UK and International Tax news
Court of Appeal Hears Another Unallowable Purpose Case
Sunday 30th June 2024
The Court of Appeal has given its judgment in another case involving the disallowance of interest paid on intra group borrowing following an intra group debt reorganisation.
In Kwik-Fit Group Ltd and others v HMRC [2024 EWCA Civ 434], the appellants were members of the Kwik-Fit group of companies (the “Kwik-Fit group”). The appeal concerned a reorganisation of intra-group debt in which they participated in 2013, following the group’s acquisition in 2011 by a Japanese company, Itochu Corporation. Under the reorganisation, a number of intra-group receivables owed by the Appellants were assigned to an intermediate holding company within the Kwik-Fit group, Speedy 1 Limited (“S1”), and certain additional receivables were created in S1’s favour. The interest rates on the amounts owed to S1 were also increased to reflect arm’s length rates at the time.
The reorganisation was devised principally to get round pre 2017 loss offset restrictions applying to non trading loan relationship deficits. For a non-trader like S1, an excess of loan relationship debits over loan relationship credits is a non-trading deficit (per s.301 CTA 2009). For the accounting periods in question, a non-trading deficit that could not be used against other profits or surrendered by way of group relief in the year that it arose was automatically carried forward to offset future non-trading profits of the company per s.457 CTA 2009. Before the rules changed with effect from 1 April 2017, there was no scope for a carried forward non-trading deficit to be surrendered to other members of the group. Instead, it was trapped in the company in which it arose and could be used only against its own non-trading profits.
S1 had £48m of non-trading loan relationship deficits carried forward from earlier periods, which would offset S1’s interest income. The Appellants could use the tax relief in respect of their interest liabilities or surrender by way of group relief to reduce the taxable profits of other members of the group. As the FTT found, the effect of the reorganisation was to use up the non-trading deficits in under three years rather than the group tax manager’s previous estimate of around 25 years.
HMRC held the view that the reorganisation engaged the unallowable purpose rule in s.441 CTA 2009 and largely disallowed the Appellants’ claims to tax relief on the interest income in respect of the accounting periods ended 31 March 2014, 2015 and 2016, capping the disallowance at the amount of S1’s non-trading deficits.
The Appellants appealed to the FTT which agreed with HMRC about the existence of an unallowable purpose but allowed the appeal in part by permitting the deduction of interest on pre-existing loans to the extent that it corresponded to the rate at which interest was charged before the reorganisation. The Upper Tribunal agreed with the FTT and dismissed appeals by both the Appellants and HMRC.
The Appellants appealed to the CA on the grounds that the FTT and UT had erred in holding the Appellants had an unallowable purpose in becoming or remaining parties to the relevant loan relationships, and that the accelerated utilisation of S1’s valid and unrelated non-trading deficits was a tax advantage for S1, and therefore that the Appellants thus had a main purpose of conferring a tax advantage on S1.
In addition, the FTT and UT erred in concluding that the Appellants’ purpose was to obtain a tax advantage for themselves, being deductible debits, in circumstances where there was no finding of a reduction in tax charges in the Appellants and nor was it put that securing a tax advantage for themselves or another person was a purpose. The Appellants’ subjective intention was confined to accelerating the use of S1’s non-trading deficits, and that could not be conflated with knowledge that the Appellants would obtain deductible debits.
The Appellants accepted that the reorganisation had a purpose of using S1’s brought forward losses but that was not a tax advantage because S1 was not better off as against HMRC as a result.
HMRC’s case had always been that the main purpose was to secure a tax advantage for S1, being the use of its losses and sought to apply the unallowable purpose rule to commercial loans on which interest was charged at an arm’s length rate. However, the effect of the transfer pricing rules was mandatory, requiring interest to be charged at an arm’s length rate on the debt, was relevant statutory context. S1 had used existing genuine losses against its interest income, precisely what the statutory code envisaged.
After a detailed analysis by the Court, which included consideration of certain points raised in the cases of Sema and Kleinwort Benson, it rejected the appellants submissions and held that the main purpose of increasing the interest rates on the assigned and existing loans was a tax avoidance purpose, as was the main purpose of entering into the new loans. It also considered that the expanded group relief available post reorganisation also had a tax avoidance motive.
The Court accordingly dismissed the appeals.
If you would like more information on the above decision, please contact Keith Rushen on 0207 486 2378.
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