A: Interest on a Kwik-Fit loan.
The question "what's unallowable, but not disallowed?" is the riddle thrown up by the latest First-tier Tribunal decision on the loan relationships unallowable purpose rule in Kwik-Fit.
Kwik-Fit had an intermediate holding company, Speedy 1, with a chunky (£48m) non-trading loan relationship deficit (or NTD) which it was forecast would take 25 years to use. Having taken advice from EY and PWC, they entered into a reorganisation intended to utilise the NTD within 2 or 3 years instead. Essentially, there were the following parts to this:
- increase the interest rate on an existing intra-group loan where Speedy 1 was already the lender, and move other existing intra-group loans to Speedy 1 and increase the interest rate on them as well (the Pre-Existing Loans); and
- create a couple of new loans (by paying intra-group dividends through the issue of loan notes replicating intra-group debt repaid or released elsewhere) and move those to Speedy 1, too (the New Loans).
HMRC sought to counter this planning by disallowing, under section 441 of the Corporation Tax Act 2009, interest deductions arising on the loans up to the amount of the carried forward NTDs used by Speedy 1 in each accounting period and save for interest at the original rate on Pre-Existing Loan where Speedy 1 had already been the lender prior to the reorganisation.
At first blush, that seems quite harsh in relation to the Pre-Existing Loans which were taken out for good commercial purposes. The real mischief there is not moving the creditor end of those loans to Speedy 1, which should not of itself change the purposes for which the debtor is party to the loan, it is increasing the interest rate when, as the FTT found, the rate would not have been increased if the debtor had not agreed to participate in the reorganisation. So the FTT partially allowed the taxpayers' appeal and held that what was disallowed under s441 CTA 2009 was all of the debits attributable to the interest on the New Loans but only the debits attributable to the increased interest on the Pre-Existing Loans. And with the total amount of the disallowance capped at the amount of NTDs used by Speedy 1 in each accounting period.
That seems like a fair and sensible outcome but there is something about the reasoning that strikes me as rather odd. The end of the judgment provides as follows:
"145. We have concluded that each of the Appellants were party to the loan relationships with Speedy 1 for an unallowable purpose such that s441 applies. The amounts of the debits in respect of their loan relationships as on a just and reasonable apportionment are attributable to the unallowable purpose and are thus disallowed by s441(3) are:
(1) In respect of the New Loans, all of the debits attributable to the interest on such loans.
(2) In respect of all of the Pre-existing Loans, the amount of the debits attributable to the increase in the interest rate on such loans. It is to this extent that the appeal is allowed.
146. The total amount of the disallowance shall be capped in each accounting period at the amount of the NTDs used by Speedy 1 in that period."
Having found that all of the debits attributable to interest on the New Loans and the increased debits on the Pre-Existing Loans are "on a just and reasonable apportionment...attributable to the unallowable purpose and...thus disallowed by s441(3)" what is the legislative basis for the NTD cap? I cannot see one. Once you attribute debits to an unallowable purpose on a just and reasonable basis under s441(3), they are disallowed. That's it. If you want to "cap" them you need to attribute them to something other than an unallowable purpose.
There are various ways that the FTT could have got there. If, for example, they had held that the unallowable purpose was creating new, or increasing existing, credits to offset the NTDs, then they could potentially have held that the only debits which fell to be attributed to that unallowable purpose, and consequently which fell to be disallowed by s441(3), were those which corresponded to the new or increased credits which were so offset. But they did not.
In relation to the New Loans, they went so far as to find, in paragraph 133, that the borrowers did not have any commercial purpose in being party to the loans, that "the tax avoidance purpose was not only a main purpose for which these debtors were party to the loans but it was the main purpose" and, as such, "we have concluded that the debits in respect of the New Loans are wholly attributable to the unallowable purpose".
Having made that finding of fact, how could interest on the New Loans not be disallowed even when it exceeds the NTD cap? Answers on a postcard please.