CFM38135 - Loan relationships: tax avoidance: unallowable purpose: a main tax avoidance purpose: determining purposes and main purposes
Source: gov.uk (2025-05-07)


CTA09/S442

This page covers:

An introduction to determining purposes and main purposes (#An introduction to determining purposes and main purposes)

Principles (#Principles)

A question of fact and evidence (#A question of fact and evidence)

Determination is by the fact-finding tribunal; not by asking the decision-maker (#Determination is by the fact-finding tribunal; not by asking the decision-maker)

Purpose may change over time (#Purpose may change over time)

Purpose is a matter of subjective intention (#Purpose is a matter of subjective intention)

Determining whether a relevant consideration amounts to a purpose or a main purpose is a question of significance (#Determining whether a relevant consideration amounts to a purpose or a main purpose is a question of significance)

Consequences are relevant but not determinative (#Consequences are relevant but not determinative)

Motive is relevant but not determinative (#Motive is relevant but not determinative)

In relation to a purpose to secure a tax advantage, factors of particular potential relevance in assessing significance include degree of attention, size of tax advantage, the position on net tax benefits and what would have happened ‘but for’ the tax advantage (#In relation to a purpose to secure a tax advantage, factors of particular potential relevance in assessing significance include degree of attention, size of tax advantage, the position on net tax benefits and what would have happened ‘but for’ the tax advantage)

In relation to commercial purposes: there may be a commercial purpose and also a purpose to secure a tax advantage; the use of funds borrowed to acquire a commercial asset, commercial downsides, and directors determining that a transaction is in the company’s interests are all potentially relevant but not determinative (#In relation to commercial purposes: there may be a commercial purpose and also a purpose to secure a tax advantage; the use of funds borrowed to acquire a commercial asset, commercial downsides, and directors determining that a transaction is in the company’s interests are all potentially relevant but not determinative)

Choosing between different ways of carrying out a commercial transaction taking into account tax may, or may not, mean that there is a main purpose to secure a tax advantage (#Choosing between different ways of carrying out a commercial transaction taking into account tax may, or may not, mean that there is a main purpose to secure a tax advantage)

What was concluded on purpose in Court of Appeal unallowable purpose cases (#What was concluded on purpose in Court of Appeal unallowable purpose cases)

Summary (#Summary)

Difficulty in the context of financing (#Difficulty in the context of financing)

Introduction

For the ‘unallowable purpose rule’ (at s441-442) to be engaged there must be an ‘unallowable purpose’: that is, a purpose for which the company is party to the loan relationship (or enters into a ‘related transaction’, as defined for the purposes of the rule), which is not amongst the business or other commercial purposes of the company.

It is specifically provided that if there is a purpose of securing a tax advantage (a ‘tax avoidance purpose’), and if this is the main purpose, or one of the main purposes, for which the company is party to the loan relationship or related transaction (s442(3)-(5), CFM38130 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38130)to CFM38140 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38140)), then this is an unallowable purpose. This is referred to as a ‘main tax avoidance purpose’ in the following.

This section considers how to determine purposes and main purposes; and, specifically, how to determine whether there is a main purpose for which the company is party to the loan relationship to secure a tax advantage. See CFM38125 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38125) for further detail on whose purposes are relevant; and CFM38140 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38140) for further detail on what a tax advantage is and whose tax advantage may be in point.

In addition to determining whether or not there is a main purpose to secure a tax advantage, it is highly likely to be necessary to assess whether there are any purposes which are amongst the company’s business or other commercial purposes and not in the specific exclusions (‘allowable purposes’), and the significance of any such purposes. This assessment is highly likely to be relevant to determining the significance of securing the tax advantage, and to the question of attribution on a just and reasonable apportionment.

Case law concerning the unallowable purpose rule and various other purpose and main object tests has established various principles. (That determining main object is a comparable issue to determining main purpose is confirmed by the 2018 Court of Appeal judgment in Travel Document Service & Ladbroke Group International vs HMRC [2018] EWCA Civ 549 (TDS v HMRC), paragraph 41.)

