Unless an exemption or relief applies, payments of yearly interest that have a UK source are subject to UK withholding tax at the basic rate (currently 20%).
One of those exemptions is the Qualifying Private Placement (QPP) exemption and it should be considered in all transactions whenever an obligation to withhold tax on interest is a possibility.
The exemption is particularly beneficial to borrowers seeking finance from non-UK lenders in jurisdictions where the relevant double tax treaty does not provide full relief from withholding tax on interest (e.g. China, Italy, Japan and Mexico). It can also offer a swift solution where there is insufficient time on a transaction to seek double tax treaty relief to a withholding, as consent for the exemption to apply is not required from HMRC.
So, what is the exemption and how does it work?
What is a QPP?
A QPP is a security which represents a loan relationship to which a company is a party as a debtor. The security, the lender and the borrower all need to meet certain conditions for the exemption to apply and these are explained below.
The exemption is not confined to private placements and can apply to any loan that meets the conditions to constitute a qualifying private placement.
The conditions
The security must not be listed on a recognised stock exchange and must have a term of less than 50 years and a minimum value of £10m (or be part of a placement with an aggregate minimum value of £10m).
The lender must be beneficially entitled to the interest payable for genuine commercial reasons and not part of a tax advantage scheme. It must provide a creditor certificate to the borrower confirming its beneficial entitlement to the interest and that it is resident in a jurisdiction that is a 'qualifying territory'. A 'qualifying territory' is a jurisdiction with which the UK has a double tax treaty containing a non-discrimination article. Beware however of loans from Jersey or Guernsey because although the double taxation agreements with both countries contain a non-discrimination article, they do not satisfy the criteria of a 'qualifying territory' which requires that the non-discrimination provision effects a 'national of a state'. The term 'state' does not apply to a Crown Dependency and therefore, neither Jersey or Guernsey are considered to be 'qualifying territory'.
The borrower must enter into the security for genuine commercial reasons (and not part of a tax advantage scheme) and there must be no connection between it and the lender. In addition, the borrower must have received a 'creditor certificate' from the lender.
Creditor certificates
A creditor certificate is a written statement confirming that the lender is beneficially entitled to interest on the security and that it meets the lender conditions (see above). There is no prescribed form for the certificate and this could be given in the transaction documentation or a separate document.
The borrower must hold a certificate for each creditor under the relevant security. In a bilateral security, this should present no problems but in a syndicated loan facility with multiple lenders this can complicate matters. In these circumstances, the QPP regulations treat each lender’s participation in the lending syndicate (i.e. the private placement) as a separate loan relationship and consequently, the borrower can only pay interest without any withholding to those lenders that have provided a valid creditor certificate (assuming all of the other conditions are also satisfied).
If the placement is a single security where more than one person is beneficially entitled to interest, then unless each person entitled to the interest can provide a valid creditor certificate, the QPP exemption will not be available at all to the borrower in respect of the relevant loan.
Problem areas
Unlike with the treaty passport procedure, a borrower that is not a company cannot rely on the exemption. This condition is often missed by partnership borrowers who assume that they can utilise the QPP exemption.
It is the beneficial owner of the interest that must provide the relevant creditor certificate. Unfortunately however, it is not clear whether the narrow English law meaning or the international fiscal meaning (relying on the Indofood International Finance Ltd v JP Morgan Chase Bank NA London Branch [2006] case) of 'beneficially entitled' applies and this can cause confusion in intermediary lending structures and where the contractual lender differs from the person entitled to the interest. In these circumstances, the solution may be for a creditor certificate to be provided by the contractual lender and the underlying creditors but where one is perhaps a fund with numerous investors, this may be easier said than done.
Withdrawal/cancellation of creditor certificates
A creditor certificate is not valid is it is withdrawn or cancelled.
Where the lender ceases to meet the relevant conditions (referred to above) it must notify the borrower of this and having done so, the creditor certificate is invalidated the day after the date on which the borrower receives notification of the withdrawal. The one-day grace period is intended to avoid a borrower being informed that a certificate is no longer effective on an interest payment date as the borrower may, on that date, have no ability to immediately alter existing payment instructions and ensure that tax is withheld from the relevant payment.
In certain circumstances HMRC can cancel a creditor certificate and if it does, it must notify the borrower of this. The cancellation takes effect from the date the relevant notification is received and all payments of interest made on or after that date on which a withholding is required, must have tax withheld from them (unless another exemption from UK withholding tax is available). Unlike the rules relating to withdrawn creditor certificates, there is no grace period when HMRC cancels a certificate.
Record keeping
Since it is the borrower's responsibility to ensure that all the QPP exemption conditions are satisfied before it makes a gross payment of interest, it is crucial that it keeps records to evidence its ability to rely on the exemption and the date on which any withdrawal or cancellation notification is received.
Practical considerations
If the QPP exemption is to be relied on, unless this is in conjunction with LMA documentation, there could be a number of traps for the unwary. In particular, which party bears the cost of any withholding following a breach of any of the QPP conditions.
If you have any queries concerning withholding tax on interest, please contact one of our tax specialists.
