CFM38150 - Loan relationships: tax avoidance: unallowable purpose: attributable on a just and reasonable apportionment

CTA09/S441(2)-(3)

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Introduction

Where the 鈥榰nallowable purpose rule鈥� (in s441-442) is engaged, as a loan relationship has an 鈥榰nallowable purpose鈥� in an accounting period, then so much of any debit (or exchange gains credit) in respect of that relationship as is attributable on a just and reasonable apportionment to the unallowable purpose may not be brought into account under the loan relationship regime (or otherwise). The rest of this section only refers to debits for ease of drafting.

This section considers attribution on a just and reasonable apportionment.

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 rest of this section.

Where a loan relationship does not have an unallowable 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 unallowable purpose (or more than one), and also an allowable purpose (or more than one), 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 partly to the unallowable purpose, in which situation the remainder is effectively being attributed to the allowable purpose.

There are no express statutory provisions as to how attribution to the unallowable purpose on a just and reasonable apportionment is to be determined.

The question of what constitutes attribution on a just and reasonable apportionment was considered by the Court of Appeal in BlackRock Holdco 5 LLC v HMRC [2024] EWCA Civ 330 (BlackRock v HMRC). The Court of Appeal in Kwik-Fit Group Ltd and other companies v Revenue and Customs Commissioners [2024] EWCA Civ 434 (Kwik-Fit v HMRC) and in JTI Acquisitions Company (2011) Ltd v HMRC [2024] EWCA Civ 65 (JTI v HMRC) also considered the question; and each expressly referred to the discussions in BlackRock v HMRC.

It is worth summarising the facts (see CFM38167 for more detail), and the conclusions on purpose (see CFM38135), for each of these, as it is relevant to the analysis on attribution on a just and reasonable apportionment.

BlackRock v HMRC and JTI v HMRC each involved arrangements in which, as part of the commercially driven acquisition of a third-party target company by the group, UK companies were debt and equity financed by their parents, respectively, to acquire preference shares in the target company (BlackRock v HMRC), or ordinary shares in the target company (JTI v HMRC). In each case the Court of Appeal found that the borrowing company had a main purpose to secure a tax advantage by way of the deductible debits on the loans, that is a main tax avoidance purpose. In BlackRock v HMRC,听the Court of Appeal also held that the company had a main commercial purpose (paragraphs 167 and 172), of making 鈥渧ery significant profits鈥�. In JTI v HMRC, the Court of Appeal stated that there was no sufficient basis for interfering with the FTT鈥檚 decision that the company did not have a commercial purpose at all (paragraph 71).

Kwik-Fit v HMRC involved a reorganisation which included creating new loans with a creditor company, moving certain existing loans to the creditor company and increasing the interest rate on them, and increasing the interest rate on an existing loan owed to the creditor company. This was in a context where the creditor company had brought forward non-trading deficits which it did not expect to be able to use for many years. The Court of Appeal held (paragraph 79) that the borrowing companies had a main purpose to secure the tax advantage, the generation of the deductions for the benefit of the borrowing companies or other group companies, in circumstances where the corresponding income was sheltered from tax by the brought forward non-trading deficits.

Paragraphs 179 to 180 of BlackRock v HMRC contain a helpful summary of the main principles on attribution on a just and reasonable apportionment as follows (which principles are expanded upon below):

I agree 鈥� that what the legislation requires is a just and reasonable apportionment by reference to the relevant purposes. Those purposes are identified using a subjective approach: see above. The statutory test requires the identification and disallowance of 鈥榮o much of鈥� any debit that is 鈥榓ttributable鈥� to the unallowable purpose: s.441(3). That is the enquiry that the tribunal must undertake. While the determination of a just and reasonable apportionment is an objective exercise, it is not necessarily the same as the consideration of 鈥榓ll the facts and circumstances鈥� referred to by the UT, if by that the UT did not intend to have regard to the requirement to apportion by reference to the relevant purposes. The framework for the apportionment is the purposes that have been identified by the fact-finding tribunal. Subject to that point, however, I agree that all relevant facts and circumstances should be considered.
The position is straightforward if all the debits, or perhaps a defined part of them, are properly attributable solely to a tax avoidance main purpose. Conversely, if they are properly attributable to a purpose which is not an unallowable purpose then there will be no disallowance under s.441. Where debits are attributable to more than one purpose then an apportionment is required. As to the precise mechanism by which this is done, the legislation is not prescriptive. The answer to that question will inevitably be fact specific.

