In 2009 the BlackRock Group acquired Barclays Global Investors for a total sum of $13,5bn. The price was paid in part by shares ($6.9bn) and in part by cash ($6.6bn). The cash payment was paid by BlackRock Holdco 5 LLC – a US Delaware Company tax resident in the UK – but funded by the parent company by issuing $4bn loan notes to the LLC.
In the years following the acquisition Blackrock Holdco 5 LLC claimed tax deductions in the UK for interest payments on the intra-group loans.
The tax authorities (HMRC) denied tax deductions for the interest costs on two grounds:
(1) HMRC claimed that no loans would have been made between parties acting at arm’s length, so that relief should be denied under the transfer pricing rules in Part 4 of the Taxation (International and Other Provisions) Act 2010.
(2) HMRC also maintained that relief should be denied under the unallowable purpose rule in section 441 of the Corporation Tax Act 2009, on the basis that securing a tax advantage was the only purpose of the relevant loans.
An appeal was filed by the BlackRock Group with the First Tier Tribunal, which in a decision issued in November 2020 found that an independent lender acting at arm’s length would have made loans to LLC5 in the same amount and on the same terms as to interest as were actually made by LLC4 (the “Transfer Pricing Issueâ€). The FTT further found that the Loans had both a commercial purpose and a tax advantage purpose but that it would be just and reasonable to apportion all the debits to the commercial purpose and so they were fully deductible by LLC5 (the “Unallowable Purpose Issueâ€).
An appeal was then filed with the Upper Tribunal by the tax authorities. According to the judgment issued in 2022, the Upper Tribunal found that the First Tier Tribunal had erred in law and therefore allowed HMRC’s appeal on both the transfer pricing issue and the unallowable purpose issue. The First Tier Tribunal’s Decision was set aside and the tax authorities amendments to LLC5’s tax returns were confirmed.
An appeal was then filed by BlackRock with the Court of Appeal.
Judgment
The Court of Appeal found that tax deductions for the interest on the Loans were not restricted under the transfer pricing rules (cf. ground 1 above) but instead disallowed under the unallowable purpose rule in section 441 of the Corporation Tax Act 2009 (cf. ground 2 above).
Excerpt regarding application of transfer pricing rules
“34. Paragraph 1.6 of both the 1995 and 2010 versions of the OECD guidelines explains that what Article 9 of the model convention seeks to do is to adjust profits by reference to “the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances†(a comparable “uncontrolled transactionâ€, as opposed to the actual “controlled transactionâ€). The 2010 version adds that this comparability analysis is at the “heart of the application of the arm’s length principleâ€, while explaining at para. 1.9 that there are cases, for example involving specialised goods or services or unique intangibles, where a comparability analysis is difficult or complicated to apply.
35. In its discussion of comparability analysis, para. 1.15 of the 1995 version states:
“Application of the arm’s length principle is generally based on a comparison of the conditions in a controlled transaction with the conditions in transactions between independent enterprises. In order for such comparisons to be useful, the economically relevant characteristics of the situations being compared must be sufficiently comparable. To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or that reasonably accurate adjustments can be made to eliminate the effect of any such differences. In determining the degree of comparability, including what adjustments are necessary to establish it, an understanding of how unrelated companies evaluate potential transactions is required. Independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that is clearly more attractive. For example, one enterprise is unlikely to accept a price offered for its product by an independent enterprise if it knows that other potential customers are willing to pay more under similar conditions. This point is relevant to the question of comparability, since independent enterprises would generally take into account any economically relevant differences between the options realistically available to them (such as differences in the level of risk or other comparability factors discussed below) when valuing those options. Therefore, when making the comparisons entailed by application of the arm’s length principle, tax administrations should also take these differences into account when establishing whether there is comparability between the situations being compared and what adjustments may be necessary to achieve comparability.â€
Similar text appears at paras. 1.33 and 1.34 of the 2010 version.
36. As can be seen from this, it is essential that the “economically relevant characteristics†are “sufficiently comparableâ€, in the sense of any differences either not having a material effect on the relevant condition (term) of the transaction, or being capable of being adjusted for with reasonable accuracy so as to eliminate their effect.
37. Paragraph 1.17 of the 1995 version expands on the concept of differences as follows:
“… In order to establish the degree of actual comparability and then to make appropriate adjustments to establish arm’s length conditions (or a range thereof), it is necessary to compare attributes of the transactions or enterprises that would affect conditions in arm’s length dealings. Attributes that may be important include the characteristics of the property or services transferred, the functions performed by the parties (taking into account assets used and risks assumed), the contractual terms, the economic circumstances of the parties, and the business strategies pursued by the parties…â€
Again, this is reflected in the 2010 version, at para. 1.36. For present purposes, the references to functions, risk and economic circumstances are noteworthy.
