CFM38150 - Loan relationships: tax avoidance: unallowable purpose: attributable on a just and reasonable apportionment

CTA09/S441(2)-(3)

The unallowable purpose rule (in S441-442) provides that where a loan relationship has an unallowable purpose in an accounting period, then so much of any debit (or exchange gains credit) in respect of that relationship as is attributable on a just and reasonable apportionment to the unallowable purpose may not be brought into account under the loan relationship regime (or otherwise).

Where a loan relationship only has an allowable purpose or only has an unallowable purpose, then it is generally expected that all of the debits are attributable to that purpose.

Where there is both an allowable purpose and an unallowable purpose, the position is complex. The outcome of the apportionment may be to attribute the debit entirely to the allowable purpose, entirely to the unallowable purpose, or partly to the allowable purpose and partly to the unallowable purpose.

There are no express statutory provisions as to how attribution on a just and reasonable apportionment is to be determined.

The rule applies to the company that is party to the loan relationship, but the tax advantage may have been in another company (CTA09/S442(5)).

It depends on the facts and circumstances, there is a wide latitude in judgement

Leedale v Lewis [1982] UKHL TC 56 601, which deals with the meaning of just and reasonable in another part of the tax code, held that the test should be carried out in the light of all the circumstances, that it is a broad rather than an actuarial approach, and that it confers a “wide latitude in judgement”.

A number of cases on the unallowable purpose rule have stressed the importance of the evidence: for instance, Iliffe News and Media Ltd & Ors v HMRC [2012] UKFTT 696 (TC). Loan relationships were entered into for the purposes of funding certain licences which themselves were entered into for mixed commercial and a main tax avoidance purpose. The FTT held that the loan relationship was entered into for mixed purposes, commercial (non-tax) and a main tax avoidance purpose. However, for the purposes of determining to what extent any debit was attributable on a just and reasonable apportionment to the unallowable purpose, the FTT held, at paragraph 327, that no part of any debits could be disallowed:

“because there is no evidence before us which would enable us on a just and reasonable basis to attribute any amount of the interest payable under the [loan relationships] in issue to the tax avoidance purpose.”

Similarly, in Versteegh v Revenue & Customs [2013] UKFTT 642 (TC) (Versteegh v HMRC), the FTT stated (at paragraph 164) that “it is all a question of evidence”.

The test is an objective one

The question of purpose is primarily to be decided by reference to subjective intentions, as discussed in CFM38135. However, once this has been determined the legislation simply requires the attribution of debits to unallowable purposes to be carried out on a just and reasonable apportionment. The test is to be applied objectively, based, as noted above, on a consideration of all the relevant facts and circumstances.

Several possible formulations which may be used to make or test a proposed attribution of a debit (or exchange gains credit) on a just and reasonable apportionment but no substitute for the statutory test

The FTT in Versteegh v HMRC commented at paragraph 166 that:

“… attractive as Mr Ghosh’s analysis of the just and reasonable apportionment test might appear, in terms of simplicity of application, it does involve in our view a gloss on the words of paragraph 13 itself, which talks only of a just and reasonable apportionment in order to arrive at the extent to which loan relationship debits are attributable to an unallowable purpose. That may be answered in a particular case by considering the extent to which the debit is greater than it would be but for the identified unallowable purpose, but that should not, in our view, be regarded as a substitute for the statutory test itself.”

Whilst the provision should not be glossed or formulated in a different way, there are possible approaches which may be used to make or test a proposed apportionment in appropriate circumstances, as is recognised in the passage cited above from Versteegh v HMRC.

In some situations it may be appropriate to attribute some but not all of the debit in relation to a loan relationship in a period to an unallowable purpose because there is a clear ‘causal’ link. For instance, it may be appropriate to allocate part of the loan, and part of each associated debit, to an unallowable purpose. This may be apparent, for example, from a change in the arrangements. See, for example, the discussion at the end of Example 16 in CFM38190.

Further, a number of cases have considered the possibility, in appropriate circumstances, of testing a proposed apportionment by looking at the extent to which the debit is different than it would have been, ‘but for’ the identified unallowable purpose. This might apply, firstly, where the debit would have been less, or not incurred at all, but for the unallowable purpose, or, secondly, where the debit would have been incurred in any event, even had the unallowable purpose not been present. This is in particular a complex area where the case law is developing and if it may be in point this should form part of the discussions with Counter-Avoidance Technical Team (see CFM38200).

For the avoidance of doubt, if, for instance, it is established that there is one main tax avoidance purpose and two commercial (excluding UK tax) purposes, this does not of itself provide any basis for arguing one-third of the debit should be attributed to the unallowable purpose.

The question of attribution on a just and reasonable apportionment generally is under discussion in cases under litigation at the time of writing, including HMRC v BlackRock Holdco 5 LLC [2022] UKUT 199 (TCC) and Kwik-Fit Group Ltd and other companies v Revenue and Customs Commissioners [2022] UKUT 314. In particular, whilst case law decisions which are final so far have resulted in all or nothing apportionments in relation to the debits challenged, there are cases under litigation at the time of writing where it has been held that there are mixed purposes for the loan relationships and the question of whether the debits in question should be subject to partial apportionment is being considered.