This note sets out details of a possible new approach to the taxation of profits, gains and losses on derivatives held by companies which are currently excluded from the derivatives contracts regime (Schedule 26 Finance Act 2002). The main object of this approach is to provide a simpler and more certain tax treatment for such derivatives.
The current tests in UK law of whether, for the purposes of deduction of tax, payment of interest is made from a UK source are unclear and cause confusion. The statutory rules date back a long way and do not take account of modern financial practice. They have been subject to judicial interpretation, which has not always been easy to apply in practice.
The EU Interest & Royalties Directive includes a definition of where interest arises. This will be introduced in to UK law as part of implementing the Directive, but will apply only to payments of interest that are covered by the Directive. This new definition throws into relief the problems with the current approach to the question of UK source for the purposes of deducting tax from interest payments.