In this episode, Elizabeth Wilson KC and Ronan Magee take a look at the "unallowable purpose rule" in the loan relationship code and in particular three recent Court of Appeal cases – Kwik-Fit (in which Elizabeth Wilson KC and Ronan Magee acted), BlackRock and JTI Acquisitions (in which Elizabeth Wilson KC acted).

• (2:28) outline of the unallowable purpose rule. It involves a multi-layered test.
• (4:45) a key element is what, as a matter of fact, is the group's purpose in organising the borrowing. You decide this by looking at all the facts therefore. Discussion of this in relation to the JTI Acquisitions case, Kwik-Fit and BlackRock.
• (9:48) companies have been trying to narrow what the courts can consider when applying the test. The Court of Appeal has clearly shown this cannot be done.
• (11:52) JTI Acquisitions underlines that a company must prove its case on all the facts. It cannot be selective.
• (13:50) Do you need to be coming to the UK for other reasons, not just tax reasons, in order to benefit from the rule?
• (16:00) Syngenta: there must be proper evidence and not window dressing/assertions. What role do documents and witness evidence have in establishing facts? Importance of getting all your evidence (documentary and witness) before the tribunal.
• (22:45) Kwik-Fit: genuine commercial losses in one part of the group which they sought to set against profits in other parts of the group. The disallowed losses were, however, capped which shows the attribution rule in its safeguarding role.
• (29:01) new loan relationship code anti-avoidance provision ss445B - D.
• (30:47) some questions are not yet answered (eg attribution).

 Cases/legislation

 Cases

Kwik-Fit [2024] EWCA Civ 434

Blackrock [2024] EWCA Civ 330

JTI Acquisitions [2024] EWCA Civ 652

Fidex [2016] EWCA Civ 385

Travel Documents Service [2018] EWCA Civ 549

Syngenta [2024] UKFTT 998 (TC)

Gestmin [2013] EWHC 3560 (Comm)

Kogan v Martin [2019] EWCA Civ 1645

Euromoney [2022] UKUT 205 (TCC)

Legislation

 ss441 and 442 Corporation Tax Act 2009

s1139 Corporation Tax Act 2010

ss445B - D Corporation Tax Act 2009

Laura 0:10

Welcome to pump court tax check podcast series brought to you by the barristers at pump court tax chambers. We are the largest UK tax set and our podcasts aim to give you insight into recent developments in tax law and procedure. Across the series, we'll look at a range of topics covering issues that arise both in disputes and in advising clients more generally.

Laura 0:32

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0:51 Ronan

Hello, I'm Ronan McGee and welcome to this pump court tax chambers podcast.

0:56 Elizabeth

And I'm Elizabeth Wilson. And we're talking about the unallowable purpose rule

1:01 Ronan

And the three Court of Appeal cases in Kwik-Fit, BlackRock and JTI.

1:11 Ronan

We both acted together in Kwik-Fit, which is one of the cases we're going to be exploring the unallowable purpose code in the loan relationship rules through today.

1:20 Ronan

And Elizabeth also acted for the revenue in JTI acquisitions, another one of the key cases we're going to be looking at. We think this has been a good time to reflect and take stock because we now know that the three main Court of Appeal decisions, BlackRock, Kwik-Fit and JTI acquisitions are all final. And we also think that they're consistent with the Court of Appeal's earlier judgments in FedEx and in travel document service.

As such, we think it's a good time to think about what we can take from these cases and put into our further thinking about the way the code works. As part of that, we'll also be touching on the very recent decision of the FTT in Syngenta.

2:00 Elizabeth

And that's because it will help. I think it's a sort of factual application of some of the principles that have emerged out of the Court of Appeal cases. Of course, once you get to the Court of Appeal, things become very high level and abstract. So it's nice to bring it back to the practicalities.

2:21 Elizabeth

Would it help, Renan, if you just explained briefly or summarised what the rule is?

