Private placements are a potentially important source of non-bank funding for UK businesses but withholding tax can act as a barrier to investment. The government therefore announced a new exemption from withholding tax for private placements in the Autumn Statement. This was welcomed by those that had been lobbying for the change. However, the details of the proposed exemption show that it currently does not go far enough and changes will be needed if it is to achieve its intended aim. Anyone with an interest in this area should make their thoughts known to HMRC and HM Treasury before 27 February.
The difficulties experienced by SMEs in accessing finance during the credit crisis drew the government’s attention to the fact that UK businesses relied heavily on bank funding. It established an industry taskforce to explore how further to develop access to non-bank lending channels for SMEs.
The Breedon Report, published by the taskforce in May 2012, identified private placements as offering considerable scope for making additional non-bank finance available to mid-sized UK businesses. It recommended increasing the number of UK-based private placements through an initiative led by the Association of Corporate Treasurers (ACT).
The working group formed by the ACT in turn observed the favourable UK withholding tax treatment given to interest on bank loans and quoted eurobonds. It concluded that an equivalent position for interest on private placements would encourage the development of a new private placement market. It recommended that UK tax law be changed to provide the UK private placement market with a withholding tax exemption akin to the quoted eurobond exemption.
Since then, we have been working with the ACT to lobby for such a change of law. The government responded to that in the 2014 Autumn Statement by announcing a new targeted exemption from withholding tax for interest on private placements. This was followed by the publication on 10 December of draft legislation and a technical note.
Private placements are a form of selective, direct lending to non-individual borrowers. They are to be contrasted to ordinary (public) bond issues, which are made available to the general market. Funds are borrowed directly from one or more lenders – typically sophisticated non-bank investors such as insurers, pension funds and fund managers.
The general rule under UK law as it currently stands is that the borrower under a private placement must, if the debt has a UK source and is capable of remaining outstanding for a year or more, deduct income tax at the basic rate from payments of interest on that debt (ITA 2007 s 874). As the debt will be unlisted, the exemption for payments of interest on quoted eurobonds (s 882) will not apply. As the lender will not be a bank, the exemption for interest paid on advances from banks within the charge to corporation tax (s 879) will not apply either.
If the borrower reasonably believes that the investor will be within the charge to corporation tax in respect of the interest, the obligation to withhold will fall away (s 930). Otherwise, income tax will have to be deducted from interest payments, unless: a double tax treaty applies to give the investor’s home jurisdiction exclusive taxing rights over the interest; and either the lender has been directed by HMRC to make payments of interest on the debt free from withholding, or the investor is in possession of an applicable treaty passport.
The ACT working group found that the risk of withholding tax applying to interest payments to non-UK investors unable to benefit from a double tax treaty represents a significant disincentive for borrowers, given that the risk is invariably thrown back onto them under the terms of issuance.
First, it reduces the pool of investors to which UK borrowers can issue debt. Borrowers will not be prepared to issue to persons to whom they will have to gross-up payments. Persons to whom payments of interest would be subject to withholding tax without a gross-up will not invest. And even if an investor is entitled to receive payments gross, it will need to understand the intricacies of the UK withholding tax regime, resulting in discouraging expense.
Second, and perhaps more importantly, it reduces the pool of investors to whom issued debt can be transferred. The gross-up clause will typically apply to transferees only to the extent that it would have applied had they been original investors. That potentially affects the value of the debt, because it reduces the pool of potential investors. It also means that the loan documentation contains complicated provisions dealing with transfers, even though it is rarely envisaged that the original investor will transfer the loan.
The government has proposed a new exemption (to appear as ITA 2007 s 888A) from the general withholding obligation relating to interest payments. This will apply to ‘qualifying private placements’. It amounts, in effect, to an exemption for interest paid under arrangements that satisfy certain conditions.
Five of these conditions are set out in the draft primary legislation released on 10 December:
The rest of the conditions will be included in the (as yet unpublished) regulations and are described in the technical note. Two apply to the issuer:
Three apply to the investor (the person or persons for whom the ultimate benefit of the debt is held, if there are intermediaries):
And five apply to the security itself, which must:
The announcement of an exemption for private placements is welcome and the government is to be commended for responding to industry lobbying. Unfortunately, however, the details of the proposal are disappointing.
The main concern is the imposition of conditions on the investor. As noted above, the key problems with the current position are that not all potential investors are entitled to receive payments gross (reducing the pool of potential investors); and those investors that are eligible to receive gross payments must understand the conditions that they, and any transferee, will have to meet (resulting in the incurrence of cost).
By also imposing conditions on investors, the proposed exemption fails to deal with those issues. In particular, requiring the investor to be resident in a treaty state means not only that the exemption will do little to increase the pool of potential investors, because investors not resident in treaty states will still be excluded, but also that potential investors may continue to be discouraged because they will continue to have to grapple with treaties and the loan documentation will still need to include complicated tax provisions.
The technical note states that the investor conditions will fall to be certified by the investor – the thinking presumably being that the borrower will thus be relieved from bearing the risk of making an incorrect factual assessment. However, although it is not appropriate to require the borrower to determine whether investor conditions are satisfied, putting such a burden onto investors means that UK private placements will be less attractive than they might otherwise be.
The answer is not to have any investor conditions at all. It is to be noted in this regard that the ACT report did not merely recommend the introduction of an exemption for private placements. It also recommended an exemption akin to the quoted eurobond exemption. That exemption, by not imposing any conditions relating to investors, neither restricts the investor pool nor discourages investors by requiring them to understand the UK’s withholding tax regime.
While issuer and security conditions are more appropriate as a general matter, the proposal is imperfect in this regard, as well. In particular, the rationale for requiring the issuer to be a trader is unclear. Somewhat alarmingly, it is not even certain that a private placement by the holding company of a trading group would benefit from the exemption. Nor is it clear why loans with a maturity of between one and three years are excluded. The requirement that securities do not ‘provide for the loan relationship to terminate within three years of its coming into force’ also needs to be reconsidered; all loan instruments can be expected to provide for termination within three years on the occurrence of an event of default, for example.
The conditions set out in the draft legislation and the technical note are presumably intended to limit the exemption’s application to debts that would ordinarily be regarded as constituting ‘private placements’. However, the conditions need to be reassessed if the exemption is to achieve the government’s aim of encouraging more private placements.
There is now a period of consultation on the proposal. Comments on the technical note should be sent to HMRC by 27 February and both HMRC and HM Treasury are willing to discuss it with interested parties directly. We at Slaughter and May are working with the ACT to make a joint submission and hope to meet with HMRC and HM Treasury to explore how the proposal might be improved.
We would strongly encourage others – including current or potential private placement borrowers or investors and their advisors – also to share their views as part of the consultation. This is a valuable opportunity to create an exemption that will make a real difference to the UK’s nascent private placement market and every effort should be made to take advantage of that.
Comments on the draft legislation should be sent by email by 27 February 2015
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