CFM75000 - Other tax rules on corporate finance: deduction of tax

Contents

CFM75010 Introduction to deduction of taxCFM75020 Deduction of tax: TDSICFM75030 Deduction of tax: TDSI: guidance and responsibilitiesCFM75040 Deduction of tax: who is a deposit takerCFM75050 Deduction of tax: relevant investmentsCFM75060 Deduction of tax: deposits that are not relevant investmentsCFM75070 Deduction of tax: payment without deduction of taxCFM75080 Deduction of tax: accounting for tax deducted and auditsCFM75090 Deduction of tax: certificatesCFM75100 Deduction of tax: interest paid in the ordinary course of banking businessCFM75110 Deduction of tax: advances by a bankCFM75120 Deduction of tax: derivatives

Deduction of tax: overview

UK resident companies have a general obligation under ITA07/PT15/CH3 to deduct income tax from payments of yearly interest that they make (otherwise than as nominees or representatives of someone else). This obligation, however, was substantially qualified by changes to the deduction of tax rules made in FA01 and FA02. If the company reasonably believes that the recipient of the interest falls into one of the prescribed categories - which include UK resident companies - the obligation to deduct tax is switched off.

See the Company Taxation Manual (CTM35000) for more on the rules on the deduction of tax by companies, and the Savings and Investment Manual (SAIM9000) for more on deduction of tax generally.

This section of the Corporate Finance Manual sets out the modifications of the general rules for banks, building societies and other deposit takers. The modifications fall into two areas.

Under the Tax Deduction Scheme for Interest (TDSI), banks, building societies and other deposit takers must deduct tax from interest paid on all ’relevant investments’, unless they hold a completed form R85. The main provisions of the TDSI are outlined at CFM75020 onwards.

ITA09/S878 provides that interest paid by a bank, building society or deposit taker in the ordinary course of its business is payable without deduction of tax. This includes interest paid on deposits that are not ‘relevant investments’ and therefore do not come within TDSI.

Where:

an interest payment is made by a company that is a member of a banking group, but not itself a bank, or

a bank pays interest outside of the normal course of banking business, or a bank pays an annuity or makes an annual payment,

you will need to consider the general rules on deduction of tax. The relevant guidance is at CTM35210 onwards.

There is a further exemption at ITA07/S879 relating to interest payable on an advance from a bank (CFM75100).

‘Bank’, for the purposes of ITA07/S878, is defined in ITA07/S991.

TSDI

Interest paid by banks, building societies and other deposit takers on customer deposits must operate the Tax Deduction Scheme for Interest (TDSI). The broad effect of the scheme is that individuals who are UK taxpayers will receive interest net of tax at the basic rate. This means that only higher rate taxpayers have any further tax liability, and significantly reduces the number of people who need to complete self assessment returns. On the other hand, non-taxpayers may register to receive interest gross, reducing the need for people with low incomes to claim back tax from HMRC.

The main features of TDSI are:

It applies to deposit takers, which includes banks but also extends to other types of financial businesses.

It applies to ‘relevant deposits’. There is provision for gross payment to depositors who have registered as non-taxpayers. Tax is deducted at the basic rate. The deposit taker accounts for the tax to HMRC through the

mechanism in ITA07/PT15/CH15. The tax must be deducted when the interest is paid - this includes crediting interest to an

account. The depositor has a statutory right to a certificate showing the tax deducted from their interest. HMRC both audits the Scheme to ensure that deposit takers are complying with their

obligations, and extends help to new deposit takers or where there are particular areas of difficulty.

In addition, HMRC may issue notices to banks, building societies and other deposit takers, either under TMA70/S17 or TMA70/S18 (which applies to payers of interest generally) requiring returns of interest paid, whether or not tax has been deducted. Detailed guidance notes are available on the HMRC Internet site to help recipients of such notices comply with the reporting requirements.

Legislation

The primary legislation relevant to the Tax Deduction Scheme for Interest (TDSI) is at ITA07/PT15/CH2. ITA07/S851 imposes the statutory obligation on deposit takers to deduct tax from interest on ‘relevant investments’. Unlike ITA07PT15/CH3 the obligation imposed by ITA07/S851 applies to all interest, not just yearly interest.

