The UK government is consulting until 27 February 2015 on draft regulations exempting deduction of income tax at source from yearly interest payable on unlisted securities known as 'private placements' which meet certain qualifying conditions. Conditions for the exemption will include the security being issued for a minimum period of three years. The primary legislation in Finance Bill 2015 will provide for regulations to set out more detailed conditions, including a requirement for the issuer to be a trading company. The exemption is aimed at mid-size companies and infrastructure projects, thought to be the typical borrowers under this form of debt instrument.
What does the draft legislation propose?
Borrowers, including issuers of debt securities, are required to deduct a sum representing UK income tax (currently at a rate of 20%) from payments of UK source yearly interest made to lenders and investors. Although there are currently a number of exceptions from this duty to deduct UK tax, the draft clause proposes to introduce a new targeted withholding tax exception for interest payable on qualifying privately placed debt (a form of long term unlisted debt).
What further conditions are likely to be introduced by way of regulations?
The draft clause turns on the meaning of a 'qualifying private placement' since interest on such a placement will not suffer UK withholding tax. According to the draft clause, a security is a qualifying private placement if, broadly, it is an unlisted debt security issued by a company for a minimum of three years.
The draft clause, however, enables HM Treasury to add further conditions, by way of regulations, to the meaning of a 'qualifying private placement'. HMRC issued a technical note on 10 December 2014 which sets out a number of further conditions and areas they would like to cover in the regulations, including:
- the type of issuer and investor that can rely on this exception
- the type of privately placed debt which falls within the scope of this exception, and
- safeguards to prevent the exception being abused
If HMRC's proposed additional conditions were to be adopted:
- the issuer would have to be a trading company
- the investor could not be connected to the issuer and would need to be a qualifying UK regulated financial institution or equivalent non-UK entity that would need to certify that it meets the investor conditions on acquisition of the relevant unlisted debt security and at specified intervals thereafter, and
- the exception would only apply to interest on plain vanilla unlisted debt securities denominated at or above £100,000 provided they are held for genuine commercial reasons
HMRC invites comments on its proposals for the regulations until 27 February 2015.
What is the purpose behind the new exception?
The new exception is designed to unlock a new source of financing for mid-sized UK companies and for infrastructure projects. It is hoped the withholding tax exception will remove an obstacle to the development of the UK private placement market by removing UK withholding tax as a potential cost of raising finance and also removing some of the administrative aspects related to withholding tax (such as double tax treaty relief applications). The new exception also offers issuers an alternative to issuing listed debt (ie 'Quoted Eurobonds') in circumstances where listing debt on a stock exchange is not a feasible option for them.
Who will benefit from the exception?
Having an active and more developed UK private placement market will benefit both issuers and potential investors, so this exception is helpful to both. However, the devil will be in the detail of which issuers and investors will be able to benefit from this exception.
As already noted, the proposed regulations currently seek to restrict the exception to issuers that are trading companies and that issue a minimum of £10m of qualifying debt and a maximum of £300m of such debt.
The proposed regulations also contain a number of restrictions in respect of the type of investor that can qualify under the exception. For example, at present it is proposed that only UK-regulated financial institutions or equivalent non-UK entities located in a jurisdiction which has a relevant double tax treaty with the UK (and who are unconnected to the issuer) should benefit from this exception.
The Investment Management Association has welcomed the proposals and have stated that a number of their members (including Allianz Global Investors, Aviva, Friends Life, Legal & General, Prudential and Standard Life) intend to make investments of around £9bn in private placements.
When will this exception take effect?
The government intends to introduce the new withholding tax exception in Finance Bill 2015. The new legislation will take effect after the date of Royal Assent to the Finance Bill 2015.