HMRC guidance on unallowable purpose updated again

On 7 May, HMRC published a significant update to their guidance on the application of the unallowable purpose anti-avoidance rule within the loan relationships tax regime. The changes are designed to bring the guidance up-to-date for recent, significant Court of Appeal decisions, such as BlackRock, Kwik-Fit and JTI. Most notably the sections on how “purpose” is to be determined and what is the main purpose of the arrangements have been extensively rewritten.

Whilst updated guidance is always welcome, the changes to the guidance in this case will not bring any greater certainty taxpayers potentially affected by the anti-avoidance provision. Indeed, the guidance, and decisions in the recent cases, will be concerning to taxpayers. In particular, the changes do not update the examples of the application of the rules previously provided by HMRC and the inherent uncertainty of using a UK acquisition vehicle within a group structure. It remains the case that the use of such a vehicle, in particular, will need to be carefully considered and the guidance continues to make 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 BlackRock Holdco 5 LLC v HMRC [2024] EWCA Civ 330 and JTI Acquisition Company v HMRC [2024] EWCA Civ 65. 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 Court of Appeal has upheld decisions 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. A further Court of Appeal decision, Kwik-Fit Group Ltd v HMRC [2024] EWCA Civ 434 also considered the application of the rules in the context of a reorganisation which included creating new loans and revising the terms of existing loans with a creditor company to enable that company to utilise non-trading loan relationship debits.

HMRC substantially revised and expanded their guidance on their approach to the question whether a loan relationship has an unallowable purpose in 2023 following decisions in the tribunals in these cases and, it appears, in the light of a wider approach by HMRC to the application of this anti-avoidance provision. The original guidance was in many respects sadly inadequate for such an important anti-avoidance provision and the publication of more detailed guidance was, in principle, long overdue. For details of the substantial 2023 rewrite of the guidance, see our earlier article “Unallowable purpose: new HMRC guidance”.

This guidance, in the Corporate Finance Manual, has now been further updated following the recent Court of Appeal decisions.

Updated guidance

The updated manual notes that the recent Court of Appeal decisions contain significant guidance on the ascertainment of “purpose” for the purposes of the rules. This guidance relates to several aspects of this issue including: how to determine what is a purpose; determining what is a main purpose; whose purpose is relevant; and what amounts to a tax avoidance purpose.

The guidance on determining purpose and main purpose has been significantly rewritten for the new case law. It recognises that this is a complex area and highly fact specific. For example, the guidance now seeks to distinguish between purpose, consideration and consequences: “A relevant consideration may amount to a main purpose; a purpose, but one which is not a main purpose; or not a purpose at all. This is a question of significance, to be assessed by reference to all the relevant facts and circumstances; and ‘main’ carries a connotation of importance. In particular: Something may be a long-term aim which is simply part of the background noise, or may be a purpose but not a material one; something which is icing on the cake will not be a main purpose. The consequences or effects of a transaction are likely to be relevant factors to be taken into account as part of an assessment of all the relevant circumstances, but they are not determinative of purpose, they are not the same as purpose”.

Unsurprisingly, given its importance in the recent cases, the question of the relevance of the wider corporate group purpose has been reassessed in the updated guidance. This now follows the position largely set out by the Court of Appeal in JTI Acquisitions, noting that whilst the relevant purpose is that of the directors of the relevant company, the purposes of others may well be relevant. In particular, whilst recognising that this is a complex area, the new guidance notes that: “… in many situations, the group purposes are likely to be relevant in assessing the application of the unallowable purpose rule. Whether or not any such group purposes influence the directors of the company to such an extent that they become a main purpose of the directors will then need to be determined, and depends on all the relevant facts and circumstances… That is not the same as substituting for the statutory test a test of group purposes for the wider arrangements or, where applicable, for the company’s existence. For example, if from a group’s perspective a company entering into a loan relationship was brought into being to play a role in relation to a wider set of arrangements, it does not follow necessarily that the company’s purposes in being party to the loan relationship are the purposes for which it was created or of the wider arrangements. The relevance of group purposes to the decision-makers, normally the directors, in influencing their decisions will need to be assessed on the facts of each situation”.

The mere fact that the directors assess the interests of the relevant company and determine that the transaction is in the best interests of that company is recognised as relevant but not determinative of whether there is a commercial (non-tax) purpose. The guidance notes: “In particular, many situations involve directors deciding to borrow in circumstances where the proceeds fund an acquisition: directors may assess what profits the acquisition is expected to generate, whether the acquisition is made at a fair price, and whether any debt associated with the acquisition is on arm’s length terms and is affordable (can it cover ongoing debt financing costs, can the debt be repaid if required?). Directors coming to a conclusion which satisfies them on these points is potentially relevant but not determinative of whether or not the purposes for which the company is party to the loan relationship include a commercial purpose of making the acquisition of the asset and/ or of generating profits net of financing costs.”

Equally, the mere fact that a company is choosing between different ways to carry out a commercial transaction taking into account the tax consequences of those different methods may, or may not, mean there is a main purpose of securing a tax advantage. Recognising that this is a difficult question, the guidance states: “Different ways of carrying out a commercial transaction may be available. If a way is chosen which minimises tax, earlier case law on other purpose or object tests establishes that there may, or may not, depending on all the relevant facts and circumstances, be a main purpose of securing a tax advantage. It is necessary to look at all the facts and circumstances in the round.”

The guidance on attributing debits between commercial and unallowable purposes has also been substantially updated.

However, most notably, no changes have been made to the examples provided on the application of the unallowable purpose rule at CFM38190.

Comment

The publication of updated guidance by HMRC on the application of the unallowable purpose test is, in principle, to be welcomed. It is important that HMRC’s guidance stays up-to-date with developments in the courts. However, the fact that the examples provided by HMRC have not been updated and the recognition that the test of whether something is a “purpose” and if so whether it is a “main purpose” and, indeed, unallowable are all questions of facts which are highly dependent on the specific context means that, in practice, the guidance does not provide taxpayers with much in the way of certainty except in the most inoffensive circumstances.