Unallowable purpose and group tax planning
Intra-group borrowing costs of a UK newco incorporated as part of arrangements to acquire a US group were disallowed as the loan had an unallowable purpose.
The Court of Appeal (CA) has affirmed the decisions of the FTT and UT that the intra-group borrowings of a UK subsidiary which was incorporated as part of arrangements to acquire a US group should be disallowed as the loan had an unallowable purpose: JTI Acquisitions Company (2011) Ltd v HMRC [2024] EWCA 652. Both the CA and the UT considered that the FTT was entitled to look at the reason that the subsidiary was brought into existence as part of the wider group arrangements, rather than simply looking at the narrow purpose for which the loan was taken out.
The decision is important and follows HMRC's updated guidance on the application of the unallowable purpose rule. No doubt HMRC will consider that its interpretation of the legislation set out in that expanded guidance is further supported by this latest decision.
Background
The case concerns a UK newco (JTI) of a US group. JTI was formed to borrow monies from its US parent to acquire shares in another US company (LTT) from a third party. It was common ground that the finance was on arm's length terms and was used to make a commercial acquisition. However, HMRC took the view that the main reason that JTI was inserted into the acquisition structure was to secure a tax advantage in the form of UK interest costs which were surrendered to other UK group companies. The arrangements, which were advised on by Deloitte, also had an overall US tax advantage, since the US parent borrowed monies from a third party bank but, since it had checked-the-box on the UK subsidiary, was not treated as receiving any interest payments in the US.
The borrowing was subject to an advance thin capitalisation agreement (ATCA) with HMRC, which was entered into approximately a year after the arrangements. However, whilst Deloitte advised that an ATCA might reduce the risk of a challenge from HMRC and offer a level of comfort from a HMRC audit risk perspective, the FTT noted that the ATCA of itself did not provide blanket clearance to other targeted anti-avoidance provisions such as unallowable purpose rule.
The FTT agreed with HMRC that the loan relationship debits in this case had an unallowable purpose. In broad outline, the FTT held that it was entitled to consider the reason why JTI was introduced into the arrangements rather than focussing on the narrow question of what it used the borrowings for in concluding that there was a main purpose of obtaining a tax advantage. Furthermore, the FTT was not persuaded by the oral evidence that the main purpose of the borrowings were commercial. It gave more weight to the contemporaneous documentation in concluding that the UK tax deductions were the main purpose of the arrangements, which was borne out by tax planning documentation put forward by Deloitte.
In addition, the FTT considered that, in considering the purpose or motive of JTI in entering into the loan, it was entitled to have regard to the wider group purpose of the arrangements, including the US parent's decision to incorporate JTI to undertake the borrowing.
The FTT's conclusion was thus that the unallowable purposes rules did apply: securing a tax advantage was the main purpose of the appellant being a party to the loan relationship. JTI appealed the FTT's decision on a wide number of grounds. However, ultimately the UT rejected the appeal and confirmed the decision of the FTT (for more detail on the UT's decision, see the section below). JTI then appealed the decision of the UT to the CA.
Decision of the Upper Tribunal
The UT noted that whilst JTI raised a number of issues to challenge the FTT's decision, the points largely revolved around three key questions of statutory interpretation of the rules in CTA 2009 ss 441 and 442, namely:
- Are the existence of the company and the loan relationship "givens" in the analysis of the purpose for which the company is a party to the loan relationship?
- Are commercial asset purchases bought with borrowing at arm's length outside the scope of ss 441 and 442?
- Is the use to which the proceeds of the borrowing are put determinative?
On the first point, JTI argued that the rules presuppose the relevant entity is a party to the loan relationship and simply ask what is its purpose. That did not include looking at why that particular company, as opposed to another, was a party to the loan relationship. Rather the legislation was limited to looking at why that particular company (JTI) entered into the loan relationship.
The UT has rejected that argument, noting that the reason the provisions are "drafted in expansive terms, is to prevent tax avoidance by the use of loan relationships, as more specifically described therein. It seems to us that it would defeat Parliament's intention if an over-compartmentalised and narrow interpretation... were to be adopted... the natural reading of s442 and the words "the main purpose for which... the company is a party to a loan relationship..." invite the straightforward question "why are you a party to the loan relationship?" That enquiry readily accommodates being able to stand back and ask, where relevant, why that company in particular (as opposed to someone else) was a party to the loan relationship".
Furthermore, the UT considered that this wider approach was supported by other cases, including BlackRock Holdco 5 LLC and Kwik-Fit Group Ltd.
On the second point, the UT held that there is no hard and fast rule that, where the borrowing is used to purchase a commercial asset, a finding of unallowable purpose must be precluded. There was no statutory support for the argument. "While the legislation contemplates at the outset the company will have commercial or business purposes those will clearly not preclude the finding of an unallowable purpose. There is no carving out or privileged treatment for purchases of commercial assets with arm's length borrowing from the legislation's acknowledgment that a purpose of securing a tax advantage may nevertheless be found amongst the company's business or commercial purpose."
