CFM38190 - Loan relationships: tax avoidance: unallowable purpose: situations where the unallowable purpose rule would or would not normally apply

Background/ approach

As set out in CFM38115, in considering whether and how the unallowable purpose rule (at S441-442) might apply to a particular set of facts, it is necessary to answer a number of questions, including:

• Is there a loan relationship to which a company is party?
• Is one or more of the purposes for which the company is party to the loan relationship or a related transaction an unallowable purpose?
  • Is it a purpose not amongst the business or other commercial purposes of the company?
  • Is it a purpose of securing a ‘tax advantage’ for the company or any other person, and if so, is this a main purpose (‘a main tax avoidance purpose’)?
  • Is it a purpose in respect of activities that are not within the charge to Corporation Tax?
• What debits are attributable on a just and reasonable apportionment to the unallowable purpose?

The preceding sections at CFM38100 onwards have set out the technical position, and practical guidance, on the tests, including at CFM38170 factors relevant to assessing evidence of a main tax avoidance purpose. These may also be relevant in forming a view as to which debits are attributable on a just and reasonable apportionment basis to the unallowable purpose.

These questions can only be determined by considering the specific facts of a case, established by careful examination of the evidence available. Having established the underlying facts, many are further dependent on judgements (for example weighing in the balance several relevant facts which point in different directions) which can be difficult to make in some instances of financing.

Accordingly, the following examples set out a selection of illustrative underlying fact patterns that have been identified as useful in indicating HMRC’s views on the kinds of situations in which the unallowable purpose rule may or may not apply, bearing in mind the technical and practical guidance given elsewhere.

The examples do not in any way limit HMRC’s ability to counteract using other legislation.

The examples are analysed on the basis that they represent a summary of all material features of, or factors in play in relation to, the complete transactions or arrangements in question. The analysis does not apply where there are other significant features or factors in play, for instance where there are other drivers for arrangements, or where the transactions or arrangements form part of wider arrangements. It is not possible to “add together” sets of underlying facts. For instance, if the view is that the unallowable purpose rule will not normally apply to each of two examples, it does not follow that there is automatically the same view in relation to the facts of those examples combined. In some examples it may be possible to remove some of the facts and the analysis that S441-442 will or will not normally apply would still be the same. Some fact patterns are chosen because they are situations HMRC encounters frequently, others because they make it easier to focus on the point in issue.

It is not possible to cover all possible permutations, and nothing should be read from an absence of other fact patterns with different permutations.

As set out in CFM38200, these examples cannot and should not be used as a starting point: the starting point is for case teams to understand the transaction and the factual context. Only once this has been done can case teams assess whether or not any example is of assistance in determining a view on the case in question. That process will include, in particular, understanding the commercial (non-tax) purposes that are being put forward and testing the evidence in relation to them.

In all examples, it is assumed that there is capacity to use interest deductions obtained on the loan relationship, possibly by way of group relief. Some examples are by reference to groups, others to solo companies (that is, there is no group) simply to cover a range of illustrative situations. Beyond that, for simplicity and ease of drafting, the following assumptions and definitions apply as relevant unless otherwise specified:

• The purposes for which the company is party to the loan relationship are clearly the purposes of the directors, who all share the same knowledge and views. Where relevant, the directors are fully aware of and take into account group purposes, determined by the parent’s directors, in relation to the company’s role in wider group arrangements.
• The financing costs on the loan relationship in question consist entirely of interest.
• Irrespective of any question of priority, it is assumed that no other regimes in the UK tax code which might apply to restrict the interest (including transfer pricing, Corporate Interest Restriction, hybrids, and loss refreshing) exist, in order to illustrate more effectively the approach in relation to the unallowable purpose rule.
• There is no withholding tax.
• All group relationships are 100%.
• There are no permanent establishments involved.
• References to the ‘net global tax benefit’ are to the net tax benefit for the group on a worldwide basis, in relation to UK and non-UK tax, benefit being used in a general sense (not applying the legislative test of tax advantage), as discussed in CFM38170.
• Some of the examples make reference to a ‘UK Commercial Opportunity’. This is an opportunity for a relevant company to use the funds borrowed for the acquisition of (non-share) assets to pursue a commercial (non-tax) opportunity as a commercial development of its existing business wholly located in the UK which will generate fully taxable UK profits and to which standard tax rules apply. For instance, it might be to acquire new plant and equipment for use in the UK in the relevant company’s profitable UK operating business, which is fully taxable in the UK, and where standard tax rules apply to the acquisition of the plant and equipment. Other examples cover different factual permutations, including the acquisition of shares.
• References to third parties are to entities which are in a commercial sense independent of the company (and, where relevant, the group) in question.

Examples where S441-442 will not normally apply

For each of the following, where it is stated that S441-442 will not normally apply, this means that HMRC will normally accept that there is no disallowance, on the basis that there is no unallowable purpose, and/or that, if there are one or more unallowable purposes, on the application of the rule on a just and reasonable apportionment no debits should be attributable to those purposes. In each example there are one or more tax advantages.

