Case: Loan relationship held for unallowable purpose
 UKFTT 0254 (TC)
Judge Tony Beare
Decision released 13 April 2019
CORPORATION TAX – loan relationship rules – whether a note issued as part of a structure for refinancing the US sub-group without generating net taxable interest income in the UK had an unallowable purpose – yes – extent of deductions referable to the unallowable purpose considered
Oxford Instruments UK 2013 Limited  TC 07094
This appeal relates to the refinancing of the US sub-group of the Oxford Instruments plc (OI plc) group of companies (the Group) and the implementation of a so-called tower structure. In addition to other 7 other steps, the arrangements involved:
•the issue to the Appellant (a UK member of the Group) of preference shares by its immediate parent (a US member of the Group);
•the issue by the Appellant of $140m promissory notes (the US promissory notes) to its immediate parent; and
•the making of a US “check the box” election by the Appellant’s immediate parent to treat the Appellant as its branch for US federal income tax purposes.
In relation to the refinancing transactions, the FTT found the following facts:
(1)The US promissory notes and the preference shares were issued at step 8 of a single scheme comprising that step and seven preceding steps (the Scheme);
(2)The sole purposes of OI plc in implementing the Scheme were as follows:
(a)to achieve certain commercial objectives (the US objectives); and
(b)before taking into account an amount of tax relief that the group had committed to disclaim under the Scheme amounting to 25% of the interest on $94m of the principal amount of the US promissory notes (the Disclaimer), to do so without increasing the net taxable income of the Group in the UK;
(3)The US objectives were as follows:
(a)to refinance $94m of existing loan notes and other loan facilities;
(b)to introduce a further $46m of debt into the US sub-group in order to achieve an appropriate capital structure;
(c)to simplify the debt in the US sub-group; and
(d)to provide a flexible structure to allow for further acquisitions by the US sub-group;
(4)The UK corporation tax consequences of the Scheme were intended to be as follows:
(a)steps 1 to 7 would give rise to taxable interest income in another UK group company (the other UK subsidiary) equal to 5.5% of $140m; and
(b)before taking into account the Disclaimer, step 8 would give rise to a tax deduction of an equal and opposite amount for the Appellant, which the Appellant could surrender to the other UK subsidiary;
(5)The US objectives would all have been achieved if the Scheme had not included step 8 and had instead comprised only steps 1 to 7. However, if step 8 had not been implemented, the Scheme would have given rise to net taxable income in the UK in an amount which was equal and opposite to the net deductible interest in the US;
(6)If that had been the case, the Scheme would still have been beneficial for the Group because:
(a)at the time the Scheme was implemented, the group had available UK corporation tax losses which, until they were used, would have sheltered the interest income arising in the other UK subsidiary; and
(b)in any event, the US federal income tax rate applicable to the US sub-group was considerably greater than the rate of UK corporation tax applicable to the other UK subsidiary, with the result that the tax saving in the US as a result of the payments of interest on the US promissory notes would considerably exceed the tax arising in the UK as a result of those payments, even after the available UK corporation tax losses were all used;
(7)Thus, even if the Scheme had not included step 8 and had instead comprised only steps 1 to 7, OI Plc would still have chosen to procure the implementation of the Scheme;
(8)By the time the directors of the Appellant were considering whether the Appellant should implement the transactions comprising step 8 of the Scheme:
(a)the US objectives had been achieved. The only main purpose of the Scheme which had yet to be achieved at that point was that of not increasing the net taxable income of the group in the UK;
(b)it was clear from the Scheme documents that the Scheme would include step 8 and that step 8 would result in the appellant receiving a spread of 2.6% per annum on the difference between its interest payments on the US promissory notes and the dividends on the preference shares and that the exact size of that spread was determined almost a month before the appellant resolved to issue the notes and to subscribe for the preference shares;
(9)If it would not have been possible to justify, from an arm’s length perspective, a dividend rate on the preference shares greater than the rate of interest on the promissory note then step 8 of the Scheme would never have occurred. Instead, OI Plc would either have adopted an alternative re-financing structure or procured the implementation of steps 1 to 7 of the scheme without implementing step 8 of the Scheme.
