The recent Upper Tribunal (“UT”) decision in JTI Acquisitions Company (2011) Ltd v HMRC [2023] UKUT 194 (TCC) has further illuminated the interpretation and application of the “unallowable purposes” rule in the UK’s loan relationships legislation.  The unallowable purposes rule serves to deter and counteract tax avoidance involving loan relationships. A slate of cases considering the unallowable purposes rule, including JTI Acquisitions, has been progressing through the UK courts over the last five years.

Under the UK’s loan relationships legislation, a tax deduction is denied in respect of an accounting period to the extent that the interest on a loan relationship is, on a just and reasonable basis, attributable to an unallowable purpose or intention.  An unallowable purpose includes a main purpose of securing a tax advantage for the company claiming the tax deduction (sections 441 – 442 Corporation Tax Act 2009).  In any litigation, the tribunal or court is required to determine on the facts of the case whether the main purpose of a company (or one of its main purposes) in entering into a loan relationship is for commercial reasons, or to obtain a tax advantage.

Background Facts

• JTI Acquisitions Company Limited (“JTI”) had been incorporated in the UK as a subsidiary of a US group. JTI was established to acquire a non-UK target company in a commercial acquisition.
• The US group provided loan finance to JTI for the acquisition. The loan was subsequently assigned to a Cayman finance company, with the loan notes listed on the Cayman Islands stock exchange to qualify as a quoted Eurobond.
• No interest income was recognised in the United States (“US”) as JTI and the Cayman finance company were treated as disregarded entities for US tax purposes.
• As part of the complex financing arrangements, the non-trading loan relationship debits recognised by JTI were claimed as group relief by members of the same UK tax group as JTI.

The First-tier Tribunal (“FTT”) held that debits on the interest-bearing debt should be denied, as the main purpose of JTI in being a party to the loan relationship was to achieve a UK tax advantage. The UT dismissed the taxpayer company’s appeal (on all decisive points) against the FTT’s decision.

Decision of the UTT

The focus for the taxpayer company at the appeal before the UT was on the commercial purpose for which the loan relationship had been created.  Some commercial aspects of the transaction were obvious and visible: namely, the acquisition of the third-party target company with the purchase being funded by borrowings at an arm’s length rate of interest.  The appellant company argued before the UT that its purpose in obtaining the borrowing, and therefore generating loan relationship debits to surrender as group relief, had been a commercial one. 

The UT held otherwise.  The appellant had secured a tax advantage.  Although that advantage was “localised” in the UK (paragraph 138 of the judgement), it was an advantage which flowed from a complex financing arrangement with international elements.  The borrowing by the appellant company in the UK was an “essential feature” which was brought into existence by the wider financing “scheme.”  The UT determined that the words of the unallowable purposes test focused on why JTI was party to the loan relationship.  Additionally, that required consideration of why the borrower was JTI, and not someone else.  Answering that question brought into consideration the wider, carefully structured financing scheme which encompassed more of a tax-driven dynamic (in the form of a nine-step plan, termed a “skinny” in the case evidence). 

Any group purpose was not, in itself, determinative.  But the UT held that the awareness by the directors of JTI of the wider group purpose, including the arrangement of the international elements of the financing scheme, could be a relevant factor in the determination of JTI’s own purpose.

What’s in a director’s mind?

The test of a company’s purpose for the purposes of the loan relationships code is a subjective one, expressed through the “directing minds” of that company’s directors.  The directors’ intentions in deciding to implement a transaction are therefore of critical importance.  The UT considered that the “key personnel” whose directing minds were relevant included not just directors of JTI (in the UK) also of JTI’s ultimate parent in the wider US group (paragraph 148 of the judgement). 

There had been no genuine decision making in the UK regarding the raising of loan finance for the acquisition.  Instead, the decision makers had been located in the United States.  The US decision makers’ intention had been for JTI to be part of the wider scheme of securing a UK tax advantage by creating a loan relationship which could generate debits for UK group members by way of group relief. 

The importance (and difficulties) of oral evidence

The oral evidence of the key director of JTI was, essentially, ignored as being “vague, elusive, lacking in substance, contradictory to the factual matrix and ultimately unconvincing” (paragraph 155 of the judgement, citing the FTT judgement).  Reading the UT’s decision, it is hard not to draw an inference that the views of the tribunal regarding the oral evidence presented were coloured by other parts of the “factual matrix” being examined in the case, particularly the transaction documents and tax structuring advice in the “skinny.” 

Oral evidence, presented before a tribunal or court, is immediate and current.  By contrast, and speaking generally, the actual thought processes of any director of a company from the relevant time a transaction with a taxation feature was undertaken can be harder to discern with certainty.  In cases such as JTI Acquisitions, the words of a company director in oral evidence are critical.  But those words in evidence might, sometimes, unfairly colour what could be considered by a court to have been within the “directing mind” of that company at the decisive historical moment on which the appeal is focused.