An extra assumption is that in each example the company is borrowing the amount on arm’s length terms.

By way of explanation of the approach in including the examples, many of these cover situations in which:

• the amount borrowed is intended to, and does, fund a business investment straightforwardly linked to the UK, where in particular the UK’s involvement generates a material net group commercial (non-tax) benefit
• there are one or more elements of the underlying facts which might be seen as potentially bringing the unallowable purpose rule within scope

Example 1

In summary, this deals with UK external financing where there is:

• a choice of debt as against equity to fund a UK Commercial Opportunity
• in circumstances where commercial (non-tax) reasons from the company’s perspective are finely balanced as between debt and equity

It also addresses further variations.

This must be read in the context of the opening section on background/ approach.

The directors of a UK parent (‘P Co’) have identified a UK Commercial Opportunity and require external financing for it. That financing is potentially available in the form of debt or equity from the capital markets and the directors consider which to obtain. There are a number of competing commercial (non-tax) reasons in favour of debt or equity, so that the decision is finely balanced from a commercial (non-tax) perspective. The deciding factor for P Co’s directors to choose financing by way of debt is that they expect to get a tax deduction for the interest. If the directors thought that the tax deduction was not available, they would choose financing by way of equity.

S441-442 will not normally apply.

Alternatively, suppose the directors have identified the UK Commercial Opportunity and require financing for it, but, in this case, for commercial (non-tax) reasons they are only prepared to pursue the UK Commercial Opportunity using debt financing. The directors consider the tax treatment and expect that a tax deduction will be available for it. They will not go ahead with the UK Commercial Opportunity if that is not the case, as this would be post-tax loss-making, and they would rather pursue other opportunities. The view would be the same, that is, S441-442 will not normally apply.

Example 2

In summary, this deals with cross-border group financing where there is:

• a choice of debt as against equity to fund a UK Commercial Opportunity
• in circumstances where:
  • commercial (non-tax) reasons from the lender’s perspective drive the lender’s preference to offer debt but expressly subject to the proviso that debt costs are tax deductible
  • commercial (non-tax) reasons from the borrower’s perspective are finely balanced as between debt and equity

This must be read in the context of the opening section on background/ approach.

The directors of a UK subsidiary (‘S Co’) have identified a UK Commercial Opportunity and require financing for it. S Co has a non-UK parent (‘P Co’) resident in a jurisdiction with comparable tax rates to the UK. Subject to the following, the financing is potentially available from P Co by way of equity or debt.

It is expected that in the hands of P Co (1) dividends on an equity financing would be non-taxable, and (2) interest on a debt financing will be fully taxed. It is the starting position of P Co’s directors, in response to any requests for financing from P Co’s subsidiaries, that they will offer such financing by way of debt in preference to equity to the extent that the cost of that debt is tax deductible in the relevant jurisdictions. This is because of P Co’s directors’ view that it is generally preferable for commercial (non-tax) reasons to invest by way of debt rather than equity in the circumstances of their group, but that they expect tax deductions to be available on the debt costs.

Being aware of this starting position, and not having any strong preference for equity rather than debt taking into account only commercial (non-tax) reasons, the directors of S Co request financing by way of debt from P Co. In doing so, they expect the interest on the debt financing to be tax deductible. If and to the extent they thought the tax deduction was not available, they would request equity.

S441-442 will not normally apply.

Example 3

In summary, this deals with cross-border group financing where there is:

• a choice of debt as against equity, or as against debt from another group creditor, to fund a UK Commercial Opportunity
• in circumstances where:
  • commercial (non-tax) reasons are finely balanced as between debt and equity from the borrower’s and the lenders’ perspective
  • a net global tax benefit is available, deriving from difference in tax rate/ losses

This must be read in the context of the opening section on background/ approach.

The directors of a UK subsidiary (‘S1 Co’) have identified a UK Commercial Opportunity and require financing for it. That financing is potentially available from S1 Co’s non-UK parent (‘P Co’), or from S1 Co’s non-UK sister subsidiary (‘S2 Co’) either by (1) equity, or (2) debt, on the same terms.

P Co is in a jurisdiction which has comparable tax rates to the UK: it is expected that (1) dividends received on an equity financing would be non-taxable, and (2) interest received on a debt financing will be fully taxed at the local rate. S2 Co is in a jurisdiction with a lower tax rate than the UK or has existing tax losses which could be set against the interest received: it is expected that (1) dividends received on an equity financing will be non-taxable, and (2) interest received on a debt financing will bear less or no tax, either because of the lower tax rate or because of the availability of losses. The directors of S1 Co expect dividends on an equity financing not to be UK tax deductible and interest on a debt financing to be UK tax deductible. S1 Co choosing to borrow from S2 Co, rather than borrowing from P Co, or obtaining equity from either, will therefore produce a net global tax benefit.