In particular, the question of purpose has been considered by the Court of Appeal in TDS v HMRC, BlackRock Holdco 5 LLC v HMRC [2024] EWCA Civ 330 (BlackRock v HMRC), JTI Acquisitions Company (2011) Ltd v HMRC [2024] EWCA Civ 65 (JTI v HMRC), and Kwik-Fit Group Ltd and other companies v Revenue and Customs Commissioners [2024] EWCA Civ 434 (Kwik-Fit v HMRC). BlackRock v HMRC and JTI v HMRC each involved arrangements in which, as part of the commercially driven acquisition of a third-party target company by the group, UK companies were debt and equity financed by their parents, respectively, to acquire preference shares in the special purpose vehicle acquiror of the target company (BlackRock v HMRC), or ordinary shares in the target company (JTI v HMRC). Kwik-Fit v HMRC involved a reorganisation which included creating new loans with a creditor company, increasing the interest on certain existing loans and moving them to the creditor company, and also increasing the interest rate on an existing loan owed to the creditor company. The creditor company had brought forward non-trading loan relationship deficits (non-trading deficits) which it did not expect to be able to use for many years.

The upshot, as I see it, is that: (i) Even where a company entering into a loan relationship was brought into being to further a wider scheme, the company’s purposes in becoming a party to the relationship are not necessarily those for which it was created or those of the wider scheme; (ii) On the other hand, the context, and in particular the purposes of the wider scheme which the company was intended to advance, may, depending on the facts, bear on the company’s purposes in entering into the loan relationship; iii) The company will have a ‘tax avoidance purpose’ within the meaning of section 442 of CTA 2009 if it is seeking to play its part in a scheme which, to the knowledge of the relevant decision-makers, was designed to secure a tax advantage; iv) If it can be said that the company wishes to go along with such a scheme whatever [italics in original] its purposes might be, it may well be that the company has an unallowable purpose regardless of whether it appreciates that the scheme was designed to secure a tax advantage. It may suffice that those promoting the scheme have that intention; v) The fact that the decision-makers consider that entering into the loan relationship is in the company’s interests for other reasons does not preclude them from having a ‘tax advantage purpose’; and vi) A Tribunal determining whether a company had a ‘tax avoidance purpose’ is not required to adopt a ‘tunnel-visioned’ approach looking simply at how the company was proposing to use the money it was borrowing.

Where the following makes statements on the likely factual position, this is based on HMRC’s experience. In any given case, it will ultimately be a question of the specific facts in that case.

Principles

The principles come from a plain reading of the statutory language, and/or from a number of cases in relation to the unallowable purpose rule and to other purpose or object tests.

A question of fact and evidence

Case law in relation both to the unallowable purpose rule and to other purpose or object tests has established that what the purposes are, and whether or not a purpose is a main purpose, is a question of fact which depends on the evidence in relation to all the relevant facts and circumstances of the particular case.

For instance, in Commissioners of Inland Revenue v Brebner [1967] UKHL TC 43 705 (IRC v Brebner) the House of Lords held (at pages 718 to 719) that:

The question whether in fact one of the main objects was to avoid tax is one for the Special Commissioners to decide upon a consideration of all the relevant evidence before them and the proper inferences to be drawn from that evidence.

In Kwik-Fit v HMRC at paragraph 87, the Court of Appeal notes that “the important point is that whether a purpose is a main purpose is a question of fact”.

Determination is by the fact-finding tribunal; not by asking the decision-maker

The question of fact as to whether something is a purpose or a main purpose or a consideration which is not a purpose at all is determined by the fact-finding tribunal, and is not answered simply by asking the decision-maker. One or both of these points are made expressly in many cases.

For instance, as quoted above, in IRC v Brebner the House of Lords stated that the matter was “for the Special Commissioners” (which would now be the FTT).

In TDS v HMRC, in which the company was holding the shares of a subsidiary which, in the period in question, constituted a deemed loan relationship, the lead witness offered evidence that the company was at all times holding the shares solely for bona fide commercial reasons, and this evidence was not directly challenged in cross examination. The Court of Appeal found that this did not prevent the FTT coming to a view that the company had a main tax avoidance purpose for holding the shares, irrespective of whether or not that had been challenged, and the witness’ different evidence could be attributed to his “taking a different view as what counts as a ‘purpose’ for holding shares”.

In BlackRock v HMRC sub-paragraph 124(f), the Court of Appeal stated:

f) It is for the fact finding tribunal to determine the object or purpose sought to be achieved, and that question is not answered simply by asking the decision maker.

In Kwik-Fit v HMRC, having confirmed the question of purpose as one of fact, the Court of Appeal at paragraph 87 went on to say it was a question “for the fact-finding tribunal, which cannot be interfered with in the absence of an error in law”.

