Tax

In JTI Acquisition Company (2011) Limited (“JTI”) v The Commissioners for His Majesty’s Revenue & Customs (“HMRC”) [2024] EWCA Civ 652, the Court of Appeal was asked whether JTI, a UK tax resident company, could bring into account debits in respect of interest payable on loan notes issued to a US group company for UK corporation tax purposes. The Court of Appeal handed down its decision on 13 June 2024, upholding the previous decisions by the First-tier Tribunal (“FTT”) and the Upper Tribunal that the debits were attributable to an unallowable purpose, and therefore should be disallowed.

Background

The circumstances giving rise to the disputed deductions by JTI are, in brief, as follows:

• Joy Global Inc (“JGI”) (a US corporation) agreed to acquire LeTourneau Technologies Inc (“LTT”) (a US corporation) for $1.1 billion.
• Pursuant to an acquisition structure proposed by Deloitte, JGI decided that a new UK company (being JTI, the appellant) would acquire LTT.
• Joy Technologies Inc (a US subsidiary of JGI) (“JTI US”): i) contributed $50 million to JTI as equity; ii) provided JTI with $500 million of interest-free “quasi-equity”; and iii) lent JTI $550 million through the issue of interest-bearing loan notes which were capable of being listed on a recognised stock exchange, thereby qualifying for the UK’s domestic “quoted Eurobond” exemption from withholding tax.
• JTI used the funds to acquire LTT for $1.1 billion.
• The non-trading loan relationship debits that arose on the loan notes were claimed  by other (taxable) UK group companies via group relief.

HMRC disallowed the tax deductions claimed by the JTI group companies, contending that they were attributable to an “unallowable purpose”.

Legislative provisions

The anti-avoidance provisions in the Corporation Tax Act 2009, as they apply to loan relationships, provide that, if a loan relationship has an unallowable purpose, the company may not bring into account any debit in respect of the relationship that is attributable to the unallowable purpose on a just and reasonable apportionment.

An “unallowable purpose” is defined as a purpose which is not amongst the business or other commercial purposes of the company. A tax avoidance purpose is any purpose which consists of securing a tax advantage for the company or any other person, and is only regarded as a business or other commercial purpose of the company if it is not the main purpose (or one of the main purposes) for which the company is a party to the loan relationship.

FTT and Upper Tribunal decisions

Based on the evidence presented to it, including witness evidence at the hearing and contemporaneous communications and board minutes documenting the LTT transaction, the FTT concluded that there had been no genuine decision making at the UK level in relation to JTI’s issuance of the loan notes, and that the object of the actual decision makers (who were at the US level) had been to secure a UK tax advantage for UK group members by bringing that loan relationship into existence. This was, in the FTT’s view, the main purpose of the loan relationship, and the evidence (which the FTT described as “ultimately unconvincing”) had failed to establish the commercial case for JTI’s formation and designation as the purchaser of LTT and issuer of the loan notes. The FTT accepted that there was a commercial reason to acquire LTT, but the “sinews” between that and the formation of JTI to make the acquisition were absent.  As there would have been no loan relationship debits “but for” the avoidance scheme, the FTT concluded that they were wholly attributable to an unallowable purpose.

On appeal, the Upper Tribunal upheld the FTT’s decision, noting among other things that: (i) a tribunal is entitled to look at all the facts and circumstances in determining a party’s “main purpose”, and this may include consideration of why one particular company (rather than another) has been designated as a party to the loan relationship; (ii) there is nothing which generally precludes the unallowable purpose rule from applying to arm’s length finance costs for a commercial acquisition; and (iii) the use to which the loan is put is relevant to the purpose of the borrowing, although not necessarily determinative.

Court of Appeal decision

JTI’s lawyers argued that the FTT and Upper Tribunal had asked themselves the wrong question, focusing on why JTI had been selected to acquire LTT, rather than why JTI had issued the loan notes. If they had considered the latter (correct) question, they would have found that the purpose of JTI’s issuance of the loan notes was to fund the commercial acquisition of LTT. JTI may have been selected to make the acquisition for tax reasons but, once it had been selected, its purpose of entering into the loan was to fund that acquisition.

Applying BlackRock HoldCo 5, LLC v Revenue & Customs Commissioners (2024) (“BlackRock”) and Inland Revenue Commissioners v Brebner (1967), the Court of Appeal was satisfied that JTI’s purpose was (to echo Nugee LJ in BlackRock) “to play the part that had been devised for it so as to obtain a tax advantage”. JTI’s directors knew what was expected of JTI in terms of the acquisition structure and the resulting tax advantages. JGI formed JTI and chose it to make the acquisition with a view to securing tax advantages, and JTI’s directors knew that the loan to JTI formed part of a wider scheme which, for tax reasons, was “bolted on” (as the FTT put it) to the acquisition. Accordingly, the Court of Appeal found that the FTT was correct to conclude that JTI’s directors went along with a scheme that had been adopted for tax reasons; they were seeking to fulfil JTI’s role in a plan which had been decided on in order to secure a tax advantage. As such, JTI had a main purpose of tax avoidance.

On the question of whether the FTT’s findings – that there were no commercial purposes for JTI entering in to the loan – could be challenged by the higher courts, the Court of Appeal noted that there were very limited circumstances in which an appellate court is permitted to interfere with a finding of fact by a lower court. Although JTI’s challenge to the FTT’s conclusion was that there must have been a commercial purpose of using the loan to fund the acquisition, the Court of Appeal held that the FTT is not required to adopt a “tunnel-visioned” approach which looked simply at how the loan would be used. Like the Upper Tribunal, the Court of Appeal held that it could not interfere with the FTT’s conclusion that JTI did not have a commercial purpose in issuing the loan notes to JTI US. The Court of Appeal did acknowledge that a differently constituted FTT might have reached a different conclusion, but that was “not to the point”.

The Court of Appeal concluded that no apportionment between purposes was necessary. The FTT found, as a matter of fact, that JTI issued the loan notes for the main purpose of securing a tax advantage, and it had no commercial purpose in doing so. Even if the FTT had found that there was a commercial purpose, the loan relationship debits would have been wholly attributable to the unallowable purpose because “but for” the avoidance scheme, they would not have arisen.

Practical implications

The judgment of the Court of Appeal in this case, along with those in BlackRock and Kwik-Fit Group Ltd v Revenue & Customs Commissioners (2024), emphasise the importance of the facts. There is a high bar that must be reached before an appellate court will be prepared to overrule a finding of fact in a previous decision, and so it is crucial, not only that contemporaneous evidence supports the underlying commercial rationale, but that evidence presented to the FTT is as compelling as possible.

That will be important not only in proving that tax avoidance is not a main purpose, but also that the debits in question would have arisen absent the wider scheme. At the very least, taxpayers should, where interest debits are available to be claimed, ensure that commercial purposes for entering into a loan relationship are clearly documented and understood by the relevant parties, and retain contemporaneous evidence of such purposes.

The Court of Appeal decision is available here, and it is not yet known whether JTI will seek leave to appeal.