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25/06/24

Tax Gross Up Clauses

Tax Gross Up Clauses
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A tax gross up clause is a provision in contracts or agreements that ensures an individual or entity receives an amount after taxes equivalent to what they would have received if no taxes were imposed.

The purpose of the tax gross up clause is to protect the recipient from the financial impact of tax liabilities and is commonly included in employment agreements to cover things such as bonuses, relocation expense or loan agreements, amongst other things.

Due to the complexity of arrangements in such matters, commercial disputes between parties can arise as well as tax disputes with HMRC. Our Team is able to assist in relation to both types of disputes.

In a previous article titled ‘UK Withholding Tax,’ we outlined the basic operation of ‘withholding tax’ on interest payments under Loan Agreements required by Section 946 of the Income Tax Act 2007.

As a matter of normal practice, a Loan Agreement will prohibit a borrower from deducting or withholding, an amount from any payment unless that deduction is required to be withheld by law.

Accordingly, as a matter of commercial prudence, the Loan Agreement under which the loan is made and which contains the operative terms and conditions of the transaction, will include a clause ensuring that if the borrower, when obliged by law to withhold any amount from a payment, such as withholding tax on interest, will be required to pay to the lender such an additional amount as is required. This will ensure the lender receives the same amount as it would have, had no deduction for the amount of tax been made.

This clause, known as a gross up clause will include other circumstances for example, a payment is made to secure an indemnity for the recipient in the event of such taxes arising. This additional payment will also be subject to tax and the sequence of additional tax calculations will continue until the recipient receives the full amount, net of all the taxes, as would have been the case, had there been no taxes.

Tim Thompson of KANGS outlines the situation.

‘Grossing Up’

Nature of Calculation

Under a Loan Agreement, the borrower is contracted to pay 100% of the interest falling due to the Lender.

However, the borrower is obliged to withhold tax at, say, 20% from the interest accrued. In such circumstances, the borrower will pay 80% of the interest to the lender and 20% to HMRC.

Under the Loan Agreement, the borrower will have to pay to the lender such further sum as will ensure that the lender actually receives and retains 100%, i.e. the full amount of the money loaned.

Whilst that sum may appear to be 20%, that 20% itself may also be subject to withholding tax, with the consequence that the borrower will still have a residual liability on each reduction to the lender until the point is reached where the lender has been repaid in full.

Example of a Typical ‘Grossing up’ Clause.

There are many forms of such a clause, each appropriately tailored to suit such unique transaction.

However, a typical example is:

‘All payments to be made under this Agreement shall be made in cleared funds, without any deduction or set-off and free and clear of and without deduction for or on account of any taxes, levies, imports, duties, charges, fees and withholdings of any nature now or hereafter imposed by any governmental, fiscal or other authority save as required by law. If a Party to this Agreement is compelled to make any such deduction, it will pay to the receiving Party such additional amounts as are necessary to ensure receipt by the receiving Party of the full amount which that party would have received but for the deduction.’

How Can We Help?

Any form of Loan Agreement under which the payment of interest is required, whether involving overseas parties, will be a highly technical document encompassing, amongst other things, potential tax liability of various descriptions.

As a result of the complexity of such matters, disputes can arise. We offer a vast amount of experience in advising and guiding clients involved in commercial disputes of every nature as well as advising and representing taxpayers in disputes with HMRC.

If we can be of assistance, please do not hesitate to contact the Team at KANGS using the details below:

Tel:       0333 370 4333

Email: info@kangssolicitors.co.uk

We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through live conferencing or telephone.

Hamraj Kang

Hamraj Kang
Senior Partner

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Tim Thompson

Tim Thompson
Partner

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