Purpose may change over time

The purpose of a loan relationship may change over time. For instance, a loan relationship may have a wholly allowable purpose when a company enters into it but change to having an, or acquire an additional, unallowable purpose at a later date (and the other way round). Moreover, a purpose held for only a moment in time in the accounting period may be an unallowable purpose.

In Fidex Ltd v HMRC [2016] EWCA Civ 385a (Fidex v HMRC) (see CFM38167 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38167) for further detail), the company had an existing holding of bonds, and then entered into a tax planning structure, involving the issue of shares, that led to the derecognition of the bonds for accounting purposes, which triggered a debit. The FTT found that the purposes for which Fidex originally entered into the bonds were commercial (non-tax), and that commercial (non-tax) purposes continued to apply, but that the company acquired a main tax avoidance purpose of crystallising the debit, which was held for a moment in time. The UT, at paragraph 112, confirmed that the FTT had evidence on which it could conclude that:

Fidex became possessed of a purpose, or an additional purpose, for the holding of bonds, and that was a main tax avoidance purpose, and therefore an unallowable purpose.

The fact that Fidex may have retained other purposes, and that it did nothing different with the bonds, did not, in the light of the evidence of the tax avoidance purpose, make that finding impermissible. (At the stage of attribution on a just and reasonable apportionment, the UT found that the debit on the derecognition of the shares was wholly attributable to the main tax avoidance purpose, and disallowed it, and this was confirmed by the Court of Appeal.)

In TDS v HMRC, TDS originally acquired and held shares in a subsidiary, and in a subsequent period entered into a swap and novation, that resulted in a substantial reduction in fair value of the shares. TDS was deemed to be a creditor of a loan relationship with respect to the shares, in relation to which debits and credits were required to be brought into account on a fair value basis. TDS accepted that a main purpose of entering into the swap and novation was securing the debit on the reduction in fair value. At paragraph 46, the Court of Appeal found that there was a change in purpose so that there was a main purpose of securing that debit:

While, therefore, there is no question of TDS having had the tax advantage in mind when it acquired the shares, it was evidently intending to use them in the tax avoidance scheme during the currency of the Swap.

(At the stage of attribution on a just and reasonable apportionment, the Court of Appeal found that the debit was wholly attributable to the main tax avoidance purpose and disallowed it.)

Purpose is a matter of subjective intention

The test is one of subjective intention.

Again, this is established in IRC v Brebner, as summarised in the Court of Appeal decision in TDS v HMRC at paragraph 41:

Lord Pearce concluded (at 27) that ‘[t]he “object” which has to be considered is a subjective matter of intention’, and Lord Upjohn (with whom Lord Reid agreed) said (at 30) that ’the question whether one of the main objects is to obtain a tax advantage is subjective, that is, a matter of intention of the parties’.

This test has been applied, and often IRC v Brebner is directly cited, in other purpose or object tests, as applicable. The test has also been consistently followed in unallowable purpose rule cases.

For instance, in Versteegh Ltd and others v Revenue and Customs Commissioners [2013] UKFTT 642 (TC) (Versteegh v HMRC), the FTT stated at paragraph 155:

What is important, in our view, is that the significance of the tax advantage to the taxpayer must be considered as a matter of subjective intention, which necessarily involves a careful analysis of all the reasons the taxpayer had for entering into the transaction.

This approach is taken in, and endorsed by, TDS v HMRC (as quoted above) and the BlackRock, Kwik-Fit and JTI Court of Appeal cases. See, for instance, sub-paragraph 124(a) in BlackRock v HMRC:

Save in ‘obvious’ cases, ascertaining the object or purpose of something involves an inquiry into the subjective intentions of the relevant actor.

The test is one of actual subjective intentions.

In Kwik-Fit v HMRC the Court of Appeal, in considering arguments made by the group in relation to the implications of the transfer pricing rules, held at paragraph 92:

More importantly, what we are concerned with under the unallowable purpose rule is [the relevant companies’] subjective purposes. Except insofar as the group sought to ensure that the rate would not be challenged as being excessive, it is clear that the transfer pricing rules played no part in the decision making process. Those rules therefore cannot assist in determining the [relevant companies’] purposes.