The provision of either debt or equity would be sensible taking into account commercial (non-tax) reasons from the perspective of each of P Co and S2 Co; there is also no substantive commercial (non-tax) difference in the choice from the perspective of S1 Co; in summary, commercial (non-tax) reasons are finely balanced.

The directors of P Co, S2 Co and S1 Co decide that the financing will be offered/ obtained by debt financing from S2 Co, rather than by debt financing from P Co, or by obtaining an equity investment from P Co or S2 Co. The deciding factor is that that choice will produce a net global tax benefit given the asymmetry in tax treatment of interest paid/ received. If the sets of directors thought the tax deduction on interest was only available on borrowing from P Co, they would agree that financing would be offered/ obtained by borrowing from P Co. If the sets of directors thought the tax deduction on interest was not available at all, they would agree that financing would be offered/ obtained by equity.

S441-442 will not normally apply.

Example 4

In summary, this deals with cross-border group financing where there is:

• external debt financing, and a choice to route financing to a UK subsidiary for the UK subsidiary to acquire shares in a non-UK company from a third party
• in circumstances where:
  • there is a strong commercial (non-tax) link to the UK subsidiary, including the operational involvement of the UK subsidiary, and there is no commercial (non-tax) link to any other jurisdiction
  • the return on the target shares acquired is likely to be received in a form on which Corporation Tax is not paid

It also addresses further variations.

This must be read in the context of the opening section on background/ approach.

A non-UK headquartered multinational group has a number of types of business. One of these types of business is currently carried out by, and only by, a UK subsidiary (‘S Co’) in the UK.

The directors of the non-UK parent (‘P Co’) of the multinational group have identified an opportunity to acquire the shares in a company (‘T Co’), resident and operating in another jurisdiction, and carrying out the type of business carried on by S Co. The directors of P Co wish to acquire T Co because they assess that, firstly, this will enable a profitable expansion into that jurisdiction, T Co being expected to generate substantial profits mid-term post the acquisition, and, secondly, this will assist S Co’s existing operating business in the UK. A significant factor in coming to this assessment is their expectation that the employees of S Co and T Co will mutually beneficially exchange technical operational expertise and experience. No other part of the group is expected to contribute from a commercial (non-tax) perspective to the success of the acquisition. The directors of P Co discuss their assessment with the directors of S Co who agree. Further, both sets of directors consider that, given these circumstances, it would be appropriate for S Co to acquire T Co.

Financing from outside the group is required to acquire T Co, and for commercial (non-tax) reasons debt financing is strongly preferable. For commercial (non-tax) reasons, P Co will be able to obtain this most cheaply. For these commercial (non-tax) reasons, P Co and S Co agree that P Co will borrow externally and on-lend (at a small margin) the funds to S Co; and S Co will use the funds to buy the shares in T Co.

Interest paid/ received is taxed at comparable tax rates and on a comparable basis in P Co and S Co. Each set of directors expects that there will be a net group tax deduction equal to the external interest paid: interest paid on the external debt owed by P Co, and the internal debt owed by S Co, will be tax deductible; and the interest received from S Co on the internal debt held by P Co will be taxable. The directors of S Co expect that the return on the shares is most likely to be received in a form on which Corporation Tax will not be paid: they expect any dividends paid by T Co to attract one of the dividend exemptions and, although there is no current intention of doing so, if T Co were to be sold in the long-term whilst held by S Co, the directors of S Co expect the substantial shareholding exemption to apply. If both sets of directors did not think that a net group tax deduction broadly equal to the external interest paid was available, they would not go ahead with the acquisition.

S441-442 will not normally apply.

This view would be the same if, rather than the commercial (non-tax) reasons being strongly in favour of debt, the commercial (non-tax) reasons as between debt and equity to finance the acquisition of the shares are finely balanced, but the deciding factor for P Co’s directors to choose financing by way of debt is that they expect to get a net group tax deduction broadly equal to the interest paid.

The view would also be the same if, rather than financing from outside the group being required, P Co has cash reserves available which it chooses to loan to S Co, both sets of directors then expecting broadly no net group tax deduction (or taxable amount) in respect of interest, as the interest cost deduction in S Co will be broadly matched by taxability of interest receipt in P Co.

Example 5

In summary, this deals with UK external financing where there is:

• a choice of whether or not to go ahead with a UK Commercial Opportunity by way of acquisition of assets
• in circumstances where no or minimal Corporation Tax is likely to be paid immediately (as a result of claiming capital allowances)

This must be read in the context of the opening section on background/ approach.

The directors of a solo UK company have identified a UK Commercial Opportunity and require financing for it. That financing is potentially available from third parties by way of debt.

The directors consider the tax treatment and expect the investment to attract 100% capital allowances on a standard basis. The result will be that there is likely to be no or minimal UK tax paid by its UK operating business in the following year. The directors expect the interest paid on the debt financing to be tax deductible. The directors would not go ahead with the investment if a tax deduction was not available on the interest or if the capital allowances were not available.