If a deposit is not a ‘relevant investment’ and therefore falls outside of ITA07/S851:

Where the payer is a bank, the exemption at ITA07/S878 for interest paid in the normal course of banking business will apply (see CFM75100), enabling the interest to be paid gross, but

Where the payer is a deposit taker other than a bank, ITA07/PT15/CH3 is not automatically disapplied. The provisions of ITA07/PT15/CH11 will mean that, in many cases, the interest is payable gross, but each case needs to be considered on its merits.

The main secondary legislation is the Income Tax (Deposit-Takers)(Interest Payments) Regulations 2008 (SI2008/2682). The guidance notes for deposit-takers (see below) set out the various subsequent Orders that amend these regulations.

Responsibilities

TDSI is administered by the HMRC's Savings Scheme Office (SSO) at Bootle, part of Charities, Assets and Residence. Queries on the operation of TDSI should be addressed to SSO. Technical queries on the provisions for deducting tax at source are dealt with by CT&VAT Financial Products Team.

Investors who have questions about the tax treatment of interest they receive from banks or other deposit takers should contact their own tax office.

Guidance

Comprehensive guidance on the operation of the TDSI scheme (‘TDSI - Guidance for deposit-takers’) is to the found on the HMRC website (search for ‘TDSI’).

Deposit taker

‘Deposit-taker’ is defined at ITA07/S853. It includes banks - a bank, for this purpose, being any person within the definition at ITA07/S991 (1)(b) whose permission under Part 4 of the Financial Services and Markets Act (FSMA) 2000 to accept deposits includes permission to accept deposits that are ‘relevant investments’ (see CFM75050).

It also includes:

the Bank of England, municipal banks, local authorities securities houses (persons whose business consists wholly or mainly in dealing in financial

instruments, such as shares, debt securities and derivatives), and any other person or persons prescribed by Treasury Order.

Relevant investments

Banks and other deposit-takers must deduct basic rate tax from interest if the deposit is a relevant investment. To decide whether an account is a relevant investment, it is necessary to first look at the status of the investor. It may be a relevant investment if the person beneficially entitled to the interest is:

an individual or individuals, a partnership (including a Scottish partnership), all the members of which are individuals, the personal representatives of a deceased person, or the trustees of a discretionary or accumulation trust.

But even where the investor is in one of these categories, there are a number of exceptions that may stop the account from being a relevant investment. CFM75060 describes the main exceptions.

A deposit will not be a relevant investment if it is held by:

A company or unincorporated association; this includes joint accounts where at least one of the account holders is a company.

A pension fund. A charity. A local authority or similar public body. A unit trust, whether authorised or unauthorised.

Investments that are not relevant investments

ITA07/S856 to S870 list deposits that are not relevant deposits. The major categories are described below.

Not ordinarily resident (NOR) accounts

A bank or other deposit taker can pay interest gross on an account held by an individual if they hold a valid declaration by the account holder that he or she is not ordinarily resident in the UK. The ‘NOR declaration must be made on form R105 (or an approved substitute). An NOR declaration can be made for a joint account, or for a partnership of individuals, if all of the individuals concerned are NOR. The trustees of a discretionary or accumulation trust can also make an NOR declaration if they are NOR, and all of the beneficiaries of the trust are either NOR individuals or non-resident companies.

Qualifying certificates of deposit and qualifying time deposits

A qualifying time deposit is not a relevant investment. The definition is at ITA07/S866. It is a deposit of more than £50,000 (or the foreign currency equivalent) that matures on a specified date, which must be less than 5 years from the date on which the deposit is made. There must be no right to increase the deposit or to make partial withdrawals, and it must be non-assignable. There is an equivalent provision for transferable certificates of deposit (as defined in ITA07/S865. They are not relevant investments if the principal is more than £50,000 and the instrument has a maturity of less than 5 years.