Kwik-Fit v HMRC at paragraph 99 summarised the above as follows:

鈥� In summary, it is an objective exercise which requires apportionment by reference to the relevant purposes. The exercise is a fact specific one.


Principles

Attribution on a just and reasonable apportionment is by reference to the relevant (subjective) purposes

As stated in BlackRock v HMRC [179], 鈥�what the legislation requires is a just and reasonable apportionment by reference to the relevant purposes鈥�.

These are the (subjective) purposes which have already been determined.

It is clear that these purposes should not be substituted at the stage of attribution on a just and reasonable apportionment by other purposes. In Kwik-Fit v HMRC, having found that the transfer pricing rules formed no part of the decision-making process and were not relevant to the determination of the subjective purposes (see CFM38135), the Court of Appeal confirmed (paragraph 101) that the transfer pricing rules did not assist Kwik-Fit in relation to attribution on a just and reasonable apportionment.

Attribution on a just and reasonable apportionment depends on the facts and circumstances

The principle that attribution on a just and reasonable apportionment depends on the facts and circumstances is established in a number of unallowable purpose rule cases, including in BlackRock v HMRC. As cited above, the Court of Appeal stated at paragraph 179 that 鈥渁ll relevant facts and circumstances should be considered鈥� subject to the point that the framework is the (subjective) purposes that have been identified by the fact-finding tribunal.

Evidence is critical

A number of cases on the unallowable purpose rule have stressed the importance of the evidence: for instance, Iliffe News and Media Ltd & Ors v HMRC [2012] UKFTT 696 (TC). Loan relationships were entered into for the purposes of funding certain licences which themselves were entered into for mixed commercial and a main tax avoidance purpose. The FTT held that the loan relationship was entered into for mixed purposes, commercial (non-tax) and a main tax avoidance purpose. However, for the purposes of determining to what extent any debit was attributable on a just and reasonable apportionment to the unallowable purpose, the FTT held, at paragraph 327, that no part of any debits could be disallowed:

because there is no evidence before us which would enable us on a just and reasonable basis to attribute any amount of the interest payable under the [loan relationships] in issue to the tax avoidance purpose.听

Similarly, in Versteegh v Revenue & Customs [2013] UKFTT 642 (TC) (Versteegh v HMRC), the FTT stated (at paragraph 164) that 鈥渋t is all a question of evidence鈥�.

The test is an objective one

The question of purpose is primarily to be decided by reference to subjective intentions, as discussed in CFM38135. However, as the Court of Appeal confirmed in BlackRock at paragraph 179, as cited above, once this has been determined the legislation simply requires the attribution of debits to an unallowable purpose on a just and reasonable apportionment, applying the test objectively. The Court of Appeal went on to reject two proposed approaches to attribution on a just and reasonable apportionment put forward by BlackRock, specifically on the basis that the approaches re-introduced subjectivity: this is discussed in more detail below.

The legislation is not prescriptive; there are several possible approaches, but there is no substitute for the statutory test

In HMRC鈥檚 view the following apply as a plain reading of the statutory language:

  • the legislation is not prescriptive

  • there are several possible approaches which may be used to make/ test/ check attribution on a just and reasonable apportionment in appropriate facts and circumstances, but there is no substitute for the statutory test

  • the application of the test is fact specific

  • the language is sufficiently flexible that it is possible to deal with the situation where there is a main purpose to secure more than one type of tax advantage and/ or with the situation where the main purpose is to secure a tax advantage which is different from a tax advantage from the loan relationship itself

  • there is a wide latitude in judgement

There is case law support for many of these points, including the following.

