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CTA09/S442(3)-(5)

For the ‘unallowable purpose rule’ (at s441-442) to be engaged, there must be an ‘unallowable purpose’: that is, a purpose for which the company is party to the loan relationship (or enters into a ‘related transaction’, as defined for purposes of the rule), which is not amongst the business or other commercial purposes of the company.

It is specifically provided that if there is a purpose of securing a tax advantage (a ‘tax avoidance purpose’), and if this is the main purpose, or one of the main purposes, for which the company is party to the loan relationship or related transaction (s442(3)-(5), CFM38130 to CFM38140), then this is an unallowable purpose. This is referred to as a ‘main tax avoidance purpose’ in the following.

This section considers the background to this limb of the test. See CFM38125 for further detail on whose purposes are relevant; CFM38135 for further detail on determining purposes and main purposes; and CFM38140 for further detail on what a tax advantage is and whose tax advantage may be in point.

Background

It is relevant context that:

• one of the policy principles underlying the UK tax system is that, as far as possible, it should not distort normal commercial behaviours, subject to deliberate policy choices to encourage or discourage certain behaviours

• the UK tax system generally gives deductions for commercially driven expenses

• it is expected that companies will take tax into account as a factor in their decision-making processes

• a number of purpose-based provisions exist to ensure that a taxpayer cannot secure a UK tax benefit to the extent that arrangements are driven by UK tax, rather than, or as well as, by commercial (excluding UK tax) reasons

It is relevant context as regards financing in particular that:

• it is expected that tax will be taken into account as a factor for companies and groups when they put in place financing arrangements

• many of the non-tax commercial reasons to distinguish debt and equity are of less significance in the intragroup context; in practice, the availability of tax deductibility may often be a more significant factor in determining the debt/equity mix within a group context

Against this background, the part of the unallowable purpose rule dealing with a main tax avoidance purpose is intended to prevent UK tax deductions being given for debt financing costs that are driven by UK tax considerations rather than by commercial (excluding UK tax) considerations: it can be difficult to draw this line.

Since the unallowable purpose rule was enacted, a number of further anti-avoidance provisions have been introduced to the loan relationship regime. In particular, the regime anti-avoidance rule, see CFM39500, has been introduced to deter and counter attempts to exploit or sidestep the loan relationship rules generally. There is some overlap with the main tax avoidance purpose limb of the unallowable purpose rule, that is, some situations which would be challenged by this part of the rule are now also addressed by the regime anti-avoidance rule. However, the provisions in respect of a main tax avoidance purpose in the unallowable purpose rule play a different role.

Further, as set out in this manual and elsewhere, there are a number of other regimes (some of which have been introduced or substantially changed since the unallowable purpose rule was introduced) which tackle specific tax concerns in relation to financing. These include, for instance, the transfer pricing regime, the Corporate Interest Restriction regime, and the hybrids regime (and previously the arbitrage regime):

• the transfer pricing regime, see INTM410000, aims to achieve a fair division of taxing profits, to address international double taxation, and to counter other tax advantages generated by non-arm’s length pricing by ensuring that transactions between connected parties are treated for tax purposes by reference to the amount of profits that would have arisen if the same transactions had been executed by unconnected parties, the arm’s length principle

• the Corporate Interest Restriction regime, see CFM95000, aims to ensure relief on financing costs is commensurate with the extent to which a business’ activities are subject to Corporation Tax

• the hybrids regime, see INTM550000, tackles tax planning strategies that exploit gaps and mismatches between the tax rules of different countries

Again, there is some overlap with the main tax avoidance purpose limb of the unallowable purpose rule – that is, some situations which would be challenged by this part are now also addressed by these regimes – but the provisions in respect of a main tax avoidance purpose in the unallowable purpose rule play a different role.

See CFM38165 for discussion of the relative priority in application of the regimes.