General client accounts

A general client account is one that:

is not held for one or more particular clients, and where the account holder's use of the money is governed by statutory regulations that require them to pay

interest to some or all of the clients on whose behalf the monies are held.

Banks are likely to hold general client accounts for solicitors, or for stockbrokers, fund managers or other financial intermediaries whose handling of client monies is regulated by the Financial Services and Markets Act. A designated client account is a relevant deposit unless one or more of the clients is a company, or all of the clients are not ordinarily resident in the UK.

Foreign banks and foreign branches

A deposit is not a relevant deposit if it is held by:

a non UK branch of a UK bank, or any branch of a non UK bank other than one situated in the UK.

Other exceptions

A debenture issued by the bank is not a relevant deposit; nor is a debt on a security that is listed on a recognised stock exchange. There is also an exception for loans made by another deposit-taker in the ordinary course of his business (although since most deposit-takers are companies, interest on such loans will normally be payable gross in any case).

Tax-exempt savings products

Interest on cash deposits held within Individual Savings Accounts (ISAs) is outside of the TDSI scheme.

Payment without deduction of tax

An investor may register an account for payment of interest without deduction of basic rate tax if they are an individual who is ordinarily resident in the UK, and they do not expect to be liable to income tax for the year in which the interest is paid. The registration is made on form R85.

Once the deposit-taker receives a fully completed R85, they must make all subsequent interest payments without deducting tax until the account is de-registered, or the investor dies or becomes bankrupt, or an investor who is a child reaches the age of 16. They do not have to check the accuracy of the information that the investor provides.

An account is de-registered if the investor instructs the bank to do so - as they must do if they realise they are, or will be, liable to tax. HMRC's Savings Scheme Office (SSO) can also instruct a bank to de-register an account if they have reason to believe that registration is not appropriate.

Accounting for tax deducted

The bank, or other deposit-taker, accounts for basic rate tax deducted from interest on relevant deposits under the normal CT61 procedure - see CTM35050. ITA07/PT15/CH15 applies to interest on relevant deposits:

even if the deposit-taker is not resident in the UK, and even if the deposit-taker is not a company.

The statutory authority for this is ICTA88/S480A (2)-(4). For the purposes of Schedule 16, crediting interest to an account is the same as paying it.

Audit

Savings & Audit (Saving Scheme Office) periodically audits a sample of accounts to check that deposit-takers are deducting the right amount of tax at the right time, and that gross payment of interest is only being made where it is permitted by law. The audit includes consideration of the deposit-taker's systems and controls, a check of the calculation of the sum of basic rate tax shown on the quarterly CT61(Z) return, and a sample check of accounts where tax is not being deducted, either because the investor has declared themselves to be not ordinarily resident in the UK, or because form R85 is held.

HMRC staff who examine the accounts of banks and other deposit-takers should refer to SSO any questions or problems that arise concerning the operation of the tax deduction scheme.

Certificates

ITA07/S975 imposes a duty on any person making a payment under deduction of tax to provide the recipient of the payment, on written request, with a statement setting out the gross amount of the payment, the tax deducted and the amount actually paid.

A bank or other deposit-taker that deducts tax from interest must therefore supply a certificate if the investor asks for one in writing. It is not obliged to send certificates routinely to all investors, although

many banks do. It cannot charge the investor for the certificate, although it can make a charge for a duplicate.

Enforcement of the statutory duty lies with the investor, not with HMRC. HMRC staff who are told by a customer that he or she has been unable to obtain a certificate of tax deducted should be told of their legal right, and advised to take up the matter with the bank (or other payer of interest) concerned.

Interest paid in the ordinary course of banking business

If a bank pays short interest, other than on a relevant investment (see CFM75050), it does not have to deduct income tax.

If it pays yearly interest, and the interest is not being paid on a relevant deposit, the bank might still potentially be obliged to deduct tax under ITA07/PT15/CH3. However, ITA07/S878 provides an exemption for interest paid by a bank in the ordinary course of its business.

