It will come as no surprise that the UK imposes certain restrictions on companies’ ability to deduct interest when calculating the profits that are subject corporation tax.  One of these restrictions is the unallowable purpose rule in section 441 of the Corporation Tax 2009. The rule turns off a company’s ability to deduct interest payments where its borrowing is for a non-commercial purpose and the deductions are attributable to that purpose. A company is taken to have a non-commercial purpose if one of its main purposes is to secure a tax advantage for itself or another person. 

So, if a company enters into a loan and one of its main purposes for doing that is to get a tax relief (as a shorthand, one might say if the company has a main tax avoidance purpose for entering into the loan), then it can’t deduct the interest to the extent that the deduction is attributable to that main tax avoidance purpose. 

Three Court of Appeal decisions (all published between April and June 2024) explore what it means for a company to have a main tax avoidance purpose and the extent to which interest deductions should therefore be disallowed. 

In a special edition of Slaughter and May’s Tax News podcast, I spoke to Tax Partners Dominic Robertson and Charles Osborne about these cases (BlackRock, Kwik-Fit and JTI) and what they mean for taxpayers – in particular in an M&A context. 

Denial of tax deductions for debt financing in an M&A context

The context for both BlackRock and JTI was the acquisition of a US business by a US group, and in each case, there was a UK tax-resident vehicle that took on debt to finance the acquisition. This was (in both cases) pursuant to advice that borrowing in the UK would be tax-efficient (it was envisaged that the UK vehicle would surrender excess deductions to UK members of the group and thereby reduce the group’s overall tax bill). 

In both cases, the Court of Appeal decided that no tax deductions were available for interest on the debt. In BlackRock, it was acknowledged that the borrowing had a commercial purpose (of acquiring the target business) as well as a main tax avoidance purpose, but all interest deductions were attributed to the latter. In JTI, the Court of Appeal accepted the (surprising) conclusion of the fact-finding tribunal that there was no commercial purpose at all.  

Where does this leave us? 

Whether tax deductions are available for acquisition financing will depend on the facts. It is clear from the cases that, where a UK vehicle is interposed in an acquisition structure only to push debt into it and create tax deductions, the unallowable purpose rule would operate to deny those deductions. But there will be situations where tax deductions for interest on acquisition financing can still be obtained – Dominic and Charles consider examples in the podcast. 

The podcast also considers in more detail what can be learned from the cases (and in doing so, it touches on Kwik-Fit, a slightly different scenario concerning the re-organisation of intra-group debt), and I asked Dominic and Charles what is likely to happen if HMRC opens an enquiry into an existing financing structure and what this could teach us about minimising the risk of a future challenge when putting financing in place now.   

Listen to the podcast here, or search for “Tax News Slaughter and May” on your preferred podcast app!