New Withholding Tax Exemption for Qualifying Private Placements in the UK

On 1 January 2016 the implementing regulations for the new “qualifying private placement exemption” took effect. The new private placement exemption allows a UK corporate borrower to pay interest gross if certain conditions, contained in section 888A of the Income Tax Act 2007 and in the new implementing regulations, are met. While this change is intended to broaden the investor base that can invest in UK projects, its implications are much wider.

The UK generally imposes a 20% withholding tax on payments of interest made by a UK borrower where that interest has a UK source (and some foreign borrowers where the interest has a UK source). There are already numerous exemptions to this, the principal ones being where the lender is a UK bank (or UK branch of a non-UK bank), where the lender is a UK resident company or a UK branch of a non-resident company, or where the lender is resident in a jurisdiction that has an appropriate double taxation treaty with the UK that reduces the interest withholding tax to zero. There is also an exemption for listed bonds (known as the “quoted Eurobond” exemption) that is typically used where it is intended that the financing may be sourced from a wider net of investors.

In order to qualify for the exemption, two sets of conditions have to be met. The basic conditions were introduced in the Finance Act 2015 and provide that the exemption is available for:

• interest paid on a security;
• which represents a loan (which includes debt issued in the form of notes or bonds) to which a company is a party as a debtor; and
• which is not listed on recognised stock exchange.  

The second, more detailed, set of conditions is contained in the implementing regulations and provide that:

a) The securities must be “relevant securities” which means:

• their term must not exceed 50 years;
• at the time they are issued, they had a minimum value of £10 million or, combined with other “relevant securities” comprised in a single placement by the same debtor, the placement had a minimum value of £10 million; and
• they were entered into by the borrower for genuine commercial reasons and not as part of a tax advantage scheme.

b. The borrower must hold a “creditor certificate” which is a written statement by or on behalf of the creditor confirming:

• the creditor is a resident of a country that has a double tax treaty with the UK that includes a non-discrimination article; this is a treaty provision which prevents a state from subjecting the nationals of another state to any tax or connected requirements which are more burdensome than those applied to its own citizens; and
• the creditor is beneficially entitled to the interest on the relevant security for genuine commercial reasons and not as part of a tax advantage scheme.

c. The borrower must reasonably believe that they are not a connected person (for UK tax purposes) in respect of the lender.

Where all of these exemption conditions are satisfied, the borrower can pay interest free of any UK withholding tax. Crucially, there should be no need to seek advance approval from HM Revenue & Customs that all conditions are satisfied, reducing the administrative burden typically experienced as part of a double tax treaty clearance procedure.

In December 2014 we issued our briefing “Tax exemption to boost non-bank lending in the UK” when the Chancellor had just announced, in the 2014 Autumn Statement, his plans to introduce the exemption from withholding tax for interest on private placements. At that time, the hope was that the new exemption would improve liquidity in the infrastructure funding market as well as allowing access to certain types of investor for whom it would have been historically uneconomic to lend to UK ventures. Now that the flesh has been added to the Chancellor’s proposal, has this hope been lived up to?

Lenders resident in countries which have double tax treaties with the UK will benefit from the new exemption. First, such lenders will no longer need to engage in the tax treaty clearance procedure, which will benefit both them and borrowers, as interest can be paid gross immediately. Secondly, existing debt which meets the conditions will also qualify for the exemption which means that the need to renew existing treaty clearances will be removed.

Where we expect to see the biggest change, however, is for lenders resident in a country with a double tax treaty with the UK where the rate of withholding is merely reduced under the treaty rather than eliminated altogether. In those cases, lenders based in jurisdictions such as China and Italy will now be able to lend directly to the UK without suffering any withholding on interest. The impact of this is likely to be twofold. First, existing lenders will be encouraged to commit more capital to the UK market. Secondly, new lenders may be encouraged to lend into the UK now that withholding will be eliminated (rather than merely reduced).

While the new exemption is more limited in scope than some would have hoped, its introduction should, as a minimum, reduce the procedural formalities on existing borrowers and lenders. Whether or not this will have a significant impact on liquidity in the UK non-bank lending space is not clear.

Borrowers and lenders seeking to rely on the exemption should ensure that facility documentation is drafted accordingly. Borrowers should, for example, ensure that they are able to obtain the “creditor certificate” and where a lender has failed to provide such a certificate borrowers should seek to exclude the obligation to gross-up interest payments.

Further changes to UK withholding are currently being considered by HM Revenue & Customs which may lead to wider relaxations to the withholding regime. More details on this are likely to follow in mid-2016.