CFM38167 - Loan relationships: tax avoidance: unallowable purpose: leading case law

The following summarises, in the ‘Summary’, what happened, the tax treatment claimed by the taxpayer, and the substantive HMRC challenge in relation to the ‘unallowable purpose rule’ (at s441-442), and, in the ‘Decision’, the decision by the Court of Appeal on debits, for the cases covered.It also summarises, in the ‘Summary’, what happened, the tax treatment claimed by the taxpayer, and the substantive HMRC challenge in relation to the existence of a main object to obtain a tax advantage, and, in the ‘Decision’, the decision by the House of Lords on this point, for IRC v Brebner. The cases covered are:


JTI Acquisitions Company (2011) Ltd v HMRC [2024] EWCA Civ 652

Previous decisions: [2022] UKFTT 166 (TC), [2023] UKUT 194 (TCC).

Summary

1.    Joy Global Inc (“JGI”) agreed to acquire LeTourneau Technologies Inc (“LTT”, a 3 party US company) for $1.1bn in May 2011. Advisers suggested the following acquisition structure which the group adopted:

  • JGI borrowed $500m externally (step 0).

  • JTI Acquisition Company (2011) Limited (“JTIAC”) was incorporated with a US parent, Joy Technologies Inc (“JTI”) (step 1).

  • JGI contributed $550m (step 2) and lent $550m (step 3) to JTI.

  • JTI contributed $50m as equity (step 4), contributed $550m of quasi equity (step 5), and lent $550m in the form of a quoted Eurobond (the loan relationship) (step 6) to JTIAC.

  • JTIAC used the $1.1bn to acquire LTT (step 7).

  • JTI formed a Cayman Island group company (step 8) and assigned the $550m receivable to it (step 9).

2.    Claimed tax treatment: JTIAC incurred losses as interest debits accrued on the $550m loan relationship and these were surrendered as group relief to other UK group companies. The corresponding interest credits were not taxed in the Cayman company. A check the box election for US tax purposes was made with respect to JTIAC and the Cayman company, with the effect that the corresponding interest credit was not taxed in the US. An Advance Thin Capitalisation Agreement was agreed by HMRC in 2012 in relation to the interest on the loan relationship. The group did not accept that the unallowable purpose rule should apply.

3.    HMRC argued that the unallowable purpose rule should apply to disallow all debits.

Decision

4.    In summary, the Court of Appeal held that the unallowable purpose rule applied to disallow all debits.


Kwik-Fit Group Ltd and other companies v Revenue and Customs Commissioners [2024] EWCA Civ 434

Previous decisions: [2021] UKFTT 283 (TC), [2022] UKUT 314.

Summary

1.    In 2013, a creditor company within the Kwik-Fit group, Speedy 1 Ltd (“Speedy”), had carried forward non-trading loan relationship deficits (non-trading deficits) of £48m which were ‘trapped’ (could not be surrendered as group relief or otherwise used quickly against its non-trading profits).

2.    The group carried out a reorganisation, which involved dividends being paid by direct and indirect subsidiaries up the ownership chain to Speedy, along with an equity injection into Speedy by its parent, and also included restructuring of some but not all intragroup loans. This loan restructuring included:

    • creating new intragroup loans, which were issued in satisfaction of dividends, with the receivables assigned to Speedy (the ‘new’ loan relationships)

    • moving existing intragroup loans to Speedy, and increasing their interest rate from between 0 and 1.89% to LIBOR+5% (the ‘existing assigned’ loan relationships)

    • increasing the interest rate from 0.74% to LIBOR+5% on an existing intragroup loan receivable owed to Speedy (the ‘existing non-assigned’ loan relationship)

3.    There was no change to any interest rates on other existing loans in the UK sub-group, in particular the interest on a loan owed by Speedy remained the same. The reorganisation had the effect of greatly increasing Speedy’s net interest income.

4.    It was accepted that the existing loan relationships had been incurred in the course of business activity for commercial (non-tax) purposes.

