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CFM75100 Deduction of tax: interest paid in the ordinary course of banking business
Other exceptions
A debenture issued by the bank is not a relevant deposit; nor is a debt on a security that is listed on a
recognised stock exchange. There is also an exception for loans made by another deposit-taker in the
ordinary course of his business (although since most deposit-takers are companies, interest on such
loans will normally be payable gross in any case).
Tax-exempt savings products
Interest on cash deposits held within Individual Savings Accounts (ISAs) is outside of the TDSI
scheme.
Payment without deduction of tax
An investor may register an account for payment of interest without deduction of basic rate tax if they
are an individual who is ordinarily resident in the UK, and they do not expect to be liable to income tax
for the year in which the interest is paid. The registration is made on form R85.
Once the deposit-taker receives a fully completed R85, they must make all subsequent interest payments
without deducting tax until the account is de-registered, or the investor dies or becomes bankrupt, or an
investor who is a child reaches the age of 16. They do not have to check the accuracy of the information
that the investor provides.
An account is de-registered if the investor instructs the bank to do so - as they must do if they realise
they are, or will be, liable to tax. HMRC's Savings Scheme Office (SSO) can also instruct a bank to de-
register an account if they have reason to believe that registration is not appropriate.
Accounting for tax deducted
The bank, or other deposit-taker, accounts for basic rate tax deducted from interest on relevant deposits
under the normal CT61 procedure - see CTM35050. ITA07/PT15/CH15 applies to interest on relevant
deposits:
• even if the deposit-taker is not resident in the UK, and
• even if the deposit-taker is not a company.
The statutory authority for this is ICTA88/S480A (2)-(4). For the purposes of Schedule 16, crediting
interest to an account is the same as paying it.
Audit
Savings & Audit (Saving Scheme Office) periodically audits a sample of accounts to check that deposit-
takers are deducting the right amount of tax at the right time, and that gross payment of interest is only
being made where it is permitted by law. The audit includes consideration of the deposit-taker's systems
and controls, a check of the calculation of the sum of basic rate tax shown on the quarterly CT61(Z)
return, and a sample check of accounts where tax is not being deducted, either because the investor has
declared themselves to be not ordinarily resident in the UK, or because form R85 is held.
HMRC staff who examine the accounts of banks and other deposit-takers should refer to SSO any
questions or problems that arise concerning the operation of the tax deduction scheme.
Certificates
ITA07/S975 imposes a duty on any person making a payment under deduction of tax to provide the
recipient of the payment, on written request, with a statement setting out the gross amount of the
payment, the tax deducted and the amount actually paid.
A bank or other deposit-taker that deducts tax from interest must therefore supply a certificate if the
investor asks for one in writing. It is not obliged to send certificates routinely to all investors, although
many banks do. It cannot charge the investor for the certificate, although it can make a charge for a
duplicate.
Enforcement of the statutory duty lies with the investor, not with HMRC. HMRC staff who are told by a
customer that he or she has been unable to obtain a certificate of tax deducted should be told of their
legal right, and advised to take up the matter with the bank (or other payer of interest) concerned.
Interest paid in the ordinary course of banking business
If a bank pays short interest, other than on a relevant investment (see CFM75050), it does not have to
deduct income tax.
If it pays yearly interest, and the interest is not being paid on a relevant deposit, the bank might still
potentially be obliged to deduct tax under ITA07/PT15/CH3. However, ITA07/S878 provides an
exemption for interest paid by a bank in the ordinary course of its business.
Example
A Canadian company places surplus funds on a long-term deposit with a UK bank. This is not a relevant
deposit, so ITA07/PT15/CH2 does not apply. Nevertheless, since the company's place of abode is
outside the UK, ITA07/PT15/CH3 would normally oblige a UK payer of interest to deduct tax (unless
clearance had been obtained to pay the interest gross under the Double Taxation Treaty between the UK
and Canada). Since, however, the interest is being paid by a bank in the ordinary course of its business,
the obligation to deduct tax is switched off.
’Bank’ takes its meaning from ITA07/S991 - see CFM14060.
Statement of Practice 4/96
HMRC’s view, set out in Statement of Practice 4/96, is that any yearly interest paid by a bank is paid
within the ordinary course of its business, unless the interest falls within one of two defined
circumstances.
• The interest is not regarded as paid in the ordinary course of business where the borrowing relates to the
capital structure of the bank. Borrowing relates to the capital structure if it is within the definitions of Tier 1, 2
or 3 capital adopted by the Bank of England, whether or not it actually counts towards Tier 1, 2 or 3 capital for
regulatory purposes.
• Interest is not paid in the ordinary course of business where the transaction giving rise to the interest is
primarily attributable to an intention to avoid UK tax. CT&VAT (Financial Products) Team will advise in any
case where HMRC staff believe that this paragraph of the Statement of Practice may be in point.
Advances by a bank
The exemption at ITA07/S875 applies to interest paid by a bank. There is a further exemption at
ITA07/S879 that applies in certain circumstances where interest is paid to a bank.
The obligation under ITA09/S874 to deduct tax is switched off if:
• it is payable on an advance from a bank, and
• at the time when the interest is payable, the person entitled to the interest is within the charge to corporation
tax as respects the interest.
‘Bank’ is defined at ITA07/S991 (CFM14060). The person entitled to the interest does not have to be
the bank that first made the advance: ITA07/S879 will continue to apply even if the bank assigns the
loan to a UK company that is not a bank.
This provision assumes much less importance for interest paid by a company, or a partnership whose
members include a company, on or after 1 April 2001. From that date, there is no obligation to deduct
tax where the payer reasonably believes the person entitled to the interest to be a company resident in
the UK. Similarly, payment can be made gross if there is a reasonable belief that the interest is being
brought into charge to corporation tax by a UK permanent establishment of a non-resident company.
These provisions also apply to interest paid by a local authority on or after 1 October 2002.
These relaxations only remove the obligation to deduct tax from yearly interest imposed by
ITA07/PT15/CH3 on companies, local authorities and partnerships with company members. They do
not apply to the obligation under ITA07/S874(1)(d) to deduct tax from interest paid to non UK
residents.
Example
A company incorporated in Italy is recognised as a bank in the UK for the purposes of ITA07/S991.
Its UK branch makes a normal business loan to X Ltd, a UK trading company. Since the bank's normal
place of abode is outside the UK, X Ltd has to consider whether it should deduct tax from the interest
payments under ITA07/S874. However, since the advance was made by a bank, and the interest is being
paid to its UK branch, which is within the charge to CT in respect of the interest, X Ltd is able to pay
the interest gross by virtue of ITA09/PT15/CH11.
If the Italian company ceased to be a bank within the meaning of ITA07/S991, X Ltd would require
authorisation under the relevant Double Taxation Treaty in order to continue paying the interest gross.
Derivatives
Banks do not need to deduct tax from payments that they make under the terms of swaps, futures,
options and similar derivatives. Such payments, even where they arise on interest rate derivatives, are
not interest. Neither will they, in general, be annual payments, since the counterparty to the derivative
will normally have obligations as well as rights under the contract, payments made by the bank will not
be pure income profit in the counterparty's hands.
The point is put beyond doubt for derivative contracts within CTA09/PT7. CTA09/S570 specifically
provides that there is no requirement to deduct tax from payments.
Banks may on occasion pay true interest in connection with dealings in derivatives. For example, they
may pay interest on margin accounts or on cash held as collateral, or they may be obliged to pay interest
if they are late in making a payment due under the contract. CTA09/S570 does not extend to interest
paid on money debts of this kind. The normal rules on deduction of tax need to be considered.