Elizabeth 3:25

So what you have, I mean, what you've been describing, Renan, is a multilayered test. What it has then is sort of safeguards, and you can see them as safeguards for the revenue. They're trying to challenge something they think has gone wrong.

And equally for the taxpayer company who just wants to say, look, I'm in business. The UK allows deductions for interest on debt. Why shouldn't I borrow to acquire my assets or whatever? And I think what these different layered tests are doing, which begins with a subjective test and then builds from just having a subjective purpose to a main subjective purpose, and then adds on the subjective element, it's a test that is supposed to end up at the right result that is just and reasonable, I think.

Ronan 4:11

The hope is that it catches what Parliament wants to catch and leaves untouched the normal commercial borrowing of companies and groups. As you say, there's a deduction for interest for a reason. The UK wants to encourage companies to situate themselves here.

The tax offering is part of what the UK has to give.

Elizabeth 4:32

To contribute to the UK economy in a truly commercial way.

Ronan 4:36

I think starting with JTI works well, actually, because that's a case where, to some extent, it was all about, do we situate this in the UK? In JTI, the appellant company was a UK SPV.

It was part of a US headed group and the US group wanted to buy an asset. It doesn't really matter what the asset was, except that it was very expensive. And the US group had committed to do so and had agreed the price and arranged the external funding.

But the group wanted to secure a tax benefit for the group as a whole. And the way they did that was that they created JTI to buy the asset and do that with internal funding from another part of the group. And JTI, as such, was paying interest to this other part of the group and got loan relationship debits.

And that would create a deduction for them in their tax return or for any company to which they surrendered the debits. Now, for US reasons, the other half of the transaction wasn't taxable. So looked at from a group perspective, there was a big net saving. What was the result?

Elizabeth 5:38

How the First Tier saw it, and this is a reflection of how the facts came out in the First Tier Tribunal, was that it was essentially a US acquisition of a US asset with actually US funding. And the UK company, this new company, was just slotted into it solely to secure UK tax advantage to get the UK debits. And so the First Tier said that the sole reason for that company agreeing to the borrowing the loan relationship was to secure that UK tax advantage. And it then went on and denied all the debits on that borrowing.

Ronan 6:20

One of the criticisms I've read of the decision is that the purpose that's driving all of this is the US group purpose. That's the person who's creating the company, doing all of the work, whereas the code is looking at the taxpayer company. That's the one who's party to the loan relationship. Does the decision overly attribute that group purpose to the taxpayer company?

Elizabeth 6:45

I've seen this criticism a number of times. And this idea that what's happened, what was really going on in the tribunal's mind was that it was attributing the group purpose, who I think certainly by the end, everyone understood was to secure this UK tax benefit.

That was why it created the company at all. The group purpose was being attributed to this, the directors of the company. And that is, as you say, that's applying the asking the wrong company, what was the purpose of the wrong company? And the test is very clearly, and all of Court of Appeals decisions are now very clear on that, you ask what's the purpose of the company entering into borrowing? My view is that there's no attribution going on. And that's an unfair criticism. If you read the decision and you see all of the facts as they came out. The big point is that it's a purpose test. Real people have purposes and decisions are made in the real world by real people operating real companies.

Elizabeth 7:52

And in the real world, if a group decides that it wants to secure some particular benefit and so it gets advice and it sets about creating a group company to play a role in its group scheme, and the directors of that company who are very often involved in the formulation of the scheme at the group level themselves, they know that and they positively want to help the group achieve its group purpose. You stand back and you say, well, what's the purpose of that company, the director of that company, in carrying out steps assigned to it? Answer, in the real world, to achieve the group purpose. So it's not, there's no question of attributing or deeming or somehow faking it that you're asking questions of the wrong company.

What you're doing is simply looking at how these groups and individuals are operating and making decisions as a matter of fact. And obviously, in a different case, you can have different facts. But in JTI, that was what the tribunal considered to be happening.

