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“Ephemeral” Payments and Beneficial Entitlement

Tax legislation, and the decisions of tax courts and tribunals, can sometimes appear to be full of surprises. 

The decision of the UK’s Court of Appeal in Hargreaves Property Holdings Limited [2024] EWCA Civ 365, delivered on 15 April 2024 (“Hargreaves”), rejected the taxpayer’s appeal.  In doing so, the Court of Appeal followed the judgment of the Upper-tier Tribunal in concluding that a UK company was not “beneficially entitled” to interest assigned to it for the purposes of UK tax legislation (and therefore was not within an exception from withholding of UK income tax).  

Much of the Court of Appeal’s reasoning was taken up with considering the meaning of the statutory expression “beneficially entitled” in the context of section 933 of the Income Tax Act 2007 (“Section 933”), which exempts a payment from withholding of UK tax at source. 

What appears, at first sight, to be surprising, in the light of the Court of Appeal’s judgment, is that the construction of “beneficially entitled”, in the context of Section 933, has often gone unchallenged.

We considered the Upper-tier Tribunal decision in Hargreaves in BrassTax in August 2023.[1]  The case concerned a UK tax resident company, which was the ultimate parent company of a UK property group (Hargreaves Property Holdings Ltd (the “Taxpayer”)). The Taxpayer had received financing from connected overseas lenders. Following tax planning advice, the terms of the loans were amended so that: (i) the loans were repayable on 30 days’ notice by the lender or at any time by the appellant; (ii) all payments were made in Gibraltar from a source outside the UK; (iii) no assets in the UK were secured; and (iv) Gibraltar or Jersey was the governing law and the courts of Gibraltar or Jersey had exclusive jurisdiction.

Shortly before the interest was paid by the borrower, the lender also assigned for consideration its right to interest to a third party. Initially, the third party was a Guernsey company (“Storrier”) or Guernsey trusts. In later years, the loans were assigned to a UK resident company (“Houmet”). The consideration for the assignment was an amount equal to almost all of the interest which Houmet received.

Together, these changes were made with the intention of ensuring that the interest was (as far as relevant to the Court of Appeal judgment):

  1. in the case of interest paid to Houmet, regarded as being paid within the statutory exception from withholding of income tax under Section 933 (i.e. interest paid to UK resident companies) and specifically that Houmet was “beneficially entitled” to the interest; and
  1. not regarded as “yearly interest.”

The Court of Appeal’s focus in its judgment was mainly on whether interest paid to Houmet was interest to which Houmet was “beneficially entitled.”

“Beneficial entitlement”

The Court of Appeal agreed with the Upper-tier Tribunal that the reference to "beneficially entitled" in Section 933 is not immune from the requirement that UK tax legislation must be construed purposively.

What was needed for the exception in section 933 to apply was for “beneficial entitlement” to connote a “real and practical entitlement”.  In the words of the Court of Appeal, “[i]f the person in question would, in truth, have none of the benefits that entitlement would ordinarily bring, they will not be beneficially entitled.”[2]

The provisions of Section 933 require the person beneficially entitled to the interest income to be a UK resident company.  In an ordinary case, the scope of the exception in Section 933 might be expected to be co-extensive with the interest being taken into account for UK corporation tax purposes. 

Indeed, the Counsel for the Taxpayer argued that this was the approach taken in many other cases before the courts over the years.  Counsel argued that UK tax resident companies had received interest income, had been treated as beneficially entitled to such income, and, accordingly, had been taxed on that interest income.  Section 933 had applied to exempt such taxable interest from UK withholding at source.  So why was it problematic to apply the exception in Section 933 to Houmet, a UK resident company?

The Court of Appeal did not disagree with that base case. “In most cases, therefore, a UK resident company that is legally (or equitably) entitled to interest income and does not receive it on behalf of anyone else would be expected to be able to benefit from the exception in [Section] 933.”[3]  However, the accurate test of being beneficially entitled under Section 933 required more, in the shape of applying the statutory test to the reality of the transaction.

Why Hargreaves was different

On the facts of the case, Houmet’s involvement “was entirely ephemeral.”[4]  Viewed realistically, the transactions did not confer the benefit of an entitlement to the income.  Houmet was not able to use the interest income for any purposes other than onward payment.  There was no material margin charged by Houmet. Parliament could not have intended, the Court of Appeal determined, that Houmet would be able to claim the Section 933 exception from withholding tax “by way of steps that were entirely tax-motivated, and which has not been established as having benefited in any real sense from the interest that it paid away. Houmet's involvement not only had no commercial purpose but had no practical or real effect.”[5] 

The test in Section 933 was not mere entitlement by a UK resident company to the interest income; the test was whether the recipient enjoyed benefits derived from the entitlement to that interest income.

On this basis, the Court of Appeal found against the taxpayer, and also concluded that the interest on the loans was yearly interest even if the loan in question had a duration of less than a year (which was required in order to subject the interest to withholding tax).

How should Hargreaves be applied in practice?

So we have an ostensibly surprising decision, which when we look closely at the reasoning of the Court of Appeal (and the Upper-tier Tribunal) might not seem so surprising after all. 

It is very hard to disagree with the Court of Appeal that Section 933, as a statutory provision, should be immune from the requirement that UK tax legislation must be construed purposively. It is as if a magic trick is explained, and on closer examination, the only surprise is why no one saw through the trick earlier. 

However, within the Court of Appeal’s approach lies a challenge for tax practitioners.  Does every transaction in which UK source interest is paid to a UK resident company now need, following Hargreaves, to be examined from a realistic viewpoint to determine how the recipient is beneficially entitled to that interest?  Do we need to identify the benefits derived by the UK corporate recipient of the interest?  Do we have to evaluate if that receipt was ephemeral?

In most cases, the answer should be relatively clear.  A seam of unacceptable tax avoidance was perceived by the Court of Appeal to run through the facts of Hargreaves.  But even in more commercially legitimate arrangements, such as financings and securitisations, old and familiar provisions may need to be reconsidered following Hargreaves

Which, far from being magic, is one reason why the practice of taxation law can be consistently surprising.


[1]     Hargreaves Property: What Does the Latest Decision Mean for UK Withholding Tax?

[2]     Hargreaves at paragraph 54, per Lady Justice Falk.

[3]     Hargreaves at paragraph 62, per Lady Justice Falk.  Emphasis added in bold.

[4]     Hargreaves at paragraph 70, per Lady Justice Falk.

[5]     Hargreaves at paragraph 72, per Lady Justice Falk.

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