New HMRC guidance on ‘unallowable purpose’
HMRC have refreshed their guidance on the restriction for interest deductions for loans with an ‘unallowable purpose’
Guidance clarifies deductibility of interest
The ‘unallowable purpose’ rule operates to restrict the deductibility of interest for UK corporation tax purposes, particularly if obtaining UK tax deductions is a main purpose of the borrower being party to the underlying loan. Part of the UK tax code for over a quarter of a century, this rule has recently been thrust into the limelight by a perceived increase in HMRC’s readiness to argue for its application to the financing of commercial transactions, backed up by repeated successes in litigation. This has created considerable uncertainty as to the precise scope of the rule and the extent to which it is acceptable to factor UK tax consequences into the design of the financing arrangements for a business or planned acquisition. In this context, HMRC’s refresh of their published guidance (which had been largely unchanged since the rule’s introduction) will be of keen interest to everyone involved in company financing or acquisition structuring.
The new guidance is significant as it provides valuable insight into HMRC’s current thinking on when the unallowable purpose rule might apply to restrict UK tax deductions for interest.
It is important to remember, however, that this is an area in which things are continuing to evolve, with important litigation ongoing: the Upper Tribunal’s decision in JTI Acquisition is imminent and the Court of Appeal is due to hear the taxpayers’ appeals in the BlackRock and Kwik-Fit cases during the first half of next year.
That matters, firstly because aspects of the new guidance may itself be superseded by events in a relatively short space of time, and, secondly, because the ongoing litigation appears to have influenced some aspects of how the guidance is drafted. For example, the guidance (unsurprisingly) reflects the stance adopted by HMRC on various points which are at issue in the live cases.
This means that the guidance takes the view that the directors of a company will usually be aware of broader ‘group purposes’ and take these into account in their decision making - so that, for instance, the reason a particular company is part of an acquisition structure at all can be a critical fact when deciding if the rule applies. That is a point HMRC has so far been successful in arguing before the Tribunals, but the guidance also notes the possibility of a ‘subconscious purpose’ to obtain a tax advantage – an idea which the Tribunals have typically rejected.
HMRC’s guidance is not binding on taxpayers and a taxpayer’s ability to hold HMRC to published guidance depends on its ability to establish a legitimate expectation as a matter of public law. Nonetheless, it is worth remembering that the Uncertain Tax Treatment regime can impose a disclosure obligation on taxpayers diverging from HMRC’s known position – even if that position is subject to challenge in the courts. The carrot of additional insight into HMRC’s view on how to approach the ‘unallowable purpose’ rule therefore comes with the potential stick of greater practical consequences in the form of HMRC challenge for deviating from that approach. It will therefore be important for taxpayers to understand how positions they are taking in relation to existing or proposed financing arrangements correspond to the new guidance – if necessary, obtaining or refreshing advice.
The ongoing litigation perhaps also goes some way to explaining the relatively limited guidance in some areas. The most prominent of these relates to the fact that, if the ‘unallowable purpose’ rule applies, then its effect is to require a disallowance of amounts which on a ‘just and reasonable apportionment’ are attributable to the ‘unallowable purpose’. What exactly constitutes a ‘just and reasonable apportionment’ in all but the most straightforward case is – and sadly largely remains – shrouded in mystery, with HMRC’s discussion abruptly ending in a reference to the ongoing cases.
Notwithstanding the various points noted above, the guidance is likely to be warmly received by many taxpayers. It offers a considerably more systematic approach to thinking about the ‘unallowable purpose’ rule than the guidance it replaces, drawing together key themes from the case law as this currently stands, and reflecting a generally pragmatic approach to assessing risk with a number of helpful examples. Importantly, it acknowledges that tax considerations will inevitably be taken into account in financing decisions and that even when these sway key decisions it does not automatically follow that tax relief should be denied.
Whilst not lessening (and arguably increasing) the importance of properly considering the ‘unallowable purpose’ rule, HMRC will be hoping that the guidance goes some way to allaying fears that worries over its application could impede investment and also lead to a greater consistency of approach.
