CFM38135 - Loan relationships: tax avoidance: unallowable purpose: a main tax avoidance purpose: is there a main purpose?
CTA09/S442
For the part of the unallowable purpose rule (at S441-442) which deals with a main tax avoidance purpose, it is necessary to identify whether or not there is a purpose of securing a tax advantage (see CFM38140) which is the main purpose or one of the main purposes (‘a main purpose’). What constitutes a main purpose, as opposed to something which is a purpose, but not a main one, or which is not a purpose at all, has been considered in case law concerning the unallowable purpose rule and other purpose tests.
What constitutes a main object, which is regarded as a comparable issue (see, for instance, Travel Document Service & Ladbroke Group International v HMRC [2018] EWCA Civ 549 (TDS v HMRC) at paragraph 41), has also been considered in case law.
A question of fact and evidence
What the purposes are and whether or not a purpose is a main purpose is a question of fact which depends on the evidence in relation to all the relevant facts and circumstances of the particular case. For instance, in IRC v Brebner [1967] 43 TC 705 (IRC v Brebner), in relation to an objects test, Lord Upjohn in the House of Lords held (at pages 718 to 719) that the question of whether the main object, or one of the main objects, was to avoid tax, to determine if the relevant provision applied, was a matter of fact for the fact-finding tribunal on the basis of the evidence before them:
“The question whether in fact one of the main objects was to avoid tax is one for the Special Commissioners to decide upon a consideration of all the relevant evidence before them and the proper inferences to be drawn from that evidence.”
This has been reaffirmed in many cases since IRC v Brebner, including in many unallowable purpose cases.
Purpose is a matter of subjective intention
The test is one of subjective intention: see, for instance, TDS v HMRC citing IRC v Brebner at paragraph 41:
“Lord Pearce concluded (at 27) that ‘[t]he “object” which has to be considered is a subjective matter of intention’, and Lord Upjohn (with whom Lord Reid agreed) said (at 30) that ’the question whether one of the main objects is to obtain a tax advantage is subjective, that is, a matter of intention of the parties’.”
This has been applied in unallowable purpose rule cases: for instance, the FTT in Versteegh Limited and others v The Commissioners for HM Revenue and Customs [2013] UKFTT 642 (TC) (Versteegh v HMRC) stated at paragraph 155:
“What is important, in our view, is that the significance of the tax advantage to the taxpayer must be considered as a matter of subjective intention, which necessarily involves a careful analysis of all the reasons the taxpayer had for entering into the transaction.”
The relevance of the consequences or effects of a transaction
Other object or purpose tests
It follows as a natural reading of the language, and there are a number of cases in relation to other purpose or object tests which establish in relation to those tests, that the consequences or effects of a transaction:
- are likely to be relevant factors to be taken into account as part of an assessment of all the relevant circumstances; but
- are not determinative
(The question of the precise application of some of the following cases in the context of the unallowable purpose rule is under discussion in cases under litigation at the time of writing.)
In the context of determining whether or not expenses are wholly and exclusively for the purposes of the trade, see BIM37000, Mallalieu v Drummond [1983] 57 TC 330 is a leading case. It is discussed in detail at BIM37910. It establishes that effect is to be distinguished from object and that whether or not an effect is an object is a question of fact. This is set out at pages 365-366:
“The object of the taxpayer in making the expenditure must be distinguished from the effect of the expenditure. An expenditure may be made exclusively to serve the purposes of the business, but it may have a private advantage. The existence of that private advantage does not necessarily preclude the exclusivity of the business purposes. For example a medical consultant has a friend in the South of France who is also his patient. He flies to the South of France for a week, staying in the home of his friend and attending professionally upon him. He seeks to recover the cost of his air fare. The question of fact will be whether the journey was undertaken solely to serve the purposes of the medical practice. This will be judged in the light of the taxpayer’s object in making the journey. The question will be answered by considering whether the stay in the South of France was a reason, however subordinate, for undertaking the journey, or was not a reason but only the effect.”
