INTM522030 - Thin capitalisation: practical guidance: third-party loan agreements: the grossing up clause for withholding tax

It is common for a loan agreement to contain a withholding tax ‘grossing up clause’. This is an agreement that if the borrower is obliged to withhold income tax on making an interest payment, the borrower will nevertheless pay to the lender a sum equal to the gross interest. A grossing up clause is a normal feature of cross-border loan agreements, and it is of no particular concern to HMRC as long as the payer of the interest continues to comply with the obligation to withhold tax. However, the following points should be considered if grossed-up payments are made:

• the correct amount of tax should be withheld and paid over to HMRC.
• only the lender is entitled to apply for repayment of the tax withheld, and HMRC will repay it to them unless the lender specifically mandates HMRC to do otherwise. This will mean that the borrower has paid the gross amount to the lender as well as accounting for the tax to HMRC; this means the borrower has paid the tax twice.
• the additional amount paid to the lender to make up the withheld tax is not additional interest, but it is treated as a loan relationship expense.
• unfortunately, if a grossing up clause is honoured, it may reduce the likelihood of the lender making a treaty clearance application, since they will not be prompted by receipt of the net amount.
• In the event that the borrower receives back the withholding tax, perhaps because the lender makes a successful treaty claim, the repayment will be a loan relationship credit.