CFM38200 - Loan relationships: tax avoidance: unallowable purpose: approach to enquiries

CTA09/S441-442

Practical approach to enquiries

In terms of some specific points on the practical approach to enquiries in relation to the application of the unallowable purpose rule (at S441-442):

  • Given the potentially significant resource requirements for both the taxpayer and HMRC in examining questions of purpose, it will often be appropriate to adopt an iterative approach to requests for information and documents, that is, assessing the risk initially from discussions and key documents, and then, where appropriate, asking for more information and documents.
  • Initial approaches will usually be made on an informal basis, but HMRC’s formal information powers (see CH23000) should be used where, and as soon as, appropriate. These powers have rights of independent review and appeal. Given the essential nature of comprehensive contemporaneous evidence to forming a view on purpose it will not be unusual for HMRC to use formal information powers to gain assurance that all relevant information and documentation has been provided.
  • It is important to consider the evidence in relation to both unallowable purposes and also allowable purposes.

Understanding the factual context and obtaining evidence

In deciding whether or not to enquire into a transaction, and in pursuing any such enquiry, the case team will need to understand the transaction and the factual context, in order to understand whether or not the unallowable purpose rule applies, and in particular the relevant purposes. The examples in CFM38190 are intended to be helpful in giving an indication of HMRC’s view on the hypothetical situations set out, on the basis of the assumed underlying facts described and the general assumptions provided. However, the 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.

Checking the position in relation to applicable tax-related factors set out in CFM38170 will often be helpful as part of the exercise of understanding the factual context where the question of a main tax avoidance purpose is relevant. The position on applicable factors may also be relevant to forming a view as to what debits (or exchange gains credits) are attributable on a just and reasonable apportionment basis to an unallowable purpose.

Types of evidence to establish purposes – general

In order to establish the purposes of a transaction, the stated intentions of relevant individuals who were involved in making decisions at the time are helpful but not determinative: it will often be necessary to look beyond this. For instance, it is preferable to review contemporaneous documentary evidence including the exchanges at the material times among key personnel to be able to ascertain the intentions of the relevant decision makers. Further, in some circumstances it is relevant, and may potentially be significant, to have regard to wider evidence, because it may be relevant to determine whether the requisite subjective intention exists, as discussed further below. In summary, it is important to consider all the evidence available, and it is likely that inferences will need to be drawn.

This approach is supported, for example, in Ingenious Games LLP and Others and Revenue and Customs [2019] UKUT 226 (TCC). This case discussed the issue of determining whether an entity had a subjective intention, in that case to carry on its business with a view to a profit, at paragraphs 341-344:

“Whilst the stated intention of the controlling minds of the entity is highly relevant, the tribunal is entitled to examine their witness evidence critically and decide what weight to attach to it, and in particular to decide whether that stated intention reflected the reality of the situation in the light of other available evidence and the inherent probabilities.

In particular, a tribunal might prefer contemporaneous documentary evidence to the oral evidence of the controlling minds. Leggatt J warned about the unreliability of evidence based on recollection … In determining whether there is the requisite subjective intention, all the evidence must be considered. As mentioned in Gestmin v Credit Suisse at [22] which we have cited at [342] above, contemporaneous documentary evidence will always be highly relevant. Objective evidence is also relevant and, depending on the context, it may be significant. This may include evidence about whether there was, in fact, a real potential for, or likelihood of, profit. This is not because there is an objective test or override. Rather, the potential for profit is one part of the evidence that may be relevant to determine whether the requisite subjective intention exists.”

For more detail on the courts’ approach to oral evidence, please see the judicial consideration of this in Kimathi & Ors v FCO [2018] EWHC 2066 (QB) in which the Gestmin v Credit Suisse guidance was considered alongside two more recent cases.

When obtaining evidence as to the stated intentions of decision-makers, it is important to ensure that evidence is obtained from decision-makers who are party to all the purposes that have a bearing on the purposes for which the company is party to the loan relationship. For instance, in some situations, only some of the directors may be aware of all the relevant purposes.

Contemporaneous documentary evidence

In looking at contemporaneous documentary evidence, the sorts of documents case teams will typically want to see will include (although this list is not exhaustive):

  • The papers of the board of the company and of any other boards, management or governance bodies relevant to the arrangements –minutes, supporting papers submitted (for instance, step plans and slide packs), resolutions.
  • Papers, notes of meetings and calls between those having input in the arrangements (including external persons).
  • Electronic communications such as (but not restricted to) emails between those having input in the arrangements (including external persons). Being comparatively informal means of communication, such communications can be helpful in recording considerations taken into account in an unvarnished way, but equally it is important to recognise that they may not always express a position carefully or exactly. It is also important to consider whose communications should be obtained and to review the content of those communications in the light of the role of the individual and their responsibilities at the time. For instance, it is likely to be relevant to see the communications of members of the tax department, but equally such communications might be reasonably expected to focus on tax – that fact alone does not necessarily suggest that tax is the only material factor involved.

In accordance with usual principles and subject to the usual provisos (for example, in relation to legal professional privilege) all papers provided should be complete and should include all drafts etc.: it will often be important to understand how a proposed transaction developed, including any changes, from its inception through to its implementation. The ability or inability to supply contemporaneous documentary evidence on request is likely to have a significant impact on the speed of an enquiry.

