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HMRC wins 'unallowable purpose' case

Out-Law News | 30 May 2019 | 12:00 am | 6 min. read

A UK company had an 'unallowable purpose' in issuing a promissory note and therefore could not deduct the interest payable to a US group company, the First-tier Tribunal in the UK has decided in a case concerning a company in the Oxford Instruments group.

The judge said (42-page / 631KB PDF) there was an unallowable purpose even though the arrangements, which related to the restructuring of a US sub-group, had been designed to be tax neutral as far as the UK group was concerned.

"The mere fact that a transaction happens to result in a net neutral tax position….does not mean, in and of itself, that there has been no “tax advantage”….In a case where that net neutral or net positive tax position arises as a result of both the generation of income and the generation of deductions, the deductions are still reliefs from tax pursuant to which the amount of income giving rise to tax is reduced," the judge said.

"This case deals with a number of issues around the application of purpose tests which will be of interest and if an appeal proceeds that will be keenly tracked," said Jake Landman, a tax disputes expert at Pinsent Masons, the law firm behind Out-Law.com.

"Important issues considered included whether the burden is on HM Revenue & Customs (HMRC) in such appeals, whether purposes of other group companies are relevant, the limited circumstances when the purposes of a tax advisor can usurp those of a company and whether a commercial consequence can be described as just an inevitable effect and therefore not a purpose," he said.

Landman Jake

Jake Landman

Legal Director

This case deals with a number of issues around the application of purpose tests which will be of interest and if an appeal proceeds that will be keenly tracked.

As part of the refinancing of Oxford Instrument's US sub-group in 2013, a 'tower structure' was recommended by accountancy firm Deloitte. At its simplest a tower structure typically involved a UK company being 'sandwiched' between two US companies and for interest to be paid by the lowest UK company. The UK company would be a hybrid entity, regarded as a company in the UK and as a branch in the US. This meant that interest could be paid which was not taxable in the hands of the recipient US company and an US interest deduction could be obtained when interest was paid to the UK group.

In Oxford Instruments' case, following a series of transactions, the UK company claimed an interest deduction for interest which had accrued on a £140 million promissory note, issued in connection with a subscription for preference shares by the company. HMRC denied the deduction on the basis that the company's main purpose in entering into the loan was to obtain a tax advantage; an 'unallowable purpose' within an anti-avoidance provision in the loan relationship tax legislation, section 441 of the Corporation Tax Act 2009.

Oxford Instruments challenged that there was an unallowable purpose. It argued that the structure left the Oxford Instruments group 'flat' for UK tax purposes, with debits in the appellant company matched with credits in another UK group company.

The judge said that the purpose to be considered was that of the directors of the relevant company. He dismissed arguments from HMRC that the purpose of Deloitte, the company's tax adviser or of the company's ultimate parent company (OI Plc) was relevant as there was no evidence that the directors had ceded to Deloitte de facto control of the company or were acting as the "puppets" of OI Plc.

The judge found that the sole purposes of OI Plc, in procuring the implementation of the scheme, were to achieve certain US commercial objectives and to do so without increasing the net taxable income of the Oxford Instruments group in the UK. However, by the time the directors of the appellant company came to be considering whether the company should subscribe for preference shares in a US group company in exchange for issuing the promissory note (described as step 8 of the scheme), the US objectives had been achieved and therefore could not be one of their purposes.

Taking part in the arrangements meant that the appellant company made a profit of around 2.6% a year on the spread between the dividends it obtained on the preference shares and the interest on the promissory note. However, the judge said that the spread was "simply an inevitable known consequence (or effect) of (Oxford Instruments') participation in step 8 of the Scheme but not any part of [its] purpose in so doing".

He said that the spread was "the means of justifying the step within the context of the Scheme as a whole but it was not the driver for the step". He said it was not "in any meaningful sense" a purpose of the company in issuing and remaining party to the promissory note. He said the sole purpose of the company in so doing was to generate the necessary deduction to surrender to the member of the group receiving taxable income as a result of the restructuring.

"In my view, [Oxford Instruments'] only purpose in issuing, and remaining party to, the $140m Promissory Note was to secure a tax advantage for OIOH 2008 Ltd [the other group company] and that therefore Section 441 of the CTA 2009 applies to it in relation to the note," Judge Tony Beare said.

He said that even if he was wrong and obtaining the spread was a purpose, all of the debits arising in respect of the promissory note should be apportioned to the tax advantage purpose so that the deduction would be denied.

"Even if the obtaining of the spread could be said to be a purpose of [Oxford Instruments] in that sense, it is clear that that purpose was just a means to secure the tax advantage purpose and not a self-standing purpose in its own right. It was, in effect, a necessary stopping point in the journey to the desired ultimate destination but was never a destination in its own right. [Oxford Instruments] would never have implemented the transactions comprising step 8 of the Scheme solely in order to obtain the spread and in the absence of the tax advantage to which those transactions were intended to give rise," he said.

However, he did say that if he had found as a fact that, in addition to the tax advantage main purpose [Oxford Instruments] had had a purpose of achieving the US objectives and/or obtaining the spread as part of its main purposes in issuing, and remaining party to, the $140m Promissory Note, none of the debits arising in respect of the promissory note would be attributable to the tax advantage main purpose and so the deductions would have been allowable.

As to whether HMRC or the taxpayer has the burden of proof in relation to the unallowable purpose rule, the judge said that as there was nothing in the language of the provision to indicate that HMRC have to establish that the taxpayer has an unallowable purpose, the burden of proof was on the taxpayer.

"I am inclined to consider that, as is the case with every other appeal against a closure notice in relation to UK corporation tax, it is for the taxpayer to show that the notice, and the consequent amendments to its company tax return, are incorrect and therefore that the burden of proof in this case is on [Oxford Instruments]", the judge said.

In 2013, when the planning was implemented, the UK's anti-arbitrage rules could limit tax deductions in relation to hybrid structures, but only where the purpose of the arrangement was to reduce UK tax. Oxford Instruments obtained a clearance from HMRC that the anti-arbitrage provisions would not apply on the basis that they would disclaim some of the available interest deductions. However, the clearance made it clear that it only applied to the anti-arbitrage provision and not to any other anti-avoidance provision.

In a postscript at the end of the decision the judge expressed sympathy for Oxford Instruments since because of the anti-arbitrage clearance it had entered into the structure believing it had the blessing of HMRC. He said he was satisfied that HMRC's subsequent challenge had come about as a result of a change in its view as to the application of the unallowable purpose rule to tower structures but expressed the view that if HMRC had been intending when they gave their clearance to mount an unallowable purpose challenge to the structure then "notwithstanding the disclaimer at the end of [HMRC's] clearance letter, it would have been misleading for [HMRC] to have provided the clearance which they did".

"Purpose tests occur throughout the tax code and HMRC are increasingly looking to test the scope of such anti avoidance provisions. HMRC is trying to apply such provisions to more transactions where the consensus has been they should not apply," Jake Landman said.