Court of Appeal upholds unallowable purpose tax avoidance decision

“The Court of Appeal did again confirm that there will be circumstances where regard was had to tax considerations when deciding to borrow and it will not necessarily involve falling foul of the unallowable purpose rule. However, there remains limited guidance from these recent judgments as to when situations are likely to fall on the right side of the line so as to permit deduction,” said Jake Landman, tax law expert at Pinsent Masons.

Availability of tax deductions for interest on intra group debt is an issue that is of major importance for business across sectors from healthcare and life sciences to energy and beyond.

In the case (25 pages / 359 KB), JTI Acquisitions Company (2011) Limited (JTI UK) had been established in the UK as a subsidiary of a US group (JGI). The company was set up to acquire another US group in a commercial acquisition and borrowed initially from the US group in order to fund this. This resulted in substantial interest debits arising in JTI UK, with the company expecting to be able to surrender any unused debits to other members of the JTI UK group by way of group relief. The group already had other operations in the UK.

As part of a plan prepared by one of the ‘big four’ accountancy firms, the acquisition structure aimed to create a UK tax deduction for intra group interest on the loan used to purchase the US target without there being a corresponding tax on the interest receipt. The initial plan was discussed between the group CFO and group vice president of tax in the US. They then put the proposal to the UK CFO and other relevant individuals. When the three appointed directors of the newly formed JTI UK were asked to consider the acquisition and loan, they were aware of the tax benefits to the group although they were asked to consider the proposal on its own merits in the interests of JTI UK.

The position was challenged by HM Revenue and Customs (HMRC). It was argued that JTI UK should not be allowed to deduct the interest arising on its loan relationship. This was because HMRC considered that the main purpose of the loan was to secure a tax advantage and that the deductions were therefore prevented by the ‘unallowable purpose’ rule.

The First-tier Tribunal (FTT) concluded that the taxpayer had a tax advantage purpose as the main purpose of the transaction and had no commercial purpose for entering into the loan. No question of apportionment between purposes therefore arose with all of the tax deduction denied. The Upper Tribunal (UT) upheld that decision.

Before the Court of Appeal, JTI argued that the FTT and UT had both asked the wrong questions. The company stated that relevant purposes should be the reasons JTI UK incurred the borrowing, not those of the group in deciding that the company should be the borrower. JTI argued that group purposes can be relevant, but only in connection with identifying the borrower’s purposes. Various attempts were also made to distinguish the circumstances in the recent Court of Appeal BlackRock judgment including that Blackrock had not needed to borrow the money, whereas the JTI group had a funding shortfall for their acquisition.

The Court of Appeal upheld the FTT and UT decisions.

The Court of Appeal identified six principles from the case law about considering purposes. Firstly, even where a company entering into a loan relationship was brought into being to further a wider scheme, the company’s purposes are not necessarily 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 bear on the company’s purpose in entering into the loan relationship. Thirdly, the company will have a ‘tax avoidance purpose’ 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.

The court also held that if it can be said that the company wishes to go along with such a scheme, whatever the 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 best 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 when looking simply at how the company was proposed to use the money it was borrowing.

The Court of Appeal accepted that the focus should be on the intentions of the taxpayer’s decision-makers and that the purposes of a wider scheme are relevant only if they inform those intentions. Whilst the FTT had made some errors in its analysis, the Court of Appeal felt that it was clear from its decision as a whole that the FTT had a basis to find that the relevant decision-makers had a main tax avoidance purpose.

It is perhaps worth bearing in mind some of the contemporaneous evidence in this case. There were initial emails between the US decision makers discussing professional fees for implementation versus the anticipated UK income tax saving. In addition, when the proposal was put to the UK, one of the group accountants commented that the proposal appeared to be purely for tax reasons. Further, whilst the decision making was valid from a corporate law perspective, the UK directors of JTI UK were found to have relied on the US group CFO (who had been involved in the initial tax planning) on the JTI UK board when deciding on the loan and transaction.

The Court of Appeal, like the UT, concluded that there was no sufficient basis for interfering with the FTT’s conclusion that there was no commercial purpose in issuing the loan notes to JTI.  In addition, the Court considered that even if it had have found commercial purposes it would have apportioned all of the debits to the tax main purpose.

Landman said: “It is possible that one or more of the recent Court of Appeal judgments on unallowable purpose will proceed to the Supreme Court. However, it may be that it is not until the courts consider cases where the fact pattern involves less complex tax planning that some clearer guidance emerges as to when deductions will be allowed.”