Thirdly, the UT rejected the argument (which overlapped with the second argument) that the use to which the borrowing was put was determinative. The use was a relevant factor, but not determinative. Instead, a wide ranging and fact sensitive enquiry of all the circumstances is required.
JTI relied, in particular, on extracts from ministerial assurances at the time the unallowable purpose rule was first introduced that it would not bite on ordinary borrowings to acquire shares, except where there were "artificial" arrangements. The UT has, however, rejected the suggestion that the ministerial statement contained any assurances for companies funding commercial activities. "The fact the statement dismissed the fear that tax deductions for borrowing costs would be denied, or that companies funding commercial activities or investments in a commercial way, had nothing to fear is easily reconcilable with the position that the provisions would only bite when securing a tax advantage was one of the main purposes, but would not if the purposes were commercial."
The resolution of these three arguments against JTI dealt with many of the arguments put forward by it before the UT. However, the UT did consider a number of other related complaints concerning the FTT decision.
JTI complained that, when considering the "purpose" of the arrangements, the FTT applied the wrong principle that it should look beyond the company's decision makers to ascertain purpose. The UT rejected that point on the basis that, read in context, the FTT was saying that "consideration of other "directing minds" outside of the company was relevant to ascertaining the purposes of the directing minds of the company. The FTT's subsequent discussion of cases ... highlighting the likelihood that the purposes of a company within a group may include purposes beyond those of the particular company show the FTT was looking at the issue from the perspective of the particular company viz the appellant. It was not suggesting that what the directing minds of other entities thought was relevant purely in its own right. It also follows from our analysis that the words "the main purpose for which" the company "is a party to" the loan relationship are capable of including the question why the company (as opposed to another) was chosen, and that the purposes of others outside the appellant's legally constituted decision-makers might be relevant."
In this context, JTI also argued that the finding that its board did not make a genuine decision when determining whether the transaction should be entered into was a finding it was not entitled to make. HMRC in contrast pointed to "window dressing" in relation to the pack of documents made available to the board (deliberately omitting Deloitte's structure paper, for example), in other words of things being done to give the impression a fully informed decision was going to be made whereas the genuine decision was to be made elsewhere.
Whilst accepting that the use of the word "genuine" in this context was "not the most apposite" (as the FTT was not saying the decision was invalid or was ineffective in company law nor that it was not formally possible for the appellant's board to say "no"), there was no error of law by the FTT. The UT considered that the FTT used the term in the sense that there was no genuine decision making. "All the FTT, we think, was seeking to convey was that the decision to acquire LTT using the appellant was effectively a "done deal" and that there was no real possibility the appellant would not decide to acquire LTT. In addition, from a presentational point of view, the decision-making was depicted by others to look like the appellant was making a de novo decision to acquire LTT, in circumstances where it might realistically have said no, and with a view to giving the impression the decision was not for tax reasons."
JTI also complained that the oral evidence of commercial purpose had not been cross-examined. In the absence of cross-examination, the FTT was not entitled to determine that evidence was not correct (based on the case law in Chen v Ng [2017] 5 UKPC 27). The UT also rejected that argument. When the FTT had to determine "the purpose for which the appellant was a party to the loan relationship it was making an essentially evaluative decision.
It had to weigh witness and documentary evidence and reach a conclusion. Where witness and documentary evidence conflicts or is inconsistent, or where witness evidence does not appear to tell the whole story, it seems to us that a fact-finding tribunal must make a decision as to which evidence to accept and the weight to be accorded to it by exercising its best judgment. In those circumstances, a failure to accord weight to witness evidence should not necessarily be impugned simply because the witness evidence was not formally challenged in cross-examination.... Clearly, it is desirable for weaknesses in witness evidence to be put to the witness, but, allegations of fraud or dishonesty apart, a failure to do so does not mean that it is axiomatic that a tribunal must accept the witness evidence uncritically and, further, it will not necessarily result in unfairness or an error of law."
Finally, whilst the UT did agree with JTI that the FTT misinterpreted the legislation in holding that, where JTI had failed to establish the tax avoidance purpose was not the main, or one of the main purposes, then the question of just and reasonable attribution was not necessary, the UT considered that the error was not material, because the FTT proceeded to analyse the question of attribution in the event it was wrong in its view that attribution was not relevant.
Court of Appeal decision
The CA noted that the issues on the appeal could be conveniently addressed under three headings:
- Was there an unallowable purpose?
- Was there a commercial purpose?
- Apportionment.
Was there an unallowable purpose?
