UK Tax Update

In this issue, Bingham’s London Tax Group summarises some of the latest UK tax developments relevant to the financial services industry: the UK government commences a consultation on possible changes to the UK’s withholding tax rules on interest, changes are made to the deemed release of debt rules, the EU financial transaction tax develops further, and HMRC invites claims for repayments of stamp duty reserve tax and amends its guidance on beneficial ownership of shares underlying depositary receipts.

Withholding Tax on Interest

As promised in the Budget 2012, HM Revenue & Customs (HMRC) published its consultation paper on possible changes to the rules on the deduction of UK income tax at source. The proposals include:

1. Removing the “quoted Eurobond” exemption from withholding for listed debt in cases where the debt is issued intra-group and listed on a stock exchange on which there is no substantial or regular trading (focus is on the Grand Cayman and Channel Islands Stock Exchanges, which the consultation paper explains have approximately £15 billion of bonds in issuance by UK groups);
2. Requiring withholding tax to be accounted for in cash even where interest is paid in kind; HMRC would therefore no longer be obliged to accept funding bonds as payment for the tax deducted; and
3. Removing the distinction between “short” and “yearly” interest: under current law, short interest (broadly, interest on a debt with a life of less than one year) is not subject to deduction of UK income tax at source; this would no longer be the case.

It is not entirely surprising that the quoted Eurobond exemption has come under the spotlight, though changes in any of these areas will have a broad impact across various financing arrangements. The paper also raises the possibility of a disguised interest rule for income tax purposes.

Draft legislation is expected this autumn, with any resulting changes in the law to be included in the Finance Bill 2013.

The consultation paper can be accessed here.

Deemed Releases of Corporate Debt

At the end of February, HMRC announced changes to the UK’s “deemed release” rules which treat cancellation of debt income as arising to a UK debtor company in certain circumstances where its debt is acquired by a connected company or where it becomes connected to one of its creditor companies. Many UK debt restructurings involve debt buy-ins which are structured so as to fall within one of the statutory exceptions from the charge.

The proposed draft legislation includes a change to the method of calculating the amount of the charge where a connected company acquires debt and introduces a targeted anti-avoidance provision, which applies where arrangements are entered into, and the main purpose — or one of the main purposes — of any party entering into them is the avoidance or reduction of a deemed release charge under the relevant sections. The draft legislation also includes a further provision that has retrospective effect from 1 December 2011, which was designed to counteract a disclosed structure implemented by one of the UK’s major banks after that date and before the date of the announced changes.

In our view, the two main points to note are:

1. The potential scope of the draft anti-avoidance provision and its practical application are not yet entirely clear. For instance, the draft statutory wording appears broad enough to have potential application in a scenario in which a taxpayer has deliberately structured a commercial transaction to fall within one of the available statutory exceptions from the charge (where an alternative structuring option that would trigger the charge was also commercially available). However, HMRC’s draft guidance on the scope of the provision provides some comfort in this respect as it indicates that the “use of these exceptions would not of itself be regarded as abusive”.
2. It is highly unusual for the UK to introduce truly retrospective tax legislation, and this instance was regarded as controversial by both UK tax practitioners and the UK press. This may indicate a change in HMRC’s attitude to introducing such legislation to target specific anti-avoidance transactions, but the better view may be that this was a one-off and exceptional case which should not be regarded by the legislature as an acceptable precedent for similar retrospective changes (although the Chancellor’s Budget speech did forewarn of potential retrospective legislation to combat stamp duty land tax savings schemes).

EU Financial Transaction Tax (FTT)

The European Parliament’s Economic and Monetary Affairs Committee recently adopted a revised proposal for the FTT which builds upon, and in some respects materially widens the scope of, the Commission’s FTT proposal of November 2011. This revised proposal forms part of the EU’s ongoing consideration of the FTT.

Under the adopted text:

1. An “issuance principle” is proposed, similar to UK stamp duty, whereby financial institutions located outside the FTT zone would be liable for the tax if they traded securities originally issued within the zone. This would apply in addition to the “residence principle” contained in the Commission’s proposal, by which securities traded by at least one institution established within the zone would be caught irrespective of where the relevant securities were issued. Enforcement of this issuance principle (again, reflecting the UK stamp duty approach) would be effected by making the payment of FTT a requirement to the valid acquisition of legal ownership of the traded securities;
2. FTT could be implemented by “enhanced cooperation” in a number of EU Member States, though it is recognised that introducing the tax in a very limited number of Member States could have a distortive effect on competition; and
3. Pension funds would be exempt.

Depositary Receipts: Stamp Duty Reserve Tax

In HSBC Holdings plc and the Bank of New York Mellon Corporation v HMRC, the First-tier Tribunal decided that the UK’s 1.5 per cent stamp duty reserve tax (SDRT) charge on a transfer of HSBC shares to the issuer of American Depositary Receipts (ADRs), as part of a capital raising exercise by HSBC, was contrary to the EU Capital Duties Directive, on which HSBC was entitled to rely as an EU company irrespective of the location of investors.

HMRC has announced that it will not appeal against the decision. The 1.5 per cent SDRT charge therefore no longer applies to issues of UK shares and securities to depositary receipt issuers and clearance services anywhere in the world. HMRC does not consider that the Tribunal’s decision has any impact upon transfers of shares and securities to depositary receipt systems or clearance services that are not an integral part of an issue of share capital. Therefore, the 1.5 per cent stamp duty and SDRT charges continue to apply to such transactions.

HMRC invites repayment claims from persons who have paid SDRT under sections 93 or 96 of the Finance Act 1986 on an issue of shares in a UK-incorporated company to a depositary receipt issuer or a clearance service located within or outside the EU. SDRT repayment claims must be made within four years of the later of the date on which the SDRT was paid and the date on which the accountable person must account for SDRT.

Depositary Receipts: Beneficial Ownership

HMRC has also issued some new guidance addressing one of the other points raised in the HSBC Holdings case: the beneficial ownership of shares underlying depositary receipts.

Prior to the case, HMRC’s settled practice had been to regard the holder of a depositary receipt as having beneficial ownership of the underlying shares for UK tax purposes. Soon after the Tribunal’s decision, HMRC amended its Capital Gains Manual to explain that, for the purposes of the UK taxation of chargeable gains, “the holder of a typical ADR issued in accordance with New York state law will typically not be the beneficial owner of the underlying shares”, which called into question the generally understood UK tax treatment of various transactions in ADRs.

HMRC has since issued Business Brief 14/12 containing (further) amended guidance which seems to revert to HMRC’s previously-held view that holders of ADRs such as those in the HSBC Holdings case (and other depositary receipts issued outside the UK where beneficial ownership cannot be conclusively determined by reference to the law governing the arrangements relating to the issue of the depositary receipts) will continue to be regarded as holding the beneficial interest in the underlying shares. However, the Business Brief explains that where the relevant overseas law results in the depositary receipt holder not being the beneficial owner of the underlying shares, there may be practical UK tax consequences, for example, a transfer of shares to a depositary receipts issuer in return for depositary receipts would be a disposal of the shares for UK tax purposes.