Determining whether a relevant consideration amounts to a purpose or a main purpose is a question of significance

Consequences are relevant but not determinative

Motive is relevant but not determinative

In relation to a purpose to secure a tax advantage, factors of particular potential relevance in assessing significance include degree of attention, size of tax advantage, the position on net tax benefits and what would have happened ‘but for’ the tax advantage

A relevant consideration may amount to a main purpose; a purpose, but one which is not a main purpose; or not a purpose at all. This is a question of significance, to be assessed by reference to all the relevant facts and circumstances; and ‘main’ carries a connotation of importance. In particular:

something may be a long-term aim which is simply part of the background noise, or may be a purpose but not a material one

something which is icing on the cake will not be a main purpose

The consequences or effects of a transaction are likely to be relevant factors to be taken into account as part of an assessment of all the relevant circumstances, but they are not determinative of purpose, they are not the same as purpose. In particular:

in some cases, it may be a purpose to achieve a consequence or effect, even if the consequence or effect is not achieved

in some cases, if a consequence results, but is not consciously considered in advance, securing that consequence may not be a purpose

in some cases, unless it is incidental, if a consequence is an inevitable result (is inextricably involved), securing that consequence will be a purpose even if it is not consciously considered in advance

knowing or consciously taking into account or expecting that a particular consequence will result is relevant, but does not necessarily mean that it is a purpose or main purpose to secure that consequence

In assessing subjective intentions it is useful to consider motives and it may be helpful to ask the question why; however, motives are not necessarily the same as purposes, and subjective intentions are not limited to conscious motives.

There are a number of specific factors which may be relevant but are not determinative in the context of assessing the significance of the tax advantage in arrangements involving loan relationships:

the extent to which tax advantages are known or expected or taken into account, noting that knowing or expecting or taking into account the consequence/ effect that there will be a tax deduction for debt financing costs may, in particular, be relevant but not determinative; the degree of attention paid to securing the tax advantages

the size of the tax advantage, in particular in comparison to the size of commercial benefits (excluding UK tax benefits)

the impact on net UK tax benefits, or on net global tax benefits, where tax benefits takes its general sense (which is different from the specific legislative definition of tax advantage, see CFM38170 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38170) for more discussion)

whether or not the arrangements would have happened, or would have happened in a different way, had the potential for the tax advantage never existed, or ceased to exist in the course of developing the arrangements, that is, ‘but for’ the tax advantage

Many of these propositions were established in case law on the wholly and exclusively test or other purpose or object tests, but have been confirmed as applicable to the unallowable purpose rule.

Key case law quotes

Some key case law quotes in relation to these principles are set out below (as always, to be read in the light of the facts and circumstances of the case in question).

Versteegh v HMRC

In the FTT decision in Versteegh v HMRC, the FTT stated at paragraph 158:

In the same way that the mere presence of a commercial purpose cannot rule out the existence of tax avoidance as being a main purpose, the mere existence of a tax advantage, known to the taxpayer, does not on its own render the obtaining of that tax advantage a main purpose. All the authorities point to the question of being one of degree and significance to the taxpayer, and that the question is one of fact for the tribunal, having regard to all the circumstances.

Fidex v HMRC

At the UT level of this case, the UT stated at paragraph 110:

what you do with an asset may be evidence of your purpose in holding it, but it need not be determinative of that purpose. The benefits you hope to derive as a result of holding an asset may also evidence your purpose in holding it. A finding that such a hope exists may, depending on the circumstances, be sufficient for a finding that a purpose of holding the assets was the obtaining of that benefit.

TDS v HMRC

In TDS v HMRC, in which the shares in a subsidiary were a deemed loan relationship for the relevant period, the Court of Appeal stated at paragraph 41:

[w]hen determining what the company’s purposes were, it can be relevant to look at what use was made of the shares

and cited the comments in Fidex v HMRC approvingly.

The Court of Appeal in TDS v HMRC also commented at paragraph 46:

[h]ad the tax advantage in view been small, there might have been scope for argument as to whether an intention to use the shares to achieve it implied that obtaining the advantage was now a main purpose of holding the shares. In fact, however, the hoped-for gain was large both in absolute terms (more than £70 million) and relative to the apparent value of TDS (some £280 million). That being so, I agree … that the inescapable inference was that securing the advantage had become a main purpose of holding the shares.

They went on to hold at paragraph 48:

a ‘main’ purpose will always be a ‘more than trivial’ one, but the converse is not the case. A purpose can be ‘more than trivial’ without being a ‘main’ purpose. ‘Main’ has a connotation of importance.