The appellant argued that the FTT had asked itself the wrong question. "Instead... of focusing on the purposes for which the appellant borrowed the $550 million, they asked why the appellant was the group entity selected to effect the acquisition of LTT. JGI may have chosen the appellant for tax reasons, but it is the appellant's purposes that matter, and the appellant entered into the loan relationship because it needed the money to buy LTT. The appellant may have known that a tax advantage for the group would be generated, but simply knowing that something will have a consequence does not mean that it is done for that purpose... The relevant purposes are those for which the appellant incurred the borrowing, not those of the group in deciding that the appellant should be the borrower. What matter, moreover, are the subjective intentions of the appellant's decision-makers: the members of its board".
The CA referred at length to the earlier decision of the CA in BlackRock HoldCo 5 [2024] STC 740 and the judgments of Falk LJ and Nugee LJ. The CA noted that it had been accepted that it was the subjective purpose for which the borrower is party to a loan relationship that mattered and these may not be the same as the purpose for which a company exists or a wider scheme of which the loan forms part. Equally, however, the purpose for which a company exists or a wider scheme were not regarded as irrelevant. On the contrary, the CA suggested that although the purpose or purposes of being a party to a loan relationship cannot simply be elided with the purpose for which the relevant entity exists, in a case where an entity has no other function, it may be artificial to divorce what occurs at the board meeting and the wider context.
The CA formulated six principles from the earlier BlackRock case:
Even where a company entering into a loan relationship was brought into being to further a wider scheme, the company's purposes in becoming a party to the relationship are not necessarily those for which it was created or those of the wider scheme;
On the other hand, the context, and in particular the purposes of the wider scheme which the company was intended to advance, may, depending on the facts, bear on the company's purposes in entering into the loan relationship;
The company will have a "tax avoidance purpose" within the meaning of section 442 of CTA 2009 if it is seeking to play its part in a scheme which, to the knowledge of the relevant decision-makers, was designed to secure a tax advantage;
If it can be said that the company wishes to go along with such a scheme whatever its purposes might be, it may well be that the company has an unallowable purpose regardless of whether it appreciates that the scheme was designed to secure a tax advantage. It may suffice that those promoting the scheme have that intention;
The fact that the decision-makers consider that entering into the loan relationship is in the company's interests for other reasons does not preclude them from having a "tax advantage purpose"; and
A Tribunal determining whether a company had a "tax avoidance purpose" is not required to adopt a "tunnel-visioned" approach looking simply at how the company was proposing to use the money it was borrowing.
In this case, not only were all the directors "alive to what was expected of the appellant, and why", but one of the directors was a contributing architect to the wider scheme and the other directors had followed the lead of that director. The FTT had concluded that the appellant's directors went along with the scheme which, to their knowledge, the group had adopted for tax reasons. It was in that sense that the "decision makers were at JGI level". The appellant's directors were seeking to fulfil the company's role in a plan which those "at JGI level" had decided on to secure a tax advantage.
As a result, and echoing the words of Nugee LJ in BlackRock, the CA held that "the appellant's purpose was to play the part that had been devised for it so as to obtain a tax advantage. That being so, the appellant had a tax avoidance purpose.
Commercial purpose?
The FTT had held that it was unable to find any bona fide commercial purpose for the appellant being party to the loan relationship. The appellant argued that the appellant's purpose for being party to the loan relationship was to part fund the acquisition of LTT.
In line with the approach of the UT, the CA has held that this was not a case in which the appellate courts should interfere with the factual findings of the FTT. The underlying argument was that the appellant must have had as a purpose in issuing the loan notes using the money it was borrowing as it intended. The CA has held that whilst that was a conclusion open to the FTT (and one another FTT might have agreed with), it was equally not a conclusion that was open to challenge. The FTT is not required to adopt a "tunnel-visioned" approach looking simply at how the company was proposing to use the loan.
Apportionment
The FTT had held that, even if it had accepted that there was a commercial as well as tax avoidance purpose, it would have attributed all of the debits to the tax avoidance purpose. The CA agreed with that approach. But for the scheme to secure a tax advantage which was "bolted on" to the purchase of LTT, there would have been no loan relationship and so no debits.
Comment
The decision is an important one in the context of the application of these provisions and follows the publication by HMRC of updated guidance. In particular, the decision indicates that the reason why a particular company has been used is a relevant consideration in this context and that the mere fact the borrowing is used to make a commercial acquisition will not be sufficient to take it outside the scope of the anti-avoidance rules. Moreover, it may be difficult to persuade HMRC (and the courts) that the wider group purpose for the borrowing was not a relevant consideration in the thinking of the particular board members authorising the borrowings, especially in scenarios where the UK company has been specifically incorporated to undertake a specific role in the wider group arrangements.
Finally, it is interesting to note that Lewison LJ also expressed surprise that HMRC had not sought to argue the case on Ramsay principles ("where a scheme aimed at avoiding tax involves a series of steps planned in advance, it is both permissible and necessary not just to consider the particular steps individually but to consider the scheme as a whole").
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