S441-442 will not normally apply.

Example 6

In summary, this deals with UK external financing where there is:

• a choice of which of alternative assets to invest in, and of whether or not to go ahead at all
• in circumstances where:
  • the acquisition of assets is expected to benefit a profitable, fully taxable UK operating business
  • the acquisition of one of the assets is expected to attract a tax advantage under another part of UK tax law, the capital allowances code

This must be read in the context of the opening section on background/ approach.

The directors of a UK company (‘A Co’), have identified two opportunities, each of which will result in the acquisition of assets which are expected to benefit A Co’s profitable UK operating business which is fully taxable, and the directors require financing for either opportunity. That financing is potentially available from third parties by way of debt.

The first investment will attract capital allowances (on a standard basis): the second will not. Both are pre- and post-tax profitable. The first opportunity is slightly less pre-tax profitable, but post tax more profitable, than the second opportunity, because of the availability of the capital allowances.

The directors of A Co wish to maximise the post-tax position and choose, for that reason, the first opportunity. The directors would not go ahead with either opportunity if a tax deduction was not available on the interest and would choose the second over the first if the capital allowances were not available.

S441-442 will not normally apply.

Example 7

In summary, this deals with UK group financing where there is:

• a choice to move an existing loan receivable, without any alteration of terms
• in circumstances where:
  • financing continues to be required for a profitable, fully taxable UK operating business
  • the income stream by way of interest can be offset with trapped losses

This must be read in the context of the opening section on background/ approach.

The UK parent (‘P Co’) of a UK headquartered multinational group, or wholly UK group, owns UK subsidiaries, S1 (‘S1 Co’), S2 (‘S2 Co’) and S3 (‘S3 Co’). S1 Co has an existing loan which it owes to S2 Co: the loan requires consent for assignment. The interest on the loan is fully deductible in S1 Co and taxable in S2 Co, and this is expected to continue to be the case if there is no change to the arrangements. The directors of S1 Co initially obtained the loan, and S1 Co continues to require the funding, to be used in S1 Co’s profitable UK operating business which is fully taxable in the UK. S3 Co has trapped NTLRDs arising before April 2017, which can only be set against future non-trading profits of S3 Co and which, in the absence of taking any steps, are not expected to be used for many years.

The directors of P Co wish the S1 Co loan to be assigned by S2 Co to S3 Co, so that the interest receipt in S3 Co can be set against those NTLRDs, whilst S1 Co continues to have a tax deduction for the interest paid, the asymmetry resulting in a net UK tax benefit.

The directors of P Co propose that S2 Co assigns the loan to S3 Co for full value with the consent of S1 Co, and with no change in terms of the loan, other than the identity of the lender. They propose that S2 Co pays a dividend of the amount received (it has sufficient existing distributable reserves to do so). They further propose that S3 Co is funded to acquire the benefit of the loan from S2 Co by an injection of equity from P Co from existing cash. The commercial (non-tax) impact of the arrangements is that S1 Co will continue to have the funding it requires for its operating business, on the same terms save for the identity of the lender; S2 Co will have received full value for an asset, the loan it made to S1 Co, and have paid a dividend; S3 Co will have received an injection of equity and will have acquired an asset; and P Co will have made an injection of equity into S3 Co and have received a dividend from S2 Co.

The directors of S1 Co, S2 Co and S3 Co consider the respective commercial (non-tax) impact, and the expected tax treatment, taking into account the net UK tax benefit intended to arise, and agree with the proposals made by P Co. If the tax deductibility of the interest was lost as a result of the transfer, or if the losses were not available for use against the interest receipts, the directors would not go ahead with the transfer.

S441-442 will not normally apply.

Example 8

In summary, this deals with UK external financing where there is:

• a choice to borrow to pay dividends from existing distributable reserves to third party shareholders
• in circumstances where:
  • this is to meet market expectations on returns
  • many recipients may not pay tax on receipt of dividends

It also addresses a further variation.

This must be read in the context of the opening section on background/ approach.

A UK parent (‘P Co’) funded itself initially through an initial mix of debt and equity from the capital markets. The directors of P Co wish to pay a substantial dividend, from existing distributable reserves, to meet immediate third party market expectations on returns. P Co requires external financing to do so. The directors decide that P Co will borrow from the capital markets so that it has sufficient cash to pay a substantial dividend.

The directors are aware that many recipients of the dividends may not pay tax on them. The directors expect interest on the borrowing to be tax deductible. If the directors thought a tax deduction was not available, they would not go ahead with the borrowing to fund the dividend so the dividend would not be paid.

S441-442 will not normally apply.

This view would be the same if the directors of P Co decide that it will borrow from the capital markets to enable it to repurchase or redeem share capital from shareholders, rather than paying a dividend, in order to meet immediate market expectations on returns.

