No relief for loan restructuring due to unallowable purpose

In Kwik-Fit Group Limited v HMRC [2021] TC08226, the First Tier Tribunal (FTT) found that loans transferred between group companies following a reorganisation did not maintain their allowable purpose meaning the interest was disallowed.

• The Kwik-Fit Group had a number of existing intra-group loans, which originally were for commercial purposes.
• One of the group companies, Speedy 1, had a significant non-trading Loan relationship deficit (NTD) of £48 million. The company estimated it would take 25 years to utilise the Losses based on the level of loan receivables due to it.
• Following the acquisition of the group by the Itochu Corporation, a reorganisation of these receivables was undertaken. The aim was to make Speedy 1 the group treasury company and a number of group loans were assigned to it.
• All loans which Speedy 1 was a party to had the interest rate increased to LIBOR + 5%. This was a mix of loans newly assigned to Speedy 1 and existing loans with previously lower interest rates.
• Kwik-Fit argued that the imposition of the increased interest rate was due to it being the arm's length rate for transfer pricing purposes and it should be deductible on that basis.
• The result was that the surplus NTDs were utilised in two to three years instead of the anticipated 25 years.
• HMRC opened enquiries into the companies who were party to the loans and subsequently issued Closure notices disallowing the interest due to Unallowable purpose. 
• The Kwik-Fit Group appealed the closure notices.

CTA 2009 details the loan relationship rules and sections 441 and 442 set out where debits are to be disallowed due to an unallowable purpose:

• An unallowable purpose is one that is not one of the business or commercial purposes of the company.
• It is also one of the reasons that the company is party to the transaction.
• Tax avoidance is classed for these purposes as an unallowable purpose where it is one of the main purposes for entering into the transaction. Obtaining a tax advantage falls within this category.
• Tax advantage is defined at s.1139(2) CTA 2010 as including a relief from tax, a repayment of tax or an avoidance of a charge to tax.

The FTT found:

• That the main purpose of the reorganisation of the group loans was to accelerate the utilisation of the NTDs in Speedy 1.
• Whilst the purpose of the loan and the purpose of being a party to the transaction are two separate issues, in this case, the main purpose for both in relation to the new loans was the securing of the tax advantage for the group.
• The existing loans had a commercial purpose. The increase in interest rates provided a new, additional, main purpose to the existing loans, which was one of obtaining a tax advantage.
• The Transfer Pricing argument did not stand up to scrutiny as:
  • The arm's length rate only needs to be applied when calculating the tax due. There is no requirement to alter the actual rate on the loan.
  • The increase was only applied to loans where Speedy 1 was the lender. The Transfer Pricing rules cannot be selectively applied.

The FTT held that the main purpose of the new loans was unallowable and all interest was to be disallowed. For the existing loans, the main purpose for the the increase of the interest rate was unallowable and so the difference between the original interest rate and LIBOR + 5% was to be disallowed. The total amount disallowed in each accounting period was to be capped at the amount of NTDs used by Speedy 1 in that period.

Useful guides on this topic

Loan relationships
How are loans made to and by a company taxed? What are the rules when loans are written down? What is the difference between a trading and non-trading loan relationship? What are the rules for connected party loans?

Losses: Trading and other losses
When can a company offset its losses? What restrictions are there? How are loss claims made?

External link

Kwik-Fit Group Limited v HMRC [2021] TC08226