Leedale v Lewis [1982] UKHL TC 56 601, which deals with the meaning of just and reasonable in another part of the tax code, held that the just and reasonable test for the purposes of that part of the tax code should be carried out in the light of all the circumstances, and that it conferred a 鈥渨ide latitude in judgement鈥�.

The FTT in Versteegh v HMRC commented at paragraph 166 that the legislation should not be glossed, although allowed for possible approaches which may be used to make or test a proposed attribution of a debit on a just and reasonable apportionment:

鈥� attractive as [Counsel鈥檚] analysis of the just and reasonable apportionment test might appear, in terms of simplicity of application, it does involve in our view a gloss on the words of paragraph 13 itself, which talks only of a just and reasonable apportionment in order to arrive at the extent to which loan relationship debits are attributable to an unallowable purpose. That may be answered in a particular case by considering the extent to which the debit is greater than it would be but for the identified unallowable purpose, but that should not, in our view, be regarded as a substitute for the statutory test itself.

As cited above, the Court of Appeal in BlackRock v HMRC [180] stated:

Where debits are attributable to more than one purpose then an apportionment is required. As to the precise mechanism by which this is done, the legislation is not prescriptive. The answer to that question will inevitably be fact specific.

Possible approaches include attribution on the basis of a clear 鈥榗ausal鈥� link; and asking a 鈥榖ut for鈥� question

The following considers possible approaches to make/ test/ check a proposed attribution on a just and reasonable apportionment.

In some situations, it may be possible and appropriate to separate out particular debits or defined parts of debits, referred to as separable debits in the following for ease of drafting, that is, for example, to identify:

  • particular debits, or defined parts of debits, of a loan relationship on an ongoing basis; or

  • particular debits, or defined parts of debits, of a loan relationship within an accounting period; or

  • debits associated with a particular part (but not all) of a loan relationship

It may then be possible and appropriate to attribute the separable debits either wholly or not at all to an unallowable purpose because in each case there is a clear 鈥榗ausal鈥� link of those separable debits either wholly to an unallowable purpose or not at all to an unallowable purpose, that is, in practice wholly to an allowable purpose.

An example of separable debits of a loan relationship on an ongoing basis is one element of the final position on attribution on just and reasonable apportionment in Kwik-Fit v HMRC. This was that, on the existing loans, all the debits arising from the increase in interest rates payable, but none of the debits in relation to the original interest rates, were attributed to the unallowable purpose and disallowed. In the language of the above, using a separable debits approach, separable debits relating to the increase in interest rates were wholly causally linked to the unallowable purpose, attributable to it, and should be disallowed, whereas separable debits relating to the original interest rates were wholly causally linked to the ongoing commercial purpose, attributable to it, and should not be disallowed. 听

An example of separable debits of a loan relationship within an accounting period is another element of the final position in Kwik-Fit v HMRC. This was that HMRC had applied a cap to the disallowance of interest debits within the relevant accounting period once the non-trading deficits were used up. The Court of Appeal found that the unallowable purpose was a main purpose to secure a tax advantage being the generation of the deductions for the benefit of the borrowing companies or other group companies, in circumstances where the corresponding income was sheltered from tax by the brought forward non-trading deficits. In the language of the above, using a separable debits analysis, once the non-trading deficits were used up, there was no longer a main purpose to secure a tax advantage, and the remaining separable debits were wholly causally linked to the ongoing commercial purpose, attributable to it, and should not disallowed.

An example of separable debits of part of a loan relationship is the discussion at the end of Example 16 in CFM38190. In that Example the directors of a company decide to make a loan of 拢4 million for commercial purposes, funded by an external borrowing of the same size. There is then a change in arrangements: one of the directors persuades the other directors to increase the size of that loan (and the external borrowing) by 拢1 million solely as a result of the director鈥檚 personal interest, that is an unallowable purpose. Subject to the further detail provided on that Example, and the context of the opening section of CFM38190 on background and approach, HMRC will normally start with the view that, on a just and reasonable apportionment, separable debits relating to the additional 拢1 million of principal (of both loans), and those separable debits only, are wholly causally linked to the unallowable purpose and attributable to it, and therefore should be disallowed.