Ronan 8:57

And that was one of the features of the evidencing, Kwik-Fit as well, was that the director was very candid about the fact that, well, we're a group, we all want the group to succeed. And so when the group had this plan that was for the assistance of the group as a whole, everyone wanted to play their part to obtain the group's benefit by doing its bit.

Elizabeth 9:18

Yes, that was right. He was very candid. I should just go back a little bit on JTI. In fact, the findings were a little bit more complicated than I've explained, but I don't think it matters.

What was clear is that as a matter of principle, how do you apply a purpose test? And the answer is you look at all the facts, all the facts are on the table and you apply the test in the real world. I just wanted to make an observation, really, which is that I think if you look at all the cases that we've had to date anyway, I think to get round the fact that we all know it seems pretty obvious that group companies who are assigned a role and know about it will have a purpose of helping the group out. To get round that, what the appellant companies have been trying to do is to narrow, almost as a matter of law, the nature of the test.

So they say, actually, the only thing that the tribunal is allowed to look at is that 10 minute meeting, the board meeting when they sign off the transaction and they agree that the company, it will be lawful and so on for it to enter into the borrowing. Firstly, because it means that you're almost allowed to shut your eyes to the wider facts. You can shut your eyes to the fact that the directors know why they were being asked to enter into that loan.

And then so it opens up these other arguments to the company that otherwise they're a bit stuck on because actually, and this is really, I think, what the Court of Appeal was saying in Blackrock, even if the directors are told to deliberately shut their eyes to any benefit, any tax benefit to the wider group and deciding whether to do something to enter into the borrowing, and even if they follow that instruction to the letter, and they genuinely in that 10 minutes, they don't think about the tax advantage. It doesn't mean that the company's purpose in entering into that borrowing was not to secure the group benefit, because you simply don't limit your inquiry to that 10 minutes or to the board minute that's written for that 10 minutes. In Blackrock, the directors knew why. And they may have been thinking about it a week before. And so of course, the inquiry is just much larger than that.

It's that point that Lord Justice Nugee makes that a simple starting point in ascertaining a person's purpose is to consider why they did it.

Exactly. I mean, and that's really neat. That's just the best summary of the whole of the purpose test.

But another criticism of JTI is that, well, from JTI's perspective, all it was seeking to do was to buy a new commercial asset.

And it didn't have any means of doing that other than by receiving cash because it didn't have any. And the only cash that was on offer was the loan relationship. So how can it be said that its main purpose was to secure the debits on that loan relationship, rather than acquiring the asset it was trying to acquire?

I think the answer, certainly the answer that the court's accepted at every level is that there's something's gone wrong in the way you phrased the question.

So you've written in the answer in the way you put it. You can't take it as a given that JTI, this new SPV, Special Purpose Vehicle, wanted to acquire the commercial asset, and it existed, and that the only decision, the only issue was how was it going to fund that? That could be the facts in another case, but it wasn't the facts in JTI. It wasn't the way the tribunal found the facts.

This idea that there were givens was put in a number of different ways, actually, throughout the JTI appeal. It was put both as a, almost as a factual argument, which is they should be givens, but then it sort of evolved into very much an argument about statutory construction and the law, which is as a matter of law, when you apply the allowable purpose test, you should treat these certain things as givens. They were not relevant.

They were excluded from consideration.

Elizabeth

They were excluded. So it wasn't that relevant facts were being ignored. It was simply that the law said you weren't allowed to look at them. That whole approach has been rejected kind of

Quite roundly.

By all the courts. And what the company's got to do, its job is to win the case on the facts in the first tier tribunal.

But coming back to that point we had about the interest deduction is something that the UK makes available to companies as part of its pitch for why to put things in the UK. Is it enough if that's all that you're looking for? Or do you have to be coming to the UK to look for something more? Do you have to be looking for other advantages of the UK to be able to get a deduction?

