Interest deductions - Updated guidance on Unallowable Purpose Rule

HMRC released updated guidance in May 2023 on its current position in respect of the unallowable purpose (UAP) rules - an anti-avoidance provision preventing interest deductions where a loan is wholly or partly in place for tax driven reasons - and how it is expected to apply so as to restrict UK tax deductions for interest.

Of particular interest are 17 examples provided indicating whether or not an UAP adjustment is expected to apply – these are a useful guide when navigating potential UAP scenarios. Overall, the examples highlight that HMRC expect to see some form of direct commercial rationale between the UK borrowing entity and the entity or asset to be acquired in light of the borrowing.

It is important to understand that the UAP rule landscape is an ongoing area of litigation, particularly given the Upper Tribunal’s decision in JTI Acquisition is soon expected to be released; and the taxpayers’ appeals are awaited for both the BlackRock and Kwik-Fit cases (see our summary of the Blackrock decision). Nevertheless, the guidance insightful when acknowledging that tax is a general consideration in financing decisions, and that denial of tax relief is not an automatic conclusion in all instances.

In particular, the guidance highlights the following:

• The application of these rules is complex, and highly fact dependent requiring detailed examination of all available evidence, for example, they must be applied on a period by period basis, and the purpose of an entity in being party to a loan relationship may change between periods.
• When considering the purpose of the company, it is typically the purposes of the Directors that are considered.
• However, where the Directors are rubber stamping or acting as “puppets”, it will be necessary to consider the purpose of those that are driving the transaction, which could involve other group entities or advisers.
• It is expected that a Director will have awareness of the overall group context when making a decision on behalf of a particular group entity.
• Where a Director is a Director of multiple companies, it is considered difficult for the Directors to distinguish those two roles in their own minds in practice, and the assumption will likely be they have not done so absent clear facts to the contrary.
• The existence of a tax advantage is not determinative that a disallowance will arise. Equally, the existence of a commercial purpose is not determinative that no adjustment will arise.
• Whilst cases to date have largely been binary in outcome (i.e. an interest deduction has been allowed or denied in full), it is not necessarily the case that will always be the outcome.
• HMRC will seek to understand the overall group context of a transactions, and in particular whether there is a net UK or net global tax benefit.
• In determining the relative importance of any tax benefit amongst other commercial (non-tax) factors, HMRC will look to the degree of attention paid to the tax benefit by the Group, and by proxy may consider the level of associated fees of components of advice sought.
• HMRC will consider whether a transaction would have happened at all absent a tax benefit, or whether it would have happened in a different way.
• The guidance reaffirms the clear legislative position that interest may be disallowed to the extent it relates to activities not expected to generate tax (for example, if the interest relates to funding of a permanent establishment of a UK company in respect of which a branch exemption election has been made). Helpfully, the guidance is explicit that whether the investment results in taxable profits is unlikely to in itself be significant where the lack of tax arising is as a result of the nature of the investment (e.g. an acquisition of UK or non-UK shares which is expected to generate exempt dividends or gains) provided there is commercial rationale in the UK entity holding the investment.
• The guidance reflects upon the Economic Secretary's Hansard comments that were issued on introduction of the rules. In summary, those comments are considered to still be of relevance, and HMRC considers their guidance is in accordance with those comments. HMRC notes that any changes in examples in the latest guidance, or exclusions of examples which previously existed is not intended to reflect any change in view.

It is also important to note that the Uncertain Tax Treatment regime demands certain disclosure obligations where the taxpayer may be seen to be at odds with HMRC’s position. This renders it important for clients to review their current or prospective transactions under the purview of the UAP rule so as to update their thinking, and proactively document the commercial rationale of said transactions closely.

How we can help

The guidance and ongoing litigation demonstrate that the deductibility of interest remains an area of focus for HMRC and complexity for businesses. For help and advice on your acquisition structures and transfer pricing arrangements, please get in touch with our Transfer Pricing Team Meenakshi Iyer and Andrew Stewart; or our International Tax Team Ross Robertson and Millie Bojic.