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HMRC internal manual

Double Taxation Relief Manual

Double Taxation Relief Manual: Guidance by country: United States of America: Conduit arrangements: from 2003

The new Agreement applies from 1st May 2003 for US withholding taxes and 1st January 2004 for other US taxes. This provision was not in the old Agreement.


No enquiries should be opened in relation to this provision without reference to CTIAA, Business International.

Bilateral double taxation treaties provide benefits for residents of the two contracting states. The “conduit arrangement” provision is designed to ensure that the benefits of the new Agreement go only to those residents and not to residents of third countries who have deliberately arranged their transactions in such a way as to obtain treaty benefits to which they would not otherwise be entitled. The provision is therefore an anti-treaty abuse measure and like similar measures found in other UK double taxation treaties is transaction-based.

Whilst the UK has traditionally favoured such transaction-based measures in its double taxation treaties the US prefers entity-based rules. This treaty contains both: the “anti-conduit” rule, which focuses on transactions, and the limitation on benefits article, which focuses on entities [see DT19867A for zero rate on dividends and DT19882 for Art 23 generally. The two approaches are complementary, providing clear objective tests for determining entitlement to benefits and strong protection against treaty abuse.

This was the first time a UK double taxation treaty had included a limitation on benefits article and the transaction-based anti-abuse measure needed to be framed in such a way as to complement the operation of that article. The provision is therefore somewhat different from the UK’s usual anti-treaty shopping provision. However, the UK will apply the new provision in a manner consistent with its practice under those other treaties. This means that a resident of a third country will be denied the benefits of the treaty if he deliberately attempts to secure them by entering into a conduit arrangement as defined in the treaty.

Whether the provision will apply in any given situation will depend on the particular facts and circumstances.

How will the Revenue apply the “conduit arrangement” rule?

Every case will be considered on its particular facts and circumstances to determine whether the transaction or series of transactions meets the definition of a conduit arrangement. The definition contains an objective test (defining a conduit) and a subjective test (a motive test). Only if both tests are satisfied so that the transactions or series of transactions constitute a conduit arrangement will the relief provided by the relevant article be denied.

When making such a determination it is important that the Revenue is able to put a transaction or series of transactions into their proper context.

It will be necessary to consider all of the arrangements involving payments between UK and US taxpayers, and between US taxpayers and a taxpayer of a third country before the true pattern and purpose of the transaction or series of transactions can be established.

When this level of understanding has been achieved, the Revenue will be able to determine whether or not the transaction or series of transactions meets the objective part of the conduit test and whether the obtaining of treaty benefits was a main purpose or merely an incidental consequence.

Given this, it is difficult to be prescriptive as to what type of transaction might constitute a conduit arrangement. But here are two examples of what might meet the definition:

  1. A company resident in a country which does not have a tax treaty with the UK makes a loan to its UK subsidiary, but instead of lending the money direct it makes the loan indirectly via a wholly unconnected but accommodating US bank by providing a matching collateral deposit to the bank as security for the loan the bank then makes to the UK subsidiary company.

The objective test contained in the definition of a conduit would be satisfied as a US resident (the US bank) entitled to zero UK withholding tax on interest under the treaty receives interest arising in the UK and pays that interest to another person (the parent company) who is not resident in either the UK or the US but who is resident in a third country which doesn’t have a treaty with the UK that provides for zero UK withholding tax on interest.

The fact that treaty benefits are available if the UK subsidiary borrows from the US bank but would not be available if it borrowed from its parent suggests that a main purpose of the transactions might be to obtain the increased benefit of the treaty. So the motive test might also be satisfied. This will have to be determined by reference to the particular facts and circumstances.

If examination of the facts supported this interpretation, then the series of transactions would be a conduit arrangement as defined in the treaty and the relief provided for by the Interest article would be denied. Full UK withholding tax on the interest paid by the UK subsidiary company would then be due.

  1. A company organised in a country that does not have a tax treaty with the UK loans £1,000,000 to its wholly-owned UK subsidiary in exchange for a note issued by the UK company. The parent company later realises that it can avoid UK withholding tax by assigning the note to another wholly-owned subsidiary in the US. Accordingly, the parent assigns the note to its US subsidiary in exchange for a note issued by the US company. The UK company note pays 7% and the US company note pays 6 3/4%.

The loan note was assigned to avoid UK income tax on the payment of interest. The transaction constitutes a conduit arrangement as defined in the treaty as both the objective definition and the motive test at Article 3(1)(n)(i) and (ii) respectively are met.

Can a pre-existing structure constitute a “conduit arrangement”?

A “conduit arrangement” is defined as a “transaction or a series of transactions”. Therefore, provided all the other criteria are met to make the provision applicable, it makes no difference whether a structure through which the transactions flow pre-dates the entry into force of the treaty.

The previous treaty contains no transaction-based provisions for addressing abusive conduit arrangements or treaty shopping. To give an “amnesty” for pre-existing structures would undermine the effectiveness of the new rule.

Where a notice has been issued allowing the UK source income to be paid gross and it is thought that the anti-conduit rule may apply, the non-resident should set out the relevant details in a letter to the Centre for Non-Residents.

How will the UK interpret “substantially all”?

In determining whether “substantially all” of an item of income has been paid directly or indirectly to a resident of a third state the Revenue will consider all the relevant facts and circumstances of the case.

What does “at any time or in any form” mean?

An example might be US dividends received by a UK resident company in 2003 paid on to a resident of a third country in the form of interest in 2004. However, there is no presumption in the words “at any time” that the payment to the resident of the third country must take place after the payment from the source state.