Example 9

In summary, this deals with UK external financing where there is:

• a choice to change the proposed terms of debt financing for a UK Commercial Opportunity
• in circumstances where:
  • the debt financing was originally proposed to be on limited recourse terms to obtain a marginal commercial benefit without the directors appreciating the implications for tax deductibility
  • the directors subsequently become aware of the tax implications

This must be read in the context of the opening section on background/ approach.

The directors of a UK solo start-up company (‘A Co’) identify a UK Commercial Opportunity, and require financing. This is available from third parties in the form of debt or equity. For commercial (non-tax) reasons, the directors prefer debt financing.

Without taking tax advice or considering the tax treatment the directors initially propose to issue notes that have a limited recourse feature (of a type which leads to results-dependency for UK tax purposes), as that is of marginal commercial (non-tax) benefit to A Co, and they expect that a tax deduction for interest will be available. The directors then obtain tax advice and identify that the limited recourse feature proposed will cause the distributions rules to apply with the result that the interest will not be tax deductible. The directors’ view is that the marginal commercial (non-tax) benefit of the limited recourse feature is outweighed by the disadvantage of the lack of tax deductibility on interest. The directors decide to change the terms of the proposed notes to remove the limited recourse feature. A Co then issues the notes. If the directors thought it was not possible to do this so as to achieve tax deductibility, they would not go ahead with pursuing the UK Commercial Opportunity at all.

S441-442 will not normally apply.

Example 10

In summary, this deals with the UK or cross-border financing of:

• a qualifying asset holding company (QAHC).

This must be read in the context of the opening section on background/ approach.

An investment manager wishes to set up an intermediate asset holding company to be used between investors and their investments with the commercial (non-tax) purpose of facilitating the flow of capital, income and gains between investors and underlying investments. The investment manager considers the best location for that company and decides that it is in the UK, taking account the availability of the qualifying asset holding company (QAHC) regime (see IFM40000): the investment manager would not choose to locate the company in the UK were the QAHC regime not available. The investment manager arranges to set up a UK company (‘A Co’) with that commercial (non-tax) purpose, that is, to facilitate the flow of capital, income and gains between investors and their underlying investments. A Co meets the tests to be a QAHC and has notified HMRC that it wishes to be treated as a QAHC (see IFM40000). A Co is held 100% by a qualifying fund and investors in that fund loan money to A Co to fund investments made by A Co. The loans take the form of profit participating loans (PPLs), the terms of which see the profits of A Co’s investments passed back to investors as a return on the PPLs. The directors of A Co intend and expect that A Co will enjoy the statutory benefits available to a QAHC. In particular, under the QAHC regime, the return payable under the PPLs by the QAHC is not treated as a distribution and is, instead, brought into account under the loan relationship regime. The directors of A Co expect the return on the PPLs to be tax deductible and would not go ahead with the borrowing and investments were this not the case.

S441-442 will not normally apply.

Examples where S441-442 will normally apply

For each of the following, where it is stated that S441-442 will normally apply, this means that HMRC will normally start with the view that the rule is engaged, that is, there are one or more unallowable purposes, and that, on the application of the rule on a just and reasonable apportionment, debits are attributable to those purposes (and the likely basis of apportionment is indicated).

Example 11

In summary, this deals with cross-border group financing where there is:

• external debt financing, and a choice to route it via a UK subsidiary for a non- UK subsidiary to acquire shares in a non-UK company from a third party
• in circumstances where:
  • there is no commercial (non-tax) link to the UK subsidiary, a strong commercial (non-tax) link to another jurisdiction, and the UK subsidiary’s only activity is that of financing, so that, in particular, there is no material net group commercial (non-tax) benefit from involving the UK
  • a net global tax benefit is available, taking account of capacity for UK interest deductions and no capacity for interest deductions in the jurisdictions of the non-UK parent and the non- UK subsidiary acquiror given the existence of losses

This must be read in the context of the opening section on background/ approach.

A non-UK headquartered multinational group has a number of types of business. One of these types of business is currently carried out by, and only by, a subsidiary in a non-UK jurisdiction (‘S1 Co’).

The directors of the non-UK parent (‘P Co’) have identified an opportunity, and wish the group to acquire the shares in a company (‘T Co’) resident and operating in a different non-UK jurisdiction. The directors of P Co wish to acquire T Co because they assess that, firstly, it will enable a profitable expansion into that jurisdiction, T Co being expected to generate substantial profits mid-term post the acquisition, and, secondly, this will assist S1 Co’s existing operating business in its jurisdiction. A significant factor in the directors coming to this assessment is their expectation that the employees of S1 Co and T Co will mutually beneficially exchange technical operational expertise and experience. No other part of the group is expected to contribute from a commercial (non-tax) perspective to the success of the acquisition. The directors of P Co discuss this with the directors of S1 Co who agree. Further, both sets of directors consider that given these circumstances it would be appropriate for S1 Co to acquire T Co.

