UK Tax Policy and the Euro-dollar Market

Written by admin on May 4th, 2011


A. Introduction

The view of the UK Treasury and the Inland Revenue was that, the way was now open for the nationalised industries and the local authorities to borrow in this way, if the UK wanted this to happen, and that the Boards and authorities concerned were prepared to go ahead.

This led to a very important issue, which had to be fully recognised. The amendment to the Finance Bill will allow interest payments to be paid free of tax only where the bond of stock was issued through an overseas agent subject to foreign law. It did appear to mean that, when a Euro-bond was issued in London, withholding tax will still apply where the interest was paid out of UK income. Thus the effect of the amendment would be to impair the status of the London issuing houses since if the amendment leads to a rise in this type of borrowing they will be effectively excluded from participating in the increase: an increase which will derive entirely from the UK sources. It was envisaged that the UK would have a presentational problem on its hands. As, if the UK government wanted a public sector authority to borrow in foreign currencies, it had to approve in their arranging for the issue to be made through an overseas agent and in an overseas centre. In short, the UK government had cut out the possibility of the public sector itself utilising the Euro-dollar resources of London with regard to its borrowing operations .

The tax change, under which interest paid on foreign currency borrowing for home investment would be treated as an expense for corporation tax purposes, though designed to encourage such borrowing by the nationalised industries, would create an incentive also for the UK commercial concerns. Given the rate structure in the Euro-dollar market, the new tax incentive may well create substantially increased interest by UK firms, particularly those with overseas income, in currency borrowing for home activity. A central question was, how would this be regarded under the exchange control rules? There had been little interest shown by UK firms in this type of activity but given the prime need to strengthen the reserves, it plainly made sense to allow firms to borrow fairly freely in the Euro-dollar market for home investment if they found it attractive to do so. The UK government’s attitude, was that, if UK firms want to borrow on appropriate terms in Euro-dollars for home investment, they would normally be allowed to do so .

Hence, due to Lever’s proposal: An insertion of a provision in the Finance Bill was needed, to allow a corporation tax deduction in respect of interest paid on Euro-dollar bond issues, where the funds were to be invested in the UK . The change would serve no useful purpose unless the UK firms concerned were prepared to arrange for their loan contracts to be signed outside the UK, e.g. in Switzerland or Luxembourg. The reason for this was as follows: Subscribers to Euro-bond issues were interested in no shares other than those on which interest was paid gross of local tax. Under the provisions of the 1952 Income Tax Act, UK borrowers may not pay interest gross to non-residents unless the interest had a non-UK source in the hands of the bond-holder. For UK companies (including the nationalised industries) the latter condition can be complied with only by the conclusion of the approximate loan contract abroad. There are strong Revenue arguments against any relaxation, in which, Lever and the official Treasury had been inclined to accept.

However, it should be noted that; firstly, the change would not affect materially the position of the potential UK borrower who has substantial overseas income. Secondly, in respect of other companies, including the nationalised industries other than the Air Corporations, the change would encourage foreign currency borrowing only if the relative contracts are established abroad under foreign law. Thirdly, much of the extra banking business, which was created by the change, would therefore benefit overseas rather than London banks .

This meant that, the UK were not in the position, or able to hold the situation of the proposed change, and would face early pressure for the relaxation of the income tax rules on payment of interest gross. This was what the Revenue had always foreseen, and what led them to resist any changes, even changes in the corporation tax .

B. Opinions of the Inland Revenue

On the 26th June 1968 a confidential meeting on Euro-dollar borrowing was held by Lever, the Inland Revenue, the Treasury and Mr. Stainton of the Parliamentary Counsel. Lever first raised the question of an arrangement by which interest might be paid gross on loans raised in the Euro-dollar market. It was emphasised that Lever was anxious not to allow payment of interest gross to UK residents, but that it was possible to pay interest gross to non-UK residents without excluding UK banks from taking part in the arrangement of these loans .

However, the Revenue stated that they were not going to accept a position where interest was paid gross in London to UK residents. This was based under the rule that interest could not be paid gross, except where existed a non-UK source. Various Court decisions, interpreted by the Revenue, meant that the Revenue were prepared to regard interest payments as having a non-UK source when they were made under a contract concluded abroad under foreign law, with a foreign paying agent, even where the income which were used to pay the interest was itself generated in the UK . This was a new different area, as statute law did not cover it in any detail, and decisions had to be taken on interpretation based on a few court decisions. Under these circumstances, it was possible that some modification of the Revenue’s existing rules were possible. For example, it was possible to accept that a UK bank in London might pay interest gross in external sterling to non-resident accounts, as in practice this was a very similar operation to a foreign bank paying gross abroad in a foreign currency. However, it was not possible to legislate in this area in the Finance Bill of the time, as there was no time to work out the necessary complicated clause .

Lever, nevertheless, stated that he was interested in further exploring the extent to which UK banks were able to take part in loans raised abroad. However, he was content that the law was not altered involving the definition of “foreign source” income in the Finance Bill. So, the clause was approved in principle. Lever raised the question of allowing in the clause for loans the interest on which might, at the option of the lender, be paid in sterling. There was no objection to this in the meeting, provided the option was exercised at the discretion of the lender .

The “machinery problem” of the Inland Revenue

However, this issue was not passed onto Lever, because of “the machinery problem” caused by certain large barriers that were raised by the Inland Revenue . There was three issues of principle: firstly, non-resident borrowers paying interest through London – (if they are not paying interest through London there is no reason why any aspect of UK taxation should affect them). Here there is a “machinery problem”, the Affidavit procedure, which has been removed. Secondly, UK borrowers paying abroad – provided that the bonds are denominated in foreign currency and held only by non-residents, and that the issue formally takes place in a foreign market, gross payment of interest without formality is possible and, under the proposed Finance Bill change, payment will count as an expense before assessment to Corporation Tax. Finally, UK borrowers paying through London – it is here that the problems still remained. The primary problem through London would almost certainly disqualify borrowers from payment gross of tax, with or without an Affidavit procedure. The Inland Revenue will be considering whether, provided the borrowing is in the form of foreign currency bonds, with interest payable in foreign currency, and to be held only by non-residents, they could agree to payment of interest gross, without requiring the additional non-UK features of issue abroad and payment abroad .

What was not clear was, assuming that the Inland Revenue were to decide that they could allow payment gross of tax even with Issue X and payment Y in London, but on the narrower limitations of foreign currency denomination and interest and non-resident holders, the Inland Revenue would still have to take special steps to remove the obligation of Affidavit procedure, or whether this would simply not apply in any case .

Obstacles to raising foreign currency loans by UK companies

The law and the practice of the Inland Revenue was unsatisfactory in relation to Section 52 (5) and provided obstacles to the raising of foreign currency loans by UK companies. It was considered, by the Inland Revenue that there was no justification for the continued separation between annual interest payable to residents and to non-residents . These obstacles were:

Firstly, relief is not available in cases where a loan has been raised for purely investment purposes, e.g. the acquisition of a new subsidiary. This construction is an obstacle to foreign borrowing in cases where the borrower has insufficient Case IV or Case V income, and it ignores the realities of much foreign investment where the acquisition of an existing business will almost always be made through the acquisition of shares. Furthermore, it ignores the Revenue’s own practice in allowing “short interest” incurred on loans

Pages: 1 2 3 4 5

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Leave a Reply