5.    Claimed tax treatment: The group expected that the debtor companies could claim loan relationship debits in relation to the interest on the new loan relationships, and in relation to the ongoing and additional interest on the existing loan relationships, whilst existing unused ‘trapped’ non-trading deficits could be set off against the corresponding interest income received by Speedy. That meant there was asymmetry and a net UK tax benefit equal to the amount of the non-trading deficits over 3 years, rather than over at least 25 years (the group’s estimate of the minimum time it would have taken Speedy to access its surplus non-trading deficits otherwise). HMRC agreed that any debit disallowances should be capped in year 3 when the existing trapped non-trading deficits were used up (“the cap”). The group argued that the unallowable purpose rule did not apply.

6.    By the Court of Appeal, HMRC argued that the unallowable purpose rule should apply to disallow all debits on the new loan relationships, and the additional debits on the existing assigned and non-assigned loan relationships, subject to the cap.

Decision

7.    The Court of Appeal held that the unallowable purpose rule did apply to disallow all debits on the new loan relationships, and the additional debits on the existing assigned and non-assigned loan relationships, up to the cap.


BlackRock Holdco 5 LLC v HMRC [2024] EWCA Civ 330

Previous decisions: [2020] UKFTT 443 (TC), [2022] UKUT 199 (TCC).

Summary

1.    In 2009, the US-headed BlackRock group undertook the acquisition of the Barclays Global Investors business (BGI) which was a global business headquartered in the US owned by the Barclays group. The BlackRock group funded the acquisition in part through external borrowing in the US.

2.    To structure the acquisition of BGI’s US sub-group (BGI US), BlackRock incorporated three new companies: LLC4 (US-resident), LLC5 (UK-resident) and LLC6 (US-resident). LLC5 borrowed $4bn, the loan relationships, from LLC4 (its parent), and used the funds to acquire preference shares in LLC6 (LLC4 controlled LLC6 through its majority holding of common shares). LLC5 expected to earn a small margin. LLC6 then acquired BGI US.

3.    Claimed tax treatment: In the UK, LLC5 claimed a full deduction for the loan relationship debits, which it then surrendered to other group companies, whilst there was no UK tax on the income from the preference dividends received, so there was a net UK tax benefit equal to the deductions. LLC5 was tax transparent for US tax purposes, and the US tax treatment meant that effectively there was no US tax on the receipt of interest, creating asymmetry and a net global tax benefit. The group argued that the unallowable purpose rule did not apply (and that the debits should not be challenged under transfer pricing).

4.    HMRC argued that the unallowable purpose rule should apply to disallow all debits that arose on  the $4bn loan relationships (HMRC also challenged the debits under  transfer pricing, not covered by this summary).

Decision

5.    In summary, the Court of Appeal found that the unallowable purpose rule did apply to disallow all debits.


Travel Document Service & Ladbroke Group International vs HMRC [2018] EWCA Civ 549

Previous decisions: [2015] UKFTT 0582 (TC); [2017] UKUT 0045 (TCC).

Summary

1.    Travel Document Service (“TDS”) and its subsidiary, Ladbroke Group International (“LGI”), were members of the Ladbroke group. In 2008, they and other group companies undertook arrangements including the following key steps:

  • TDS entered into a total return swap over its shares in LGI. This meant that TDS transferred its economic interest in the shares to another group company and received a return akin to interest.

  • A significant amount of loan debt was created and then novated into LGI for nominal consideration (creating a new loan relationship) which reduced the fair value of the LGI shares by £254m.

  • The arrangements resulted in certain commercial (non-tax) benefits (including extraction of reserves).

2.    TDS claimed tax treatment: as a result of entering into the swap, under the “debt as shares” rules (s91B FA 1996, now repealed), TDS was deemed to be a creditor of a loan relationship with respect to the LGI shares. Debits and credits of the deemed loan relationship were required to be brought into account on a fair value basis. As a result of entering into the novations, which resulted in the reduction in the fair value of the LGI shares, TDS claimed a deduction of £254m under the loan relationship provisions. There was no matching taxable credit elsewhere in the group. By the FTT, the group had agreed that one of TDS’s main purposes for entering into the transactions by way of swap and novations was to secure a tax advantage, being the £254m debit, but argued that the unallowable purpose rule did not apply.

