The Upper Tribunal has dismissed the taxpayer’s appeal in a recent case concerning the unallowable purposes rule. The taxpayer group had claimed a deduction in respect of the reduction in fair value of a shareholding in a group company which was deemed to represent a loan relationship. The deeming arose because the shares, in combination with a total return swap, were designed to produce an interest-like return. The First-tier Tribunal determined that the unallowable purpose rule applied to not only deny relief for this deduction (which was the intended benefit) but also for the interest debits in respect of borrowings transferred as part of the arrangement. The Upper Tribunal has now upheld that decision. Although the facts are specific to the particular arrangement, the decision provides useful guidance as to how the Courts will apply the unallowable purposes rule.
This case tells us a number of things about the unallowable purposes rule:
- The rule can apply to a deemed loan relationship. The taxpayer’s purposes for being a party to a deemed loan relationship can be identified by testing the real world rights and liabilities which give rise to that deemed loan relationship;
- A company which only has commercial purposes for holding an asset can acquire another main purpose for the duration of a scheme which is intended to achieve a tax advantage. In this case, shares in a subsidiary which were held for a bona fide commercial purpose before, during and after the scheme, acquired an additional ‘bad’ main purpose during the period of the scheme, namely to reduce the value of the shares to secure a tax advantage;
- The purposes of the taxpayer are a factual matter and, in this case, the use to which the shares were put was evidence as to those purposes;
- Interest debits can be wholly attributed, on a just and reasonable basis, to an unallowable purpose even if the same debits would have arisen with an alternative non-tax driven transaction. In this case, the transfer of borrowings to a subsidiary to reduce its value was in the nature of a distribution, and it was no defense to say that the same interest debits would have arisen if the subsidiary had simply borrowed intra-group to pay a dividend. This follows because the borrowings were not transferred with a business or commercial purpose but in order to obtain a tax advantage, and so all of the interest debits in the subsidiary are attributable to the unallowable purpose;
- The unallowable purposes rule can apply to disallow interest debits from a borrowing which is entered into with a main purpose of securing a tax advantage for another person even if the other person does not actually realise the intended tax advantage. In this case, the fact that the fair value loss on the deemed loan relationship asset was disallowed did not prevent the debits on the transferred borrowing also being disallowed because the transferred borrowings still had a ‘bad’ main purpose;
- Interest deductions arising after the completion of the scheme steps could be disallowed because it was found that the subsidiary had an unallowable purpose for assuming the transferred borrowings.
There have now been at least seven Court decisions which have considered the unallowable purposes rule and this decision further illustrates the need to carefully consider the requirements of the legislation as interpreted by this line of case law.
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