Deduction of tax: yearly interest: practical application
Applying case law principles
It is always a question of fact whether, in any particular case, interest is yearly or short. The intention of the parties will be the most important factor in deciding the question (see SAIM9075). This will be the case in particular where a loan has a duration of less than 12 months but is ‘rolled over’, once or more than once, to a second year. If the intention of the parties, when the borrowing was first put in place, was for the borrowing term to be less than 12 months, HMRC will require clear evidence that this was the original intention. Without such evidence, HMRC will be unable to accept that the intention of the parties was to have a borrowing term of less than 12 months.
The question of whether interest is short interest, from which the payer has no obligation to deduct tax, is most likely to arise in the context of payments made by a UK resident to a person whose usual place of abode is outside the UK. If the interest is short, there is no need for the recipient to apply under a relevant Double Taxation Agreement to receive the interest gross (or with tax withheld at a reduced rate). There is guidance at INTM505010 onwards.
A UK resident may make a series of loans, each of less than a year, to a non-resident, and claim that the interest is short. HMRC staff should refer to the guidance at INTM542010 in such cases.
Uncertainty may also arise as to whether there is a duty to deduct tax from interest in circumstances comparable to that in Bebb v Bunny (SAIM9075) - where a sum of money remains outstanding for a period that may, or may not, be a year or more. For example, a manufacturer might guarantee to refund the purchase price, with interest from the date of claim, if a product proves faulty: such claims may normally be processed speedily but, in disputed cases, may drag on for over a year.
Where the parties intend at the outset that monies due will not be left outstanding for a year or more, the interest will be short - even if, in a few cases, there are delays which prolong the period over which interest accrues. If however the parties anticipate at the beginning that the debt will exist for a year or more, or appear to be indifferent as to whether it will or not, the interest is likely to be yearly.
Where the payer of the interest is uncertain about whether it is short or yearly, they may in practice ‘play safe’ by deducting tax. If the recipient of such interest objects to the tax deduction, HMRC staff should advise him or her to take up the matter with the payer, see SAIM9180.
If, conversely, the payer decides that interest is short and pays it gross, HMRC staff should not challenge that view unless
- the decision appears to be completely unjustified on the facts and in the light of relevant case law, or there is reason to suspect a definite intention of avoiding the payment of withholding tax; and
- material sums of tax are at risk.