Vodafone Cellular v Shaw (Inspector of Taxes) [1997] 69 TC 376 (Vodafone v Shaw) was again concerned with whether or not expenses were wholly and exclusively for the purposes of the trade. Details of this case can be found in BIM38220. Millett LJ, in summarising previous case law, stated that effect is to be distinguished from object; that although subjective intentions are determinative, these are not limited to conscious motives in mind in the taxpayer’s mind at the time; that some effects or consequences are so closely linked that unless incidental they are to be taken to be a purpose; but that, on the facts of the case, a particular effect of expenditure was incidental.
In the context of applying the transactions in securities legislation, in Inland Revenue Commissioners v Trustees of the Sema Group Pension Scheme [2002] EWHC 94 (Ch), Lightman J at paragraph 53 stated that obtaining a tax advantage merely being “icing on the cake” or a “relevant factor” is not sufficient to establish that doing so is a main object:
“The tax advantage may not be a relevant factor in the decision to purchase or sell or in the decision to purchase or sell at a particular price. Obviously if the tax advantage is mere 'icing on the cake' it will not constitute a main object. Nor will it necessarily do so merely because it is a feature of the transaction or a relevant factor in the decision to buy or sell. The statutory criterion is that the tax advantage shall be more than relevant or indeed an object; it must be a main object.”
This was expressly approved by the Court of Appeal at paragraph 119 (Inland Revenue Commissioners v Trustees of the Sema Group Pension Scheme [2003] EWCA Civ 1857).
Unallowable purpose rule
In particular, it follows as a natural reading of the language, and there are now unallowable purpose rule cases, which establish in relation to the rule that the consequences or effects of a transaction:
- are likely to be relevant factors to be taken into account as part of an assessment of all the relevant circumstances
- are not determinative
In particular, the fact that it is an inevitable consequence of a borrowing that a tax advantage by way of a deduction for the borrowing costs is expected to be obtained is a relevant factor to be taken into account as part of an assessment of all the relevant circumstances, but is not determinative that securing a tax advantage must be a main purpose. For instance, from Versteegh v HMRC at paragraph 158:
“the mere existence of a tax advantage, known to the taxpayer, does not on its own render the obtaining of that tax advantage a main purpose”.
Equally, the use made by a borrowing company of the proceeds of a loan relationship, or the use made by a lending company of the loan relationship itself, is relevant but is not determinative. For instance, Fidex Limited v The Commissioners for HM Revenue and Customs [2014] UKUT 0454 (TCC) (Fidex v HMRC) is an unallowable purpose case in relation to the use made of a loan relationship. At paragraph 110, it was held:
“what you do with an asset may be evidence of your purpose in holding it, but it need not be determinative of that purpose. The benefits you hope to derive as a result of holding an asset may also evidence your purpose in holding it. A finding that such a hope exists may, depending on the circumstances, be sufficient for a finding that a purpose of holding the assets was the obtaining of that benefit.”
TDS v HMRC at the Court of Appeal level is another example of an unallowable purpose case in relation to the use made of a loan relationship, in this case a deemed loan relationship. Travel Document Service (TDS) acquired and held shares in a subsidiary, Ladbroke Group International (LGI). It subsequently entered into a swap and novation which had not been thought of when it acquired the shares, and as a result of which, further to anti-avoidance legislation, the holding of shares was treated as if it was a loan relationship. The lead witness offered evidence that TDS was at all times holding the LGI shares solely for bona fide commercial reasons, and this evidence was not directly challenged in cross examination. The witness did not dispute that TDS’s entry into the swap and novation had as a main purpose securing a large tax advantage that depended on TDS holding the LGI shares.
Newey LJ at the Court of Appeal (paragraph 41) stated that:
“When determining what the company’s purposes were, it can be relevant to look at what use was made of the shares.”
and cited the above comments in Fidex v HMRC approvingly.
At paragraph 46, Newey LJ then found that:
“While, therefore, there is no question of TDS having had the tax advantage in mind when it acquired the shares, it was evidently intending to use them in the tax avoidance scheme during the currency of the Swap.”
