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UK Court of Appeal Adopts Realistic Approach to Withholding Tax Exemption in Recent Judgment

In a recent judgment, the UK Court of Appeal has demonstrated a realistic approach to withholding tax exemption issues, marking a significant development in the interpretation of tax laws. The case, involving Hargreaves Property Holdings Limited (Hargreaves), underscores the courts' readiness to apply a purposive interpretation to domestic tax exemption tests, a method often reserved for treaty contexts.

Hargreaves, a holding company for a UK real estate group, restructured its loan financing for tax purposes, involving repeated assignments of loan rights to third parties, initially in Guernsey and subsequently to a UK resident company named Houmet. These assignments occurred shortly before loan repayments and re-advancements by the original lenders. The central issue was whether Hargreaves' payments were subject to UK withholding tax. Hargreaves argued unsuccessfully that the payments were eligible for double tax treaty relief or were not of a "UK source" nature.

The Court of Appeal addressed two key questions:

1. Whether Houmet was beneficially entitled to the interest such that a domestic exemption for payments to UK resident companies applied.

2. Whether the payments constituted "yearly interest" or "short interest," as withholding tax applies only to the former.

Hargreaves contended that Houmet's "beneficial entitlement" should not be interpreted through a purposive approach, referencing a line of cases, including the recent Court of Appeal decision in Bostan Khan v HMRC [2021]. However, Lady Justice Falk refuted this argument, stating that the statutory provisions must be construed purposively, in line with principles established in WT Ramsay Ltd v Inland Revenue Commissioners [1982]. She emphasized the need to determine if the statutory provisions were intended to apply to the realistically viewed transaction.

Falk dismissed the relevance of the "international fiscal meaning" of beneficial entitlement from Indofood International Finance v JP Morgan Chase Bank [2005], focusing instead on domestic law. She noted that the legal owner of a property is not its beneficial owner if they do not enjoy ownership benefits, serving merely as a "legal shell." The burden of proof was on Hargreaves to demonstrate that the requirements were met.

Hargreaves failed to provide sufficient evidence regarding Houmet's role or the reasons for the interest assignment. Although the First Tier Tribunal (FTT) acknowledged that Houmet was not a trustee, the Court of Appeal required more to establish beneficial entitlement. Applying Ramsay principles, the court concluded that Parliament did not intend for the exception in section 933 of the Income Tax Act 2007 to extend to a company like Houmet, involved fleetingly for tax-motivated reasons without real benefit from the interest.

The Court of Appeal also clarified that the legislative test's "reasonable belief" element did not apply in this context. If the reasonable belief was incorrect, the exemption was unavailable, serving as an additional requirement rather than a relaxation.

This case has practical implications for borrowers. Typically, UK non-bank lenders covered by the relevant exception provide a tax confirmation of their status, including beneficial entitlement, upon accession to the agreement. However, this confirmation is usually for the agent's benefit and without recourse against the lender if incorrect, leaving the borrower at risk. Borrowers may need to seek contractual protections to ensure accurate tax confirmations.

On the second issue, the Court of Appeal considered whether the loans' interest was "yearly" or "short interest." Although the loans were repayable on demand and repaid within a year, they were repeatedly replaced by loans from the same lenders. The court agreed with the FTT and Upper Tribunal (UT) that a "business-like" assessment of the loan's likely duration should be applied, as set out in HMRC v the Joint Administrators of Lehman Brothers International [2019]. Despite individual loans lasting less than a year, they provided long-term funding for Hargreaves, fulfilling a commercial need and leaving the borrower's assets unsecured. Thus, the interest on these loans was subject to UK withholding.

The Court of Appeal's decision highlights the importance of a realistic and purposive approach in interpreting tax exemption provisions, offering valuable insights for international tax practitioners and borrowers alike.



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