A number of cases have considered the possibility, depending on the facts and circumstances, of making/ testing/ checking a proposed attribution on a just and reasonable apportionment by asking a 鈥榖ut for鈥� question. That is, by looking at the extent to which the debit is different from what it would have been, including whether the loan relationship and therefore the debits on that loan relationship, would not have happened at all, 鈥榖ut for鈥� an identified purpose, usually the unallowable purpose. (This is separate from asking a 鈥榖ut for鈥� question in the context of determining subjective purposes, see CFM38135). The answer to the 鈥榖ut for鈥� question is not determinative in all situations 鈥� for instance, a debit may occur for two reasons, on the basis of each of which alone it would have happened 鈥� but asking the 鈥榖ut for鈥� question may often be relevant.

Asking the 鈥榖ut for鈥� question was relevant in each of Fidex Ltd v HMRC [2016] EWCA Civ 385a (Fidex v HMRC), BlackRock v HMRC, Kwik-Fit v HMRC, and JTI v HMRC in making/ testing/ checking a proposed attribution on a just and reasonable apportionment, see below.

Asking the 鈥榖ut for鈥� question does not, however, involve considering imagined scenarios.

In BlackRock v HMRC, the taxpayer argued that, if the tax rules had changed at the last minute, the board of the borrowing company would have entered into the loans even if the tax advantage had not existed and so applying a form of 鈥榖ut for鈥� approach no disallowance should be made. The Court of Appeal agreed that the UT had been right to reject this argument, previously accepted by the FTT. From paragraph 183:

The answer to the apportionment question is not altered by imagining what might have happened if the tax rules had changed at the last moment. That did not occur. In reality the board accepted and adopted the structure that had been devised to achieve a tax advantage.

It is recognised that other possible approaches may be appropriate on a fact specific basis. For instance, the Court of Appeal in BlackRock v HMRC stated at paragraph 184, but did not elaborate any further on when such an approach could be considered appropriate or how it could be applied, that:

听some form of apportionment based on economic advantage could be appropriate in some cases.

The Court of Appeal went on to consider two possible approaches on the facts, put forward by BlackRock as an alternative if their primary argument failed: their primary argument had been that 100% of the debits should be attributed to a main commercial purpose of making/ managing investments. These two possible approaches were summarised in paragraphs 177 and 178 as follows:

... The first was to apportion by reference to the relative anticipated financial significance of the tax relief and the commercial advantage (being the excess of dividends over interest payable), taking account of the fact that at the time the Loans were entered into it was anticipated that tax relief for a substantial portion of the interest costs would be denied under the worldwide debt cap rules 鈥he second approach was to allocate to the tax advantage purpose the proportion of the total interest expense that was anticipated to be allowable at the time the Loans were entered into, again after taking account of the anticipated restriction under the worldwide debt cap rules, with the balance being apportioned to [the borrowing company鈥檚] commercial purpose.

The Court of Appeal rejected these at paragraph 184 as reintroducing a subjective element to the objective test of attribution on a just and reasonable apportionment:

鈥� I do not consider that it would be appropriate to adopt either of the two approaches put forward in this case. Apart from the fact that the FTT was not asked to consider those alternatives, they both re-introduce subjective elements into what should be an objective exercise, namely [the borrowing company鈥檚] expectations about the relative level of tax benefits as compared to other factors.