Financing from outside the group is required to acquire T Co, and for commercial (non-tax) reasons debt financing is strongly preferable. For commercial (non-tax) reasons, P Co will be able to obtain this most cheaply.

P Co proposes that it will borrow externally, and then offer to lend that money to a UK subsidiary (‘SPV Co’), provided that SPV Co will use those funds to acquire, as an investment, preference shares in S1 Co which in turn will use that funding to acquire the shares in T Co. SPV Co has either been set up for the role or was previously dormant and has now become active solely to undertake the role. The offer will be made to SPV Co on a take it or leave it basis.

The directors of P Co and of SPV Co expect that a substantial net global tax benefit will be achieved by routing the financing via SPV Co rather than directly to S1 Co. This is because there is no capacity to use interest deductions in the jurisdiction of either P Co or S1 Co given the existence of losses: however, there is capacity in the UK. The only reason why the directors of P Co propose the involvement of SPV Co is the ability to use the interest deduction to reduce UK taxable profits, and the directors of SPV Co are aware of this and take it into account in their decision-making. There is no material net group commercial (non-tax) benefit from SPV Co’s involvement and, in particular, from SPV Co holding preference shares in S1 Co. The only commercial (non-tax) benefit, which is from SPV Co’s perspective on a standalone basis, is that the terms of the loan and onward investment in preference shares, and the commercial (non-tax) position, are such that SPV Co would expect to earn a small (intra-group) pre-tax margin on its investment. The part of the arrangements involving SPV Co is unnecessary from a commercial (non-tax) perspective. If the asymmetry was not available (for instance, if no tax deduction was available for the interest in the UK), P Co would have borrowed and lent directly to S1 Co to acquire shares of T Co.

HMRC will normally start with the view that there is a main tax avoidance purpose, and that, on a just and reasonable apportionment, all loan relationship debits are attributable to that unallowable purpose.

Example 12

In summary, this deals with cross-border group financing where there is:

• a choice to enter into wholly internal debt financing between a parent and a UK subsidiary which the UK subsidiary uses to acquire shares in a group company from a non-UK subsidiary
• in circumstances where:
  • there is no commercial (non-tax) link to the UK subsidiary, and no material net group commercial (non-tax) benefit from involving the UK
  • a net global tax benefit is available, taking account of capacity for UK interest deductions and, given the existence of losses, non-taxation of interest receipt in the non-UK parent, and a lack of capacity for interest deductions in the jurisdiction of the non-UK subsidiary transferor

This must be read in the context of the opening section on background/ approach.

A non-UK headquartered multinational group has businesses and operating companies in the UK, including a UK subsidiary (‘S1 Co’), and in a second, non-UK jurisdiction. The directors of the non-UK parent (‘P Co’) identify that the UK has capacity to use more interest deductions and that, given the existence of losses, there would be non-taxation of any interest receipt in the non-UK parent, and a lack of capacity for interest deductions in the second, non-UK jurisdiction. They review the holding structure of companies in the group. A company in the second, non-UK jurisdiction (‘S2 Co’) holds all the ordinary and preference shares in a company in that jurisdiction (‘S3 Co’). Both companies operate broadly the same business and their employees mutually beneficially exchange technical operational expertise and experience. No other part of the group contributes from a commercial (non-tax) perspective to the success of the business. The directors of P Co propose that P Co will make a loan to S1 Co, which will enable S1 Co to acquire all the preference shares in S3 Co from S2 Co. There will be no other change to the commercial arrangements after the acquisition: for instance, the employees of S2 Co and S3 Co will continue to mutually beneficially exchange technical operational expertise and experience.

The directors of P Co, S2 Co and S1 Co expect that a substantial net global tax benefit will be achieved by the proposed transaction because of an asymmetry between the tax deduction on interest in relation to the borrowing in the UK and the non-taxation of the interest receipt in the hands of P Co. The only reason why the directors of P Co propose the transaction is this asymmetry, and the directors of S2 Co and S1 Co are aware of this and take it into account in their decision-making. There is no material net group commercial (non-tax) benefit from the transaction. The only commercial (non-tax) benefit, which is from S1 Co’s perspective on a standalone basis, is that the terms of the loan and onward acquisition of preference shares, and the commercial (non-tax) position, are such that S1 Co would expect to earn a small (intra-group) pre-tax margin on its investment. The transaction is unnecessary from a commercial (non-tax) perspective. If the asymmetry was not available (for instance, if no tax deduction was available for the interest in the UK), the transaction would not go ahead.

HMRC will normally start with the view that there is a main tax avoidance purpose, and that, on a just and reasonable apportionment, all loan relationship debits are attributable to that unallowable purpose.

Example 13

In summary, this deals with UK group financing where there is:

• a choice to create new loans
• in circumstances where:
  • there is no material commercial (non-tax) requirement for loans
  • the income stream by way of interest can be offset with trapped losses

This must be read in the context of the opening section on background/ approach.