Example

A Canadian company places surplus funds on a long-term deposit with a UK bank. This is not a relevant deposit, so ITA07/PT15/CH2 does not apply. Nevertheless, since the company's place of abode is outside the UK, ITA07/PT15/CH3 would normally oblige a UK payer of interest to deduct tax (unless clearance had been obtained to pay the interest gross under the Double Taxation Treaty between the UK and Canada). Since, however, the interest is being paid by a bank in the ordinary course of its business, the obligation to deduct tax is switched off.

’Bank’ takes its meaning from ITA07/S991 - see CFM14060.

Statement of Practice 4/96

HMRC’s view, set out in Statement of Practice 4/96, is that any yearly interest paid by a bank is paid within the ordinary course of its business, unless the interest falls within one of two defined circumstances.

The interest is not regarded as paid in the ordinary course of business where the borrowing relates to the capital structure of the bank. Borrowing relates to the capital structure if it is within the definitions of Tier 1, 2 or 3 capital adopted by the Bank of England, whether or not it actually counts towards Tier 1, 2 or 3 capital for regulatory purposes.

Interest is not paid in the ordinary course of business where the transaction giving rise to the interest is primarily attributable to an intention to avoid UK tax. CT&VAT (Financial Products) Team will advise in any case where HMRC staff believe that this paragraph of the Statement of Practice may be in point.

Advances by a bank

The exemption at ITA07/S875 applies to interest paid by a bank. There is a further exemption at ITA07/S879 that applies in certain circumstances where interest is paid to a bank.

The obligation under ITA09/S874 to deduct tax is switched off if:

it is payable on an advance from a bank, and at the time when the interest is payable, the person entitled to the interest is within the charge to corporation

tax as respects the interest.

‘Bank’ is defined at ITA07/S991 (CFM14060). The person entitled to the interest does not have to be the bank that first made the advance: ITA07/S879 will continue to apply even if the bank assigns the loan to a UK company that is not a bank.

This provision assumes much less importance for interest paid by a company, or a partnership whose members include a company, on or after 1 April 2001. From that date, there is no obligation to deduct tax where the payer reasonably believes the person entitled to the interest to be a company resident in the UK. Similarly, payment can be made gross if there is a reasonable belief that the interest is being brought into charge to corporation tax by a UK permanent establishment of a non-resident company. These provisions also apply to interest paid by a local authority on or after 1 October 2002.

These relaxations only remove the obligation to deduct tax from yearly interest imposed by ITA07/PT15/CH3 on companies, local authorities and partnerships with company members. They do not apply to the obligation under ITA07/S874(1)(d) to deduct tax from interest paid to non UK residents.

Example

A company incorporated in Italy is recognised as a bank in the UK for the purposes of ITA07/S991.

Its UK branch makes a normal business loan to X Ltd, a UK trading company. Since the bank's normal place of abode is outside the UK, X Ltd has to consider whether it should deduct tax from the interest payments under ITA07/S874. However, since the advance was made by a bank, and the interest is being paid to its UK branch, which is within the charge to CT in respect of the interest, X Ltd is able to pay the interest gross by virtue of ITA09/PT15/CH11.

If the Italian company ceased to be a bank within the meaning of ITA07/S991, X Ltd would require authorisation under the relevant Double Taxation Treaty in order to continue paying the interest gross.

Derivatives

Banks do not need to deduct tax from payments that they make under the terms of swaps, futures, options and similar derivatives. Such payments, even where they arise on interest rate derivatives, are not interest. Neither will they, in general, be annual payments, since the counterparty to the derivative will normally have obligations as well as rights under the contract, payments made by the bank will not be pure income profit in the counterparty's hands.

The point is put beyond doubt for derivative contracts within CTA09/PT7. CTA09/S570 specifically provides that there is no requirement to deduct tax from payments.

Banks may on occasion pay true interest in connection with dealings in derivatives. For example, they may pay interest on margin accounts or on cash held as collateral, or they may be obliged to pay interest if they are late in making a payment due under the contract. CTA09/S570 does not extend to interest paid on money debts of this kind. The normal rules on deduction of tax need to be considered.