The main lesson to be learned is that it all depends on the specific facts and how they are presented to the fact-finding tribunal! JTI is the third unallowable purpose case decided by the UK Court of Appeal this year, the previous two being BlackRock and Kwik-Fit. 

What are the cases about?

All three concern the loan relationship unallowable purpose rule (in section 441 of the Corporation Tax Act 2009) under which deductions for loan relationship debits (these would be mainly interest, but can also include other costs) are denied to the extent that they are attributable to an unallowable purpose (which would include a main purpose of securing a tax advantage).

These unallowable purpose cases are heavily fact dependent, but even with that caveat it is interesting to compare the differences and similarities between these three cases and to pull out some common themes. In all three cases the taxpayer was found to have an unallowable purpose for being party to the loan relationship. In Black-Rock and Kwik-Fit the taxpayer was also found to have a commercial purpose but only in Kwik-Fit was there any attribution of debits to the commercial purpose (meaning that the interest deductions were partly preserved).

In JTI, a funding structure was put in place for the acquisition of a US company by a US headed group, using a UK acquisition vehicle (JTIAC) with debt pushed down to the UK from the US. It resulted in approximately £40m of non-trade loan relationship interest debits being claimed as group relief. HMRC issued closure notices disallowing the interest debits pursuant to section 441. Around £9m of corporation tax is at stake.

The FTT had found that there was a main purpose for issuing the loan notes of securing a tax advantage and no commercial purpose. The UT dismissed the taxpayer’s appeal and now the Court of Appeal has dismissed the further appeal, on the basis that the FTT was entitled to find as fact that there was no commercial purpose for the loan relationship so the debits are wholly attributable to the unallowable purpose. 

BlackRock and JTI both involve financing structures put in place after a decision to acquire a target was made higher up in the group. Both structures aimed at creating UK tax deductions for the interest on the funding and the taxpayer in each could be described as having played the part in the scheme devised for it so as to obtain a tax advantage. On the face of it, JTI had a better fact pattern than BlackRock, because the UK taxpayer claiming the loan relationship debits, JTIAC, directly acquired the target company, whereas in BlackRock a US entity was interposed between the taxpayer and the target for US regulatory reasons. This did not appear to help JTIAC, however, as the FTT concluded that the evidence before them in JTI was insufficient to determine any commercial purpose for JTIAC entering into the loan relationship and this was not a decision the UT or Court of Appeal were able to overturn. 

The Court of Appeal did note that a differently constituted FTT might have found there had been a commercial purpose but concluded that the FTT was entitled to make the decision it made based on the evidence before it. But even if there had been a commercial purpose, on a just and reasonable attribution, it would not have made a difference to the outcome because the Court of Appeal agreed with the FTT that the debits would have been wholly attributable to the unallowable purpose.

Wide-angled lens required

On the issue of whose purpose is relevant, the Court of Appeal agreed with Counsel for the taxpayer that the focus is on the intentions of the taxpayer’s decision-makers and that the purposes of the wider scheme are relevant only if they inform those intentions. The taxpayer had emphasised the fact that the reason for the borrowing was to fund the acquisition, an acquisition that was being made for commercial purposes, and argued that the FTT was wrong to effectively zoom out from this to look at the wider scheme. But the Court of Appeal rejected the idea that the tribunal should adopt a “tunnel-visioned” approach, looking simply at how JTIAC was proposing to use the borrowed funds. The Court of Appeal read the FTT’s decision as concluding JTIAC’s directors went along with the scheme which, to their knowledge, the group had adopted for tax reasons. On this bases the directors of JTIAC were “seeking to fulfil the company’s role in a plan which those [at the parent level] had decided on to secure a tax advantage”.

Lord Justice Lewison expresses his surprise that both sides argued the appeal as though the Supreme Court’s decision in Rossendale had never been decided. In Rossendale, the Supreme Court concluded that where a scheme aimed at avoiding tax involves a series of pre-planned steps it is it is “both permissible and necessary not just to consider the particular steps individually but to consider the scheme as a whole” when purposively construing the legislation. But it is difficult to see what this could add in an unallowable purpose case given the determination of the taxpayer’s purpose (as set out by the Court of Appeal in all three cases) already takes into account the existence of a wider scheme, and Lewison LJ does not go on to explain what Rossendale would have added. 

“But for” test

Even if there were a main commercial purpose for JTIAC being party to the loan relationship, the FTT would have determined that all the debits were attributable to the unallowable purpose on the basis of Fidex because “but for” the avoidance scheme, there would have been no debit at all. Counsel for the taxpayer attempted to persuade the Court of Appeal that “but for” the acquisition of the target, there would have been no borrowing and no debit. The Court of Appeal concluded, however, that Fidex pointed to the opposite conclusion – but for the scheme to secure the tax advantage which was “bolted on” to the purchase of the target, there would have been no loan relationship and no debit. 

What does this mean for other unallowable purpose cases?

As I said at the start, it all depends on the specific facts. To give the taxpayer the best chance of succeeding in its claim that loan relationship debits should be deductible, all the relevant facts must be presented to the FTT in the best possible light including selecting reliable, credible witnesses. It is worth putting the effort in at this stage because if the FTT does not find a commercial purpose, the threshold for this finding of fact to be overturned on appeal is very high. Even if a main commercial purpose is established, the debits could still all be attributable to the unallowable purpose under the “but for” test which will likely be the case where the taxpayer is playing a part in a wider scheme to obtain a tax advantage. In some cases (depending on the facts!) it may be possible to persuade the tribunal that there is not a main tax avoidance purpose in the first place.

If you have any questions about how the unallowable purpose cases might affect your company and how to respond to an HMRC challenge under these rules, please contact me or your usual Slaughter and May contact.