Companies must deduct basic rate tax from interest which amounts to ‘annual payments’ where that interest is paid to individuals or trustees.
Before 2016/17, most interest paid to individuals had basic rate tax deducted at source, whether the payer was a bank or not. Since 6 April 2016, deposit takers (banks building societies and certain other institutions including NS&I) have not been required to deduct basic rate tax in respect of relevant investments. But other companies which make ‘annual payments’ (whether of interest or otherwise) must deduct basic rate tax and report that deduction on the quarterly forms CT61.
From 2016/17, it has become tax efficient to pay a director or shareholder interest from a private company if that interest can be set against the individual’s personal savings allowance of £1,000, (£500 for higher rate taxpayers). But the company must understand whether the interest is correctly categorised as an annual payment in order to deduct basic rate tax or not.
How to define an annual payment
The recent case of Hargreaves Lansdown Asset Management Ltd (HL) (TC06383), turned on the definition of ‘annual payments’.
HL is a major player in the financial services world. Its customers can invest in a wide range of external fund providers through HL’s administration system. The fund providers levy an annual management charge (AMC) as a percentage of the client’s fund value, which is usually collected directly from the fund rather than being directly billed to the investor. The fund providers also pay HL a rebate of part of the clients’ AMC.
HL pays the entire rebate to its clients as a monthly ‘loyalty bonus’, as it is required to do so by the Financial Conduct Authority. HL argued that the loyalty bonus does not amount to annual payments.
HMRC argued that these loyalty bonuses constituted ‘trail commission’, as defined Brief 04/2013, which sets the view that such sums are annual payments and should be taxed as such from March 2013. This would enable HMRC to assess HL under ITTOIA 2005 s 957 to collect substantial tax which it considered should have been withheld at source by HL.
What is an annual payment?
There is no statutory definition, so the judge reviewed the case law. An annual payment, he found, has four characteristics, all of which must be satisfied:
1. Payable under a legal obligation
The terms and conditions which HL held out to customers were, the judge said, sufficient to represent an offer (to pay the bonus) capable of acceptance (by satisfying HL’s criteria). This is the traditional essence of a contract, so no help for HL there. One-nil to HMRC.
2. Capable of recurrence
One of the first things a student of tax learns about annual payments is that they don’t have to be paid annually. ITTOIA 2005 s 683(3) specifies that the frequency of payment is not a factor in determining whether payments are annual. All that is necessary is that the payments may continue beyond the year (even if they end up failing to!).
Even though HL claimed they had a right to reduce bonus payments to nil, the simple facts were that the payments not only could recur but verifiably had recurred. Two-nil to HMRC.
3. Constitutes income and not capital
HL fully accepted that the bonus payments were of an income nature. Three-nil to HMRC.
4. Represents “pure income profit”
The judge looked at a number of arguments and precedents in an attempt to clarify the rather archaic phrase ‘pure income profit’. These say it must either be in the nature of bounty or taxable without adjustment (by analogy with traders, profit rather than turnover). According to HL, a client had to do something to ‘earn’ the loyalty bonus – ie paid their AMC and not sold their investment in the last month. The judge felt that those conditions were not of themselves onerous enough to prevent the bonus being pure income profit. You might think this amounted to four-nil to HMRC, but...
The final outcome
In the end, this case did not turn on either side’s chosen arguments. The judge instead examined the relationship between the bonus and the AMC. He concluded: “The loyalty bonus is a mechanism for reducing net cost, nothing more and nothing less.”
The loyalty bonus, being simply a cost reduction, is not an annual payment, and in fact, it is not taxable at all – no more than 10p off a loaf in Sainsbury’s is taxable income of the shopper!
More generally, we are reminded of the four necessary steps to define an annual payment.