Whilst in HMRC鈥檚 experience this arises very rarely, if it is not possible to separate out debits, and so particular debits are attributable to both unallowable and allowable purposes, the following sets out HMRC鈥檚 views on some possible approaches (in each case 鈥榥et tax benefit鈥� is being used in a general sense, as it is used in CFM38135 and CFM38170):

  • HMRC notes the possibility of using relative weight of purposes, but expects this often to be very difficult, as it will often be very difficult to compare like with like. In particular, in HMRC鈥檚 experience, it is very difficult to compare net UK tax benefits with net non-UK tax benefits. For the avoidance of doubt, counting and comparing the number of unallowable and allowable purposes is not an appropriate approach: if, for instance, it is established that there is one main tax avoidance purpose and two commercial (excluding UK tax) purposes, this does not of itself provide any basis for arguing one-third of the debit should be attributed to the unallowable purpose.

  • Whilst HMRC notes the possibility that it may, occasionally, be helpful to consider what attribution would result in a counteraction of a net UK tax benefit achieved, again, HMRC expects this often to be very difficult.

  • For the avoidance of doubt, it is HMRC鈥檚 experience that an approach based on seeking to counteract net global tax benefit is highly unlikely to be an appropriate approach in most circumstances.


Attribution on a just and reasonable apportionment in key Court of Appeal unallowable purpose rule cases

In the Court of Appeal decision in Fidex v HMRC (see CFM38167 for further detail), the company had an existing holding of bonds, and then entered into a tax planning structure, involving the issue of shares, that led to the derecognition of the bonds for accounting purposes which triggered a debit. The FTT found that the purposes for which Fidex originally entered into the bonds were commercial (non-tax), and that commercial (non-tax) purposes continued to apply, but that the company acquired a main tax avoidance purpose of crystallising the debit. The Court of Appeal held in paragraph 74 that 鈥淸t]he [relevant] debit arose from and was entirely attributable to Project Zephyr. But for this tax avoidance scheme there would have been no debit at all.鈥� In paragraph 75, it held that 鈥渙n a just and reasonable apportionment, the debit was wholly attributable to an unallowable purpose鈥�.

In BlackRock v HMRC, the Court of Appeal held, in paragraph 182, that on the facts the commercial advantage was overall in the nature of a by-product and that no debits were attributable to the main commercial purpose which had been found, and, in paragraph 185, that a 鈥榖ut for鈥� approach produced this answer:

As already discussed, the purpose for which [the borrowing company] was created cannot be divorced from its purpose in entering into the Loans. Further, the structure of the transaction was presented as a fait accompli to the board. The commercial advantage to [the borrowing company] was of significance to it because it would not benefit from the tax advantage, but, overall, it was more in the nature of a by-product. On the facts there is no principled basis to identify any particular amount or proportion of the debits as being attributable to the commercial purpose...鈥� (paragraph 182)
听鈥� there is a simpler answer based on the 鈥榖ut for鈥� approach that both parties were content that we should adopt on the facts of this case. If that approach is adopted then the only proper answer is not the one that the FTT gave. Rather, in the absence of the tax advantage the decision to enter into the Loans would never have been made. (paragraph 185)

The result in BlackRock v HMRC was set out in Kwik-Fit v HMRC at paragraph 99 as follows:

The facts in 鈥楤lackRock鈥� did not permit any element to be apportioned to the commercial purpose ([182]). The same result was reached if a 鈥榖ut for鈥� approach was adopted, as the parties had suggested ([185]).

In JTI v HMRC, the Court of Appeal found, at paragraphs 75 and 81, that all the debits were attributable on a just and reasonable apportionment to the sole, unallowable purpose, but that, even had there been a commercial purpose, all the debits would have been attributable to the unallowable purpose:

On the FTT鈥檚 findings in the present case, the appellant issued the loan notes for the main purpose of securing a tax advantage and had no commercial purpose in doing so. On that basis, no apportionment can be necessary. As the FTT itself said in paragraph 179 of its decision, having 鈥榝ound that to obtain the UK tax advantage was the main purpose for the Appellant being party to the loan relationship, no apportionment of the debit arising in each accounting period is in point鈥欌��
If, contrary to the FTT鈥檚 view, the appellant had a commercial purpose in issuing the loan notes, the present case is analogous to 鈥楩idex鈥�. It would remain the case that, but for the scheme to secure a tax advantage which was 鈥榖olted on鈥� to the purchase of LTT, there would have been no loan relationship and so no debit.

