Our understanding was that the recipient would then claim foreign tax credit relief for the amount allowed under the UK-Lithuania double tax treaty (5%/10%) and claim the remainder back from HMRC.
The recipient has now been informed that because Lithuania has entered into a double tax treaty with Japan, there should be no withholding tax and there will be no foreign tax credit relief available going forwards. Accordingly, they also wish to simplify matters so that they can receive the royalties gross going forwards.
Although initially it seems unclear why a double tax treaty between 2 other countries can affect the double tax treaty with the UK, the existence of a ‘most favoured nation’ clause can come into play.
Currently, even though under Article 12 of the UK-Lithuania double tax treaty, the UK can charge 5% or 10% tax on royalties, this treaty is subject to a ‘most favoured nation’ clause.
This clause was included in paragraph 6 of the EXCHANGE OF NOTES OF 19 MARCH 2001 which is available at the following links:
https://library.croneri.co.uk/cch_uk/bit/52-kenyalith2001-h12
https://www.gov.uk/government/publications/lithuania-tax-treaties
This clause has an impact on the rates of tax (or maximum rates of tax) which may, in accordance with the Treaty concerned, be charged. Therefore, following the Lithuania-Japan treaty coming into force., the amount chargeable was limited to nil.
The Contracting States agree that where Lithuania agrees to a lower rate of tax than 5 per cent in respect of the royalties specified in paragraph (2)(a) of Article 12 or 10 per cent in respect of any other royalties in any Convention between Lithuania and a third State which is a member of the Organisation for Economic Co-operation and Development at the date of signature of this Convention, and that Convention enters into force either before or after the date of entry into force of this Convention, the competent authority of Lithuania shall notify the competent authority of the United Kingdom of the terms of the relevant paragraph in the Convention with that third State immediately after the entry into force of that Convention and such lower rate of tax shall be substituted in Article 12 of this Convention for 5 per cent in respect of the royalties specified in paragraph (2)(a) or 10 per cent in respect of any other royalties with effect from the date of entry into force of that Convention, or of this Convention, whichever is the later.
HMRC have confirmed in their manual at DT12152:
Note 2: Under the 2001 Convention, Lithuania tax on royalties paid to a UK resident recipient who is the beneficial owner of the royalties is reduced to:
1. 5% of the gross amount where the royalties are for the use of industrial, commercial or scientific equipment
2. 10% of the gross amount of other royalties
However, a “most-favoured nation” provision in the 2001 Convention was triggered when the Lithuania/Japan Convention entered into force on 31 August 2018. The effect of this provision is that from 31 August 2018 no source state taxation is permitted under the 2001 Convention in respect of any category of royalties.
There is no straightforward method of checking whether a most-favoured nation clause has been triggered, so it would be wise to refer to HMRC’s manuals on a regular basis to see if any changes have been made.
https://www.gov.uk/hmrc-internal-manuals/double-taxation-relief/dt2140pp
Your client, as the UK payer of the royalties, will still need to deduct 20% withholding tax unless the Lithuanian recipient has completed a DT-Individual or DT-company form, thus allowing the reduced/0 % rate to be withheld.
Your client will still need to continue completing a CT61 for every quarter in which royalties are paid, even if no tax is withheld.
It is possible for your client company to pay the royalties gross under s911 ITA 2007 if they reasonable believe the recipient is entitled to relief under the terms of the relevant double taxation agreement. See CTM35270. However, should this belief be incorrect your client will be liable for the tax not deducted. If HMRC believe relief entitlement may not be due, they can issue a notice under s912 ITA 2007 to disapply s911. Owing to the inherent risk of liability, it will be rare for a payer company to utilise s911 unless they have a close link with the recipient.
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