CFM38115 - Loan relationships: tax avoidance: unallowable purpose: technical summary
CTA09/S441-442
This page covers:
The effect if there is an unallowable purpose: attribution on a just and reasonable apportionment
Introduction
Generally, under the loan relationship regime, a company can obtain a deduction for interest, losses or expenses which it incurs in respect of a loan relationship. However, the 鈥榰nallowable purpose rule鈥� at s441 can operate to limit the deduction in cases where the loan has an unallowable purpose.
Specifically:
the unallowable purpose rule is engaged, where, in an accounting period, the purposes for which the company is party to the loan relationship or enters into a related transaction include a purpose which is not amongst the business or other commercial purposes of the company, an 鈥榰nallowable purpose鈥� (s442(1))
where a loan relationship has an unallowable purpose, any debits (or exchange gains credits) are not to be taken into account to the extent that, on a just and reasonable apportionment, the debits (or exchange gains credits) are attributable to the unallowable purpose (s441(3))
The following sets out a technical summary of the rule, intended to be sufficient that it is possible to read this and then go straight into the practical guidance in CFM38170听迟辞 CFM38200, for an overall understanding of HMRC鈥檚 views and approach. However, CFM38120听迟辞 CFM38167听set out the technical position in more detail and need to be referred to for a fuller understanding.
Is there an unallowable purpose?听(CFM38120)
What is an unallowable purpose?
Whether or not the unallowable purpose rule is engaged, that is whether or not there is an unallowable purpose, needs to be considered for each accounting period during any part of which the company is party to the loan relationship.
An unallowable purpose is a purpose which is not amongst the business or other commercial purposes of the company.
An example of a purpose which is not amongst the business or other commercial purposes of a company could be a purpose to promote a personal interest of one of the directors.
Two types of purpose are specifically excluded from being amongst the business or other commercial purposes of the company. These are:
- a purpose of securing a 鈥榯ax advantage鈥� (a 鈥榯ax avoidance purpose鈥�) if this is the main purpose, or one of the main purposes, referred to in the following as a 鈥榤ain tax avoidance purpose鈥� (s442(3)-(5),听CFM38130听迟辞 CFM38140)
- a purpose in respect of activities that are not within the charge to Corporation Tax (s442(2), CFM38145)
Purposes which are amongst the business or other commercial purposes of the company and not in the specific exclusions are referred to as 鈥榓llowable purposes鈥� in the following.
A loan relationship can have mixed purposes, that is, there can be one or more unallowable purposes and one or more allowable purposes.
Determining the purposes and main purposes听(CFM38135)
Case law has established a number of principles in relation to determining what purposes there are and which are 鈥榤ain鈥�. In particular:
what the purposes are is a question of fact which depends on the evidence in relation to all the relevant facts and circumstances of the particular case, and is determined by the fact-finding tribunal
the purposes may change over time: for instance, a loan relationship may have a wholly allowable purpose when a company enters into it but change to having an, or acquire an additional, unallowable purpose at a later date (and the other way round)
purpose is a matter of subjective intention
something may be a main purpose; a purpose, but not a main purpose; or a relevant consideration, but not a purpose at all 鈥� this is a question of significance, to be assessed by reference to all the relevant facts and circumstances, and 鈥榤ain鈥� carries a connotation of importance
the consequences or effects of a transaction are likely to be relevant factors, but 听are not determinative, they are not the same as purpose
in assessing purpose it is useful to consider motive; however, motive is not necessarily the same as purpose
as regards commercial (non-tax) purposes, where funds borrowed are used to acquire a commercial asset that is potentially relevant but not determinative
It is often appropriate to start with the question 鈥榳hy鈥� in assessing the purposes for which a company is party to a loan relationship, but it is necessary to consider all the relevant facts and circumstances, taking into account all of the principles identified above.
Whose purpose?听(CFM38125)
Based on HMRC鈥檚 experience, in most situations involving groups the relevant purposes will be the purposes of the directors of the company that is party to the loan relationship, who will know and take into account and be influenced by any group purposes in relation to the company鈥檚 role in wider arrangements. For more detail, and for situations where this may not apply, see the discussion in CFM38125.
