Tribunal finds unallowable purpose rule is expansive in its prevention of tax avoidance

In the case, JTI Acquisitions Company (2011) Limited (JTI UK) had been established in the UK as a subsidiary of a US group (JGI). It was set up to acquire another US group in a commercial acquisition. The structure adopted by JGI involved substantial debt interest arising in JTI UK. They expected to be able to deduct the interest in calculating JTI UK’s profits for UK tax purposes and to be able to surrender the consequent losses to other members of the JTI UK group by way of group relief. The group already had other operations in the UK.

The acquisition structure was part of a step plan prepared by one of the ‘big four’ accountancy firms. One of the objectives of that plan was to create a UK tax deduction for intra group interest on the loan used to purchase the target without there being a corresponding tax on the interest receivable in the hands of the lending group company. Further, the US company which secured the external finance used for the intra group lending also got a tax deduction in the US for the interest paid externally.

HMRC challenged this position, arguing that JTI UK should not be allowed to deduct the interest arising on its loan relationships. This was because it considered the main purpose of the plans was to secure a tax advantage and that the deductions were therefore prevented by the unallowable purpose rule.

The First-tier Tax Tribunal (FTT) found against JTI. Now the Upper Tribunal (UT) has agreed with the FTT that the unallowable purpose rule applied to the debt and no deductions should be allowed.

The main thrust of JTI’s appeal to the UT was on the proper approach to be taken to establishing the purpose of the taxpayer. Jake Landman of Pinsent Masons, who specialises in resolution of tax disputes, said: “The UT did not accept the taxpayer’s arguments on the interpretation of the unallowable purpose rule and has provided some clear guidance on how the provisions should be interpreted, which will have a wider impact, particularly given the number of unallowable purpose enquiries that are ongoing. A Court of Appeal decision in the case of Blackrock is expected later in the year, which may well provide further guidance on both the statutory interpretation and attribution issues.”

Firstly, the UT identified the purpose of the statutory provisions to be to “prevent tax avoidance by the use of loan relationships” and that, since they were “expansively drafted” it would defeat parliament’s intention to apply an “over-compartmentalised and narrow interpretation” to the provisions.

Specifically, it found that the wording of the statute “readily accommodates” asking why the taxpayer company, as opposed to someone else, was party to the loan relationship, and in addition should not be narrowed down to looking only at the purpose of the taxpayer company on its own.

This meant that the group’s perspective, or another group company's purpose, could be taken into account. While the UT accepted that the wider group purpose should not be determinative of the question of main purpose, it was relevant to a taxpayer company's purpose because “it informs the determination of the taxpayer company's purpose”.

The UT confirmed that when considering the taxpayer company's perspective, wider facts beyond what the loan was used for can be taken into account and that this approach is consistent with other recent UT cases that have considered the unallowable purpose rule, such as those involving Blackrock and Kwik-Fit.

The UT rejected JTI's argument, advanced as a point of statutory interpretation, that where there is a purchase of commercial assets with arms-length borrowing, unallowable purpose can never arise. The UT thought that if there was such a hard-and-fast rule then other cases, such as the Travel Document Services case, would have followed a different analysis than the one that was previously employed.

The UT also rejected JTI's final statutory interpretation argument that the use to which the loan was put should be the determinative factor. Again, the UT found that this was just one of the relevant factors to be taken into account in a “wider-ranging and fact-sensitive enquiry”. Based on these principles of interpretation and the findings of fact by the FTT, the UT upheld the core decisions of the FTT that the loan relationship had an unallowable purpose.

The UT additionally concluded that a number of extra statutory materials put forward by JTI UK shed no light on the meaning of the relevant aspects of the unallowable purpose rule.

Landman said: “The UT’s dismissal of the relevance of a 1996 ministerial statement may disappoint many taxpayers who have sought to rely on this during unallowable purpose enquiries by HMRC. However, the UT did not conclude that such statements were inherently irrelevant to interpretation, but rather that this particular statement did not advance the taxpayer’s position in this case.”

Leaving aside statutory interpretation, the UT also rejected the main aspects of JTI's challenge to the FTT's application of the law to the facts. Whilst the UT agreed with JTI that the FTT had erred in its approach to related transactions, the UT considered that, applying the correct legal principles, the FTT would have had to have adopted the same approach of taking into account all the facts and circumstances anyway.

The UT disagreed with JTI that the FTT had not properly focused on UK tax advantage. Whilst the FTT had noted the avoidance of tax in the US, the UT considered that it had been correct to have only approached this aspect as being context. In addition, the UT rejected JTI's arguments that the FTT had not been entitled to regard the acquirer's decision to enter into the transaction as a ‘done deal’. Further, the UT rejected the argument that the FTT should not have ignored certain JTI witness evidence on the basis that it was unchallenged. This was because the UT considered that all relevant aspects had been covered in the round during cross examination.

The UT did find that the FTT had made an error with regards to attribution. The UT agreed with JTI that the question of which of the loan relationship debits were to be attributed to the unallowable purpose does arise and rejected the FTT’s reasoning. The FTT had decided that the attribution question did not arise at all because JTI had failed to establish that the tax avoidance purpose was not a main purpose. However, this did not have a material impact on the outcome because the FTT had also decided that, if it was wrong on the attribution point, all the debits should be attributed to the unallowable purpose and the UT found no error in that attribution.