BlackRock HoldCo 5, LLC v The Commissioners for HMRC

Transfer pricing comparisons may hypothesise third-party covenants which an independent lender would require where they make the economically relevant characteristics, particularly risk, sufficiently comparable. The analysis concerns economic substance and is not confined mechanically to terms between lender and borrower.

Under sections 441 and 442 of the Corporation Tax Act 2009, the company’s subjective purposes for entering the particular loan relationship must be identified. Purpose differs from effect, and tax relief is not a purpose merely because it is an inevitable consequence of borrowing. Where obtaining a tax advantage is nevertheless a main purpose, debits attributable to it must be disallowed on a just and reasonable apportionment. The apportionment is objective, fact-specific and framed by the purposes found.

A UK-resident group company borrowed US $4 billion from an affiliated company and invested the proceeds, together with other consideration, in preference shares used to fund the acquisition of a United States business. It claimed deductions for the interest, producing non-trading deficits available for surrender within the UK group.

The First-tier Tribunal allowed the deductions in [2020] UKFTT 443 (TC). The Upper Tribunal reversed that decision in [2022] UKUT 199 (TCC). It held both that the transfer pricing comparison could not hypothesise absent third-party covenants and that all the debits were attributable to an unallowable tax-avoidance purpose.

The appeal concerned whether the transfer pricing rules permitted those covenants to be hypothesised, whether the company had commercial and tax-advantage main purposes, and how the interest debits should be apportioned under section 441 of the Corporation Tax Act 2009.

1. Appeal allowed in part. The transfer pricing ground succeeded, but the interest deductions remained wholly disallowed under the unallowable purpose rule. Falk LJ gave the leading judgment. Nugee LJ added concurring reasons on unallowable purpose, and Peter Jackson LJ agreed with both judgments.

2. The transfer pricing rules did not prohibit hypothesising third-party covenants merely because they were absent from the actual transaction. The comparison required by Part 4 of the Taxation (International and Other Provisions) Act 2010 must ensure that economically relevant characteristics, particularly the risks assumed, are sufficiently comparable. Reasonably accurate adjustments may eliminate material differences. Here, group control removed risks which an independent lender and borrower would otherwise face. Covenants could therefore be hypothesised to place the independent parties in an economically equivalent position. Sections 152(5) and 154(4) also demonstrated that third-party arrangements were not categorically irrelevant. The First-tier Tribunal was entitled to find that an independent lender would have advanced the loans with suitable covenants. Interest deductions were consequently unrestricted under the transfer pricing rules.

3. For sections 441 and 442 of the Corporation Tax Act 2009, the relevant inquiry was the company’s subjective purposes for being party to the particular loan relationship. The company’s purpose in entering the loans could differ from the purpose of its existence or the wider arrangements, although the surrounding context remained relevant. Purpose had to be distinguished from effect. Conscious motives were important but not exhaustive. Only some consequences are so inevitably and inextricably involved that they must be purposes. Ordinary tax relief on borrowing was not, without more, such a purpose.

4. The company nevertheless had both a tax-advantage main purpose and a commercial main purpose. Its role in the otherwise United States and equity-funded structure existed to obtain UK tax advantages for the group. The directors understood the intended function and adopted the structure. Their proper exclusion of benefits accruing to other group companies when assessing the company’s own interests did not remove that tax purpose. The investment was also genuinely profitable for the company and therefore served a commercial purpose.

5. A just and reasonable apportionment is an objective, fact-specific exercise directed to how much of each debit is attributable to the identified purposes. The First-tier Tribunal erred by asking what would have happened had tax relief disappeared at the last moment. But for the anticipated tax advantage, the decision to enter the loans would never have been made. No principled part of the debits could be attributed solely to the commercial purpose. All interest debits were therefore attributable to the unallowable purpose and disallowed.

6. The Upper Tribunal had also erred procedurally by making additional factual findings without first setting aside the First-tier Tribunal’s decision. The Court of Appeal re-made the decisions using its power under section 14 of the Tribunals, Courts and Enforcement Act 2007.

1. Court of Appeal (Civil Division): In [2024] EWCA Civ 330, allowed the taxpayer’s appeal on transfer pricing and on the tribunals’ legal approach to purpose, but re-made the unallowable purpose decision with the same substantive result. It upheld the attribution of all interest debits to the tax-advantage purpose.
2. Upper Tribunal (Tax and Chancery Chamber): In [2022] UKUT 199 (TCC), allowed HMRC’s appeal on both transfer pricing and unallowable purpose and confirmed the amendments denying the deductions.
3. First-tier Tribunal: In [2020] UKFTT 443 (TC), held that the interest was deductible. It found commercial and tax-advantage main purposes but attributed all debits to the commercial purpose.