Lifecycle of a transaction: tax disputes on intra-group debt

This article was originally published in the Tax Journal, October 2025 and is reproduced with permission from the publisher.

 

Speed read

Where there is potential for a tax dispute, it is crucial to map your position early: proactively building a “defence” file can best prepare taxpayers for HMRC enquiries when they arise years later. Where an enquiry is opened, start by stabilising evidence and identifying the legal questions. The best approach may depend on the information route HMRC use: informal requests, formal Sch 36 notices, interviews/meetings and/or email reviews. Each of these has potential pitfalls, including over-disclosure, inadvertent privilege waivers, and inconsistent narratives. If the enquiry moves to a dispute, ensure internal stakeholders understand the options available, be it pushing for full or partial closure notices, using Alternative Dispute Resolution or utilising appeal routes. 

 

Case study

Continuing the case study in our lifecycle of a transaction series, Fundco (Luxembourg) acquired Jersey Propco (Jersey-incorporated, but UK tax resident), which owns Property A in the UK. Earlier in this series, we mapped the structuring choices and onshoring of residence, the transfer pricing (TP) lens on shareholder lending and management services, the buyer protections/warranty and indemnity insurance (W&I) dynamics, and the VAT picture (including TOGCs, option to tax and capital goods scheme).

Now HMRC have opened a corporation tax enquiry into the first post-acquisition period, focusing on the intragroup debt used to fund the deal and the associated TP, Corporate Interest Restriction (CIR) and anti-hybrid questions - the classic purpose, pricing, capacity trio. HMRC are requesting that the taxpayer provides information and documents which explain the rationale for the loan, along with analysis supporting the terms on which it has been put in place.

 

First principles: enquiry and information powers framework (direct tax)

We start with a brief reminder of HMRC's enquiry (and discovery) powers, as well as the framework for HMRC to obtain information and documents from taxpayers and third parties.

• Corporation tax (CT) enquiries and closure: For companies within CT self-assessment, HMRC can open an enquiry into a return under FA 1998 Sch 18. The key is timing. If the return is filed on or before the statutory filing date, the window is 12 months after the statutory filing date for companies within groups that are not “small“, and 12 months after HMRC receives the return for other companies. If the return is filed late, HMRC may open an enquiry up to and including the next quarter day (31 January, 30 April, 31 July, 31 October) following the first anniversary of the actual filing date. Where the company amends its return, a fresh window runs to the next quarter day following the first anniversary of the amendment. A notice is “given“ when received, not when posted. Enquiries end with a closure notice, which could be a partial closure notice (PCN) where only a discrete issue is ready to crystallise.
• Discovery and time limits: Separately, HMRC may make a discovery assessment for companies under FA 1998 Sch 18, subject to safeguards (where a return has been filed) and time limits that mirror TMA principles: four years by default, extended to six years for careless taxpayer behaviour and 20 years for deliberate behaviour. Those horizons can inform how hard HMRC push their position on “behaviours” and penalties.

In substance, HMRC are testing whether the documents and emails tell a consistent story with the loan relationship put in place.

• Information powers: HMRC's primary information powers are in FA 2008 Sch 36. A “taxpayer notice” requires the taxpayer to provide information or documents reasonably required to check the taxpayer's tax position. A third-party notice requires third parties to provide such information and usually needs Tribunal approval if the taxpayer does not consent. Legal professional privilege (LPP) is preserved. HMRC can only request information/ documents in the possession or power of the recipient of the notice.
• Appeals: If a taxpayer disagrees with a closure notice or discovery assessment, there is a 30-day right of appeal to HMRC. A taxpayer can seek a statutory review or one can be offered by HMRC. The appeal must be notified to the First-tier Tribunal if the taxpayer declines an offer of a review or to the extent a review upholds HMRC's position.
• Penalties and interest: Inaccuracy penalties are charged under FA 2007 Sch 24, calibrated by behaviour and the quality of disclosure, with greater mitigation if the taxpayer brings the underlying error to HMRC's attention, i.e. if the disclosure is unprompted. Inaccuracy penalties must be assessed within 12 months of the tax being agreed or determined by the tribunal but in practice HMRC seeks to review the penalty position in tandem. Interest and late-payment penalties are in FA 2009 Schs 53 and 56.

 

What HMRC are testing in this case study?