3.    LGI claimed tax treatment: LGI claimed £12m deductions for interest debits on the novated loans. There was matching taxation of interest credits elsewhere in the group. By the Court of Appeal, the group had accepted that the purposes for which LGI was party to the novated loans included a main purpose to enable TDS to obtain a tax advantage, being the £254m debit, but argued that the unallowable purpose rule did not apply.

4.    HMRC argued that the unallowable purpose rule should apply to disallow all the deductions claimed by TDS and LGI.

Decision

5.    In summary, as regards both TDS and LGI, the Court of Appeal held that the unallowable purpose rule did apply to disallow all debits.


Fidex Ltd v HMRC [2016] EWCA Civ 385a

Previous decisions: [2014] UKUT 0454 (TCC), [2013] UKFTT 212 (TC).

Summary

1.    Fidex Ltd (“Fidex”) was an orphan company sponsored by BNP Paribas that bought bonds and issued commercial paper into the debt capital market. In 2004 and 2005, a series of steps (Project Zephyr) were undertaken:

    • In 2004, BNP Paribas purchased shares in Fidex to bring it into the BNP Paribas group for tax purposes.

    • Fidex issued preference shares to a third party, Swiss Re, closely reflecting the rights of the bonds, which Fidex had held since 2000.

    • From 1 January 2005, Fidex switched its accounting policy from UK Generally Accepted Accounting Practice  to International Financial Reporting Standards accounting standards. As a result of this change the bonds and the preference shares were derecognised.

2.    Claimed tax treatment: The bonds were a loan relationship held as assets. Fidex recognised the reduction in accounting value of the bonds between 2004 and 2005 under para 19A, Sch 9A FA 1996 (now s316 CTA 2009): if the carrying value of a loan relationship changed between one accounting period and the next by reason of a change in accounting policy, the difference was taxable/ deductible in the second year. As a result of the reduction, Fidex claimed a deduction of around €84 million. The resulting loss was available for group relief throughout the BNP Paribas group.  The group argued that the unallowable purpose rule did not apply.

3.    HMRC argued that the unallowable purpose rule should apply to disallow the €84 million debit.

Decision

4.    In summary, the Court of Appeal held that the unallowable purpose rule did apply to disallow the €84 million debit.


Commissioners of Inland Revenue v Brebner [1967] UKHL TC 43 705

Note: the case deals with the transactions in securities legislation, not the unallowable purpose rule, but the discussion of what constitutes a main object is relevant to the unallowable purpose rule.

Summary

1.    A takeover bid was made for a company which, if successful, was likely to put an end to the company’s business. Brebner and the other directors did not wish this to happen as they had commercial interests which would be damaged if the company ceased to operate; the company’s prospects of continuing to make profits were good; and the employees would lose their jobs. The directors and some others made a higher counteroffer, which was accepted by most of the shareholders: the price was based on the need to defeat the takeover offer. This was financed by a bank loan, with a clause providing for early repayment. The members of the buying group expected to effect repayment as far as possible by taking assets out of the company, but there had been no calculation as to how much cash could be extracted. After purchase, it was identified that the company had surplus cash of £75,000 in capital and revenue reserves. Paying a dividend of £75,000, with liability to surtax on the surtaxable part, would not have provided the required finance and was not contemplated. After considering several transactions, the one adopted was to issue and allot shares paid up by the capitalisation of revenue and capital reserves; and then to effect a court approved reduction of capital, returning capital to the shareholders.

2.    Claimed tax treatment: the amount received by the shareholders was capital and so no tax was due. The taxpayer claimed the transaction had a bona fide (effectively, genuine) commercial reason and that obtaining a tax advantage was not the (or one of the) main object(s), and therefore HMRC could not counteract the transaction under the transaction in securities legislation.

3.    HMRC applied the transactions in securities legislation to counteract the transaction (under what is now s698 ITA 2007), which would mean the amounts received by the shareholders were taxed as dividends.

Decision

4.    The House of Lords saw no reason to overturn the Special Commissioners decision that the transaction was entered into for commercial reasons and that there was no main object to obtain a tax advantage.