Quoted Eurobonds – source of interest

Quoted Eurobonds – source of interest

Quoted Eurobonds are often used in structuring debt where offshore entities provide funds for UK activities, e.g., property investment or trading. Conveniently, there is an exemption from withholding tax on the interest paid on Quoted Eurobonds so the overseas investor will not usually be subject to UK tax on that interest.

While interest on quoted Eurobonds is exempt from the requirement to withhold UK tax, this does not necessarily imply that the interest is not UK source. Indeed, the exemption is only relevant in cases where the interest is in fact UK source, since otherwise the obligation to deduct withholding tax would not be relevant in the first place. Furthermore, the relevant case law on the subject shows that the situs of a debt instrument is by no means the sole indicator of the source of interest paid in accordance with that instrument.

The most important case concerning the source of interest for UK tax purposes is the 1970 case of Westminster Bank Executor and Trustee Co (Channel Islands) Ltd v National Bank of Greece, often referred to simply as the Greek Bank case. In their June 2018 decision in Ardmore Construction Limited v Revenue and Customs Commissioners, the Court of Appeal confirmed the multi-factorial approach adopted by the Upper Tribunal to determine the source of interest, based on the principles set down in the Greek Bank case. Although in Ardmore, the loan was a simple loan, not a quoted Eurobond, that distinction makes any difference to the principles at issue, especially as the Greek Bank case itself involved bearer bonds issued by the National Bank of Greece.

Although the multi-factorial test is not one that can be simply stated in a convenient set of definitive factors, in Ardmore the Upper Tribunal identified nine that are relevant for this purpose:

1. residence of the debtor;
2. residence of the original guarantor;
3. location of the security originally provided;
4. ultimate or substantive source of discharge of the debtor’s obligation;
5. residence of the creditor;
6. place where credit was advanced;
7. place of payment of the interest;
8. jurisdiction in which proceedings might be brought to enforce the interest obligation; and
9. proper law of the contract.

The Upper Tribunal found, and the Court of Appeal agreed, that the most important factors were factors 1-4, with factors 5-9 being less important.

HMRC’s stated view is that the residence of the debtor is the most important factor in determining the source of the interest, so in any case of doubt, it seems highly likely that HMRC will argue that the interest is UK source if the debtor is UK resident. A further important factor which suggests that the interest is UK source is whether the ultimate or substantive source of discharge of the debtor’s interest obligation will be profits earned in the UK.