In substance, HMRC are testing whether the documents and emails tell a consistent story with the loan relationship put in place: did contemporaneous records show business need, rather than a tax one, as the driver, and was the amount of debt and interest rate arm's length? If HMRC are of the view that the loan was not put in place for commercial purposes, or that the terms are not arm's length, they will seek to deny some or all of the deductions taken by the borrower in respect of the interest debits.

Considering this in more detail:

• Unallowable Purpose on shareholder debt (CTA 2009 s 441): The core question here is whether a main purpose of the intra-group loan relationship was to obtain a tax advantage outside the borrower's commercial purposes. HMRC will look for contemporaneous evidence that the debt existed to support the acquisition and ongoing property business, not to manufacture tax deductions. Internal communications, board papers, investment committee packs, treasury policy, lender terms and cash-flow modelling must show a consistent position. Recent Court of Appeal decisions show how the unallowable purpose rule can trump otherwise orthodox intra-group funding where the contemporaneous record points the wrong way. The courts have emphasised the importance of real-world commercial drivers and warned against post-hoc rationalisation (see, for example, JTI Acquisitions Company (2011) Ltd v HMRC [2024] EWCA Civ 652, in particular the comments of the First-tier Tribunal ([2022] UKFTT 166 (TC)) at [4]‑[6]).
• Transfer Pricing (TIOPA 2010 Part 4): HMRC will test both quantum (could an independent borrower sustain this level of debt?) and pricing (would an independent lender extend these terms?). With regards to quantum, this may also include challenging whether the debt levels exceed what an independent lender would provide, or a prudent borrower may borrow, under thin capitalisation rules. HMRC will also compare the contract to the conduct: repricings, waivers, covenant resets or informal roll-forwards that lack paper trails undermine the file. Annual refreshes will also be important, as adopting an arm's-length position in year 1 will not provide a lifetime licence. (See our earlier article (“lifecycle of a transaction: transfer pricing considerations” (Rachit Agarwal, Monia Volpato and Uwe Zoellner), Tax Journal, 2 May 2025) for a more in depth look at the relevant TP considerations.)
• CIR (TIOPA 2010 Part 10) and anti-hybrids (Part 6A): CIR can cap deductions even where TP/ unallowable purpose considerations are satisfied; the group ratio may help, but trapped net group expense is common in property structures. The anti-hybrid rules require a clear map of entity and instrument characterisations across jurisdictions to show there is no deduction/non-inclusion or double deduction mismatch (or that the rules neutralise any that arise). Where debt has been modified in turbulent markets, it is important for taxpayers to be alive to accounting re-measurement (IFRS/FRS 102 “10% test” ) and related-party status changes, as both can move tax needles and invite questions.

 

How HMRC ask for information

Informal requests

Many enquiries begin with a broad, informal request for information - for example, all drafts of loan agreements, all legal and accounting advice on deductibility, all board packs and models, all lender correspondence, and all emails among named custodians. On first instincts, this may feel collaborative; however, in practice it often overreaches and can lead to further issues down the road. The right response is therefore likely to be a combination of cooperative discipline.

Start by restating the issues HMRC are genuinely testing here; in this case study, that would be unallowable purpose, TP (quantum and rate), CIR and anti-hybrids. Keep the respective legal questions to be answered under each issue at the front of your mind when collating information and documentation.

Where one has been prepared (and this is discussed further below), the starting point for the response should be the information in the taxpayer's defence file. More broadly, the response should as a minimum cover the final executed agreements, alongside a concise chronology of decision-making. For “all drafts“ requests, it is worthwhile explaining early that drafts are frequently iterative and risk misinterpretation, and perhaps therefore proposing supplying only those “drafts” that genuinely illuminate a potential issue that HMRC have identified - albeit in practice HMRC will usually want to see all drafts to make this assessment themselves. Again, this is where a chronology or short context note can be useful alongside providing documentation to properly “set the scene”.

The right response to informal requests from HMRC is likely to be a combination of cooperative discipline.

Where HMRC asks for “all tax advice”, it is important for taxpayers to consider early on whether legal professional privilege applies and, if so, whether to assert it, especially over drafts. This typically must be on a once and for all basis. If privilege is waived over a small number of documents, this can have a domino effect over all of the legal advice received. There can be pros and cons of waiving privilege, and it will be important to review the strength of your “evidence” both with and without all of the legal advice and to balance this against the potential risks of disclosure.