The UK parent (‘P Co’) of a UK headquartered multinational group, or wholly UK group, owns UK subsidiaries S1 (‘S1 Co’), S2 (‘S2 Co’) and S3 (‘S3 Co’). S3 Co has trapped NTLRDs arising before April 2017, which can only be set against future non-trading profits of S3 Co, and which, in the absence of taking any steps, are not expected to be used for many years.

The directors of P Co wish S3 Co to become entitled to interest receipts from other UK group companies so that the interest receipt in S3 Co can be set against those NTLRDs, whilst the other UK group companies continue to have a tax deduction for the interest paid, the asymmetry resulting in a net UK tax benefit. The directors of P Co propose that S1 Co and S2 Co take out loans from S3 Co which is funded to make the loans by an injection of equity from P Co from existing cash. S1 Co and S2 Co did not have any existing commercial (non-tax) requirement for the funds. The commercial (non-tax) impact of the arrangements is that S1 Co and S2 Co have obtained loans for which they had no existing commercial (non-tax) requirements; S3 Co will have received an injection of equity and will have acquired two assets; and P Co will have made an injection of equity into S3 Co. There is no material net group commercial (non-tax) benefit. The directors of S1 Co, S2 Co and S3 Co consider the respective commercial (non-tax) impact, and the expected tax treatment, taking into account the net UK tax benefit intended to arise, and agree with the proposals made by P Co. If the interest was not tax deductible, or if the losses were not available for use against the interest receipts, the directors would not go ahead with the arrangements.

HMRC will normally start with the view that there is a main tax avoidance purpose, and that, on a just and reasonable apportionment, all loan relationship debits are attributable to that unallowable purpose.

Example 14

In summary, this deals with cross-border group financing where there is:

• external financing, and a choice to borrow to pay a dividend from existing distributable reserves to the parent of a non-UK headquartered multinational group, which the parent uses to lend to fund acquisition of shares in a third party non-UK company by a non- UK subsidiary acquiror
• in circumstances where:
  • there are net commercial (non-tax) disbenefits, for the UK subsidiary and for the group, from involving the UK
  • there is a net global tax benefit by way of two net tax deductions for costs on borrowing equal to the acquisition cost, the first in the non-UK subsidiary acquiror and a second in the UK

This must be read in the context of the opening section on background/ approach.

A non-UK headquartered multinational group, with the parent (‘P Co’) in a low tax jurisdiction, has two types of business, one carried on by a subsidiary in the UK (‘S1 Co’) and one carried out by a subsidiary (‘S2 Co’) in a second, non-UK jurisdiction with tax rate comparable to the UK’s.

The directors of P Co have identified an opportunity, and wish the group to acquire the shares in a company (‘T Co’), resident and operating in the same jurisdiction as S2 Co. The directors of P Co wish to acquire T Co because, firstly, they assess that it will enable a profitable expansion in that jurisdiction, T Co being expected to generate substantial profits mid-term post the acquisition, and, secondly, that this will assist S2 Co’s existing operating business in that jurisdiction. A significant factor in coming to this assessment is their expectation that the employees of S2 Co and T Co will mutually beneficially exchange technical operational expertise and experience. No other part of the group is expected to contribute from a commercial (non-tax) perspective to the success of the acquisition. The directors of P Co discuss this with the directors of S2 Co who agree. Further, both sets of directors consider that given these circumstances it would be appropriate for S2 Co to acquire T Co.

In terms of financing the acquisition, the group will require external funding to make the acquisition. The starting position is that S2 Co could borrow from a third party bank to fund the acquisition. If S2 Co simply borrowed from the third party bank, there would be one tax deduction in the group on costs of borrowing of an amount equal to the acquisition amount.

The directors of P Co consider whether there are other structures which might increase the net global tax benefit.

They identify as an alternative that S1 Co could pay an amount equal to the acquisition cost by way of dividend to P Co, which S1 Co would obtain by way of borrowing from a third party bank. The dividend paid would be entirely covered by distributable reserves, but would be in addition to S1 Co’s normal pattern of paying dividends. P Co would then lend the amount received to S2 Co. S2 Co would use the funds to acquire T Co. The cost of the borrowing for S1 Co would be more expensive than for S2 Co.

From a group perspective, there are material net commercial (non-tax) disbenefits – any commercial (non-tax) benefit is significantly outweighed by a net increased cost of external borrowing compared to the starting position. In the circumstances of S1 Co, the directors of S1 Co would see paying the dividend and taking on the borrowing to fund the dividend as a material net commercial (non-tax) disbenefit.

The structure would be intended to have the following tax results. S1 Co would get an interest deduction for the interest paid to the third party bank. P Co would not pay tax on the dividend received from S1 Co and would pay minimal tax on the interest received from S2 Co. S2 Co would get a deduction for the interest paid to P Co. Accordingly, there would be two net group tax deductions on costs of borrowing of an amount equal to the acquisition cost: one in the UK in S1 Co in relation to the borrowing which funds the dividend, one in S2 Co in relation to the financing for the acquisition. (However, there is no intended group asymmetry from a tax perspective on S1 Co’s borrowing: this is from a third party bank.)

