No joy for JTI, but whose purposes are unallowable?

The ‘unallowable purpose’ rule is an anti-avoidance measure that disallows tax deductions in respect of payments made under loan relationships or derivative contracts, to the extent that such deductions are attributable – using a ‘just and reasonable apportionment’ – to a purpose that is defined as ‘unallowable’. If the main or one of the main purposes for which a company is party to a loan relationship (or enters into a related transaction) is to obtain a tax advantage, whether for that company or for someone else, then the legislation treats that purpose as ‘unallowable’.

Following judgments in BlackRock [2022] UKUT 199 (TCC) and Kwik-Fit [2022] UKUT 314, the Upper Tribunal’s decision in JTI Acquisitions [2023] UKUT 194 (TCC) is the latest episode in the drama, and it will be regarded by many tax practitioners as decisively widening the scope of the rule.

The facts in JTI are similar to those in BlackRock, inasmuch as they concern the interposition of a UK-resident company in the acquisition structure for a US-US acquisition. Here, Joy Global, a US-headed group, acquired another US-headed group for $1.1bn. A financing structure was established whereby a newly incorporated, UK tax resident company was interposed as the acquisition vehicle, with a view to generating UK tax deductions on the debt financing for the acquisition. A check-the-box election was made for US tax purposes, so as to create a hybrid mismatch in respect of the interest payments. The anti-hybrids rules have since been tightened, but the mismatch may have fuelled HMRC’s determination to win its argument on the unallowable purpose issue.

The First-tier Tribunal found that the loan had an unallowable purpose – because the UK company had been included in the structure in order to obtain UK tax deductions – and it apportioned all of the debits to that purpose. The Upper Tribunal has upheld that decision (in all but the most minor respects), and I would like to focus here on a specific aspect of its reasoning.

It is worth considering whether the rule can really have been intended to disallow all debits in cases where the taxpayer has a main commercial purpose in being party to the loan, but both the taxpayer and the loan owe their very existence to group tax planning (as they did both in BlackRock and in JTI). The Upper Tribunal’s decision in JTI answers that question with a confident ‘yes’, but its reasoning does not entirely seem to resolve the interpretative conundrum which underpins that question, namely: what evidence should be used to determine purpose?

The legislation talks about the purposes ‘for which’ the company is a party to the loan. A thing cannot have an intrinsic purpose; people create or use things for purposes, and different people can use the same thing at the same time for different purposes. So, the purpose of something cannot be tested in the abstract; we must define whose purposes matter.

It was held in Travel Document Service [2018] EWCA Civ 549 (TDS) that the company’s own subjective purposes (as expressed principally through its board of directors) are what matter here. And that makes sense. It would be very difficult for the taxpayer to apply the rule in practice if it had to take account of other people’s purposes (how would it necessarily know about them?). Moreover, the definition of an ‘unallowable purpose’ is one which ‘is not amongst the business or other commercial purposes of the company’. By definition, other people’s purposes are not amongst the company’s own purposes, so it would seemingly be impossible to argue for an interpretation that expressly operates by reference to the wider group’s purposes.

In JTI, the taxpayer sought to build upon that logic by arguing that, by referring to ‘a loan relationship of a company’, the legislative provisions presuppose the existence of a company and the existence of a loan relationship of that company. Those are ‘givens’. Therefore, the rule cannot apply solely because the taxpayer and the loan would not have existed but for the wider group’s tax planning purposes.

The Upper Tribunal dismissed that argument, but in terms which, in my view, do not obviously put it to bed. It clearly thought that the rule ought to apply here, but it could not realistically have departed from the subjective test outlined in TDS. This leads to a conclusion in para 42 which seems to leave considerable room for doubt about its implications:

‘The other company’s / group’s perspective is relevant to the taxpayer company’s purpose because it informs the determination of the particular taxpayer company’s purpose.’

And why does this matter? Because these cases are, in the end, all about the court’s assessment of the evidence – its ability to infer the company’s subjective purposes from the documentary record and witness evidence – and how the relevant purposes are circumscribed has a bearing on the evidence that is admissible and how much weight should be accorded to different types of evidence.

As with the best television series, in tax there is always a plot twist around the corner. I suspect, therefore, that the ‘group purpose’ arguments may yet encounter further antagonists before the grand finale.