Finally, as a matter of housekeeping, it is recommended that taxpayers keep a disclosure log of what has been provided and when, because these enquiries often run for years and teams change, be that of the taxpayer, HMRC and/or advisers.

Pitfalls to avoid:

• “Data-dumping“ - that is, volunteering entire categories (drafts, legal advice, whole inboxes) unless they are truly required (and not privileged) and have been properly reviewed before disclosure.
• Drip-feeding contradictory materials without a covering explanation to clarify any discrepancies.
• Above all, once an enquiry is in prospect, it is essential to suspend deletion of any relevant material.

Formal FA 2008 Sch 36 information notices

A Sch 36 notice provides a formal rulebook for the provision of information and documents to HMRC. The legal test is that the information or documents must be reasonably required to check the tax position. This “reasonably required” test can act as an anchor for pushing back on “fishing expeditions” and ensure that a proportionate scope is adopted (see, for example, R (Derrin Brother Properties Ltd) v HMRC [2014] EWHC 1152 (Admin) at [20]). An information notice is also limited to requesting what is in the company's possession or power, and does not override legal professional privilege. There is a specific procedure which must be followed where privilege is being asserted in response to a Schedule 36 notice which taxpayers need to be aware of (see SI 2009/1916).

In practice, the best approach on being presented with a Schedule 36 notice is often to narrow and stage disclosure: have a meeting with HMRC to explain what exists and where; agree custodians and date ranges for email searches; and sequence production so context lands before (or at least alongside) volume. Also flag early areas where the taxpayer will not be able to provide what HMRC is asking for - either because it is not in its possession or power (and therefore HMRC may need to consider applying to the tribunal for a third-party notice if taxpayer consent is not forthcoming), or because the taxpayer wishes to challenge that the information is reasonably required. It is important to keep the tone constructive: a taxpayer can narrow without grandstanding, and can appeal selected items while still producing the rest.

Pitfalls to avoid:

• Missing deadlines — appeals must be made within 30 days regardless of the deadline to provide the information.
• Producing large volumes of emails before supplying any essential context that may sit outside of those communications.
• Handing over privileged chains by mistake, without having made an informed decision on whether to waive LPP.
• Failing to explain systems or record locations so innocent gaps may be misread.

Interviews and meetings (witness/factual)

Outside some criminal contexts, interviews are always voluntary and can be valuable, especially for complex treasury or covenant mechanics. It is helpful where a taxpayer does agree to HMRC conducting interviews to set ground rules in writing in advance: scope and attendees; who answers business facts and who covers technical points; that the meeting is not under caution; and that you will take a full note (and request any HMRC recording) so an agreed account of the meeting can be recorded.

For taxpayers, treat the interview as a guided tour of the documentary record. Evidence should always be the starting point. If recollection strays, let the documents lead. However, also use this as an opportunity to emphasise what you consider to be important that sits outside of the documents. Taxpayers will often find that they are not short of documentation setting out the technical tax analysis for a transaction, but may struggle to find commercial drivers, for example, packaged in such an accessible way. If during an interview a question is asked that would be better answered by someone else or the question is document-specific and needs proper consideration, it is fine to say you will come back in writing. The key thing is not to speculate and commit to providing more information/documents on the fly before reviewing these first.

Pitfalls to avoid:

• Unintentionally providing an inconsistent account -for example, through multiple voices answering the same question, or by speaking without having the relevant documents available.
• Committing to further disclosure from the room without considering the availability and content of what is being promised.

Emails and e-discovery sweeps

HMRC regularly ask for emails to test purpose and conduct vs contract; this is very common in unallowable purpose and TP enquiries, like the case study here.

It is best to approach an email disclosure with a targeted protocol rather than as an entire inbox export.

• Identify custodians (the people who actually made decisions);
• fix proportionate date ranges around decision points;
• choose sensible terms that map to the issues (pricing, covenants, refinancing, management services); and
• produce whole chains so that the overall message in communications is not misread.

Where HMRC seek very broad terms (for example, “all emails between A and B for 18 months” ), it is prudent to invite them to explain what this would test that the focused set does not.

Disputes on funding rarely turn on a single “killer point”. They are evidential and the enquiries that fare best anticipate future areas of review and treat legal agreements, board packs, and internal communications as potential evidence.

