Unallowable purpose: new HMRC guidance

Update: The guidance has been further updated in May 2025. See our article, “HMRC guidance on unallowable purpose updated again”.

HMRC have substantially revised and expanded their guidance on their approach to the question whether a loan relationship has an unallowable purpose. The guidance, in the Corporate Finance Manual, has been updated following recent court decisions and, it appears, in the light of a wider approach by HMRC to the application of this anti-avoidance provision.

In particular, the guidance now includes substantially new sections on how “purpose” is to be determined for the purposes of the application of the rules, what is the main purpose of arrangements, how HMRC will approach the question whether a loan relationship has an unallowable purpose and many more examples of the application of the rules.

The new guidance, and decisions in those recent cases, will be concerning to taxpayers. The use of UK acquisition vehicles within a group structure, in particular, will need to be carefully considered and the new approach makes clear that, even where there is a bona fide commercial acquisition, HMRC will seek to challenge such situations in the absence of a clear commercial nexus between the acquiring company and the target and where the use of a UK vehicle is chosen largely due to the availability of loan relationship debits.

Background

The UK loan relationship rules contain an anti-avoidance provision in CTA 2009 ss.441 and 442 known as the unallowable purpose rule. This provision, broadly, disallows debits on a loan relationship (on a just and reasonable basis) where that loan relationship or a related transaction has an unallowable purpose. An unallowable purpose is one that is not amongst the business or commercial purposes of the company and, in particular, includes the situation where the main, or one of the main, purposes is a tax avoidance purpose. A tax avoidance purpose is any purpose that consists of securing a tax advantage (widely defined) for the company or another person.

There have been a number of recent cases that have considered the application of the unallowable purpose rule in recent years, including in particular JTI Acquisition Company v HMRC [2022] UKFTT 166 and HMRC v BlackRock Holdco 5 LLC [2022] UKUT 199. Both of these cases involved the use of a UK vehicle as part of a group structure to make a genuine commercial third party acquisition financed by intra-group borrowings. In both cases, it was a consideration for the structure used, in part at least, that there would be the ability to use the debits arising in the UK on the borrowings. In both cases, the FTT and the UT have held that in these circumstances it was a “main purpose” of the loan relationship that the UK tax advantage arising from the debits should be obtained. This was despite the fact that the tax advantage in these cases was simply the availability of the debits (and the ability to use them within the wider UK group) and this arose from the normal operation of the rules allowing deduction for the costs of borrowing.

Updated guidance

Despite the importance of the unallowable purpose rule in the context of the loan relationship rules, HMRC’s previous guidance (in the Corporate Finance Manual) was extremely limited and contained very little by way of detail. That position has now been rectified with a substantial expansion to the guidance published in May 2023.

In particular, four areas of the guidance have been considerably expanded to provide additional guidance on the approach that HMRC will take when considering the application of the rules: the meaning of purpose in this context; the question whether a purpose is a main purpose; HMRC’s approach in practice; and the examples of when the rules will, or will not, apply.

Meaning of purpose

The new guidance on purpose confirms that the relevant purpose is that of the company that is party to the loan relationship and that the company’s purpose is, in principle, to be determined from the purposes of the directors of that company and that purpose is a matter of subjective intention. However, a major concern for HMRC is the way in which the overarching purposes of the group of companies to which the borrowing company is party may impact on the purposes of that company.

The guidance makes the point that the purpose of other parties may be the relevant purpose where the directors have “ceded control to shareholders or advisers” or are acting as mere puppets. HMRC also take the view that the purposes of others may be relevant where arrangements have deliberately been put in place so the directors do not know about the purposes of the decision makers and the directors choose not to ask.

But the broader, more general issue is, essentially, to what extent the parent’s or wider group’s purposes may be taken into account. The guidance acknowledges that this is a difficult and complex area and is the subject of continuing cases, including JTI Acquisition Company and BlackRock Holdco 5. The guidance makes the point that the directors will often be briefed and have knowledge of the wider group purpose for a UK company’s involvement in arrangements, but then simply states that “[w]hether or not any such group purposes amount to a main purpose of the directors of the company will then need to be determined, and depends on all the facts and circumstances”. However, clearly a mere instruction to ignore the wider group purpose in making a decision on the UK company’s involvement in arrangements is unlikely to have any effect on the significance of such knowledge of the group purpose.

