Originally published: April 2024
Last week, the UK court of appeal (CoA) issued a highly anticipated verdict in the Blackrock Holdco 5, LLC case on UK interest deduction rules (https://lnkd.in/eEFBCC6Z). For a discussion of the upper tribunal (UT) judgement, see here https://lnkd.in/enZgctmM. In this case, a UK resident company (LLC 5) took out a shareholder loan for a minority interest in a US target structure (the rest was held by LLC 5’s shareholder). The UT denied interest deduction was based on (1) transfer pricing (TP) rules, as a third party would have required a covenant for access to dividend flow from US target and (2) unallowable purpose as LLC 5’s existence was tax motivated (interest deduction, with losses to be group relieved). The wide, HMRC favourable reading on both parts caused controversy and doubts in practice.
On TP, CoA overturned the UT and argues there is no need to reject third party comparables for theoretical risks that do not apply in a group context. In other words, the loan is comparable to third party loans that where a borrower controlled the dividend flow (whether directly or though a group covenant). So, the TP unease seems mostly resolved.
On unallowable purpose, CoA limited the UT verdict by holding that only the purpose of the loan should be considered, inevitable consequences of the loan do not equate purpose and not all acquisition debt has an unallowable purpose. The taxpayer’s defence on this point was “It Never Entered My Mind” (https://lnkd.in/eNJdGzMQ) and indeed, CoA accepts that the board approved the structure on its non-tax merits. But, CoA concludes “[h]owever it might be dressed up, LLC 5 became a party to the Loans to obtain a tax advantage” and “[t]he board obviously understood what the Loans were designed to achieve”. CoA infers this from LLC 5’s place in the structure and the lack of LLC 5’s non-tax function in relation to the US acquisition – an inference CoA considers so strong that all interest cost had an “unallowable purpose”.
Purpose tests are always slippery. Mental states like purpose cannot be directly observed. CoA’s inferring purpose from abstract factors illustrates this and provides little comfort for future cases. Group structures usually include so many intertwined decisions and there will always be a risk of HMRC linking the minds of decision makers to an unallowable purpose. As firm conclusions usually appear impossible, conservative taxpayers will not assume interest deduction. Ironically, that might help. An overly simplified description of these rules highlights the underlying paradox: as long as you don’t think you’ll get a deduction, your deduction is safe.
Obvious disclaimers: this is not advice. These views are my own and do not necessarily represent my employer.
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