CFM38120 - Loan relationships: tax avoidance: unallowable purpose: the unallowable purpose condition

CTA09/S442

The unallowable purpose rule (at S441-442) is engaged where the ‘unallowable purpose condition’ is met, that is, at times during an accounting period, the company is party to the loan relationship or enters into a related transaction (as defined for the purposes of the rule) in respect of the loan relationship for purposes which include a purpose which is not amongst the business or other commercial purposes of the company (S442(1)).

The term ‘related transaction’ in the loan relationship regime generally is any disposal or acquisition (in whole or in part) of rights or liabilities under the relationship (see CFM31075). For the unallowable purpose rule, it is specifically provided that the reference to related transaction includes anything which equates in substance to a disposal or acquisition (S442(1A)).

The test must be considered for each accounting period during which the company is party to the loan relationship. Specifically, it is necessary to consider whether or not there is an unallowable purpose in each period and, if there is, what debits (or exchange gains credits) are attributable to it on a just and reasonable basis of apportionment.

It is necessary to consider whether there is a purpose for which the company is party to the loan relationship which is not amongst the business or other commercial purposes of the company.

An example of a purpose which is not amongst the business or other commercial purposes of a company could be a purpose to promote a personal interest of one of the directors.

Two types of purpose are specifically excluded from being amongst the business or other commercial purposes of the company. These are:

• a ‘tax avoidance purpose’ (S442(5)) if this is the main purpose, or one of the main purposes, for which the company is party to the loan relationship or related transaction (S442(3)-(4)), referred to in the following as ‘a main tax avoidance purpose’ (CFM38130 to CFM38140)
• a purpose of any part of the company’s activities in respect of which the company is not within the charge to Corporation Tax (S442(2), CFM38145)

Purposes which are amongst the business or other commercial purposes of the company and not in the specific exclusions are referred to as ‘allowable purposes’ in the following.

A loan relationship can have mixed purposes, that is, there can be one or more unallowable purposes and one or more allowable purposes.

The purpose of a loan relationship may change over time. For instance, a loan relationship may have a wholly allowable purpose when a company enters into it but change to, or acquire an additional, unallowable purpose at a later date (and vice versa).

In Fidex Limited v The Commissioners for HM Revenue and Customs [2014] UKUT 0454 (TCC) (Fidex v HMRC), the company had an existing holding of bonds, and then entered into a tax planning structure, involving the issue of shares, that led to the derecognition of the bonds for accounting purposes which triggered a debit. The FTT found that the purposes for which Fidex originally entered into the bonds were commercial (non-tax), and that commercial (non-tax) purposes continued to apply, but that the company acquired a main tax avoidance purpose of crystallising the debit. The UT, at paragraph 112, held that the FTT had evidence on which it could conclude that:

“Fidex became possessed of a purpose, or an additional purpose, for the holding of bonds, and that was a main tax avoidance purpose, and therefore an unallowable purpose.”

The fact that Fidex may have retained other purposes, and that it did nothing different with the bonds, did not, in the light of the evidence of the tax avoidance purpose, make that finding impermissible.

Moreover, a purpose held for only a moment in time in the accounting period may be an unallowable purpose, as was the case in Fidex v HMRC.