imposes penalties.
Most external loan agreements include a clause saying that if the lender incurs tax costs, such as WHT, the borrower must indemnify this cost by increasing the interest payments to a grossed-up figure. So the cost of borrowing can rise significantly.
What exemptions might apply?
As there’s a real danger of increased borrowing costs, it’s crucial to explore available tax reliefs and exemptions before entering any new loan agreements. These reliefs can be complex, so we recommend seeking professional advice.
Here are some commonly used exemptions:
- UK branch of an overseas bank. Payments of interest to the UK branch of a foreign bank relieve the borrower of WHT obligations
- Non-yearly interest payments. Although not clearly defined in legislation, interest that is not yearly generally refers to loans with a duration of less than a year. But this definition can be contentious, requiring professional advice
- Private placement exemption. This is particularly useful when a double tax treaty (DTT) between the UK and the third party lender’s jurisdiction does not reduce WHT to nil. Strict conditions must be met for the debt to qualify
- Qualifying asset holding companies. Payments made by these entities may be exempt from WHT
- Quoted Eurobond Exemption. Interest on a quoted Eurobond may also qualify for exemption.
Borrowers may be able to benefit from other exemptions and mitigations if none of the ‘domestic’ provisions apply, some of which are listed above.
In some scenarios the basic rate of WHT (20%) may be reduced under the terms of the relevant DTT. But it’s essential to review the applicable treaty and apply to HMRC for relief at source before making any interest payments.
For a review of your current cross-border financing arrangements, advice on upcoming agreements, or help with HMRC treaty applications, please contact Harry Gooch.