The facts were very interesting and quite stark as found, which is not one non-tax reason for having a UK buy that asset stood up under scrutiny.

Again, so you could have a different case, facts come out differently, different answer.

And it's the time zones or the English speaking staff or particular expertise or things like that that might trip the balance.

There could be all sorts of non-tax reasons, but they need to be identified. You've got to do more than just assert them. There can't just be a post-rationalisation of a tax scheme. Go back to Nugee, Law, Justice Nugee, they need to be why or a really important part of why you have decided to have a UK company acquire the asset.

So is it a fair summary that what you can't do is simply park a US asset that's all the parts of its decision making are US in the UK solely to get the UK tax advantage?

I think that's fair. If you want a better outcome, then you've got to identify what are the real non-tax reasons for choosing that vehicle to own that asset. And if you have those reasons, then there's no reason why you won't get a different answer or potentially a different answer.

I mean, we see it most clearly in BlackRock in the Court of Appeal. They have been at pains to stress that not every deduction or debit is should be disallowed just because you knew it was going to arise or because the fact that you would get a deduction for your borrowing was factored into your decision making.

I mean, it's a valuable relief and it makes sense that directors would take it into account.

Yes, yes.

Fundamentally, what we're getting back to is that it's all about the evidence.

Yes. And I think Syngenta then, just to sort of bring it back down to a factual example, is helpful there.

Its approach to the facts is particularly interesting. In Syngenta, the FTT rejected submission that the reorganisation, which was funded by debt, was driven by legal entity simplification or dividend planning.

What the FTT found was that those drivers just didn't feature in the documentary evidence. And where there were commercial aspects featured in the documents, the FTT seemed to view those as window dressing. This brings in sort of one of the one of the questions that all courts and tribunals have been having to wrestle with in recent years, which is what role do documents have in identifying facts and what role do they have in particular in relation to witnesses who have come along to tell the truth, but they're telling, inverted commas, their truth.

They're being truthful, but they're just possibly wrong. One of these factors has come out of some more detailed thinking about the way that people think and that people's thoughts can be entirely unintentionally biased by the litigation process and that there are very strong biases even in, as I say, a completely honest witness who wants to do nothing but come forward and explain how things happened, gets their recollection altered by the process of creating a witness statement, preparing it, coming to court to give evidence on behalf of one party. And so even though they don't want to tell anything other than the truth and they're not telling anything other than the truth, they're wrong.

There's a decision from the Commercial Court, it's now about a decade old, called Gestmin, or G(J)estman, I've never been sure on that one. And it's sometimes understood as saying, don't pay any attention to what the witnesses actually say. Look entirely at the written documents.

Now, I don't think that's a fair description of the decision in Gestmin, which is much more nuanced than that.

Do you think that's what they did in Syngenta? I think they come a bit close to it. I mean, there's a bit of a discussion as to whether or not Gestmin can be said to apply.

And the Court of Appeal has, in another case called Kogan and Martin, which was about how the screenplay for a film was written and who got the credit between two co-writers. And there they said the two private individuals living together, it was just inherently improbable that all of the contributions would be recorded in the documentary evidence. And in Syngenta, this came up because some of the witnesses said, well, we sit next to each other in the office. So a lot of the stuff we deal with, we just deal with back and forth, someone walking back and forth through the office. And what we put in writing is where we want to communicate with more than one person, where there's sort of, I'm telling Elizabeth something, but I also want someone else to be aware of what's going on or they also need to feed into it. And the FTT drew a distinction between what it called a commercial case like Gestmin.

And it said that was a case where there were going to be significant documentary records that can be expected and Kogan and Martin, which it called a domestic case.

It seems to be that the way the FTT looked at it was that because there was a lot of documentary evidence in Syngenta, it says some eight and a half thousand pages, it fairly notes that's possibly got some duplication in it. But therefore, you can look at a commercial approach and you can look at expecting anything important to be reflected in a document.