The directors of all the various companies involved consider and agree to go ahead with the alternative, rather than the starting position. This is on the basis of the wish to achieve two tax deductions, one in the UK at the UK rate and one in S2 Co’s jurisdiction at a comparable rate, which outweighs the commercial (non-tax) disbenefits. Specifically, as regards the directors of S1 Co, the directors see paying the dividend and taking on the borrowing to fund the dividend as a net commercial (non-tax) disbenefit, but they decide to go ahead primarily to get the UK tax deduction and thereby enable two deductions, to be obtained for the group.

If the directors of the relevant companies thought that a UK tax deduction on the borrowing costs for S1 Co was not available, they would have gone ahead with the starting position structure, and there would not have been a dividend from S1 Co or associated borrowing.

HMRC will normally start with the view that there is a main tax avoidance purpose, and that, on a just and reasonable apportionment, all loan relationship debits are attributable to that unallowable purpose.

Example 15

In summary, this deals with UK external financing where there is:

• borrowing partly for purposes of mutual trading activities

This must be read in the context of the opening section on background/ approach.

The relevant decision-makers for a mutual golf club decide to borrow from a third party to finance construction of a new club house. The golf club trades with both members and non-members.

HMRC will normally start with the view that the club has made the borrowing at least partly for the purpose of activities which are not within the charge to Corporation Tax, the mutual trading activities, and that, on a just and reasonable apportionment, the loan relationship debits on the borrowing in so far as they relate to the mutual trading activities with members will be disallowed. In particular, interest expense would be apportioned into allowable and non-allowable parts according to the club’s taxable income from non-members and non-taxable income from members.

Example 16

In summary, this deals with UK external financing where there is:

• borrowing and lending for the personal purposes of a director

This must be read in the context of the opening section on background/ approach.

The directors of a UK solo company (‘A Co’), which has a UK operating business, decide that A Co will lend £5 million interest-free to a football club which is supported as a fan by one of the directors of the company. The loan is notionally repayable on demand, but in practice is not expected to be repaid anytime soon. The directors have decided to do so solely because of that director’s personal interest in the football club. In particular, as the lending is interest-free, there is no element of obtaining any return on the loan. The directors of A Co arrange for A Co to borrow £5 million externally: their sole reason for doing so is to fund the onward loan to the football club. A Co subsequently writes off the loan to the football club.

In relation to the loan from the third party where A Co is the borrower, HMRC will normally start with the view that the purpose is not amongst the business or other commercial purposes of A Co, and that, on a just and reasonable apportionment, all the loan relationship debits relating to the loan will be disallowed.

In relation to the loan to the football club where A Co is the lender, HMRC will normally start with the view that the purpose is not amongst the business or other commercial purposes of A Co, and that, on a just and reasonable apportionment, the loan relationship debits relating to the write-off of the loan will be disallowed.

If the facts changed such that the directors of A Co want to derive a commercial (non-tax) benefit from advertising or publicity from providing financial support to the football club, which would be a commercial (non-tax) purpose of the company, this would be taken into account in arriving at the amount attributable to the unallowable purpose on a just and reasonable basis. Suppose, for instance, that the directors of A Co originally determine to make a loan of £4 million to the football club, based on the expected commercial (non-tax) benefit from that advertising/ publicity, and require an external borrowing of £4 million to do so. The director personally interested in the club then persuades the other directors to increase the loan to the football club to £5 million (and accordingly A Co requires an extra £1 million of external borrowing) solely as a result of that director’s personal interest. None of the directors has any other reason for the loan of the extra £1 million, and in particular no additional commercial (non-tax) benefit to the club is identified.

HMRC will normally start with the view that, on a just and reasonable apportionment, all loan relationship debits relating to the additional £1 million of principal (of both loans) will be disallowed.

Example 17

In summary, this deals with UK financing where there is:

• lending to a company solely because of a family connection

This must be read in the context of the opening section on background/ approach.

A UK solo company (‘A Co’) is a close company, owned by the members of a family. A Co has a UK operating business which is not one of the provision of finance. One of the family members, who is not a company director or shareholder of A Co, owns another company (‘B Co’), also a solo close company, whose business is not commercially linked in any way with that of A Co. B Co approaches A Co for an unsecured interest-free loan, and the directors of A Co agree. The directors have decided to do so solely because of the family connection. In particular, as the lending is interest-free, there is no element of obtaining any return on the loan. A Co subsequently writes off the loan to B Co.

HMRC will normally start with the view that the purpose is not amongst the business or other commercial purposes of A Co, and that, on a just and reasonable apportionment, the loan relationship debit relating to the write-off of the loan will be disallowed.