Oxford Instruments v HMRC

In Oxford Instruments UK 2013 Ltd v HMRC [2019] UKFTT 0254 (TC) (Oxford Instruments v HMRC), the FTT pointed out that the question of establishing a main purpose to secure a tax advantage was different from just establishing the existence of a tax advantage, and that the existence of taxable matching income (no net tax benefit) could in some circumstances be highly relevant, see paragraph 112:

Of course, the fact that that matching income existed might well be highly relevant in considering whether securing the borrower’s tax advantage was the main purpose, or one of the main purposes, of the borrower in entering into the borrowing, but that is a quite separate question.

BlackRock v HMRC

In BlackRock v HMRC, the Court of Appeal summarised key points from leading case law on the wholly and exclusively test (the decisions of the House of Lords in Mallalieu v Drummond [1983] UKHL 57 TC 330 and MacKinlay v Arthur Young McClelland Moores & Co [1989] UKHL 62 TC 704; and of the Court of Appeal in Vodafone Cellular v Shaw (Inspector of Taxes) [1997] 69 TC 376). They went on to confirm that the key points were applicable to the unallowable purpose rule. The summary is in paragraph 124, and, in particular, in sub-paragraphs (b) to (e):

b) Object or purpose must be distinguished from effect. Effects or consequences, even if inevitable, are not necessarily the same as objects or purposes. c) Subjective intentions are not limited to conscious motives. d) Further, motives are not necessarily the same as objects or purposes. e) ‘Some’ results or consequences are ‘so inevitably and inextricably involved’ in an activity that, unless they are merely incidental, they must be a purpose for it.

The Court of Appeal went on to say at paragraph 150:

It is unrealistic to suppose that [the corporation tax relief available for interest and other expenses of raising debt] will not form part of ordinary decision-making processes about methods of funding a company. Indeed, it might well be wrong for directors to ignore that consideration in deciding what is in the best interests of the company concerned. … it cannot have been Parliament’s intention that the inevitable consequence of taking out a loan should engage the unallowable purpose rules, subject only to consideration of whether the value of the tax relief is sufficient to make it a ‘main’ purpose. Something more is needed….

and at paragraph 171:

It does not follow [from the conclusion that there was a main tax avoidance purpose on the case’s facts] that other debt incurred with a commercial acquisition … would fall foul of the unallowable purpose rule even if the decision to borrow had regard, as it often would, to tax considerations.

The Court of Appeal further commented at paragraph 162:

As Nugee LJ suggested in argument, a simple starting point in ascertaining a person’s purpose for doing something is to consider ‘why’ they did it.

Kwik-Fit v HMRC

In Kwik-Fit v HMRC, the Court of Appeal noted at a number of points that the existence of the non-trading deficits in the creditor company, which meant that there were net UK tax benefits from the arrangements as a whole, was relevant to finding there was a main purpose to secure the deductible debits. In particular, in paragraph 79, the Court of Appeal held that the FTT had found a single unallowable purpose, which comprised:

the generation of the deductions for the benefit of [relevant] group members in circumstances where the corresponding income was sheltered from tax by [the creditor company’s] brought forward non-trading deficits, so in effect freeing those trapped reliefs for use by [relevant members of the group].

Referring to the discussion in BlackRock v HMRC at paragraph 150, the Court of Appeal also stated at paragraph 85:

[t]he mere fact that a group organises its affairs in a manner that makes use of brought forward non-trading deficits and it expects to obtain relief for interest and other expenses of loan relationships, in each case as the legislation contemplates, cannot be enough to engage the unallowable purpose rule.

The Court of Appeal at paragraph 87 cited paragraph 53 of the High Court decision in Commissioners of Inland Revenue v Sema Group Pension Scheme Trustees [2002] EWHC 94 (Ch) (itself approved by the Court of Appeal decision in that case at paragraph 119), which said:

The tax advantage may not be a relevant factor in the decision to purchase or sell or in the decision to purchase or sell at a particular price. Obviously if the tax advantage is mere 'icing on the cake' it will not constitute a main object. Nor will it necessarily do so merely because it is a feature of the transaction or a relevant factor in the decision to buy or sell. The statutory criterion is that the tax advantage shall be more than relevant or indeed an object; it must be a main object.

The Court of Appeal went on to state that the passage:

rightly emphasised … that the significance of the tax advantage to the taxpayer must be considered with care … I would add that it should also be considered in the context of the relevant legislative code.