But I'm not sure that's quite the right distinction between Gestmin and Kogan and Martin, because in Gestmin, not only are we dealing with a commercial case, but we're dealing with a transaction where what we're trying to identify is what happened between separate parties to that transaction. Whereas in Kogan and Martin and a lot of these corporate group cases, everyone, at least at the time, is on the same side. They're on the same team.

It's more natural in those sorts of cases that things might not get written down. Or if something's important but simple, even if it does get written down, it might get one word that to everyone, everyone involved in it, clearly ticks all the boxes and everyone knows what they're talking about.

In the case, the actual oral evidence of the witnesses is seldom actually ignored. I mean, data was a slightly unusual case, but ignored is the wrong word, but not taken fully at face value. If the witnesses say, this was important to us, but you don't see it in the documentation because there's a brief reference to it there. If it is important, won't there be something, somewhere, some fact which backs that up? And is the real problem that the tribunal is getting the sense that there isn't that indirect evidence backing up what sounds then just like a whole list of assertions or, yeah.

So there's a third string or element, which is what the tribunal sees, hearing and seeing everything, reading all the documents, which is actually sometimes why I think it's a bit, it's quite hard to know exactly what did happen in any particular case, because when you read the judgment, you're reading the whole, and I think it's why actually the appellate courts are so reluctant to interfere with what are clearly sort of evaluative.

Because seeing the witness as part of the whole picture is very different to reading transcripts and reading the documents underlying it. So, yeah, I think that's probably true. But there is still at least a risk that if you don't make sure that you've got the right evidence before the tribunal, and I'm not saying this is the case in any given case, but that what you need to make sure is that if there is that indirect evidence somewhere around, you've got to get it in front of the tribunal and stick their face in it.

But that's a big rule, and that's the big lesson for many of these cases is if you haven't proved a case, you lose.

Yeah.

And the burden of proof is very clearly on the tax payer.

You're listening to Pump Court Tax Chat with me, Ronan Magee.

And me, Elizabeth Wilson.

And we're exploring the Unallowable Purpose Rule within the Loan Relationship Code.

So should we turn to Kwik-Fit?

Yes.

So this is the case that we were both in together.

So I won't ask you what happened in it, but perhaps you'd tell us what's happened in it.

So it's the Kwik-Fit group, a very large number of companies, a very large number of pre-existing intra company borrowing and debt or commercial. Somewhere up at the top of the company is Speedy, Speedy One.

At the stage at which they do the planning, Speedy One is really doing very little. It's got a very small amount of interest income, but it has a very, very large amount of losses, which it's carried forward. And because it's carried forward these losses, it can't use them.

The only thing it can do with them is set it against its own basically interest income. And it's got a very small amount.

So it can't surrender them to another company?

No, and that is expressly prohibited. And so that's a clear parliamentary intention because the Kwik-Fit group is very profitable. There are a lot of profits in all the other companies. So it's in this difficult position where it's making a lot of money on which it's paying tax.

And it has losses and these are genuine commercial losses. And it can't set the one against the other. So the idea that a director in the group or the tax manager in the group came up with was that you take some of, not all, some of this other existing inter-company borrowing and the debtor companies agree to pay more interest on that borrowing and you reorganise all the debt so that increased interest is paid to Speedy One.

So now you put all this extra interest in Speedy One, which is the right kind so it can set the losses against it. And actually they created new debt. There was one, 40 million, for example, with all the market rate interest of which Speedy One ended up being the creditor.

So you've now got all this interest income such that those losses can be used up within two to three years. And I think that the group estimated that, you know, who knows, but it might take them

25 years, I think.

Something like that.

Unusable.

So basically, commercially unusable. That sounds like not a very good scheme because they've just created income and used up their losses. But of course, if the debtor company is paying interest in that amount of the market rate, it's getting a deduction.