He went on to discuss whether, in the circumstances, the intention in relation to the use of the shares was sufficient to amount to a main purpose, and held that it was, in the light of the absolute and comparative size of the tax advantage:
“Had the tax advantage in view been small, there might have been scope for argument as to whether an intention to use the shares to achieve it implied that obtaining the advantage was now a main purpose of holding the shares. In fact, however, the hoped-for gain was large both in absolute terms (more than £70 million) and relative to the apparent value of TDS (some £280 million). That being so, I agree with Mr Ghosh that the inescapable inference was that securing the advantage had become a main purpose of holding the shares.”
Choosing between different ways of carrying out a commercial transaction
Where different ways of carrying out a commercial transaction are available, if a company chooses the way which minimises tax, it does not necessarily follow that there is a main purpose of securing a tax advantage, but, depending on all the relevant circumstances, there may be.
A leading case on this is IRC v Brebner, on a main objects test, and it is relevant to consider the facts and circumstances of that case in some detail.
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.
Lord Upjohn said, at page 718:
“My Lords, I would only conclude my judgment by saying, when the question of carrying out a genuine commercial transaction, as this was, is considered, the fact that there are two ways of carrying it out - one by paying the maximum amount of tax, the other by paying no, or much less, tax - it would be quite wrong as a necessary consequence to draw the inference that in adopting the latter course one of the main objects is, for the purposes of the section, avoidance of tax. No commercial man in his senses is going to carry out commercial transactions except upon the footing of paying the smallest amount of tax involved. The question whether in fact one of the main objects was to avoid tax is one for the Special Commissioners to decide upon a consideration of all the relevant evidence before them and the proper inferences to be drawn from that evidence.”
Accordingly, the judgement makes it clear that depending on the evidence and the inferences to be drawn from that evidence, where a taxpayer chooses between different ways of carrying out a commercial transaction so as to minimise tax, the taxpayer may not, or may, have a main object of obtaining a tax advantage.
In the circumstances of this case, the House of Lords saw no ground to overturn the Special Commissioners’ finding that the transactions in question were for bona fide commercial reasons and did not have as their main object, or one of their main objects, to enable tax advantages to be obtained.
In other cases, the courts found that the taxpayer’s choice as to how to structure arrangements was such that tax was a main object. For instance, in The Commissioners for Her Majesty’s Revenue and Customs v Lloyds TSB Equipment Leasing (No 1) Limited [2014] EWCA Civ 1062, Rimer LJ in the Court of Appeal held, at paragraph 65:
“although the FTT was no doubt entitled to find that each transaction in the relevant series served a genuine commercial purpose, it does not follow that the obtaining of the capital allowances was incapable of also being a main object of the transactions, even if it was not the main object of the transactions… Even if each of the transactions was entered into for a genuine commercial purpose, it may still be the case that a main object of structuring them in the way they were was to obtain the capital allowances”.
The meaning of ‘main’
In TDS v HMRC Lord Justice Newey in the Court of Appeal held, at paragraph 48, that there was a distinction between a purpose and a main purpose, ‘main’ having a connotation of importance:
“a ‘main’ purpose will always be a ‘more than trivial’ one, but the converse is not the case. A purpose can be ‘more than trivial’ without being a ‘main’ purpose. ‘Main’ has a connotation of importance.”
As discussed in Versteegh v HMRC, in assessing the purposes, and determining whether a particular purpose has the necessary importance, from paragraphs 157 to 158:
“… it is necessary to weigh up all the relevant factors which, on the basis of the evidence, the taxpayer took into account in coming to the decision to take a particular course of action …All the authorities point to the question being one of degree and significance to the taxpayer, and that the question is one of fact for the tribunal, having regard to all the circumstances”.
Difficulty in the context of financing
A company acting commercially will normally consider the tax consequences of a transaction. It is a natural consequence of using debt financing that tax deductions will generally be available in respect of the interest costs, which means that tax advantages will be secured (see CFM38140). Determining whether or not it is a main purpose to secure a tax advantage may be difficult in the context of financing in some situations. The technical analysis in this section, and the practical guidance given in CFM38170 to CFM38200, including the relevant examples set out in CFM38190, are intended to assist in making the determination as to whether or not there is a main tax avoidance purpose in the more difficult situations.