HMRC’s updated unallowable purpose guidance – helpful?
The “unallowable purpose” rule is an anti-avoidance provision found within the loan relationship rules. An unallowable purpose is a purpose that is not amongst the business or other commercial purposes of the company, which (for simplicity) includes the purpose of securing a tax advantage when that is the main purpose – or one of the main purposes – of entering into a transaction.
If a loan relationship is found to have an unallowable purpose, debits relating to the unallowable purpose will be disallowed.
The unallowable purpose rules have been a focus for HMRC litigation in recent years, which has helped to develop HMRC’s practice in this area. Whilst some cases remain subject to appeal, HMRC reflected some of the recent developments in their updated guidance, published in May this year.
It is clear from the guidance and case law that the test for unallowable purpose is a fact specific one, to be established after “careful examination of the evidence”1. Unfortunately, as has been demonstrated by the litigation in this area, identifying an unallowable purpose when looking back can be challenging, particularly where the contemporaneous evidence is incomprehensive.
Helpfully, at CFM38190, HMRC have included a number of examples of “good” and “bad” fact patterns, some of which are reminiscent of recent case law. However, HMRC’s examples rely heavily on a number of assumptions, including an assumption that the purposes for which the company is party to the loan relationship are clearly the purposes of the directors (who are, where relevant, fully aware of and consider the purposes of the group). Given that this point itself has been the subject of litigation and is evidence dependent, the utility of the examples may be limited in some cases.
Nevertheless, the following HMRC examples may be of interest to investment management groups.
When companies make the choice between financing their UK commercial opportunities with debt or equity, the availability of interest deductions is often a relevant consideration. A number of HMRC’s examples touch on this binary choice, albeit highlighting different factual scenarios.
In short, where the commercial motives are finely balanced between debt and equity, choosing debt finance to benefit from available tax deductions should not (on its own) give rise to an unallowable purpose.
These examples are focused on UK commercial activities, whereas the question of what is “allowable” becomes more complex when the commercial opportunity being financed is non-UK.
As a recap, the facts in HMRC v Blackrock Holdco 5 LLC2 centre around the inclusion of a UK tax-resident US LLC, Blackrock Holdco 5 LLC (Holdco 5), in an acquisition structure for a US target. HMRC contended that Holdco 5 was included within the structure solely for a tax avoidance purpose, and therefore the deductions for its loan relationship should be disallowed. Whilst the Upper Tribunal concluded the inclusion of Holdco 5 had both a commercial and an unallowable purpose, they found that the just and reasonable apportionment of the deduction was entirely to the tax avoidance element. Consequently, the deductions were disallowed. The Court of Appeal is due to hear this case in the first half of 2024.
Some of HMRC’s new examples relate to the facts in Blackrock. The “good” example highlights that, provided there is no commercial link to another jurisdiction, the inclusion of a UK holding company within the acquisition structure for a non-UK target may have an allowable purpose. This could arise where there is a strong commercial (non-tax) link between the company being acquired and the UK company. An example of a commercial link might be that both the UK company and overseas target benefit from the acquisition through the mutual exchange of expertise and experience.
The “bad” example is much closer to the facts of Blackrock, given this looks for (i) a strong commercial link to another jurisdiction; (ii) no commercial link to the UK; (iii) the UK company’s only activity being the financing, and (iv) the structuring of the acquisition giving rise to a net global tax benefit. The result of this fact pattern would be an unallowable purpose.
Given these examples derive from Blackrock, it is possible that the guidance may change again in line with the Court of Appeal’s decision, so this is an area to watch.
HMRC have also included an example dealing with the UK qualifying asset holding company (QAHC) regime. This, helpfully, confirms that an investment manager can choose a UK QAHC as its investment holding vehicle, having considered the statutory tax benefits available to a QAHC, without that structure being treated as having an unallowable purpose.
This is understandable in light of the work that has been put into establishing of the QAHC regime, which offers a more generous position for the deductibility of back-to-back shareholder debt than is available to a standard UK company. This would be undermined if the deductibility of interest for a QAHC was brought into question pursuant to the unallowable purpose rule.
Note of caution
Overall, HMRC’s updated guidance is far more comprehensive than the previous guidance in this area and the new examples are illustrative which is welcome. However, caution should be taken when relying on it. This is, of course, always true of HMRC guidance as they are at liberty to withdraw it, but where guidance is partially based on case law that is still subject to appeal, the need for caution is greater.
