The Treaty Passport – A new process for corporate interest payments

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In a welcome development, HMRC is bringing in a quicker and more efficient method of providing clearance for companies to pay interest to overseas corporate lenders at treaty withholding rates. Many tax treaties allow UK withholding tax at either nil or a reduced rate. The new DT Treaty Passport Scheme (DTTP) will be in place as from 1 September 2010 with applications for passports being accepted from 1 June 2010. HMRC has confirmed that the scheme will cover loans where the borrower and lender are either unconnected or are connected parties but will not be available to non-corporate lenders.

The current process involves the lender submitting a separate clearance application for each loan with each application requiring its own certification from the relevant overseas tax authority. Despite best efforts from borrowers, lenders and HMRC alike, considerable time can pass between the making of the loan and HMRC issuing a formal direction to the borrower. This can cause unnecessary withholding obligations on borrowers, cashflow issues and additional administration costs in reclaiming taxes withheld. It can also trigger tax gross-up clauses and create potential disputes between lenders and borrowers. In circumstances defined in the loan agreement, a gross-up clause requires the borrower to pay interest gross even if there is a withholding tax requirement, thus potentially passing the burden of the tax from the lender to the borrower.

Under the new scheme, overseas companies – and other concerns treated by their country of residence as corporations for tax purposes – will be able to apply for a passport using a new Form DTTP1. Obtaining a passport will prevent the lender from having to make individual clearance applications when the lender knows for certain that all the conditions for relief are satisfied.

Instead, the lender will notify the borrower that the loan is covered by the scheme and of the need for the borrower to notify HMRC and will provide the borrower with the lender’s Treaty Passport reference number, its country of residence and the rate at which withholding should apply. The borrower will be able to refer to an online register of passport holders to verify the lender’s identity and status. Once satisfied, the borrower will notify HMRC (on new form DTTP2) of the existence and details of the loan, the borrower’s details and the lender’s name, passport number and treaty residency. HMRC will then, at its discretion, issue a direction under Double Taxation Relief (Taxes on Income) (General) Regulations 1970 SI 1970/488 for the borrower to make payments at the rate specified in the relevant treaty from the start of the loan.

Form DTTP2 must be submitted to HMRC within 30 working days of the commencement of the loan, otherwise the scheme will not apply and the current process will continue to be relevant, including the requirement to withhold tax until a direction has been issued. HMRC is hoping to provide a facility for the notification to be made online and to be able to issue directions to borrowers within three weeks of receiving notification.

Passport applications should be submitted to and administered by the Large Business Service (LBS) DT Treaty Team, Barkley House, Castle Meadow Road, Nottingham, NG2 1AB.

Form DTTP1 includes the generic information about the lender that is currently required on each individual application. In particular, it requires certification by the foreign tax authorities that the lender is resident within the meaning of the relevant tax treaty, although a new certification will not be required if the applicant has made a certificated treaty claim within the previous 12 months. There is no requirement for the lender to have made a loan to a UK borrower before an application can be made, so prospective lenders will be able to apply for a passport in anticipation of such an event.

HMRC will undertake to deal with any passport application within 30 days of it being received by HMRC. Passports will be issued at HMRC’s discretion for five calendar years. They may be renewed on application to HMRC by letter, up to 4 months before the expiry date.
As is currently the case, the lender will be under a duty to keep HMRC informed of any material changes to its form or circumstances, such as a change of business form or country of residence.

In order to apply the passport to any particular loan, the lender must adhere to a number of conditions. In particular, lenders will have to declare that they:

  • have read the terms and conditions of the DTTP and undertake to comply with them;
  • will use the passport only where, to their certain knowledge and belief, all the conditions for relief set out in the relevant treaty are satisfied. This will include satisfying the ‘subject to tax’ test, where relevant, and the ‘beneficial ownership’ test under the principles of the Indofood case and as set out in HMRC’s International Manual at INTM332030; and
  • will not use the passport for any income that is effectively connected with or attributable to a permanent establishment of the lender in the UK.

 
There will be no need for the lender to submit individual loan documentation to HMRC when entering into each loan. But as a condition of using the scheme, lenders will undertake to co-operate with HMRC should HMRC choose to audit how the lender uses the scheme. This includes committing to respond promptly to requests for loan documentation and requests for other relevant information.

Any passport holder found to be in breach of the DTTP terms may receive a warning or have their passport holder status suspended or removed, depending on the gravity of the breach.

The Provisional Treaty Relief Scheme (PTRS) under which UK borrowers may be authorised to pay interest to unconnected lenders at reduced rates on a provisional basis, pending the receipt of a completed application by the lender or composite treaty application by the syndicate manager within three months, will continue but only for syndicated loans and will be renamed the Syndicate Loan Scheme (SLS). It is expected that the DTTP will ease entry for passport holders into loan syndicates covered by the SLS.

The DTTP will commence on 1 September 2010 and will apply to any loan entered into by the lender on or after this date. Forms DTTP1 and the scheme’s terms and conditions are available on HMRC’s website, see http://www.hmrc.gov.uk/cnr/dtt-passport-scheme.htm, so that lenders can apply for passports in advance. Form DTTP2 will be available from 1 September 2010.

There are a number of practical matters that lenders and borrowers may wish to address between now and 1 September:

  • Lenders will wish to consider the detailed terms and conditions of the DTTP and decide whether to apply for a passport. 
  • Internal procedures will need to be established to ensure the lender tells the borrower in good time that the borrower will need to notify HMRC about any particular loan, to ensure timely filing by the borrower and to clarify respective responsibilities. 
  • Finally, borrowers and lenders alike will wish to review and revise the tax gross-up clauses in their loan documents to reflect the new procedures and revised responsibilities.



Trevor Brown

4 May 2010
 


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The information in this notice is intended for general guidance only. Throgmorton does not accept any responsibility for losses incurred to any person acting or refraining to act as a result of the information in this notice. Advice should be taken in the context of specific circumstances.