My client company has borrowed money from a firm of solicitors. On preparing the accounts, I found that the interest was being paid gross. I am inclined to think that the company should be deducting income tax from the gross interest, accounting for this to the Inland Revenue on a form CT61 and paying the net interest to the solicitors. Unfortunately, the solicitors seem to think that they should be receiving the interest gross. Who is right and are there any potential problems if matters have not been properly dealt with in the past?
My client company has borrowed money from a firm of solicitors. On preparing the accounts, I found that the interest was being paid gross. I am inclined to think that the company should be deducting income tax from the gross interest, accounting for this to the Inland Revenue on a form CT61 and paying the net interest to the solicitors. Unfortunately, the solicitors seem to think that they should be receiving the interest gross. Who is right and are there any potential problems if matters have not been properly dealt with in the past?
(Query T16,047) - Interested.
Section 349(2), Taxes Act 1988 requires that lower rate interest should be deducted from interest payments, as detailed in Schedule 16 to the Taxes Act 1988. The rule is that 'where any yearly interest of money chargeable to tax under Case III of Schedule D is paid'.
There are four exclusions to this:
* interest paid to banks;
* interest paid to other United Kingdom tax charge companies;
* interest paid by a bank in the normal course of business; and
* interest paid on normal quoted Eurobonds.
If the interest is not yearly, it can be paid gross. This does not seem to be the position in the query though.
Section 85, Finance Act 2001 removed the requirement to deduct tax on payments of interest to another company within the charge to corporation tax, where the paying company believes that the recipient company is within the charge to corporation tax. If this situation is found to be incorrect, the paying company will then have to account to the Inland Revenue for the tax that should have been deducted and interest. Penalties will only apply if it had been clear to the paying company at the time that the interest was paid, that tax deduction should have taken place.
Looking at the firm of solicitors, if it has made the loan from a company (i.e. it trades through an incorporated body), interest may be paid gross. If, as is more probable, it is a partnership, the interest should be paid net, completing a CT61 quarterly.
If this situation has been ongoing for a period of time, I would recommend that contact should be made with the Inspector dealing with the company to explain the misunderstanding, and make the corrections, by paying over the tax, which should have been deducted, plus interest, swiftly. Experience tells that in this situation by taking a proactive approach, penalties can be avoided. - Summer Breeze.
In general, section 349, Taxes Act 1988 requires a company (not being subject to income tax) to deduct tax from annual payments. A similar rule applies to much interest, if it is yearly interest chargeable on the recipient under Schedule D, Case III. Recent legislative changes are discussed in the Inland Revenue Tax Bulletin for August 2001 at pages 867 and 868.
There is a long standing distinction between yearly interest, as above, and so-called 'short' interest, typically under a contract for 364 days. In Commissioners of Inland Revenue v Hay 8 TC 636 interest charged to a client by solicitors on fluctuating balances made available to him was held to be yearly interest. As the borrowing appears to cover more than a year, the company is obliged to account for income tax, despite having made no deductions.
Recent developments in law on 'mistake' make it unclear whether the overpayments can be remedied by withholding additional amounts from future payments.
Section 350(4)(a), Taxes Act 1988 (with Schedule 16) regulates the paying company's duty to account for tax withheld, making quarterly returns. Failure to do so could lead to the making of assessments to collect the amounts missing. The company's neglect exposes it to a penalty of up to £300 under section 98(1)(b)(i), Taxes Management Act 1970 but, curiously, no higher or further penalties are exigible if the company succeeds in making good the default before adverse action is taken. - Elder.
Extract from reply by 'Barham':
Section 106, Taxes Management Act 1970 imposes a penalty of £50 on recipients of interest who refuse to allow a withholding of tax authorised by the Taxes Act, and invalidates any agreement to make such payments gross.
