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 and Upper Tribunals had 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 Court of Appeal has dismissed the taxpayer’s appeal. As a result, the outcome of the case is a downside for the taxpayer from the arrangements. 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.
What does the case tell us about the unallowable purposes rule?
- The rule can apply to a deemed loan relationship. The deemed loan relationship provision was designed to counter avoidance and ‘it can hardly be supposed that Parliament wished the provision to be construed in such a way that it could be used as a vehicle for avoidance’;
- The taxpayer’s purposes for being a party to the deemed loan relationship can be identified by testing the purposes for holding the shares which gave rise to that deemed loan relationship;
- In assessing whether there is an unallowable purpose, a tax avoidance purpose is not necessarily fatal; it can be a good ‘business or other commercial purpose’ unless it was the main purpose, or one of the main purposes, for which a company is a party to the loan relationship;
- The purposes which are relevant are the company’s subjective purposes, i.e. looking to the intention of the company;
- When determining the purposes of the taxpayer, it can be relevant to look at what use was made of the shares. 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 Court of Appeal provided guidance on when a purpose is taken to be a ‘main’ purpose. In the circumstances here, the intended tax advantage was of such significance that it must have been a main purpose. The fact that the hoped for benefit was large both in absolute terms (more than £70 million) and relative to the value of the shareholding (some £280 million) led to the conclusion that securing the tax advantage had become a main purpose of holding the shares;
- The Court of Appeal also said that ‘main’ is a higher threshold than ‘more than trivial’. A main purpose will always be more than trivial but a purpose can be more than trivial without being a ‘main’ purpose; main has a connotation of importance;
- Interest debits can be wholly attributed, on a just and reasonable basis, to an unallowable purpose even if the same debits might 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 but sufficient evidence had not been presented as to how the same interest debits would have arisen if the subsidiary had instead borrowed to pay a dividend. Interestingly, the implication is that the taxpayer might have succeeded with such an argument had this evidence been presented; and
- 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.
This decision illustrates the need to carefully consider the requirements of the unallowable purposes legislation.
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