A main tax avoidance purpose听(CFM38130 to CFM38140)
A tax avoidance purpose is a purpose which consists of securing a tax advantage, either for the company or for any other person. 'Tax advantage' takes its meaning from CTA10/S1139 and includes a relief or increased relief from tax, where tax is Income Tax or Corporation Tax. In particular, there will be a tax advantage if there are deductible loan relationship debits.
For a tax avoidance purpose to be an unallowable purpose it must be the main purpose, or one of the main purposes, of the loan relationship or related transaction in respect of the loan relationship, applying the general principles set out above and also the following.
A number of factors may be of particular potential relevance in assessing the significance of the tax advantage, but are not determinative: for instance, the extent to which a tax advantage was known, expected or taken into account and the degree of attention paid to securing it; the size of the tax advantage; the net tax benefit position; and whether or not the arrangements would have happened, or would have happened in a different way, 鈥榖ut for鈥� the tax advantage.
A company acting commercially will normally consider the tax consequences of a transaction. It is a natural consequence of using debt financing that tax deductions will generally be available in respect of the interest costs, which means that tax advantages will be secured. Where different ways of carrying out a commercial transaction are available, if a company chooses the way which minimises tax, there may, or may not, be a main purpose of securing a tax advantage depending on all the relevant facts and circumstances.
Determining whether or not there is a main purpose to secure a tax advantage may be difficult in the context of financing in some situations. The technical analysis in CFM38130听迟辞 CFM38140, and the practical guidance given in CFM38170听迟辞 CFM38200, including the relevant examples set out in CFM38190, are intended to assist in making the determination as to whether or not there is a main tax avoidance purpose in the more difficult situations.
The effect if there is an unallowable purpose: attribution on a just and reasonable apportionment听(CFM38150)
Where a loan relationship has an unallowable purpose in an accounting period, any debit (or exchange gains credit) which is attributable to the unallowable purpose on a just and reasonable apportionment is not brought into account under the loan relationship regime.
Where a loan relationship only has an allowable purpose, then the unallowable purpose rule will not be engaged and there will be no restriction under it.
Where a loan relationship only has an unallowable purpose, then it is generally expected that all of the debits are attributable to that purpose and therefore disallowed.
Where there is both an allowable purpose and an unallowable purpose, the position is complex. The outcome of the apportionment may be to attribute the debit entirely to the unallowable purpose, not at all to the unallowable purpose, or 听partly to the unallowable purpose.
There are no express statutory provisions as to how attribution on a just and reasonable apportionment is to be determined.
Based on the language of the legislation, and relevant case law, in relation to the test of attribution on a just and reasonable apportionment:
it is by reference to the relevant (subjective) purposes
it depends on the relevant facts and circumstances
evidence is critical
the test is an objective one
the legislation is not prescriptive; there are several possible approaches which may be used to make/ test/ check the attribution on a just and reasonable apportionment in appropriate facts and circumstances, but there is no substitute for the statutory test
Additional points
Debits and exchange gains credits in respect of the loan relationship听(CFM38155)
The rule is not limited to loan relationship debits that relate to interest: the rule can potentially apply to any debit amounts from the loan relationship.
The unallowable purpose rule also excludes any credits in respect of exchange gains that are attributable on a just and reasonable apportionment to an unallowable purpose.
Burden of proof听(CFM38160)
Where HMRC has issued a closure notice indicating that debits (or exchange gains credits) cannot be brought into account applying the unallowable purpose rule, it is for the taxpayer to demonstrate that the notice, and the consequent amendments to its company tax return, are incorrect and therefore the burden of proof is on the taxpayer. Of course, in issuing the closure notice HMRC will need to obtain sufficient information to arrive at an informed and sustainable conclusion.
Interaction with other regimes听(CFM38165)
Where the unallowable purpose rule is applied, and as a result debits (or exchange gains credits) are not taken into account, the amount is treated as dealt with under the loan relationship regime. In general, and subject to express provision to the contrary, the loan relationship regime forms an exclusive code on the taxation of corporate finance. Amounts dealt with under the regime cannot be taxed or relieved under other tax rules, in accordance with the priority rules in CTA09/S464. This means the amount not taken into account on the application of the unallowable purpose rule cannot then be brought into account for Corporation Tax purposes under any other tax rules.
Leading case law听(CFM38167)
As there are a number of Court of Appeal judgments which are relevant to several areas, further detail on these is given in CFM38167, together with further detail on a leading House of Lords case on main objects.