There is a potential additional hurdle to clear if interest on intra-group debt is to be tax deductible in the UK.
In BlackRock Holdco 5, LLC v HMRC [2022] UKUT 199 (TCC), the borrower (LLC5) was a UK tax resident Delaware LLC in the BlackRock group of companies. It was created and used as part of the structure to acquire the North American investment management business of Barclays Global Investors from Barclays Bank plc in December 2009. LLC5 borrowed $4bn from its US parent (LLC4) by way of an issue of loan notes and sought to claim deductions from its UK corporation tax profits in respect of the interest and other expenses payable on the loans. HMRC challenged this on two main grounds, one of which was based on the UK’s transfer pricing rules.
Before the Upper Tribunal, HMRC argued that a hypothetical lender acting at arm’s length would not have made loans in the same amount and on the same terms as between LLC4 and LLC5. The potential UK tax advantage in the shape of the tax deductions for the financing costs should therefore be disallowed applying transfer pricing.
At first-instance, the First-tier Tribunal (FTT) had found that an independent lender acting at arm’s length would have made loans to LLC5 in the same amount and on the same terms as to interest as the loans actually made by LLC4. However, an arm’s length lender would have required additional covenants in order to make such loans, which were not included in the terms of the actual loans. Some of these covenants would have been from LLC5 as borrower. But others, such as negative pledges, change of control covenants, restrictions on further borrowing and undertakings not to interfere with dividend flows, would have been needed from other group companies.
The FTT had found that these additional third-party covenants would have been given had they been asked for. A key question for the Upper Tribunal on appeal was therefore whether this allowed these covenants to be read in to the arm’s length transaction with which the loans fell to be compared.
The Upper Tribunal held that it did not. Importing third-party covenants that did not exist in the actual transaction into the comparator arm’s length transaction changed the nature of what was being compared and was not permissible. This would essentially be comparing a different transaction to the actual one. It therefore followed that the loans differed from the arm’s length provision in that they would not have been made at all as between an independent lender and borrower, allowing HMRC to succeed.
The wider impact of these findings of the Upper Tribunal on transfer pricing remain to be seen for at least two reasons:
an appeal to the Court of Appeal seems likely; and
aspects of the facts were unusual. In particular, LLC5 did not control the companies below it in the structure. Might the answer have been different if it had (such that LLC5 could procure that they acted in accordance with its wishes)?
Significantly, the case also raises questions as to whether, and how, the Upper Tribunal’s interpretation of the UK transfer pricing legislation can be reconciled with the OECD’s transfer pricing guidelines as they stood at the time of the BlackRock transaction, and the arm’s length principle. The former have developed since then and now recognise that if the economically relevant characteristics of the transaction are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated in accordance with the characteristics of the transaction reflected in the conduct of the parties. How would this requirement for ‘accurate delineation’ of the actual transaction outside the terms of the written contract now sit with the finding that no third-party covenants can be read in?
In our view, the decision does not necessarily require intra-group loans to now be documented using full arm’s length facility agreements to achieve tax-deductibility. Indeed, the Upper Tribunal itself warned against groups trying to manipulate transactions by including wholly unnecessary covenants that attempt to anticipate what would be required by an independent lender.
Instead, careful consideration of the terms of intra-group borrowings, both current and future, will be needed if the financing costs are to be tax-deductible. It is clear that this extends beyond benchmarking the rate of interest, and determining an appropriate level of debt, and will be particularly acute in cases where the borrower does not have control over the amounts it needs to receive to service the debt.
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BlackRock: the transfer pricing aspects
There is a potential additional hurdle to clear if interest on intra-group debt is to be tax deductible in the UK.
In BlackRock Holdco 5, LLC v HMRC [2022] UKUT 199 (TCC), the borrower (LLC5) was a UK tax resident Delaware LLC in the BlackRock group of companies. It was created and used as part of the structure to acquire the North American investment management business of Barclays Global Investors from Barclays Bank plc in December 2009. LLC5 borrowed $4bn from its US parent (LLC4) by way of an issue of loan notes and sought to claim deductions from its UK corporation tax profits in respect of the interest and other expenses payable on the loans. HMRC challenged this on two main grounds, one of which was based on the UK’s transfer pricing rules.
Before the Upper Tribunal, HMRC argued that a hypothetical lender acting at arm’s length would not have made loans in the same amount and on the same terms as between LLC4 and LLC5. The potential UK tax advantage in the shape of the tax deductions for the financing costs should therefore be disallowed applying transfer pricing.
At first-instance, the First-tier Tribunal (FTT) had found that an independent lender acting at arm’s length would have made loans to LLC5 in the same amount and on the same terms as to interest as the loans actually made by LLC4. However, an arm’s length lender would have required additional covenants in order to make such loans, which were not included in the terms of the actual loans. Some of these covenants would have been from LLC5 as borrower. But others, such as negative pledges, change of control covenants, restrictions on further borrowing and undertakings not to interfere with dividend flows, would have been needed from other group companies.
The FTT had found that these additional third-party covenants would have been given had they been asked for. A key question for the Upper Tribunal on appeal was therefore whether this allowed these covenants to be read in to the arm’s length transaction with which the loans fell to be compared.
The Upper Tribunal held that it did not. Importing third-party covenants that did not exist in the actual transaction into the comparator arm’s length transaction changed the nature of what was being compared and was not permissible. This would essentially be comparing a different transaction to the actual one. It therefore followed that the loans differed from the arm’s length provision in that they would not have been made at all as between an independent lender and borrower, allowing HMRC to succeed.
The wider impact of these findings of the Upper Tribunal on transfer pricing remain to be seen for at least two reasons:
an appeal to the Court of Appeal seems likely; and
aspects of the facts were unusual. In particular, LLC5 did not control the companies below it in the structure. Might the answer have been different if it had (such that LLC5 could procure that they acted in accordance with its wishes)?
Significantly, the case also raises questions as to whether, and how, the Upper Tribunal’s interpretation of the UK transfer pricing legislation can be reconciled with the OECD’s transfer pricing guidelines as they stood at the time of the BlackRock transaction, and the arm’s length principle. The former have developed since then and now recognise that if the economically relevant characteristics of the transaction are inconsistent with the written contract between the associated enterprises, the actual transaction should generally be delineated in accordance with the characteristics of the transaction reflected in the conduct of the parties. How would this requirement for ‘accurate delineation’ of the actual transaction outside the terms of the written contract now sit with the finding that no third-party covenants can be read in?
In our view, the decision does not necessarily require intra-group loans to now be documented using full arm’s length facility agreements to achieve tax-deductibility. Indeed, the Upper Tribunal itself warned against groups trying to manipulate transactions by including wholly unnecessary covenants that attempt to anticipate what would be required by an independent lender.
Instead, careful consideration of the terms of intra-group borrowings, both current and future, will be needed if the financing costs are to be tax-deductible. It is clear that this extends beyond benchmarking the rate of interest, and determining an appropriate level of debt, and will be particularly acute in cases where the borrower does not have control over the amounts it needs to receive to service the debt.
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