HMRC Nudge Letters and the ‘Unallowable Purpose’ Rule
An ‘unallowable purpose’ is one which appears to be designed simply to secure a tax advantage for the company, where the purpose does not fall within the company’s normal business or commercial undertakings.
The intent of the ‘unallowable purpose’ rule is to control the deductibility of interest for corporation tax calculations in circumstances where the main purpose of the borrower being involved with the underlying loan is to seek tax deductions.
Considerable uncertainty about the interpretation of this rule has resulted in a number of cases recently coming before the courts.
In Judgments delivered by the Court of Appeal, when considering the operation of the unallowable purpose rule, it has emphasised the need to review contemporary documentation in order to ascertain the purpose behind any potentially suspicious loan relationship.
As part of its campaign against breaches of the unallowable purpose rule, HMRC has been issuing ‘nudge letters’ inviting individuals and corporate bodies, which are considered to be potentially in default, to carefully consider the accuracy of their corporation tax submissions and disclose any potential inaccuracies for discussion in the hope of a prompt resolution.
Sections 441 & 442 of the Corporation Tax Act (‘the Act’), which form part of the anti-avoidance provisions in the Corporation Tax Code, provide that a company may not bring into account any credit or debit which, on a just and reasonable apportionment, is attributable to an unallowable purpose. In effect, companies are prevented from deducting interest and other debits in corporation tax calculations if one of the main purposes of creating a loan relationship is to reduce tax liability.
Naz Maqsoom of KANGS comments upon the relevant Statutory and Case Law and ‘nudge letters.’
The Relevant Statutory Law | Corporation Tax Act 441 - 442
The Act provides as follows.
S. 441 Loan relationships for unallowable purposes
- This section applies if in any accounting period a loan relationship of a company has an unallowable purpose.
- The company may not bring into account for that accounting period any credit or debit which is attributable to the unallowable purpose.
S. 442 Meaning of ‘unallowable purpose’
A loan relationship of a company has an unallowable purpose in an accounting period if, at times during that period, the purposes for which the company:
- is a party to the relationship, or
- enters into transactions which are related transactions by reference to it,
include a purpose which is not amongst the business or other commercial purposes of the company.
Examples of an unallowable purpose would include loans created in pursuit of artificial disguised remuneration schemes made for the financial benefits of directors or loans facilitating unnecessary re-financing schemes simply designed to reduce a company’s liability to corporation tax.
Understanding HMRC Nudge Letters
In previous articles on HMRC nudge letters we have referred to the nature and operation of nudge letters.
In brief, a ‘nudge letter’ is issued by HMRC to encourage an individual or corporate body taxpayer to review their tax returns to ensure that all financial gains have been fully declared.
HMRC regularly runs ‘campaigns’ focusing on specific tax issues concerning particular groups of taxpayers. As mentioned above, HMRC is currently challenging situations where it believes that a loan relationship has been utilised to avoid paying the correct amount of corporation tax.
Even where the taxpayer knows that the nudge letter is incorrect, it should not be ignored, as HMRC is unlikely to disregard any failure to respond and further action may lead to costly consequences if the matter proceeds by way of enquiry or full investigation.
HMRC nudge letters are being issued to encourage ‘without prejudice discussions’ in an attempt to settle enquiries efficiently and economically.
Case Law
The continuing focus of HMRC on the issue of ‘unallowable purpose’ is allied to the decisions handed down by the Court of Appeal.
In 2024 three notable cases were:
- BlackRock HoldCo 5 LLC v HMRC [2024] EWCA Civ 330
- Kwik-Fit Group Ltd v HMRC [2024] EWCA Civ 434
- JTI Acquisition Company (2011) Ltd v HMRC [2024] EWCA Civ 652.
Since that time, there have been several similar cases, including the decision of the First-tier Tribunal in Syngenta Holdings Ltd v HMRC [2024] UKFTT 998.
However, it may be that the level of activity through the courts has peaked, in the short term at least, as the Supreme Court has refused permission for the three Court of Appeal decisions above to be further appealed.
Along with emphasising the importance of detailed scrutiny of documentary evidence to help ascertain the purpose of any particular transactions, the case law appears to have established that:
- the ‘main purpose’ is a question of fact depending on the individual circumstances,
- the purpose may change resulting in a wholly allowable purpose become unallowable,
- purpose is a subjective intention,
- when considering what is a ‘main’ purpose, ‘main’ carries a connotation of importance,
- the consequences or effects of a transaction may well be relevant,
- motive may well be an essential consideration,
- considering why the company became involved in a loan relationship will be essential when considering all other factors.
How Can We Assist?
Whilst HMRC has published its own updated guidance and the Appeal Court and Tax Tribunals have handed down their Judgments, inevitably areas of uncertainty will continue to be exposed and HMRC will not waiver in conducting its searching investigations.
Should you become, or anticipate becoming subject to, any form of HMRC investigation, the team at KANGS will be delighted to provide its vast experience gained in assisting and advising clients involved in HMRC disputes of every nature.
Should you require assistance with a Tax investigation or dispute with HMRC, please do not hesitate to get in touch using the contact information provided below.
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through video conferencing or telephone.
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