In Kwik-Fit v HMRC the Court of Appeal, as is discussed in more detail in CFM38135, and cited above, had found that the unallowable purpose was a main purpose to secure the tax advantage, the generation of the deductions for the benefit of the borrowing companies or other group companies, in circumstances where the corresponding income was sheltered from tax by the brought forward non-trading deficit.

The Court of Appeal held that the FTT was entitled to find that for the loans with no commercial purpose, all debits were attributable to the unallowable purpose; for the existing loans, all the debits arising from the increase in interest rates were wholly attributable to the unallowable purpose (paragraphs 100 to 101):

I can see no legal error in the FTT鈥檚 approach to apportionment in this case. [Counsel鈥檚] submissions proceeded on the basis that apportionment should be by reference to the relevant 鈥榤ain鈥� purposes rather than any ancillary one (which in this case might include simplifying group balances: see [88b)] above). He also proposed a 鈥榖ut for鈥� approach. As the FTT noted at para. 136, this is essentially the approach that it adopted鈥�
The [borrowers in relation to the new loans] were found to have had no commercial purpose in entering into the New Loans. That entitled the FTT to attribute all the debits on those loans to the unallowable purpose. Given its findings of fact, the FTT was also fully entitled to attribute all the debits arising from the increase in rates on the Pre-existing Loans to the unallowable purpose. For the reasons already discussed the transfer pricing rules do not assist the Appellants.

HMRC had applied a cap to the disallowance of interest debits within the relevant accounting period once the non-trading deficits were used up, on the basis there was no longer an unallowable purpose. The Court of Appeal said at paragraph 102:

However, HMRC correctly accepted that once the [creditor company鈥檚] losses were used up, it would no longer be just and reasonable to deny relief for the debits. This reflects the nature of the tax advantage sought to be secured, as already described (see [79] above).


Summary

Having previously determined the relevant (subjective) purposes, this is an objective exercise which requires determination of how debits are attributable on a just and reasonable apportionment by reference to those relevant (subjective) purposes.

Where debits can be separated out so that they are wholly attributable to either unallowable or allowable purposes, the position is generally straightforward.

If it appears in the first instance that debits cannot be separated out, it will often be useful to start by going back to check what (subjective) purposes have been established. After that, go onto assess the nature of the causal link between those purposes and the debits in question. It is HMRC鈥檚 experience that in many situations where the debits in question initially appear to be attributable to both unallowable and allowable purposes, full analysis results in a 100% or a 0% outcome for separable debits, on the basis that the separable debits are clearly causally linked wholly, or not at all, to an unallowable purpose. In all the cases litigated so far, the outcome can be seen as representing a 100% or 0% outcome for debits, if viewed on a separable debits basis.

It is HMRC鈥檚 experience that it is very rarely necessary to consider debits which are attributable to both unallowable and allowable purposes and cannot be separated out further. However, should that be the situation, this is in particular a complex area. If it may be in point this should form part of the discussions with Counter-Avoidance Technical Team (see CFM38200).


Other situations: the unallowable purpose rule is not engaged in respect of all debits initially under enquiry

There may be situations where HMRC begin by enquiring into debits in relation to a number of periods and/or loan relationships, but then conclude that the unallowable purpose rule is not engaged at all in respect of some of those debits, or of some of those loan relationships. For instance:

  • HMRC may begin enquiries relating to the purpose of two loan relationships, but, when the fact-finding has been completed, find that the first loan relationship only has an unallowable purpose, and the second loan relationship only has an allowable purpose: the unallowable purpose rule will not be engaged at all in respect of the debits arising on the second loan relationship

  • HMRC may begin enquiries into a loan relationship over a number of years, and find that it has an unallowable purpose in the early years, but that, by the end of a particular period, there has been a change in purpose such that for the remaining periods under enquiry it does not have any unallowable purpose: the unallowable purpose rule will not be engaged at all in respect of debits arising on that loan in those remaining years