Uncertainty around whether interest has a UK source
16th January 2026
Posted in Articles by Forbes Dawson
There is tax legislation (ITA 2007 section 874) which dictates that tax needs to be withheld from certain interest payments (generally interest on loans of a year or more) where the interest arose in the United Kingdom. This means that a UK company which borrows from a Guernsey company (say) and owes £100 of interest would have to pay £20 of withholding tax to HMRC and then pay the remaining £80 to the lender. Although this position can be overridden by the provisions of certain tax treaties and some general exclusions, that is the default position.
Whilst ordinarily it will be very clear that withholding tax is due, the question of whether interest ‘arises’ in the UK can in some cases be murky and subjective. In HMRC’s guidance they say that they consider the most important factors in determining the source of the interest to be as follows:
• the residence of the debtor and the location of his/her assets. This will influence where the creditor will seek to enforce any judgement following default;
• the place of performance of the contract and the method of payment. Here we are looking at the substantive (not immediate) origin of the funds out of which the interest was paid;
• the competent jurisdiction for legal action and the proper law of contract;
• the residence of the guarantor and the location of the security for the debt.
This is all based on an old ‘Greek Bank case’ which dictates that a ‘multifactorial, fact-sensitive test where different factors give different answers’ should be used and HMRC takes the view that the question of source should be looked at from a practical, or realistic point of view.
Example
Guernsey Propco Ltd (GPL) is a Guernsey registered and resident company which holds UK investment properties. It has an interest-bearing loan from its Guernsey holding company (governed by Guernsey law) which is unsecured. All transactions take place through Guernsey bank accounts. Does GPL need to withhold tax on interest payments relating to this loan?
Over the years many commentators would have concluded that the interest in this example does not arise in the UK. They would argue that the debtor is not resident in the UK and that the loan is governed by Guernsey law. For example in Clarke’s Offshore Tax Planning 2011-12 (and possibly later issues) Giles Clarke (something of an authority on this subject) says ‘It is tolerably clear that residence (for the purposes of jurisdiction), the source from which the interest is paid (the location of the debtor’s account) and the place of payment of the interest (the location of the creditor’s account) are each significant factors, and that if all three are in the UK, the interest will have a UK source. It is also tolerably clear that UK residence of the debtor is not in itself determinative of the situs of the interest’. Although not directly stated, this would imply that in the above example the interest should not be treated as arising in the UK (residence is Guernsey, interest paid from Guernsey account and interest paid to a Guernsey account).
Cases (such as Ardmore Construction and Hargreaves Property Holdings Ltd) have made it easier for HMRC to argue that the interest in the above example does have a UK source. Anecdotally, they are now often arguing that there is a UK source because the interest is paid out of UK business profits (in the above example the interest would be funded from the UK rental income) or because there is ‘ipso facto’ security on the loan because the lender would seek recourse to the UK property. Remember (from above) they are looking at the substantive and not the immediate origin of the funds from which the interest was paid.
Forbes Dawson view
Whether interest has a UK source continues to be a difficult issue to conclude upon in certain cases and so there will continue to be much scope for the taxpayer and HMRC to take opposing views. It would be useful if an objective score sheet could be devised to provide more certainty here. Offshore property companies should be particularly mindful of these issues when paying interest to an offshore lender as HMRC may well argue that they need to withhold tax based on the fact that the interest is derived from a UK property business. Whenever new loans are taken out, care should be taken to ‘de-risk’ the withholding tax position for the borrower. As the responsibility to withhold tax is with the borrower rather than the lender, “grossing up” clauses in loan agreements (where the lender does not take a commercial hit for any withholding tax suffered) should generally be resisted. Nevertheless, the subjective nature of the UK source rules will leave many payers of interest at the risk of attack from HMRC when they decide to pay interest gross.
