HM Revenue and Customs Brief 22/08
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Issued on the 9 April 2008
Obligation of local authorities to deduct tax from interest
This brief clarifies our position on the obligation of local authorities to
deduct income tax at the basic rate, currently 20%, in two main circumstances:
- Tax Deduction Scheme for Interest (“TDSI”) under Chapter 2 Part 15 Income
Tax Act 2007 (“ITA 2007”); or
- payments of yearly interest under Chapter 3 Part 15 ITA 2007.
Interest payments within TDSI
TDSI applies if a ‘deposit-taker’ makes a payment of interest on an
‘investment’ and, at the time the payment is made, that investment is a
A ‘deposit-taker’ includes a local authority, which includes a police
An ‘investment’ includes a deposit with a deposit taker. A ‘deposit’ means,
“a sum of money paid on terms which mean that it will be repaid (with or without
interest)- (a) on demand, or (b) at a time or in circumstances agreed by or on
behalf of the person who pays it and the person who receives it.” (Section
855(2) ITA 2007).
A ‘relevant investment’ is defined under section 856 ITA 2007. Not all
investments are ‘relevant investments’. In order for an investment to be a
‘relevant investment’ there must be a deposit.
HMRC would not expect TDSI to apply in circumstances where
there is no ‘deposit’ falling under Chapter 2 Part 15 ITA 2007.
- A police authority may confiscate money from arrested persons and hold
onto that money while the case goes to court. Persons who are not charged or
not found guilty will get their money back. Any interest payable on that money
will not fall within TDSI.
- It is the duty of the local social services authority to provide
after-care services for certain persons who are detained under section 117 of
the Mental Health Act 1983. Prior to the House of Lords hearing in 2002 that
held such after-care services must be provided free of charge, certain local
authorities may have charged for such services. If local authorities
subsequently refund the sums and pay interest on such refunds, TDSI will not
apply to the interest paid.
- Where a local authority compulsorily acquires land, the owner is entitled
to statutory compensation and statutory interest on such compensation from the
date the acquiring authority became liable to pay the compensation. Again,
there is no requirement under TDSI to deduct tax.
- Where a local authority loses in litigation and has cost orders made
against it by a court, the costs are subsequently assessed and these are paid
to the receiving party together with interest. TDSI does not apply to such
Please contact Simon Turner
for further advice on TDSI.
Deduction from certain payments of yearly interest
If TDSI does not apply (as in the four examples above), local authorities
will need to consider whether the interest payable is ‘yearly interest’ falling
under Chapter 3 Part 15 ITA 2007. If it is yearly interest, income tax should be
deducted by the local authority at the basic rate in force for the tax year in
which the payment is made.
Section 874(1) ITA 2007 applies, “if a payment of yearly interest arising in the
United Kingdom is made - …(b) by a local authority…” However, section 874 does
not apply to a payment of statutory interest under the Late Payment of
Commercial Debts (Interest) Act 1998 (section 888 ITA 2007).
‘Yearly interest’ has no statutory definition. It has been contrasted with
‘short interest’. The classic example of short interest is interest payable on a
bank loan for less than one year. However, it is not simply the case that
interest payable for a period of more than one year always constitutes yearly
interest whilst interest payable for less than one year does not.
The leading case on yearly interest is Cairns v MacDiarmid (56 TC 556) where
the intention of parties is seen as the most important factor. If there is an
intention that the debt should subsist for more than one year or it is mutually
accepted that interest may have to be paid from year to year, the interest will
be yearly. (Refer to HMRC Savings and Investment Manual (“SAIM”) 9075 – see
under Manuals of the Practitioner Zone at www.hmrc.gov.uk).
However, where there is no loan, it is very difficult to determine the
intention of the parties and whether interest payable is yearly interest at the
outset, without the benefit of hindsight. Whether or not section 874 ITA 2007
applies depends on all the facts and circumstances under which the interest is
We do not provide rulings on the issue of yearly interest, because failure to
deduct tax from an amount of interest (yearly or otherwise) does not prevent it
being taxable. Our view, therefore, is that whether or not tax is deducted at
source is primarily a matter between the payer and payee. Where the payer of the
interest is uncertain whether or not it is yearly interest, they may in practice
decide to ‘play safe’ by deducting tax. (Refer to SAIM 9076 and SAIM 9180).
If local authorities deduct tax from payments of yearly interest, they should
contact their local tax office without delay to make arrangements to pay the tax
withheld. Their local tax office will then raise an assessment under section 963
ITA 2007. (Refer to SAIM 9170).
Please contact Adeline Chan,
Lesley Hamilton or
Tony Sadler for further advice
on yearly interest.
About the Author
© Crown Copyright 2008.
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Article Published/Sorted/Amended on Scopulus 2008-04-15 15:03:26 in Tax Articles