In considering the significance of matters put forward as commercial purposes by Kwik-Fit, the Court of Appeal found that there was an additional group purpose of simplifying intercompany balances, but that “this was not considered by the FTT to be material” (paragraph 88(b)); and that the stated long-term aim of reducing the number of dormant companies was “merely part of the background noise” (paragraph 88(b)).

The Court of Appeal stated at paragraph 95:

… identifying purpose requires a consideration of subjective intentions. That is necessarily a forward-looking exercise: broadly, what is sought to be achieved, not what is ultimately achieved.

JTI v HMRC

In JTI v HMRC, the Court of Appeal at paragraph 21 noted, citing the FTT:

Whilst these debits [from the UK interest deductions] would arise for UK tax, there would be no matching taxable receipt in the Cayman Islands, or in the US, or for UK tax purposes.

Paragraph 51 of the decision is already cited above: in particular, this included stating at paragraph 51(vi):

A Tribunal determining whether a company had a ‘tax avoidance purpose’ is not required to adopt a ‘tunnel-visioned’ approach looking simply at how the company was proposing to use the money it was borrowing.

At paragraph 55, citing IRC v Brebner, the Court of Appeal highlighted the “importance of the specific facts” and stated:

the fact that a genuine commercial transaction has been carried out in a tax efficient way does not necessarily [italics in original] mean that one of the main objects was to avoid tax. … The rule will be in point if, in the particular circumstances [italics in original], a main purpose was securing a tax advantage.

They went on to say at paragraph 85:

... The fact that regard was had to tax considerations when deciding to borrow will not necessarily involve falling foul of the unallowable purpose rule.

In each of the BlackRock, Kwik-Fit and JTI Court of Appeal cases, considering that the arrangements would not have happened in that way but for securing the tax advantage was a part of the analysis.

In relation to commercial purposes: there may be a commercial purpose and also a purpose to secure a tax advantage; the use of funds borrowed to acquire a commercial asset, commercial downsides, and directors determining that a transaction is in the company’s interests are all potentially relevant but not determinative

Purposes to achieve commercial benefits not related to tax at all, and to achieve tax benefits excluding UK tax, may be commercial purposes.

The courts have expressly stated (rejecting an argument sometimes put forward by taxpayers) that if a company has a commercial purpose it can also have a purpose, main or not, to secure a tax advantage: see the quote from Versteegh v HMRC above.

The above principles are generally applicable in determining commercial purposes. It is further worth noting some specific points on their application in the context of assessing commercial purposes.

Looking at the consequences or effects, that is usually the use made of funds borrowed (or of loan relationships held as assets), will often be relevant in assessing commercial (non-tax) purposes, but they are not determinative. The courts have expressly stated that where funds have been used to acquire a commercial asset, for instance, shares in a company, that is relevant but not determinative of the analysis of purposes: see BlackRock v HMRC, and JTI v HMRC. In particular, building on the view expressed in paragraph 51, in paragraph 72 of JTI v HMRC, the Court of Appeal expressly commented in relation to the use of borrowed funds to acquire a third- party target company: “a Tribunal is not required to adopt a 'tunnel-visioned' approach looking simply at how the company was proposing to use the loan”.

In looking at commercial (non-tax) consequences in assessing commercial purposes, it is likely to be relevant though not determinative to consider any commercial (non-tax) downsides as well as benefits. Such downsides can include management time and effort, and legal and professional fees paid to advisers.

Directors may be expected to act prudently, assessing whether or not a transaction is in the interests of the company, but directors coming to a conclusion that a transaction is in the interests of the company is potentially relevant but not determinative of whether or not there is a commercial (non-tax) purpose. In particular, many situations involve directors deciding to borrow in circumstances where the proceeds fund an acquisition: directors may assess what profits the acquisition is expected to generate, whether the acquisition is made at a fair price, and whether any debt associated with the acquisition is on arm’s length terms and is affordable (can it cover ongoing debt financing costs, can the debt be repaid if required?). Directors coming to a conclusion which satisfies them on these points is potentially relevant but not determinative of whether or not the purposes for which the company is party to the loan relationship include a commercial purpose of making the acquisition of the asset and/ or of generating profits net of financing costs.

BlackRock v HMRC and JTI v HMRC are examples of two cases where the courts came to different views on the commercial purposes of borrowing used to fund an acquisition.

