United Kingdom - Market Insights

Recent cases on the unallowable purposes rule for loan relationship debits

Governments and tax authorities have long been aware that deductions for interest payments on loans can allow taxpayers to reduce profits made in their jurisdiction. They have developed a plethora of rules to counteract this and these have, to some degree, been standardised across jurisdictions, most obviously through the OECD’s Base Erosion and Profit Shifting (BEPS) Project and the EU’s Anti-Tax-Avoidance Directives 1 and 2.

It is now 30 years since the UK introduced its “unallowable purposes” rule in the Finance Act 1996. A company subject to corporation tax may not claim tax deductions for any accounting debits on a loan relationship to the extent they are attributable to an “unallowable purpose”. A company has an unallowable purpose if its purposes include one that is not a business or commercial purpose of the company. A tax avoidance purpose — one of obtaining a “tax advantage” — is only a business or commercial purpose if it is not the main purpose, or one of the main purposes, for which the company is a party to the loan.

For the first 15 years after its introduction, there were no first-instance cases on the unallowable purposes rule. Since then, several cases have come before the tribunals and higher courts, but 2024 saw a sharp increase in activity. This included three judgments from the Court of Appeal, all of them wins for His Majesty’s Revenue and Customs (HMRC), all of them now final. This chapter focuses on these three cases and one First-tier Tribunal (FtT) decision (also an HMRC win). Meanwhile HMRC has made extensive updates to its guidance on the rules (first in 2023 and then to reflect the 2024 judgments) and is pursuing other challenges that have not yet reached the courts. This is an area of HMRC focus, so it should also be one for taxpayers.

The lack of case law on the rule led taxpayers to rely heavily on HMRC’s guidance and on a statement by the Economic Secretary to the Treasury made to Parliament in 1996 when the rule was first introduced (repeated in HMRC’s guidance as “the Hansard Statement”). This included the following: “We have been asked whether financing — which, for example, is to acquire shares in companies, whether in the United Kingdom or overseas, or is to pay dividends — would be affected by the paragraph. In general terms, the answer is no, but the paragraph might bite if the financing were structured in an artificial way.”

This may be one of the reasons why three of the four cases involved debt used to fund the acquisition of shares.

BlackRock Holdco 5 LLC was party to a complex financing structure as part of the acquisition of the Barclays Global Investors business in 2009. The LLC was resident for tax purposes in the UK and claimed deductions for interest payments on a loan from its parent; both companies were disregarded for US tax purposes, so there was no interest inclusion. The First-tier Tribunal found that the tax advantage was a main purpose of the transaction, but it attributed all the deductions to the purpose of investing rather than the tax purpose. The Upper Tribunal (UT) attributed the deductions to the tax purpose and denied them. The Court of Appeal (CA) found errors in both Tribunal decisions and remade the decision. The LLC was the sole UK-resident entity in a wholly US-based and equity-funded ownership chain and much of the substantive discussion between the executives and their advisors on the transaction was about tax. The court concluded that the LLC had entered the transaction with a main purpose of securing a tax advantage; although it had a commercial main purpose as well, all the debits connected with the loan notes should be attributed to the unallowable purpose and tax relief denied.

JTI Acquisition Company (2011) Ltd similarly borrowed to fund an acquisition. As in BlackRock, a UK-resident company within a US-headed group was borrowing to acquire (directly in this case) a US target; as in BlackRock, the funding structure put in place by the group meant that the intended UK deductions were not matched by inclusions elsewhere. One point of difference was that in this case the intra-group borrowing reflected external borrowing. The FtT found that the reason for using the company to make the acquisition and for it to borrow the funds for it was to obtain the tax advantage of the interest deductions. Surprisingly, the FtT did not accept that the company also had a commercial purpose; and both the UT and the CA declined to interfere with that conclusion.

The final months of 2024 brought up a third win for HMRC on acquisition debt, this time before the FtT. Syngenta Holdings Limited made an intra-group acquisition of a UK sister company from its Dutch parent, thus bringing all the UK subsidiaries into a single UK sub-group. The FtT found that the only object of the directors was to secure the interest deductions: the deductions were therefore denied.

Somewhat different was the other Court of Appeal judgment. This arose from a reorganisation of indebtedness within the Kwik-Fit group. A member of the group had substantial losses. It was using them to shelter its profits, but this was expected to take 25 years. A plan was formed: certain existing intra-group loans were transferred in; new ones were made; low interest rates were increased to arm’s length. The intended result was that the losses would be used up in three years; meanwhile, the new or increased deductions arising in other group companies would be able to be used against profits in those companies or elsewhere in the group. HMRC had other ideas and denied the deductions. (It did accept that the deductions should be allowed once the losses had been exhausted.) The taxpayer successfully argued before the Tribunals that the debits on existing loans should be allowed to the extent that the rate on them had not been increased; on the rest it lost. The Court of Appeal took a slightly more nuanced approach: the tax advantage did not derive from the use of the existing losses in isolation; rather, it came from using existing losses to absorb the tax on new interest income, while the corresponding new interest deductions could be used in the debtor companies or surrendered elsewhere in the group. The deductions for the new interest were all attributable to the unallowable purpose, so should all be denied.

As usual, all four cases reached court some years after the events concerned: the accounting periods in issue broadly spanned the early to mid-2010s. Delays of this length may mean that witnesses are not available or their memories have faded, so the courts will rely heavily on the contemporary written record. They did so in all four of these cases.

In JTI and Syngenta in particular, the taxpayers’ witnesses tried to play down the tax reasons for the transactions and play up ostensible non-tax motivations: the courts found this self-serving and rejected it.

The taxpayer in BlackRock had taken a different tack: those planning the transactions tried to insulate the taxpayer company from having its purpose tainted by the tax benefit for the rest of the group by telling the directors not to take it into account. This too failed.

What can we draw from the cases? Unsurprisingly, four taxpayer losses offer several lessons about what not to do:

• don’t use intra-group debt where there is no income pick-up;
• don’t try to load a UK company with acquisition debt after the initial acquisition from outside the group; and
• don’t expect to convince the fact-finding tribunal that a tax-motivated transaction really has some other commercial purpose or that the relevant decision-makers ignored the tax benefit of which everyone else was aware.

The time cases take to reach court has further implications when looking forward:

• The case law may have moved on between the planning of a transaction and HMRC enquiry into it or litigation: in particular, HMRC may have brought and won cases where the taxpayer had worse facts, but it may be hard to persuade a court that those cases should be distinguished.
• The climate may change between the time a loan is put in place and the time the courts review it: what was thought run-of-the-mill planning may take on a different complexion 10 or 15 years later.

Looking back, the law has changed significantly since the first periods at issue in these four cases:

• the Finance Act 2014 brought in a loan relationships “regime TAAR” with effect from 5 December 2013; and
• following the BEPS Project, the UK has:
  • introduced a corporate interest restriction; and
  • revised its anti-hybrid rules.

All these need to be taken into account, as well as the unallowable purposes rule.

Because the unallowable purposes rule is a subjective test which takes into account the taxpayer’s motives, the outcome depends on the taxpayer’s starting position. To illustrate, there was nothing inherently wrong with the Syngenta planning: if the subsidiaries had been acquired from outside the group, there should have been no problem in principle with taking on debt to acquire them; but they were already within the group and no adequate non-tax justification for the immediate transaction was made out. Navigating this subjective and path-dependent test under HMRC’s active scrutiny at the same time as an increased number of objective but arbitrary tests, such as the corporate interest restriction, grows ever more difficult.