38. Under a sub-heading “Factors determining comparabilityâ€, the guidelines discuss among other things the importance of a functional analysis, which “seeks to identify and to compare the economically significant activities and responsibilities undertaken or to be undertaken by the independent and associated enterprises†(para. 1.20 of the 1995 version). As part of this, the guidelines identify the relevance of risks assumed by the parties:
“… Controlled and uncontrolled transactions and entities are not comparable if there are significant differences in the risks assumed for which appropriate adjustments cannot be made. Functional analysis is incomplete unless the material risks assumed by each party have been considered since the assumption or allocation of risks would influence the conditions of transactions between the associated enterprises.†(Para. 1.23 of the 1995 version; para 1.45 of the 2010 version.)
39. The OECD guidelines make clear that, in general, tax administrations should not disregard actual transactions. Both the 1995 and 2010 versions give two examples of when, exceptionally, this might be done (paras. 1.36 to 1.38 of the 1995 version; paras. 1.64 to 1.66 of the 2010 version). The first is where the economic substance of a transaction differs from its form, the classic example being debt that in economic substance amounts to equity. The second is a situation where the arrangements differ from those that would be entered into by commercially rational independent parties and the effect is to impede the application of transfer pricing principles, an example being a transfer of unlimited rights to intellectual property relating to future research. It was not suggested that either of these exceptions is in point.
40. A further point clarified by the guidelines is that the presence of a tax motive or purpose does not justify non-recognition of the parties’ characterisation or structuring of a transaction. Rather, the fact that a transaction has been entered into with tax savings in mind is not relevant for transfer pricing purposes: paras. 9.181 and 9.182 of the 2010 version.
41. Mr Prosser referred us to the 2022 version of the OECD guidelines in relation to two points. The first is the treatment of synergies available from membership of a group. The guidelines clarify that incidental benefits arising from group membership need not be adjusted for even if they are substantial. The example is given of an improved credit rating available to a borrower by virtue of membership of a group, as compared to what it would be on a standalone basis (paras. 1.177, 1.178 and 1.184 of the 2022 version). This point is also addressed in both the 1995 and 2010 versions at para. 7.13.
42. Secondly, in a section dealing with intra-group loans, para. 10.56 of the 2022 version notes that where a parent grants a loan to a subsidiary the grant of security is less relevant to its risk analysis because it already has control and ownership, such that the absence of contractual rights over the assets of the borrower “does not necessarily reflect the economic reality of the risk inherent in the loanâ€. The same section also addresses covenants, pointing out (in effect) that the drivers leading to covenants being required at arm’s length may not be present in an intra-group context and that it will be appropriate to consider whether there is in practice the “equivalent†of covenants (para. 10.86).
(…)
Summary
97. In summary on the Transfer Pricing issue, I would conclude that deductions for interest on the Loans are not restricted under the transfer pricing rules. I would therefore allow LLC5’s appeal on Ground 1, set aside the UT Decision on that issue and re-make it by dismissing HMRC’s challenge to the conclusion reached by the FTT. Insofar as the conclusion I have reached relies on evidence before the FTT about the risks assumed in the actual transaction that was not reflected in a finding of fact (see [65] and [66] above) I would make additional findings of fact, pursuant to s.14 of the Tribunals, Courts and Enforcement Act 2007, that accept that unchallenged evidence. I would also dismiss HMRC’s challenge to the FTT’s findings about the expert evidence (HMRC’s Ground 1).”
Excerpt regarding application of unallowable purpose rule
“169. I do not consider that these conclusions involve an inappropriate attack on the unchallenged evidence of Mr Kushel or Mr Fleming, or on the FTT’s findings of fact. I agree with the UT that there is an analogy with TDS. In that case a conclusion that the company had a tax main purpose in using the relevant shares as it did was found not to be inconsistent with the honestly held view of the relevant director, a Mr Turner, that the shares continued to be held exclusively for the commercial purpose for which they were originally acquired. Similarly, in this case the fact that LLC5 had a tax avoidance main purpose is not inconsistent with board members properly putting the tax benefits out of their minds when deciding whether the transaction was in LLC5’s best interests on a standalone basis. The two questions are different.
170. Accordingly, I would conclude that LLC5 entered into the Loans with a main purpose of securing a tax advantage. In other words, I agree with the FTT and UT in the result.
