What’s the Interest in Lending between Companies?

In the evolving business landscape, many companies find themselves seizing expansion opportunities by increasing their level of borrowing. This strategic move may involve complex financial arrangements, such as personal loans from directors and securing loans from entities both within the UK and internationally. With such financial maneuvers come intricate tax considerations, particularly concerning the deduction of tax at source when repaying interest on these loans. The tax implications can vary significantly depending on the nature of the lender and the geographical origin of the loan. It is crucial for businesses to navigate these waters with the utmost precision to avoid any unforeseen tax liabilities.

In the following article, we dissect the intricacies of whether tax should be deducted at source at a rate of 20% before making interest payments to these varied lenders.

The tax rules differ for each of the above types of loans. Companies (including non-resident companies trading from a branch or agency in the UK and local authorities) must deduct tax from payments of yearly interest they make to a director. Companies making these deductions are obliged to account for the amounts deducted using form CT61. Entries on these forms require disclosure of aggregated amounts paid or credited to the director and must also disclose the tax deducted for the return period. The CT61 must be submitted to HMRC within 14 days of the end of the quarterly return period and although dates of payments need not be specified on the form, separate figures should be shown for pre and post 5 April interest to reflect any change in the tax rate. Companies filing a CT61 should also provide a reconciliation of the figures in the CT61 return with the deductions claimed in the accounts for any interest paid to a director.

In contrast, most yearly interest paid to UK companies can be made without deduction of tax at source by the payee, and the recipient company is treated as receiving a “gross” amount of yearly interest. This is treated as a loan relationship credit. The exception to this rule is where the company receiving the interest is not itself the recipient but is acting as a nominee for the person beneficially entitled to the interest distribution. In such cases, income tax will still be deducted at source and the recipient of the interest will be treated as receiving yearly interest with income tax deducted at the basic rate of tax.

The situation is slightly more complex when interest is being paid to a non-UK company. The general rule is that tax should be deducted at the basic rate of tax from all interest paid to an overseas or non-UK corporate lender. However, if the UK has a double tax agreement (DTA) with the lending country it may be possible to override this position. To determine whether the DTA allows a reduced withholding tax rate or the removal of the withholding tax requirement altogether, the DTA should be checked, as the rate and rules will vary from country to country. If relying on the DTA to avoid withholding tax on interest payments the appropriate claim should be made – it is not automatic. Alternatively, a double taxation treaty passport scheme (DTTP) provides for double taxation relief on UK loan interest payments to an overseas corporate lender. To avail of this, the lending company must apply to HMRC for a Double Taxation Treaty Passport. This passport then allows a UK lender to pay interest to the overseas company without having to deduct tax at source and report this to HMRC. Borrowers are often not aware of this passport scheme or how it operates and as a result fail to withhold the necessary tax. Lenders also regularly forget to apply for the necessary DTTP clearance. As a consequence, if the size of the loan is considerable or if the failure to withhold tax remains undetected for a long period of time, significant unexpected liabilities can arise on a UK borrower.

To gain a deeper understanding of tax deductions on interest payments and how to manage them efficiently, contact our Tax Team for guidance. We are equipped to help you navigate these complexities and ensure that your financial strategies remain compliant and effective.