Double taxation treaties: Beneficial ownership: Treaty shopping
Non-UK resident persons are chargeable to income tax on income arising in the UK, except where that income is chargeable to corporation tax as part of the income of a permanent establishment in the UK. In many circumstances the income tax chargeable is restricted to that which has been deducted at source from the income by the payer.
The income of the non-UK resident person may also be taxed by the country in which they are resident. To avoid the double taxation that might arise in such circumstances, the UK enters into bilateral treaties (“DTAs”) with other countries that govern how the income is to be taxed in each country. These treaties are referred to interchangeably as double taxation agreements, double taxation conventions and tax treaties.
The UK does not have a DTA with every country or territory in the world, and those DTAs it does have vary significantly in the extent to which they restrict the taxing rights of the country in which income arises (the “source state”) and the country in which the beneficial owner (see INTM504020) of the income is resident (the “residence state”).
This guidance focuses on interest, but the issues discussed can relate equally to dividends, royalties and other forms of mobile investment income. DTAs generally limit the taxing rights of the source state in respect of these types of income - either imposing a maximum rate at which the income can be taxed or removing the right to tax it completely.
Taking yearly interest arising in the UK as an example, the income tax to which a non-resident is liable on that income will vary depending on whether the UK has a DTA with the residence state and, if there is an agreement, the maximum rate at which the UK as source state retains taxing rights. This provides an obvious incentive, particularly for residents of those countries with which the UK does not have a comprehensive DTA, to engage in what is commonly referred to as “treaty shopping”.
Treaty shopping involves the improper use of a DTA, whereby a person acts through an entity created in another state with the main or sole purpose of obtaining treaty benefits which would not be available directly to such a person.
For example, a company in a low tax jurisdiction plans to invest funds as a loan in the UK. The UK does not have a DTA with the country and therefore interest paid directly to the haven company would ordinarily be subject to deduction of UK tax at source. To avoid this withholding tax, the company channels the funds through a company set up for this purpose in, say, Luxembourg. The Luxembourg company receives interest from the UK which it then pays on to the true source country. UK withholding tax on the interest is reduced to nil under the terms of the UK/Luxembourg DTA. Luxembourg does not levy withholding tax on interest paid on to the haven country (except where the EU Savings Directive applies) under its domestic law. If there were no provisions to counteract the effect of the arrangement, the tax haven company would therefore benefit from the UK/Luxembourg DTA, though the income is subject to tax in Luxembourg only to an insignificant degree (on the marginal turn taken by the Luxembourg company) and not subject to tax at all in the UK.
Such arrangements could also be used where the beneficial owner is resident in a territory where the DTA retains a residual rate of WHT even after a clearance or claim for repayment of tax withheld. Australia or Canada, for example, where the territory of source (and obviously that can mean the UK as treaty partner in each case) retains 10% even after clearance.
HMRC views such arrangements as abusive as their effect is to grant the benefit of a DTA to the resident of a country with which either the UK does not have a DTA, or does not have a DTA that provides relief from source state taxation of interest. DTAs are the outcome of a process of negotiation as part of which benefits are secured for UK residents in return for giving up taxing rights in respect of residents of other states.
It is therefore necessary to be alert to the possibility that there may be entities within a global group acting as a means of conveying interest to low or no tax territories without suffering any (or any significant amount of) withholding tax.
This guidance discusses one of the provisions in the UK’s DTAs which can be used to counter instances of treaty shopping - the concept of beneficial ownership. Other defences also exist through provisions found in some, but not all UK DTAs. These are
- Main purpose anti-treaty shopping provisions; and
- Anti-conduit provisions.
Before embarking on any enquiry into a claim for treaty relief it is essential that the provisions of the relevant DTA are examined in detail.