171. I should emphasise that my conclusion that LLC5 had a tax main purpose is a conclusion reached on the particular facts of this case. It does not follow that other debt incurred in connection with a commercial acquisition – as the acquisition of BGI US undoubtedly was – would fall foul of the unallowable purpose rule even if the decision to borrow had regard, as it often would, to tax considerations. The facts of this case include, among other things, the use of a debt-funded UK resident entity in what is otherwise a wholly US-based, and equity funded, ownership chain, the related lack of any commercial rationale for LLC5, and the structure that then had to be put in place to ensure that LLC5 did not have control over the BGI US group, such that LLC5 not only had no commercial rationale but had no real commercial function.”
“179. I agree with Mr Prosser that what the legislation requires is a just and reasonable apportionment by reference to the relevant purposes. Those purposes are identified using a subjective approach: see above. The statutory test requires the identification and disallowance of “so much of†any debit that is “attributable†to the unallowable purpose: s.441(3). That is the enquiry that the tribunal must undertake. While the determination of a just and reasonable apportionment is an objective exercise, it is not necessarily the same as the consideration of “all the facts and circumstances†referred to by the UT, if by that the UT did not intend to have regard to the requirement to apportion by reference to the relevant purposes. The framework for the apportionment is the purposes that have been identified by the fact-finding tribunal. Subject to that point, however, I agree that all relevant facts and circumstances should be considered.
180. The position is straightforward if all the debits, or perhaps a defined part of them, are properly attributable solely to a tax avoidance main purpose. Conversely, if they are properly attributable to a purpose which is not an unallowable purpose then there will be no disallowance under s.441. Where debits are attributable to more than one purpose then an apportionment is required. As to the precise mechanism by which this is done, the legislation is not prescriptive. The answer to that question will inevitably be fact specific.
181. On the facts of this case I agree with the UT that the FTT was wrong to focus on what would have happened if tax relief had been withdrawn at the last moment. I would also concur with the result reached by the UT, namely that 100% of the debits should be apportioned to the unallowable purpose.
182. As already discussed, the purpose for which LLC5 was created cannot be divorced from its purpose in entering into the Loans. Further, the structure of the transaction was presented as a fait accompli to the board. The commercial advantage to LLC5 was of significance to it because it would not benefit from the tax advantage, but overall it was more in the nature of a by-product. On the facts there is no principled basis to identify any particular amount or proportion of the debits as being attributable to the commercial purpose.
183. The answer to the apportionment question is not altered by imagining what might have happened if the tax rules had changed at the last moment. That did not occur. In reality the board accepted and adopted the structure that had been devised to achieve a tax advantage.
184. While I understand Mr Yates’ submissions about alternative approaches and can see that some form of apportionment based on economic advantage could be appropriate in some cases, I do not consider that it would be appropriate to adopt either of the two approaches put forward in this case. Apart from the fact that the FTT was not asked to consider those alternatives, they both re-introduce subjective elements into what should be an objective exercise, namely LLC5’s expectations about the relative level of tax benefits as compared to other factors.
185. In any event, there is a simpler answer based on the “but for†approach that both parties were content that we should adopt on the facts of this case. If that approach is adopted then the only proper answer is not the one that the FTT gave. Rather, in the absence of the tax advantage the decision to enter into the Loans would never have been made.
186. Accordingly, I would dismiss LLC5’s appeal against the UT’s conclusion on apportionment.
CONCLUSION
187. In summary, I would:
a) allow LLC5’s appeal on the Transfer Pricing issue (Ground 1) and dismiss HMRC’s challenge to the FTT’s findings on the evidence (HMRC’s Ground 1), with the result that deductions for interest on the Loans are not restricted under the transfer pricing rules (see [97] above);
b) on the Unallowable Purpose issue, conclude that the FTT did make a material error in applying Mallalieu, and as a result would also allow Ground 2 of BlackRock’s appeal, dismiss HMRC’s Ground 3 and set aside the tribunals’ decisions on that issue;
c) re-make the decisions with the same result, that is by concluding that LLC5 had a tax advantage main purpose in entering into the Loans but also had a commercial main purpose (such that HMRC’s Ground 2 is also dismissed); and
d) dismiss Ground 3 of the appeal, concluding that the UT was correct to decide that 100% of the debits in respect of the Loans should be attributed to the tax advantage main purpose.
188. The result of this is that tax deductions for the interest on the Loans are disallowed under the unallowable purpose rule.”