It followed that:
(1)The sole purpose of OI plc in incorporating the appellant and procuring the implementation of step 8 of the Scheme was to ensure that, before taking into account the Disclaimer, step 8 would give rise to debits in respect of the US promissory notes which were equal and opposite to the credits arising in the other UK subsidiary and which could be surrendered to the other UK subsidiary by way of group relief for offset against its taxable income. The result was that, disregarding the Disclaimer, the Scheme (comprising steps 1 to 8) would give rise to no incremental net taxable income in the UK.
(2)Step 8 of the Scheme would never have occurred (and therefore the Appellant would not have been incorporated or resolved to enter into step 8 of the Scheme) if OI plc had considered that step 8 would not give rise to the anticipated debits described above, even if step 8 would still have given rise to the spread; and
(3)Neither the achievement of the US objectives nor the obtaining of the spread was a purpose of the Appellant in implementing step 8 of the Scheme. The spread was simply an inevitable known consequence (or effect) of the Appellant’s participation in step 8 but not any part of the Appellant’s purpose in so doing.
The issues to be resolved were as follows:
(1)Whether the US promissory notes secured a tax advantage for the Appellant or for any other person;
(2)If so, whether securing that tax advantage was the main purpose, or one of the main purposes, of the Appellant in issuing, and remaining party to, the US promissory notes; and
(3)If so, with the result that the loan relationship unallowable purpose rules in CTA 2009, s. 441 applied to the Appellant in relation to the US promissory notes, how much of the debits arising in relation to the notes are, on a just and reasonable apportionment, attributable to that unallowable purpose.
In relation to point (1), the FTT held that the US promissory notes did secure a tax advantage for the other UK subsidiary in that all of the interest arising thereon (apart from the Disclaimer) was set off against the taxable income the other UK subsidiary. Those interest deductions were a relief from tax falling within CTA 2010, s. 1139(2)(a). That was so notwithstanding the Appellant’s submission that the deductions arising should be regarded as inextricably linked to the additional interest income generated by steps 1 to 7 of the Scheme in the other UK subsidiary, with the result that the single structure gave rise to no net deductions for tax purposes. This is because the mere fact that a transaction happens to result in a net neutral tax position or even, as was the case here, a net positive tax position (as a result of the Disclaimer) does not mean, in and of itself, that there has been no tax advantage, as defined in CTA 2010, s. 1139. In a case where that net neutral or net positive tax position arises as a result of both the generation of income and the generation of deductions, the deductions are still reliefs from tax pursuant to which the amount of income giving rise to tax is reduced.
In relation to point (2), the FTT held that, by virtue of its finding of fact that the sole purpose of the Appellant in issuing, and remaining party to, the US promissory notes was to secure the deductions arising thereon and to surrender those deductions to the other UK subsidiary, it necessarily followed that the Appellant’s only purpose in issuing, and remaining party to, the US promissory notes was to secure a tax advantage for the other UK subsidiary and, therefore, that CTA 2009, s. 441 applied.
In relation to point (3), it also followed from that finding of fact that, on the just and reasonable apportionment required by CTA 2009, s. 441(3), all of the debits arising in respect of the US promissory notes were attributable to that sole purpose and therefore all of those debits were disallowable.
The interesting part of this decision is the finding that the Appellant’s interest deduction was still regarded as giving rise to a tax advantage for the purposes of the loan relationship unallowable purpose rules notwithstanding that equal and opposite taxable credits arose elsewhere in the group. It should be remembered however that the Appellant’s debits also gave rise to tax deductions in the US and, in other situations where that would not have been the case, it is likely that the separate tax avoidance motive test would not be met.
Similar schemes should now be blocked by virtue of various BEPS-related initiatives so, in that regard, the actual arrangements implemented are largely of historical interest.
For commentary on the loan relationship unallowable purpose rule, see the In-Depth commentary at ¶717-280.