The interpretation and application of the UK tax unallowable purpose rule in sections 441-442 CTA 2009 (which may deny loan relationship debits where the taxpayer had a main purpose in being party to the loan relationship of obtaining a tax advantage) continues to evolve. The UK tax authority, HM Revenue & Customs (HMRC), recently made some significant updates to its guidance on these rules (as discussed in detail here), in part to reflect the latest case law developments, but numerous cases are still making their way through the tax tribunals and up to the higher courts.
The latest instalment is the Upper Tribunal (UT) decision in the JTI case which was released last week. Has this moved the state of the law in this area on at all? Or do we need to wait for the cases scheduled to be heard before the Court of Appeal to get more useful guidance in this area?
The facts of the JTI case
It’s worth a brief recap on the facts because those are critical to any case about a purpose-based test (as explained in our briefing containing practical guidance on how to approach these types of cases here).
It will quickly become apparent from this recap (especially to those familiar with HMRC’s recently updated guidance) that the arrangements in this case contained a number of features that were likely to raise red flags for HMRC:
- The debt arose in the context of the acquisition of a US target by a US headed group, via a new UK SPV (JTIAC) – i.e., as in BlackRock, there was a “US–UK–US sandwich";
- The interest-bearing debt funding initially provided to JTIAC by its US parent was subsequently assigned to a Cayman finance company, with the debt (in note form) listed in order to qualify as a quoted Eurobond – so there was no withholding on account of UK income tax; and
- Both JTIAC and the finance company were treated as disregarded entities for US income tax purposes, so no interest income was recognised in the US.
If the tax planning worked as intended, the financing arrangement overall would therefore involve a deduction and no inclusion in respect of the interest on the debt. However, the First-tier Tribunal (FTT) agreed with HMRC that debits on the interest-bearing debt should be denied on the basis that the sole main purpose of JTIAC being party to the loan relationship was to obtain a UK tax advantage.
Spoiler: the taxpayer’s appeal to the UT was similarly unsuccessful. Although the taxpayer argued valiantly that the FTT had not been entitled to make the findings of fact that it did (which were fatal to the taxpayer’s case), the UT took the view that the FTT’s approach was simply critical evaluation of the evidence before it and rejected the arguments on this point.
What the JTI case says about how to interpret the unallowable purpose rules
The taxpayer raised various grounds of appeal which centred on the correct statutory interpretation of sections 441–442 CTA 2009, each of which would have had the effect of potentially narrowing the scope of the enquiry permitted by those provisions when determining whether there was an unallowable purpose. These grounds were all rejected by the UT, which considered that the provisions were intentionally drafted in expansive terms to prevent tax avoidance and it would defeat that intention if a narrow, over-compartmentalised interpretation were to be adopted.
There’s nothing terribly ground-breaking in what the UT said on these points, because to a large extent the UT simply confirmed the approach to interpretation of the rules that has been established by prior cases, including by the UT in BlackRock and Kwik-Fit and the Court of Appeal in Travel Document Service. But a neat summary of the key principles (which the UT provided) is always useful, so:
- A tribunal is able to, and should, look at all the facts and circumstances in determining the main purpose for which the company is a party to the loan relationship, which may include examining the reasons why that particular company (as opposed to another) was chosen to be a party to the loan relationship, because those reasons may inform the company’s purpose in being a party to the loan relationship.
- Similarly, examining the wider context of the company’s borrowing may include consideration of directing minds outside the company, which may be relevant to ascertaining the purposes of the directing minds of the company.
- There is no rule that, as a matter of law, the unallowable purpose provisions are inapplicable to arm’s length finance costs for a commercial acquisition. Whether interest incurred for a commercial purpose will be deductible depends on the facts and what the evidence shows the main purpose(s) to be. (Notably, HMRC acknowledged in this case that, in a scenario where debt has been chosen rather than equity to fund a commercial acquisition, it would be open to the tribunal to find that securing a tax advantage was a purpose but not a main purpose.)
- The use to which the borrowing is put is relevant to the purpose of the borrowing, but not determinative.
Burden of proof in unallowable purpose cases
One point in the FTT’s decision in the JTI case which drew quite a lot of attention was its reasoning about the burden of proof when applying sections 441–442. In essence, the FTT considered that if a tax advantage was found to have been secured, the burden was then on the taxpayer to establish that securing that tax advantage was not a main purpose of it being party to the loan relationship.
The FTT went on to conclude that:
- if this burden was discharged (i.e. there was no tax avoidance main purpose), it was necessary to consider just and reasonable apportionment; but
- if this burden was not discharged (i.e. there was a tax avoidance main purpose), it was unnecessary to consider just and reasonable apportionment.
The FTT’s reasoning on this point was difficult to follow and arguably applied an inaccurate gloss to the legislation. It also potentially gave HMRC an easier job in concluding that an unallowable purpose could be found.
The UT did touch on this, but only lightly – it did not express a view on the correctness of the FTT’s interpretation of the burden of proof point, focusing instead on the question of whether apportionment would follow in either scenario (a) or (b) above (concluding, rightly we think, that the FTT had misinterpreted the legislation in that respect). Whether the FTT’s view on the burden of proof is right therefore unhelpfully remains unresolved and given the taxpayer’s resounding defeat a further appeal in this case seems unlikely.
Key takeaways and next steps
In this latest decision, the UT has (unsurprisingly) broadly stuck to the same script as other recent UT decisions applying sections 441–442. It continues to be the position that taxpayers facing unallowable purpose enquiries are going to need to demonstrate, so far as possible having regard to the evidence, that securing a tax advantage was not a main purpose of being party to the relevant loan relationship. The lack of clarity over where the burden of proof lies in this respect means that this should be even more of a focus area.
But this will not be the last word on the unallowable purpose rules. The Court of Appeal hearing in Euromoney (which considers a “main purpose” anti-avoidance rule in a different part of the UK tax code) is scheduled for October 2023, with the Court of Appeal hearings in BlackRock and Kwik-Fit following in the first half of 2024. HMRC may then need to update its guidance again…
Please get in touch with the author or your usual Freshfields contacts if you would like to discuss the issues discussed in this blog post in more detail.