So it's creating debits. Speedy One's a tax free environment. So you're getting these new debits in the other group companies who are party to the scheme.

They can act very freely with those debits. They can be surrendered around the group. They can use them against their current year or past year and so on and so forth.

So what they've done is they've transformed unusable, trapped losses up in Speedy One into usable, not trapped, surrender-able debits, losses, if you like, in the appellant companies. So the revenue then challenge the debits created in all the appellant companies. And it is important to remember that the interest increase was applied only to loans involved in the planning, not elsewhere.

So it found that each of the appellant companies did have an unallowable purpose. And when it came to the attribution, it looked at the amount of interest that the companies were paying under the debts as they currently existed before the reorganisation and only disallowed the increased amount. So only the amounts of interest that were created by the reorganisation.

So if they were paying no interest beforehand on a particular debt, all of it. But if they were paying 10 originally and now we're paying 100, the 90, but then this was all subject to a cap and the cap was looking at the amount of the trapped losses once they were used up so that Speedy's interest receipts were taxable on it, the interest deductions in the appellant companies were no longer denied.

So they found an unallowable purpose. And actually, for all the pre-existing debt, it was just an unallowable purpose, wasn't it? That they retained the commercial purpose of being party to the loan relationship. But what they said was all of the interest created for the purpose of the scheme, which is how you achieve that mischievous result should be disallowed, but no more. So once the trapped losses have been used up, then that was it.

They weren't then interested in disallowing any of the debits. I think that's a really interesting attribution. And the revenue themselves were content, and that was their case all along, was to cap the disallowance of the amount of trapped losses, because it really does show the attribution rule operating, actually, in its safeguarding role as well as its counteracting role.

It is, I think you can say, targeted at the mischief. So it undoes what is perceived or found by the courts to be wrong, in inverted commas, about the arrangement. But then it goes no further.

The first tier said, well, actually, insofar as there was pre-existing interest, that had a commercial purpose. And I think they were willing, what the first tier tribunal thought was, well, we won't disallow that pre-existing interest because...

Because you'd have been paying it to someone, even if you weren't paying it to Speedy.

Yes, so that the commercial purpose there was predominant in their view and in the facts of this particular scheme. So there was no disallowance on that pre-existing interest.

One other part of the future, or I suppose the recent past and future possible cases, is a new Loan Relationship Code anti-avoidance provision in Sections 455B to 455D. Now, there's not been any decided cases on these provisions yet, so we don't yet, I suppose, know what they mean in any real sense.

But looking at them, they take a pretty intricate approach. There's a lot of sort of carving in and then carving out again, by reference to the purposes and policy objectives of provisions and then a blacklist and then all sorts of let outs back out again. And it's definitely intricate drafting.

But the approach looks pretty different to those that we're now starting to be quite familiar with from Sections 441 and 442. And it might be the case that the shape of cases that are argued by reference to these provisions are quite different to the shape of an argument on 441 and 442.

Yes.

And that maybe some of the cases that the parties have tried to bring in not very successfully, like Euromoney, in the unallowable purpose litigation might be more relevant or have more to say or tell us.

Yeah, because the new test talks about arrangements rather than sort of a lazer focus on a particular loan relationship.

Yes, yes, all of that. So that'll be just interesting to see what happens.

Thank you very much for joining us for this Pump Court Tax Chat with me, Ronan Magee.

And me, Elizabeth Wilson.

I hope what's really come across has been the fact-sensitive nature of this test and the importance, therefore, of getting the facts right at the FTT level.

But also that not all the questions have been answered yet and there's room for further exploration. See, for example, the attribution and BlackRock and the Court of Appeal.

We do hope that you'll join us for the next Pump Court Tax Chat.

Thank you very much for listening to Pump Court Tax Chat. We do hope you found it informative. If you would like us to cover any other topics or have any comments, please do get in touch with one of our staff team. You can find their contact details on PumpTax.com.

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