As already identified, it is important to keep a privileged lane separate. When evaluating privilege, bear in mind that just because something is marked as “Subject to LPP” does not necessarily mean it benefits from privilege. However, equally, where genuine legal advice does exist, it does not lose protection simply because it is attached, repeated or summarised in another email provided underlying confidentiality to the advice is not lost (see USP Strategies Plc v London General Holdings Ltd (No.2) [2004] EWHC 373 (Ch) at [29])).

Pitfalls to avoid:

• Over-collection that spawns new lines of enquiry —this is why search terms and parameters are so important.
• Producing incomplete chains of emails that read out of context, as well as producing emails without the surrounding agreements, board papers or models that give them meaning.
• Failing to conduct a privilege review alongside assessing relevance.

 

Best approach in responding to requests for information

The same problems recur - information and documents not being available years later when a HMRC enquiry arises (either because it was not recorded at the time, or because key people with the relevant knowledge have left the business) and inconsistent narratives existing between the board pack, lender documents, internal communications (namely emails) and comments made in meetings. It is imperative to build a single evidence-based chronology, supported by contemporaneous documentation.

The best recommendation is to anticipate future areas for HMRC enquiries and prepare a “defence” file in real time, which clearly and consistently documents the taxpayer's position across key areas of potential challenge. This does not need to be extensive and the hope is that you never need to use it, but it is much easier to collate this documentation at the time of a transaction or reorganisation than it is when enquiries are opened a number of years later.

 

Building a “defence” file: what “good” looks like (direct tax focus)

The key here is to ensure that your defence file answers all legal questions that you may be faced with in the future. For example:

• Deal bible: Lock final signed documents, models and board papers in a central repository, and keep drafts and working spreadsheets separate. The bible should be the spine of your defence file: it is the set you can produce with confidence at the start of an enquiry, without trawling through personal folders or old threads.
• Unallowable purpose (CTA 2009 s 441): The defence is built on commercial drivers: why leverage matched the asset's cash profile; how covenants were calibrated; what alternatives were considered and rejected for business reasons; and how the transaction committee and board recorded those points at the time. Include the investment case, cash-flow analysis, debt capacity work, treasury policy and signed term sheets. If debt terms later changed, include the paper explaining why (market, asset or covenant reasons), not a tax rationale.
• Transfer pricing (TIOPA 2010 Part 4): Bring together signed legal agreements aligned to actual conduct, change logs (repricings, waivers, covenant resets), the borrower risk profile, lender comparables and pricing mechanics. For any management services, include scope documents, recharges and comparables, and make the UK-facts explicit — this is what HMRC expect to see.
• Anti-hybrids (TIOPA 2010 Part 6A): Provide a simple map of the structure showing entity and instrument characterisations by jurisdiction and a short mismatch analysis demonstrating the absence (or neutralisation) of deduction/non-inclusion or double deduction outcomes. Refresh annually to reflect law or fact changes.
• Governance and incidentals: Keep a short email search protocol template (custodians, dates, terms, privilege filters), a legal-hold playbook (who, when, how), and a practical retention schedule that fits enquiry lifecycles. Include a privilege guide for the team (what is/isn't LPP; labels don't create privilege). If there is W&I insurance, keep the policy, notifications and broker correspondence alongside the tax covenant so any HMRC settlement preserves cover.

 

Closing an enquiry

Taxpayers who are proactively prepared for an enquiry place themselves in the best position for an efficient review of their tax position and, hopefully, a swift conclusion to the issues. Where HMRC have had a fair opportunity to review the materials and the point is capable of resolution, but the enquiry nonetheless drifts, taxpayers can consider applying to the First-tier Tribunal for a direction that HMRC issue a closure notice (or PCN) on that issue. This is not a step to take lightly, and it is most persuasive where the facts are settled, the technical positions have been fully aired, and any further delay would be disproportionate.

From there, if the taxpayer wishes to dispute any HMRC amendment in closing the enquiry, it must look at an appeal to HMRC (and potentially the tribunal) within the statutory time limits. Settlement may be an option, whether through formal Alternative Dispute Resolution (ADR) or by using mediation-type techniques with relevant HMRC stakeholders to unlock sticking points, provided any proposal is consistent with HMRC's Litigation and Settlement Strategy.

 

Conclusion

Disputes on funding rarely turn on a single “killer point”. They are evidential and the enquiries that fare best anticipate future areas of review and treat legal agreements, board packs, and internal communications as potential evidence. As best practice, defence files are collated in real time and are refreshed as debt moves and terms change. If the documents tell a consistent commercial story, the hope is that the law should follow.