In addition to the general anti-abuse rule (GAAR), numerous purpose tests are built into the UK tax code. Every time a new set of tax rules is introduced, they tend to be accompanied by at least one targeted anti-avoidance rule (TAAR), and these TAARs rely largely on purpose tests. Over the last few years, there have been a number of cases in respect of the loan relationships unallowable purpose rule, and I expect that, at least in the short term, this will remain a focus for HMRC, the UK’s tax authority.

GAAR

The GAAR allows HMRC to counteract abusive tax arrangements. The relevant legislation is complemented by detailed HMRC guidance which is intended to help with the application and interpretation of the rule (including through illustrative examples where appropriate). The guidance, as approved by the GAAR Advisory Panel, has special status; courts must take it into account when adjudicating cases involving the GAAR (which is not the case in respect of other HMRC guidance).

The main gateway condition for the application of the GAAR relates to the abusiveness of the arrangements. The existence of “tax arrangements” as an initial gateway into a possible consideration of the GAAR sets a deliberately low threshold.

“Tax arrangements” are arrangements in respect of which it is reasonable to conclude that obtaining a tax advantage was one of the main purposes. This is an objective test. According to the GAAR guidance, it means that it would be unnecessary (and inappropriate) to enquire into the subjective intentions of those involved in the arrangements. It remains to be seen whether a court would agree with this view; the alternative – that the taxpayer’s subjective intentions should be relevant to what can reasonably be concluded about the purposes of the arrangements – is arguable, at the very least. Indeed, the GAAR guidance also notes that “it would be very rare” to find a tax advantage purpose where the parties did not subjectively intend this.

The double-reasonableness test for whether tax arrangements are “abusive” sets a much higher bar. It asks whether entering into or carrying out the arrangements “cannot reasonably be regarded as a reasonable course of action”, taking into account all circumstances, including the extent to which the intended tax treatment is consistent with the principles and policy objectives underpinning the relevant legislation and the extent to which the arrangements are artificial and/or intended to exploit shortcomings in the relevant legislation.

In addition to this double-reasonableness test, the application of the GAAR is subject to a range of taxpayer safeguards, including the requirement of an opinion from the GAAR Advisory Panel before a final counteraction notice can be issued by HMRC, and the burden of proving that there are abusive tax arrangements is on HMRC. During the ten years since the introduction of the GAAR, the Panel has given around two dozen opinions, all but one of which concluded that the relevant arrangements were abusive. So far, no case on the GAAR has come before the courts.

TAARs

There are purpose-test-based TAARs across the UK tax code, and they are drafted in different ways, depending on the relevant legislative context. For example, some focus on the purposes of one or more of the parties to a transaction, and others on the purposes of the transaction itself. Some tests also take into account other factors, such as the nature of the transaction and its relationship to the relevant legislation.

The unallowable purpose test in the loan relationships regime (section 441 of the Corporation Tax Act 2009) is an example of a purpose test that operates solely by reference to a purpose condition. Where a company’s main purposes for being party to a loan include obtaining a tax advantage, section 441 provides that tax deductions for interest and other financing costs are disallowed to the extent that they are attributable to that (unallowable) tax purpose. No further conditions have to be fulfilled in order for section 441 to apply; in particular, the legislation does not explicitly impose any additional conditions by reference to the extent to which obtaining the tax advantage would (or would not) be consistent with the policy objectives of the loan relationships regime – although such considerations would, in practice, tend to feed into the application of the test.

This contrasts with some of the more recent purpose tests. One example would be the loan relationship regime TAAR, which requires a main purpose of obtaining a relevant tax advantage and that obtaining this advantage cannot be regarded as consistent with the principles and policy objectives of the relevant provisions. Another would be the anti-avoidance rule related to the use of losses in respect of the Energy Profits (Oil and Gas) Levy which was enacted in 2022. In order for this rule to apply to a particular arrangement, two conditions must be fulfilled. Obtaining a tax advantage must be one of the arrangement’s main purposes, but it must also be reasonable to suppose that the arrangement is artificial or intended to circumvent the intended limits of the relief or exploit shortcomings in the legislation.

Conditions referring to a potential exploitation of legislative shortcomings have appeared more frequently in recent legislation. Indeed, their existence appears limited to legislation that post-dates the introduction of the GAAR in the Finance Act 2003, so it would not be unreasonable to think that they might have been inspired by it and that HMRC’s GAAR guidance might therefore provide helpful pointers. It states: “Whether arrangements are intended to exploit any shortcomings in the relevant tax provisions requires consideration because the drafting of particular tax rules may lead to unanticipated consequences. This may be because the tax rules have a defect that was not apparent to the drafter, or the drafter may not have contemplated that a particular type of transaction could be carried out (whether to come within the rules or to keep outside them).”

Enforcement trends

A number of purpose test cases have recently come (and are still pending) before the UK courts. Most consider the loan relationships unallowable purpose test. For example:

• In BlackRock,  HMRC challenged interest deductions on $4 billion worth of intra-group loan notes the proceeds of which had been used by a newly-created, UK tax resident LLC to subscribe for preference shares in a US tax resident LLC which, in turn, used the subscription proceeds to acquire a US business from a third party. The Court of Appeal is scheduled to hear the case in March 2024.
• In JTI Acquisition Company,  a US-headed group interposed a newly-created, UK incorporated and tax resident company for the acquisition of a US company from a third party (in this case, the UK company itself made the acquisition). At first instance, HMRC’s disallowance of interest deductions on $550 million worth of intra-group loan notes (which were used to finance half of the purchase price, the other half having been financed through a combination of an equity injection and a non-interest-bearing loan) was upheld; the appeal was heard in March 2023, but the judgment is outstanding.
• In Kwik-Fit,  the taxpayer had reorganised, and added to, its intra-group debt funding to make use of trapped losses, and HMRC challenged interest deductions in respect of the additional as well as pre-existing financing. The Court of Appeal is scheduled to hear the case in April 2024.

HMRC has recently rewritten its internal guidance on the application of the loan relationships unallowable purpose test (CFM38100 onwards), which seems likely to indicate that HMRC continues to devote attention and resources to enquiries in this area.