In BlackRock v HMRC, the FTT had found that the borrowing company had a main commercial purpose (of “making and managing passive investments” (paragraph 121)). The Court of Appeal held this conclusion was correct: the company had a main commercial purpose (paragraphs 167 and 172). They found that the anticipated dividend flow from the acquisition of preference shares, even after the cost of servicing the loan relationships, meant that it was set to make “very significant profits”, which were more than simply a “(very welcome) consequence or effect”, they were a main commercial purpose (paragraph 172). (However, at the stage of attribution on a just and reasonable apportionment, all debits were attributed to the main tax avoidance purpose, and none to this commercial purpose, which “overall” was a by-product (see CFM38150 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38150))).

In JTI v HMRC, notwithstanding that the borrowing company used the funding to acquire the shares of the third-party target company, the Court of Appeal stated that there was no sufficient basis for interfering with the FTT’s decision. The FTT’s decision was that the company did not have a commercial purpose for which it was party to the loan relationship.

Choosing between different ways of carrying out a commercial transaction taking into account tax may, or may not, mean that there is a main purpose to secure a tax advantage

Different ways of carrying out a commercial transaction may be available. If a way is chosen which minimises tax, earlier case law on other purpose or object tests establishes that there may, or may not, depending on all the relevant facts and circumstances, be a main purpose of securing a tax advantage. It is necessary to look at all the facts and circumstances in the round.

A leading case on this is IRC v Brebner, in which the House of Lords considered whether choices made as to the way in which a commercial transaction was carried out meant that there was a main object of avoiding a tax advantage.

Lord Upjohn said, at page 718:

My Lords, I would only conclude my judgment by saying, when the question of carrying out a genuine commercial transaction, as this was, is considered, the fact that there are two ways of carrying it out – one by paying the maximum amount of tax, the other by paying no, or much less, tax – it would be quite wrong as a necessary consequence to draw the inference that in adopting the latter course one of the main objects is, for the purposes of the section, avoidance of tax. No commercial man in his senses is going to carry out commercial transactions except upon the footing of paying the smallest amount of tax involved.The question whether in fact one of the main objects was to avoid tax is one for the Special Commissioners to decide upon a consideration of all the relevant evidence before them and the proper inferences to be drawn from that evidence.

Accordingly, the judgment makes it clear that depending on the evidence and the inferences to be drawn from that evidence, where a taxpayer chooses between different ways of carrying out a commercial transaction so as to minimise tax, the taxpayer may, or may not, have a main object of obtaining a tax advantage.

In the circumstances of IRC v Brebner, and the particular objects test in question, the House of Lords saw no ground to overturn the Special Commissioners’ finding that the transactions in question were for bona fide commercial reasons and did not have as their main object, or one of their main objects, to enable tax advantages to be obtained.

By contrast, in the circumstances of The Commissioners for Her Majesty’s Revenue and Customs v Lloyds TSB Equipment Leasing (No 1) Limited [2014] EWCA Civ 1062, and the particular statutory test in question, the Court of Appeal held, at paragraph 65:

although the FTT was no doubt entitled to find that each transaction in the relevant series served a genuine commercial purpose, it does not follow that the obtaining of the capital allowances was incapable of also being a main object of the transactions, even if it was not the main object of the transactions… Even if each of the transactions was entered into for a genuine commercial purpose, it may still be the case that a main object of structuring them in the way they were was to obtain the capital allowances.

This question of the significance of taking into account the UK tax impact in choosing between several different alternatives for the structure of a commercial transaction often arises in the context of applying the unallowable purpose rule and can be a difficult question.

For instance, when a company is deciding a method of funding, in particular as between debt and equity, the availability of deductibility for interest is part of the ordinary decision-making process, but that does not necessarily mean that there is a main purpose to secure a tax advantage. Whether or not there is such a main purpose depends on the facts and circumstances as a whole.

Equally, it may be the case that when a group chooses a particular structure for a commercial transaction it has regard to tax considerations. In particular, choices around the involvement of a company, and its being party to a loan relationship, may be influenced by tax considerations. Although the unallowable purpose rule does not test the group purposes, it is likely as a matter of fact that some or all of the group’s purposes are relevant as influences in determining the directors’ purposes for the company for being party to the loan relationship (see CFM38125 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38125) for more detail). It is therefore likely to be relevant to consider the question of whether, in making its structuring choices for a commercial transaction, the group does, or does not, have a main purpose to secure particular tax consequences, and the company’s intended part from the group’s perspective in securing those tax consequences. That consideration should take into account all the facts and circumstances.

