Belfast Telegraph

Budget Changes – Withholding Taxes on Interest & Royalties

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As part of the EU, the tax treatment for UK companies paying or receiving interest and royalties to or from related parties that are resident in the EU was determined by the EU Interest and Royalty Directive. The goal of this Directive was to avoid double taxation in a European context.

Post the Brexit transition period on 31 December 2020, these Directives ceased to apply to UK companies, however, they were instead given effect in UK domestic law, meaning that for UK companies paying interest or royalties, there were little changes to consider. 

Rishi Sunak set out during the March 2021 Budget that these rules would be repealed from 1 June 2021.  This was somewhat of a policy U-turn by the government, who had previously set out that they did not intend to repeal these provisions.  This measure is not a big revenue raiser, but its aim is to ensure that EU companies do not enjoy more favourable tax treatment than those elsewhere.

This means that businesses will have to rely upon the double-tax treaty entered into with the relevant EU Member State in order to reduce or eliminate UK withholding tax on outbound payments of interest and royalties to EU connected companies.  So, what does this mean for your corporate group that spans EU jurisdictions? 

For the payment of interest, where a reduction is available under the relevant tax treaty, the UK payer will need to apply for and seek direction from HMRC to pay the reduced treaty rate before any payment is made.  Normally the process of seeking direction can be time consuming, therefore, action may need to be taken promptly to get a direction before making any payment of interest.  Otherwise, it will be necessary to deduct, report, and remit tax at the 20% rate, and make a subsequent application to reclaim any overpaid amount where treaty conditions are met.  Failure to withhold and report income tax to HMRC may result in interest and penalties being charged.

The process is somewhat more straightforward for royalties. If the UK payer believes a reduction or elimination of the domestic rate is available, the payer may make such payment without direction from HMRC if there is ‘reasonable belief’ that the conditions of the treaty are met.

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Payment of dividends between EU Member States were pulled into a similar regime as a result of the Brexit deal, with some jurisdictions and double-tax treaties requiring that withholding tax is still to be paid. As the receipt of dividends by most UK companies should be exempt from tax (and therefore no double-tax relief exists), there is now a potential sunk cost of repatriating funds back to the UK.

For UK companies who are in receipt of income streams from EU countries, it will be important to check whether future income streams may be reduced by overseas withholding taxes and whether there is a reduction available under the double-tax treaty.  UK companies should, therefore, make enquiries with overseas payers whether clearance has been sought and obtained in order to avoid any reduction in income.