Key areas to explore to understand purpose

Overall, in addition to the fundamentals of understanding what happened – what the starting position was, which companies were involved, how are they related, what transactions were effected and so on – key areas to explore to understand purpose are set out as follows (where the phrase “it is reasonable to expect” is used, this means that based on HMRC’s experience, it is likely as a matter of fact to be the case, or that this would be appropriate given the legal, tax etc. responsibilities of the company):

  • It is reasonable to expect that, where there are commercial (non-tax) purposes of, and benefits for, a company, the company will consider and evaluate them and sometimes quantify them and that this will be reflected in contemporaneous documents: what are these commercial (non-tax) purposes and benefits, and which documents are they reflected in?
  • Specifically in relation to the financing taken on by the company, HMRC would like to see any contemporaneous documents in which the company has considered the terms of the debt (including interest rate, size of principal, and maturity), in particular whether they differ from those typical in arm’s length arrangements, and how the company will service and repay the debt.
  • Where the financing taken out by a company is part of wider arrangements, it is reasonable to expect that a number of questions will be considered and evaluated and that this consideration and evaluation will be reflected in contemporaneous documents. These questions will include: what are the group commercial (non-tax) purposes or benefits of the wider arrangements; why the company was involved; what role it was intended to play; and to what extent it contributed to the net group commercial (non-tax) purposes or benefits (not just that its involvement generated, for instance, an intragroup margin). What are the answers to these questions and which documents are they reflected in? For instance, where the UK company is acting as a holding company, what link do the assets have to the company or to the business of the group in the UK? It is important to note that providing material in relation to group commercial (non-tax) purposes or benefits of the wider arrangements only addresses the first of these questions; it is very important to understand the position in relation to the company, which is addressed by the rest of the questions in this bullet point (and elsewhere in this section).
  • It is reasonable to expect, and HMRC accepts, that UK and, where applicable, non-UK tax consequences will usually consciously be taken into account in designing arrangements, and HMRC would generally expect to see contemporaneous documents reflecting how this happened: what are these tax considerations and which documents are they reflected in? In particular, HMRC wants to see any calculations of UK and, where applicable, non-UK tax for the arrangements: what are these? Is there a specific tax (UK or non-UK) issue the arrangements are intended to solve or work around: if so, what is it and where is it reflected in contemporaneous documents? HMRC also understands that in some cases the tax treatment may be regarded as so obvious that it is not consciously considered or documented. However, an absence of documentation where the tax is more complex will raise concern, and, in particular, suggestions that tax matters were deliberately dealt with verbally and not documented will raise considerable concern and arrangements will be scrutinised particularly closely.
  • What are the standard decision-making and governance processes, and how are they documented? How were the processes applied to the arrangements, including who made the key decisions? Do the processes seem appropriate in the circumstances, including the nature of the entities involved? For instance, for banking-regulated entities undertaking a significant transaction there would typically be comprehensive papers covering all aspects of the transaction –commercial, legal, accounting, tax, compliance, etc. – which are assessed by relevant teams and go to the applicable boards, whereas for a comparatively minor transaction in a small private company which is not a regulated entity there may sometimes be less full documentation and fewer people involved.
  • What were the triggers for the arrangements to be undertaken? How did the structure for the arrangements, or relevant constituent parts of them, develop? What choices were made, what alternatives were considered? What made the chosen option the preferred one? A particular area of focus in this context is to identify where there is an initial main driver to secure a tax advantage and then a taxpayer looks for a transaction which can be said to have commercial benefits as a means of achieving that driver. This may, for instance, in some cases be an area of particular risk where there is a group reorganisation not involving any new acquisition of external assets.
  • In all of this, to what extent is there objective evidence supporting stated commercial (non-tax) purposes or benefits?
  • It is not appropriate to assess the relative importance of purposes on the basis of hindsight – for instance, to argue that simply because a transaction did not in the event achieve a stated commercial (non-tax) benefit, that fact suggests it was not a purpose to achieve that benefit at the time the loan relationship was entered into. It is also the case that purposes may change.
  • Subject to this, it can be relevant in assessing the significance of purposes to consider how the company or group kept under review progress in achieving the stated intended benefits, and what subsequent actions they took in relation to them: what is the evidence on this? For instance, suppose a company’s stated purpose of becoming party to a loan relationship originally was to acquire assets in order to achieve synergy benefits. What evidence is there that the company or group monitored progress on achieving those benefits? If the arrangements are subsequently unwound by way of transferring the assets back and repaying the loan, any purposes in relation to the unwind of arrangements, and specifically the repayment, will be tested at that time, and those purposes may not be the same as those for which the company became party to the loan relationship. Nevertheless, if the evidence suggests that no consideration was given to losing the stated synergy benefits in the decision-making on the unwind of arrangements, that may cause HMRC to look again at the strength of the evidence in relation to the original stated purpose.

Referrals and guidance

Taxpayers may ask whether the unallowable purpose rule will apply to a future transaction, or to borrowing for certain purposes. HMRC officers should not comment but simply refer to the Economic Secretary’s comments at report stage (CFM38180), particularly the penultimate paragraph, and this guidance. Her comments and this guidance embody the extent of the guidance HMRC can give.

In view of the Economic Secretary’s comments, the application of the unallowable purpose rule is a matter of careful judgement and is acutely fact specific. Where HMRC officers consider that the unallowable purpose rule may apply to a transaction which has taken place, they should first consider whether there is a loan relationship (CFM30140). Having done so, before taking any action they are advised to contact and discuss the matter with a Tax Planning Specialist or International Tax Specialist, who will help with engagement with Counter-Avoidance Technical Team.