Recently HMRC has updated its published guidance to reflect its new policy not to impose late payment interest in respect of intra-EU payments of interest and royalties where those payments are made gross notwithstanding that treaty clearance to make gross payments has not been obtained at the time of making the payment.
The new policy follows a 2018 decision of the Court of Justice of the European Union (the “2018 Decision”) in which it was held that Bulgarian law was incompatible with the EU fundamental freedom to provide services. Under the relevant Bulgarian law, default interest had been applied to Bulgarian taxpayers where they paid income to residents of other EU Member States without deducting, and accounting for, Bulgarian withholding tax, notwithstanding that any liability to pay that tax was eliminated, or reduced, by an applicable double taxation treaty (“DTT”), subject only to completion of certain procedural formalities.
HMRC’s view is that, following the 2018 Decision, it is precluded under EU law from imposing late payment interest in respect of intra-EU payments of interest or royalties to the extent that application of the relevant DTT would result in no, or a reduced rate of, tax being required to be withheld from the payment.
Accordingly, HMRC will no longer impose late payment interest (even if treaty clearance has not been obtained at the time of making the payment) where:
- UK source interest is paid to a person taxable in an EU Member State; or
- Royalties are paid by a UK taxable person to a person taxable in an EU Member State.
However, HMRC say that they will continue to consider applying penalties for failing to submit the appropriate UK withholding return (CT61) in those circumstances.
Additionally HMRC will continue to impose late payment interest where an interest or royalty payment is made to a person taxable outside of the EU even if application of the relevant DTT would result in no, or a reduced rate of, tax being required to be withheld from the payment.
Although the new policy clarifies this area for taxpayers following the 2018 Decision, it is not clear what impact (if any) Brexit will have on this policy.
However, this is a positive development which should allow taxpayers to proceed with certainty (at least until the end of any Brexit transition period) and may provide a basis to recover any previously imposed late payment interest in those circumstances. We are also aware that, historically at least, in addition to late payment interest and penalties for failing to submit a return, where interest has been paid gross without the relevant treaty clearance being in place HMRC has sought to impose penalties on the payer for failure to notify HMRC of a liability to income tax (under Schedule 41, Finance Act 1998). Whilst the payer is obliged to withhold income tax from its interest payments, such withholding obligation should not equate to a liability to income tax (within the meaning of the relevant UK tax rules) on the part of the payer; the liability to the income tax on the interest, technically, should remain with the payee. Although that may seem quite technical, it has important implications. Unlike penalties for failure to submit a return, penalties for failure to notify HMRC of a liability to income tax are “tax-geared” in that the level of penalty imposed will be a percentage of the amount of tax that should have been paid (such percentage varying depending on the behaviour of the taxpayer, whether disclosure of non-compliance was voluntary, and when disclosure was made to HMRC). We have previously advised clients on this and successfully challenged HMRC on this point.