Unallowable purpose and utilising existing losses

The Court of Appeal has upheld the decisions of the FTT and UT that arrangements entered into to enable a group to utilise trapped losses more quickly had an unallowable purpose: Kwik-Fit Group v HMRC [2024] EWCA Civ 434. However, the decision of the Court emphasises that it is in fact the making available of debits arising to the other group companies that represented the tax advantage in this case, rather than the use of the trapped losses per se.

The decision emphasises that whilst what matters is the company's subjective purposes in being party to a loan relationship and it is necessary to consider the subjective purpose of the relevant decision makers (the board) in a corporate context, subjective intentions are not limited to conscious motives and some consequences are so inevitable and inextricably involved in an activity that, unless they are merely incidental, they must be a purpose for it. In particular, whilst accepting that the test of purpose is a subjective one that must, in principle, be applied at an individual company level, this was clearly a case where the overall group tax advantage was a significant factor in the evaluation of whether or not to take part in the reorganisation.

Background

The Kwik-Fit group included a company (referred to as Speedy) which had brought forward non-trading loan relationship deficits of £48m. These deficits could only be used to shelter interest receipts in Speedy itself and was regarded as "trapped" as Speedy was not allowed at the time to surrender such losses to other group entities.

Under a group debt restructuring, the interest rate on existing loans owed to Speedy was increased from 0.74% (and in some cases 0%) to a market rate of LIBOR +5%. In addition, new loans were entered into and some existing loans were assigned to Speedy. The result of the reorganisation was that Speedy would be able to utilise the trapped deficits over an estimated period of 3 years rather than 25 years. It was accepted that the overall purpose from the group's perspective was to enable Speedy to utilise the trapped losses more quickly.

HMRC accepted that the existing loans had a commercial purpose but considered that the restructuring engaged the unallowable purpose rules in CTA 2009 Part 5. Under these rules, HMRC sought to disallow all of the interest payments on the new loans and the assigned loans. On the existing loans, HMRC sought to disallow the interest to the extent that it had increased. The FTT agreed with HMRC that the loans had an unallowable purpose and agreed with HMRC's adjustments to the group's claims, except that on the assigned loans the FTT only disallowed the increased interest payments. The Upper Tribunal rejected the taxpayer's appeal finding that the FTT had been entitled to reach its conclusions and had not erred in law.

Decision of the Court of Appeal

The appellant argued that the FTT and UT had erred in holding that the accelerated use of Speedy's valid losses was a tax advantage for Speedy. The accelerated use of tax losses was not a tax advantage per se. The Court of Appeal side-stepped this point. The Court noted that the true benefit for the Kwik-Fit group was in the accumulation of deductible interest expense in the appellants who were party to the new loans (or loans with increased rates) with the knowledge that the interest receipts in Speedy would not give rise to any immediate tax charge. Whilst much of the argument had focussed on the "accelerated use of losses", this had always been used as short hand for the advantage of tax deductible interest in other group companies and there was copious references in the earlier judgments that made this point clear.

So whilst the Court of Appeal agreed that they would not describe the use of Speedy's non-trading deficits as (by itself) a tax advantage intended to be secured by the group, that was simply a matter of "detail rather than a material flaw in the FTT's approach". It was clear for the judgments read as a whole that they had in mind the true tax advantage obtained by the group of the corresponding deductions in other group companies.

Secondly, the appellants argued that there had been no finding that there had been an actual reduction in tax charge in the appellants and it had not been put to the witnesses that securing a tax advantage was a purpose. The Court of Appeal, however, noted that while ascertaining the object or purpose of something involves an inquiry into the subjective intentions of the relevant actors, it is for the fact finding tribunal to determine the object or purpose and that question is not answered simply by asking the decision maker. It was for the FTT to reach its own conclusion based on all the evidence before it and that did not depend on obtaining a concession in any particular terms in cross-examination or framing a question in a particular way to witnesses.  

As regards the fact that some group companies may not actually have obtained any tax advantage since they were loss making, that argument missed the point. Identifying the purpose of actions is a forward looking exercise, looking at what is sought to be achieved, not what is ultimately achieved. It was perfectly obvious that the group sought and expected to make material tax savings and it was not necessary for HMRC to show that any particular savings were made by specific companies.

The appellants also argued that the loans put in place were at arm's length interest rates to comply with transfer pricing rules and it would be unfair for the unallowable purpose rules to be applied to loans (such as the pre-existing loans) which had a commercial purpose and where the losses had arisen in unobjectionable circumstances. On this point, the Court agreed that in most circumstances involving commercial loans at market rates, there would be no question of the unallowable purpose rules applying. However, the FTT's conclusions in this case were based on very specific facts. Indeed, it was clear that the rate changes were not motivated by the transfer pricing rules and those changes had not been made to other group borrowings where there was no benefit from early use of the trapped losses. In practice, the transfer pricing rules had played no part in the appellants' subjective purpose.

Finally, the Court of Appeal rejected arguments that the FTT and UT had been wrong to attribute all of the (increased) debits on the loans to the unallowable purpose. The appellants had had no commercial purpose in entering into the new loans and equally the increased rates on existing loans were also correctly attributed to the unallowable purpose. HMRC accepted that once Speedy's losses were used up, then it would not longer be just and reasonable to deny relief for the debits.

Comment

The decision is one of a number of recent decisions on the scope of the unallowable purpose legislation. Whilst such cases are necessarily fact specific, it does deal with some issues of principle. In particular, there is a rejection that in requiring a "tax advantage", the legislation presupposes that HMRC can show that there is a specific tax saving -- the only question is whether there is a tax advantage, as widely defined by the legislation, contemplated as a purpose of the arrangements. It is not necessary for HMRC to show that (absent the unallowable purpose rules) that purpose would have been achieved.

The nature and determination of "subjective purpose" for a corporate entity raises some difficult questions. On this issue, the decision of the UT shows a reluctance to interfere with the fact finding role of the FTT in such cases. Equally, it rejects a very legalistic approach to the determination of purpose where overall group level tax planning is being put in place. Ultimately, the absence of a clear commercial purpose beyond the desire to utilise the tax losses more quickly was a hurdle too far for the taxpayer in this case.