LEGAL UPDATE: When negotiating an interest rate swap, tax representations are not needed where both parties are UK resident, thanks to a domestic exemption from withholding. On a cross-border transaction, this exemption will protect a UK company payer but representations are still needed, not because of any potential withholding (the usual need for tax representations) but due to a provision which prevents debit deductions where a counterparty is non-UK resident, unless an exemption applies (and for which a representation is required). One such exemption relates to double tax treaties and care is needed to apply the right treaty.
When entering into a swap agreement it is sometimes necessary to include tax representations so that the parties can be sure of the tax treatment of payments. The standard payer representation is that payments will be made without withholdings. Sometimes the payer can only make this representation if the payee makes a representation about its status.
Where the swap is between only UK counterparties, no tax representations are usually required because there is a blanket exclusion from withholding tax on derivative contracts (s 980 ITA), provided that profits and losses derived from the same derivative are taxed within Part 7 of CTA 2009. This means that generally, there is no withholding tax, and therefore no need for tax representations, if the payer is a UK resident corporate entity, and the derivative contract is not excluded from the derivative contract regime.
Even when the payee is non-UK resident, a UK payer will not generally require tax representations as to withholding since the domestic exclusion in the derivative contracts regime should bite.
However, despite there being no withholding tax, a tax representation may still be required even if the payer is a UK corporate entity because of an anti avoidance provision which can deny a tax deduction to the payer under a derivative contract in certain circumstances.
Section 696 CTA 2009 applies where a non-resident is or becomes a party to a derivative contract with a company under which notional interest payments may be made. Where it does apply, the UK company is not allowed to deduct any excess notional interest payment paid to the non-resident above that which the company received from the non-resident.
The anti-avoidance rule does not apply in most cases where the UK counterparty is a bank. There is also an exclusion where the non-UK resident counterparty is a party to the derivative contract solely for the purposes of a trade carried on in the UK through a permanent establishment. A further exclusion applies where the counterparty is non-UK resident and is resident in a jurisdiction which has a double tax treaty with the UK which makes provision (either charging or relieving) for interest.
If the permanent establishment or double tax treaty exclusions are relevant then a representation is required to confirm that effect. Having the warranty allows the UK company to legitimately deduct those debits which arise under the derivative contract.
Where double tax treaty representations are required, care needs to be taken to identify the correct double tax treaty. For example, where a swap payment is paid by the payer (either by itself or from the payer's branch) to the payee's branch or office, care must be taken not to automatically apply the double tax treaty of the jurisdiction in which the payee's branch is located. The question of which double tax treaty to apply almost always follows the legal recipient of the payment, and a branch and HQ are one legal entity. However, in the case of a payer operating through a branch, it will be the jurisdiction where the branch is located (and where any withholding tax may be imposed) which is the relevant jurisdiction for double tax treaty purposes.
For more information see this Tax Journal article.
Eloise Walker and James Tryfonos are corporate tax experts at Pinsent Masons, the law firm behind Out-Law.com. This update is based on an article which appeared in Tax Journal on 13 October 2017.
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