Having said that, the examples now included in the guidance (see below) almost entirely ignore this difference between the purposes of the company entering into the loan relationship and the wider group’s purposes, focussing instead on the group or parent’s purpose for the particular arrangements. What seems clear is that HMRC are largely unwilling to view the transaction simply from the point of view of the borrowing company itself and its (selfish) position in any structure.

Is there a main purpose?

Where there is commercial objective to arrangements (it is not a pure tax avoidance scheme), how to determine whether a purpose to obtain a tax advantage is a “main” purpose? HMRC’s guidance makes a number of general points in this context including that:

• The consequences or effects of a transaction are likely to be relevant but not determinative;
• Whether a purpose is a main purpose is a question of fact and depends on the evidence of all the facts and circumstances in the case; and
• “Main” has a connotation of importance, and will always be more than trivial.

The guidance in this part relies on caselaw on the question of main purpose in other parts of the legislation. In particular, there is discussion concerning the distinction between the purpose and the effect of actions. There is recognition that the inevitable effect of an action (deduction for interest) does not make it a purpose of the action necessarily. However, the guidance also stresses that the caselaw supports the proposition that purpose is not limited to conscious motives and that some consequences are so closely linked that unless incidental they are to be taken as a purpose. In this context, the guidance draws support from Mallalieu v Drummond, a case on the meaning of “wholly and exclusively for the purposes of the trade” in this context. Given the different context and requirements of this test (“wholly and exclusively” is very different from “main”), clearly care is needed in transposing the approach taken. At least the guidance notes that the “question of the precise application of some of the following cases in the context of the unallowable purpose rule is under discussion in cases under litigation at the time of writing”.

There is recognition that any company acting commercially will normally consider the tax consequences of a transaction. In particular, in the context of debt financing, it is a natural consequence that tax deductions will generally be available in respect of interest, which means that tax advantages will be obtained. As such, determining whether or not there is a main purpose of securing a tax advantage in the context of financing arrangements may be difficult.

Factors HMRC will take into account

The revised guidance now contains a lengthy section setting out some of the factors that HMRC will take into account in assessing evidence of a main purpose of tax avoidance.

The guidance makes the point that HMRC will seek to gain a full understanding of the factual context and the UK and non-UK tax consequences resulting from any arrangements. HMRC will seek to understand whether there is a net tax benefit to the group as a whole and a UK tax benefit to the arrangements, in particular. HMRC will also seek to understand the commercial purposes of the arrangements. For example, the guidance states that “if group financing is routed through a UK special purpose vehicle (SPV), earning a margin for the vehicle, the fact that the involvement of the SPV generates this intragroup margin does not contribute to net group commercial (non-tax) benefits. HMRC will wish to understand whether the involvement of the SPV does so in any other way, and if so, to what extent”.

“Understanding the full factual context will enable case teams to make sense of the picture as a whole, and so more effectively assess the purposes for which the company is party to the loan relationship”. It might be noted that the “purpose” here is not that of the company entering into the loan relationship, but that of the broader group and the question to what extent that is legitimate is discussed in the section on “purpose” above. Clearly, however, HMRC’s approach will focus on the purposes of the group and this is made clear where the guidance states, “based on HMRC’s experience, in most situations involving groups the relevant purposes will be the purposes of the directors of the company, who will know and take into account any group purposes in relation to the company’s role in wider arrangements, and so it is necessary to understand what those group purposes are”.

The guidance also includes a list of factors that may, depending on any particular facts, be relevant in there is a main objective of securing a tax advantage, including:

• The size of the tax advantage, both absolute and in comparison to the commercial benefits;
• The existence, or lack, of net UK tax benefits in wholly UK or cross-border financing arrangements;
• The existence, or lack, of net global tax benefits in cross-border financing arrangements;
• The degree of attention paid to securing the tax advantages (including the existence of substantial fees for tax advice);
• Where the borrowing funds activities or investments which are not expected to generate UK tax; and
• Whether or not the arrangements would have happened, or would have happened in a different way, had the potential for the tax advantage never existed (a “but for the tax advantage test”).

In particular, HMRC consider that if the arrangements would have happened in a simpler way (or not at all) but for the tax advantage, then this is a factor pointing towards securing a tax advantage as a main purpose. “In cross-border financing arrangements, whether or not there is any material net group commercial (non-tax) benefit from involving the UK is often a key point. For instance, if there is a non-UK entity who would from a commercial (non-tax) perspective be the natural entity to borrow to acquire shares in a third party, but instead financing is obtained via the UK because of the tax advantage by way of tax deduction available (perhaps as part of achieving a net global tax benefit), then in many circumstances, having assessed all relevant factors, it is likely there will in fact be a main tax avoidance purpose.”