These questions were addressed in principle in BlackRock v HMRC, Kwik-Fit v HMRC and JTI v HMRC, as already cited above, and were particularly critical to the conclusions reached in BlackRock and JTI, see below.

What was concluded on purpose in Court of Appeal unallowable purpose cases

The conclusions on purpose in Fidex v HMRC and TDS v HMRC are covered in the sub-section above on change in purpose.

In BlackRock v HMRC the acquisition of the third-party target company by the group was commercially driven. Taking into account the wider context and on the evidence of the facts and circumstances in the case, the Court of Appeal held that the choices made on structuring the overall arrangements were such that from the group’s perspective the company’s role in being part of the arrangements was to play its part by securing the tax advantage. Equally, from the company’s perspective, the Court of Appeal held in paragraph 164:

[t]he board obviously understood what the Loans were intended to achieve... [The borrowing company’s] sole raison d’etre was to enter into the Loans to obtain tax advantages for the BlackRock group.

and in paragraph 171:

…[it] not only had no commercial rationale but had no real commercial function.

The Court of Appeal concluded in paragraph 192 that the company’s role was “to play the part that had been devised for it so as to obtain [a tax] advantage”.

As noted earlier, the Court of Appeal further held that the company also had a main commercial purpose, to make “very significant profits”, which were more than simply a “(very welcome) consequence or effect”. (However, at the stage of attribution on a just and reasonable apportionment, in the Court of Appeal the main commercial purpose of the company was characterised “overall” as a by-product, and not one to which any debits should be attributed (see CFM38150 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38150)), and all debits were disallowed.)

In JTI v HMRC, the acquisition of the third-party target company by the group was commercially driven. Taking into account the wider context and on the evidence of the facts and circumstances in the case, just as in BlackRock v HMRC, the Court of Appeal held that the choices made on structuring the overall arrangements were such that from the group’s perspective the company’s role in being part of the arrangements was to play its part by securing the tax advantage. Equally, from the company’s perspective, the company’s part in being party to the arrangements, and for which it was party to the loan relationship, was to play that role so as to secure the tax advantage. However, in JTI v HMRC, by contrast with BlackRock v HMRC, it was further held that the company did not have any commercial purpose at all. (At the stage of attribution on a just and reasonable apportionment, the Court of Appeal held all debits were to be attributable to the sole unallowable purpose and disallowed.)

In Kwik-Fit v HMRC, the Court of Appeal held at paragraph 79 that there was an unallowable purpose, which:

in shorthand terms was the ‘accelerated’ use of [the creditor company’s] losses, but in longhand comprises the generation of the deductions for the benefit of the [relevant group members] in circumstances where the corresponding income was sheltered from tax by [the creditor company’s] brought forward non-trading deficits, so in effect freeing those trapped reliefs for use by the [relevant group members].

The UT had found, and this was not appealed, that the existing loans had a main commercial purpose, to which the debits arising at the original level of interest should be attributed and therefore not disallowed. (At the stage of attribution on a just and reasonable apportionment, the final outcome was that all debits in relation to the new loans, and the debits arising from the increase in rates on the existing loans, were disallowed up to a cap, previously applied by HMRC, when the brought forward non-trading deficits were used up.)

Summary

From BlackRock v HMRC paragraph 162, cited in JTI v HMRC at paragraph 50:

…a simple starting point in ascertaining a person’s purpose for doing something is to consider ‘why’ they did it.

It is often appropriate to start with the question ‘why’ in assessing the purposes for which a company is party to a loan relationship, but it is necessary to consider all the facts and circumstances, taking into account all of the principles identified above.

Difficulty in the context of financing

A company acting commercially will normally consider the tax consequences of a transaction. It is a natural consequence of using debt financing that tax deductions will generally be available in respect of the interest costs, which means that tax advantages will be secured (see CFM38140 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38140)). Determining whether or not it is a main purpose to secure a tax advantage may be difficult in the context of financing in some situations.

The technical analysis in this section, and the practical guidance given in CFM38170 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38170)to CFM38200 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38200), including the relevant examples set out in CFM38190 (https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm38190), are intended to assist in making the determination as to whether or not there is a main tax avoidance purpose in the more difficult situations.