Court of Appeal decision shows how ‘unallowable’ tax relief purposes will be considered

The decision(46 pages /465 KB) highlights that in all but obvious cases it is necessary to “look into the mind” of a taxpayer in order to determine whether tax is a “main purpose”.

Jake Landman, tax law expert at Pinsent Masons, said the recent decision showed “the Court of Appeal is keen to emphasise that subjective intentions are not limited to conscious motives and, when assessing main purpose, the fact-finding tribunal will look at various aspects to establish purpose and object not just relying on what a decision maker says was their thinking.”

“The court was however careful to emphasise that debt incurred in connection with a commercial acquisition would not necessarily fall foul of the unallowable purpose rule even if regard had been given to tax considerations in the decision,” he said.

In 2009, BlackRock Group acquired the worldwide business of Barclays Global Investors, a US business, for around $13.5 billion. This resulted in formation of BlackRock 5, a limited liability company resident in the UK, funded by $4 billion worth of loans from another group entity based in the US.

BlackRock 5 claimed tax relief for interest costs arising from the loans and sought to surrender the resulting tax losses to other members of the BlackRock group to set against the profits of their UK operations.

The deductibility of debt finance as a form of tax relief is important for businesses. However, there are a number of restrictions on deductibility, including the corporate interest restriction, transfer pricing, and anti-avoidance measures such as the unallowable purpose rules in the loan relationships regime.

In this case, HMRC challenged the deductions on two grounds. HMRC claimed that the intra group loans would not have been made between two independent parties, meaning the deductions should be denied under the transfer pricing rules. HMRC also claimed that the relief should be denied under the unallowable purpose rule on the basis that securing a tax advantage was the main purpose of the relevant loans.

The first-tier tribunal did not agree with HMRC and held that two independent businesses would have entered into a loan subject to there being certain covenants and preferred the evidence of one of the experts that such covenants would have been forthcoming in a third-party situation. It was also found that Blackrock had both a tax avoidance and a commercial purpose for entering into the loan relationship but that on a just and reasonable apportionment all of the deductions should be allocated to the commercial purpose and therefore be allowed.

The upper tribunal reversed the first-tier decision on both the transfer pricing and unallowable purpose issues before BlackRock appealed to the Court of Appeal.

The Court of Appeal’s decision was that, when applying the UK transfer pricing rules, account could be taken of certain OECD guidance such that third party covenants could be hypothesised in an intra group situation and therefore the deductions could not be challenged on transfer pricing grounds. However, the court concluded that the unallowable purpose rule applied to deny the relief due to tax being a main purpose and all the debits being apportioned to it on a just and reasonable basis.

The Court of Appeal considered that, when assessing whether there was a tax main purpose, the first-tier tribunal had been wrong in doing nothing more than finding that the tax advantage was an inevitable consequence of the loan. For tax to be a main purpose more was required and there should be a further factual assessment.

The court said that whilst there were sound reasons for BlackRock’s board to leave tax out of account in approving the transaction this was not enough in assessment of purpose.  Although the court highlighted that the purpose of the existence of an entity is separate from the purpose the entity has in entering into the loans, in this particular case, BlackRock 5 had no other function and existed solely to enter into the loans, which means that its main purpose was to enter into the loans in order to obtain tax advantages for the group. It meant that the court also found that 100% of the debits should be apportioned to the unallowable purpose.

“The court was focused on the special features of the BlackRock structure and transaction, in particular the insertion of a debt-funded UK entity into an otherwise equity funded US commercial transaction. If, like is the case in many debt funding situations, there hadn't been these particular features this may have led to a different result around tax main purpose,” said Landman.