It should be remembered that the original guidance, based on statements of the Economic Secretary in Hansard when the original legislation was debated, confirmed that the unallowable purpose rule “will not normally apply where a company borrows to acquire shares in companies, whether in the United Kingdom or overseas, or to pay dividends, provided that the borrowings are not structured in an artificial way. And a similar view is taken as regards borrowings, whether from a third party or intra group, to acquire other business assets whether located in the United Kingdom or overseas.” HMRC confirm that they still regard this as being consistent with their revised approach and whilst they do not expressly state how, this must presumably be on the basis that arrangements involving UK acquisition vehicles where there is a tax advantage are “artificial”.

Examples

The guidance now includes many more examples of when HMRC consider the rules will or will not apply. In particular, there is a focus on the use of finance structured through UK group entities in many of these examples.

However, it should be noted that the examples in many ways duck the difficult question of determining the purpose of the company entering into the arrangements (as opposed to the wider group purpose), by including the assumption that “the purposes for which the company is party to the loan relationship are clearly the purposes of the directors, who all share the same knowledge and views. Where relevant, the directors are fully aware of and take into account group purposes, determined by the parent’s directors, in relation to the company’s role in wider group arrangements.”

Unallowable purpose not expected to apply

The examples where HMRC would not expect the unallowable purpose rule to be applied in relation to debt financing of a UK group company tend to contain the following features: the choice between debt and equity financing is commercially finely balanced; there is a UK commercial opportunity for the finance or an acquisition of shares in a non-UK entity with strong operational links to the UK subsidiary; and the choice to take debt over equity takes into account the tax deductions. It would indeed be surprising if such straightforward arrangements should be caught by the unallowable purpose rule.

Perhaps more helpful is the indication in some of the examples (Examples 4 to 9) that the fact that the directors would not have gone ahead with the commercial transaction at all in the absence of the tax advantages of borrowing (or other advantages involved in the transaction) does not indicate an unallowable purpose. (This can be contrasted with the decision in BlackRock Holdco 5 LLC that the fact that the taxpayer would have gone ahead with the borrowings even if there had been no tax advantage did not prevent the whole of the tax advantage that did arise being objectively apportioned to the unallowable purpose.)

Also more helpful are the example where moving an existing intra-group loan within a UK group to a subsidiary with trapped losses to use those losses is not seen as having an unallowable purpose.

There is also an example which demonstrates that setting up a Qualifying Asset Holding Company (QAHC) in the UK will not trigger the unallowable purpose rule where it is funded through the use of loans from investors which take the form of profit participating loans (PPLs), the terms of which see the profits of A Co’s investments passed back to investors as a return on the PPLs. There is a commercial purpose in setting up the QAHC (facilitating the flow of capital/income between investors and assets) and the fact that the structure would not be put in place but for the fact the UK statutory regime provides for the return on the PPLs to be tax deductible is not a main tax avoidance purpose.

Unallowable purpose expected to apply

In contrast, the examples that HMRC provide for where the unallowable purpose rule will normally be applied tend to deal with cross-border financing arrangements routed through a UK subsidiary where there is no commercial link between the UK subsidiary and the investment and any group benefit arises from the availability of UK interest deductions. These include examples both where the UK subsidiary sits in the acquisition structure or borrows to fund dividends from distributable reserves to (indirectly) fund the acquisition.

It is clear from these examples that HMRC expect to see some form of direct commercial connection between the UK borrowing company and the company / asset to be acquired with the borrowing to justify its involvement. If its involvement is not otherwise justified than by the existence of tax deductions for interest in the UK, then HMRC will normally start from the perspective that there is a main tax avoidance purpose.

Comment

The publication of more detailed guidance by HMRC on the application of the unallowable purpose test is, in principle, to be welcomed. The original guidance was in many respects sadly inadequate for such an important anti-avoidance provision.

However, the timing of the publication of the guidance is perhaps questionable. The guidance acknowledges that some of the issues that HMRC deal with in the guidance are currently in the course of litigation and the correctness of the guidance, therefore, very much depends on the outcome of that litigation. In the meantime, the guidance appears somewhat self-serving and designed to reinforce HMRC’s preferred approach in those ongoing cases. At the very least, the guidance will need to be revisited when those cases reach the next stage of appeal.