BlackRock case: transfer pricing and unallowable purpose rule under the UK Court of Appeal's view

In BlackRock HoldCo 5, LLC v HMRC [2024] EWCA Civ 330, the Court of Appeal handed down its decision concerning the deductibility of interest of a UK company under both transfer pricing rules, in Part 4 of the Taxation (International and Other Provisions) Act 2010, and the unallowable purpose rule, in Section 441 of the Corporation Tax Act 2009.

This is a significant court decision as tax authorities from all over the world continue scrutinising and challenging taxpayers with intra-group financing transactions and similar structures to the ones discussed at the BlackRock case.

Background

In 2009, the BlackRock group acquired the business of Barclays Global Investors (BGI) using a structure that involved a UK taxpayer SPV (LLC5). In short, BlackRock HoldCo 4 LLC (LLC4), incorporated in Delaware, made a loan of USD 4 billion (circa USD2.2 billion in cash and the rest in BlackRock shares) to LLC5. LLC5 used the cash and shares to subscribe for preference shares in BlackRock HoldCo 6 LLC (LLC6), also incorporated in Delaware, and LLC6 then used the cash and shares to acquire the US part of BGI’s business.

LLC5 claimed a deduction on the interest paid on the loan which resulted in losses that LLC5 wanted to surrender to other UK members of the BlackRock group, reducing their UK tax liabilities.

Issues

HMRC challenged the deductibility of interest in LLC5 on two grounds:

1. Transfer pricing rules: the loans would not have been made between parties acting at arm’s length and, therefore, relief should be denied on that basis; and
2. Unallowable purpose rule: securing a tax advantage was the main purpose of the relevant loans.

The Court of Appeal (CoA) decided in favour of the taxpayer on the transfer pricing rules but in favour of HMRC on the unallowable purpose rule, resulting in the disallowance of the interest deduction made by LLC5.

Key highlights on transfer pricing

• The First tier Tribunal (FTT) found that an independent lender would have entered into a loan on the same terms as the parties actually did, provided certain covenants were given by third parties;
• The Upper Tribunal (UT) disregarded this conclusion, concluding that transfer pricing provisions do not permit the existence of third-party covenants to be hypothesised where those covenants are not present in the actual transaction;
• The CoA concluded, based on the 2022 OECD Transfer Pricing Guidelines, that the drivers leading to covenants -being required at arm’s length- may not be present in an intra-group context and that it was appropriate to consider whether there was in practice the “equivalent” of covenants.
The CoA found that, based on the structure and the circumstances of this case, LLC4 had no need of covenants as it was in a position to control the risks itself and it had control over the income stream of LLC5. Therefore, it would be artificial to consider that LLC4 needed covenants to guard against the risks involved;
• The CoA’s decision demonstrates the long-standing OECD guidance on the importance of delineating the actual transactions in accordance with the characteristics reflected in the conduct of the parties, in the cases where the economically relevant characteristics are inconsistent with the written contract between associated enterprises.

Key highlights on unallowable purpose

The CoA held that:

• The UT erred in making references to the purpose of LLC5’s existence without making it clear that the statutory test requires a focus on LLC5’s purposes for being a party to the loan;
• The FTT erred by proceeding on the basis that, as obtaining a tax relief was the inevitable and inextricable consequence of being party to the loan, this could, without more, be a main purpose.
  However, the use of a debt-funded UK resident entity in an otherwise wholly US-based and equity funded ownership chain, 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 had no commercial rationale, show that LLC5 had a tax main purpose for being a party to the loan;
• But for the tax advantage, LLC5 would never have made the decision to enter into the loans. While LLC5 had a commercial main purpose for being a party to the loans, overall, the commercial purpose was more in the nature of a by-product of the tax purpose. The Court, therefore, apportioned 100% of the debits to the tax main purpose.

Where does this leave us?

The CoA made some helpful comments with respect to the application of the unallowable purpose rule in Sections 441 and 442, Corporation Tax Act 2009:

• The application of the unallowable purpose rule is inherently fact specific. The CoA emphasized that its conclusion that LLC5 had a tax main purpose was reached on the specific facts of BlackRock. Taxpayers involved in transactions where the unallowable purpose rule might apply may, therefore, be able to distinguish their transactions from those considered in BlackRock.
• The CoA’s clarification that the inevitable consequence of tax relief in respect of a loan relationship does not, without more, constitute a tax main purpose will be welcomed by taxpayers, especially those who are routinely involved in debt-funded acquisitions and similar transactions involving the use of intra-group loans.
• In our view, the CoA rightly endorsed the position (although this was not in issue before the CoA, as the parties agreed on the point) that only the subjective intentions of a company should be considered in determining the purposes of the company for being party to a loan relationship.
• With respect to the Court’s conclusion on just and reasonable apportionment, it is hard to see how LLC5’s commercial purpose can be both a main purpose in itself, but then a by-product of the tax main purpose at the same time. Apportionment requires an assessment of the purposes relative to each other, but one would not expect this exercise should alter the status of a purpose. This however appears to be the result of applying a “but for” test to determine attribution of the debits.
• Whilst the CoA noted that just and reasonable apportionment will inevitably be fact specific, and alternative approaches may be appropriate, it did not lay down any principles in respect of this, which would have been useful to tax advisers and taxpayers.