BlackRock HoldCo 5, LLC v Commissioners for His Majesty's Revenue and Customs

Factual and Procedural Background

In 2009, Company A acquired the worldwide business of Company BGI for approximately US $13.5 billion, including $2.25 billion in cash and shares in Company A's parent company. The appeal concerns the structure used by Company A to acquire BGI's US business and specifically the deductibility for UK tax purposes of interest payable on $4 billion of intra-group loans arranged for that purpose. The tax authority challenged the interest deduction claim on two grounds: (1) transfer pricing rules under the Taxation (International and Other Provisions) Act 2010 ("TIOPA") and (2) the unallowable purpose rule in the Corporation Tax Act 2009 ("CTA 2009").

The First-tier Tribunal (FTT) initially decided that the interest was deductible. The Upper Tribunal (UT) allowed the tax authority’s appeal on both issues, denying the deductions. The appeals relate to accounting periods ended between 30 November 2010 and 31 December 2015. The court heard submissions from senior counsel representing both parties.

The acquisition structure involved several Delaware-incorporated limited liability companies ("LLCs"), with Company A’s financial management subsidiary as the parent. LLC6 acquired BGI US by purchasing shares from the Barclays group. Funds and shares were contributed through LLC4 and LLC5, with LLC5 issuing loan notes totaling $4 billion (the "Loans"). LLC4 held 90% of voting power in LLC6, controlling the entity that owned BGI US.

Each LLC elected to be disregarded for US tax purposes, but LLC5 was UK tax resident and subject to UK corporation tax. The dispute concerns LLC5’s claim to deduct interest on the Loans in its UK tax returns, which would create losses available for group relief within the Company A group. LLC5 had no taxable income itself as dividends on preference shares were exempt from tax.

The FTT found that the ownership and control structure was designed to address regulatory and compliance concerns rather than tax avoidance. It also found that an independent lender would not have made the Loans on the same terms without certain covenants from related entities, which were not present in the actual transaction but could have been in an arm's length scenario. The LLC5 board approved the Loans one day before acquisition completion, following tax advice anticipating UK tax advantages. The FTT concluded that securing a tax advantage was a main purpose but that LLC5 also had a commercial purpose in making and managing passive investments.

Legal Issues Presented

1. Whether the interest deductions on the intra-group Loans are restricted under the transfer pricing rules in Part 4 of TIOPA, specifically whether hypothetical third-party covenants can be considered in determining arm's length terms.
2. Whether the interest deductions are disallowed under the unallowable purpose rule in s.441 CTA 2009, based on LLC5's subjective purpose in entering into the Loans, including whether securing a tax advantage was a main purpose.
3. How to apply the just and reasonable apportionment test under s.441 CTA 2009 when a loan relationship has both commercial and unallowable purposes.

Arguments of the Parties

The opinion does not contain a detailed account of the parties' legal arguments.

Table of Precedents Cited

Court's Reasoning and Analysis

On the Transfer Pricing issue, the court analyzed the statutory provisions of TIOPA and the OECD Transfer Pricing Guidelines. It considered whether third-party covenants, absent in the actual transaction but hypothesized by experts as necessary for an independent lender, could be taken into account in determining arm's length terms. The UT had held that such hypothetical covenants could not be considered because they were not part of the actual transaction, invoking a "two party rule". The court disagreed, reasoning that the legislation’s broad definition of "transaction" and the OECD guidelines require consideration of economically relevant characteristics, which may include third-party factors to ensure comparability. The court held that the hypothetical covenants effectively adjust for differences in risk, making the actual and hypothetical transactions sufficiently comparable. It also found support in s.152(5) TIOPA, which excludes guarantees only if present in the actual transaction, implying third parties are relevant otherwise.

The court concluded that the FTT was entitled to find that an independent lender would have entered into the Loans subject to such covenants and that these would have been forthcoming. Therefore, the transfer pricing rules do not restrict the interest deductions, and the UT's contrary decision was set aside.

Regarding the Unallowable Purpose issue under s.441 CTA 2009, the court examined the statutory framework focusing on the subjective purpose of LLC5’s board in entering the Loans. It reviewed case law including Mallalieu, MacKinlay, Vodafone, and Travel Document Service, emphasizing the distinction between purpose and effect, and that some consequences inevitably involved in an activity may be purposes unless merely incidental.

The court found that the FTT erred in treating the tax advantage as an "inevitable and inextricable consequence" equating to a main purpose without further analysis. The UT’s approach to look beyond the directors’ stated intentions was also flawed, particularly as there was no evidence the board was not free to consider the transaction properly, and the directors had been properly advised to disregard tax advantages when assessing commercial viability.

Nonetheless, the court concluded that LLC5’s sole raison d'être was to obtain tax advantages for the group through the Loans, and that securing a tax advantage was indeed one of its main purposes in entering into the Loans. LLC5 also had a commercial main purpose because the transaction was profitable on a standalone basis, but this was secondary to the tax purpose.

On apportionment, the court rejected the FTT’s subjective approach and agreed with the UT that an objective assessment is required. Applying a "but for" test, the court found that but for the tax advantage, the Loans would not have been entered into. Consequently, 100% of the interest debits should be attributed to the unallowable purpose, resulting in disallowance under the unallowable purpose rule.

Holding and Implications

The court issued the following rulings:

• On the Transfer Pricing issue: The appeal is allowed. Interest deductions on the Loans are not restricted under the transfer pricing rules. The UT Decision on this issue is set aside, affirming the FTT’s conclusion.
• On the Unallowable Purpose issue: The appeal is allowed in part. The FTT’s error in applying Mallalieu is acknowledged and its decision set aside. The court re-makes the decision concluding that LLC5 had a tax advantage main purpose in entering into the Loans, alongside a commercial main purpose.
• On Apportionment: The court dismisses the appellant’s appeal and agrees with the UT that 100% of the interest debits are attributable to the unallowable purpose and thus disallowed.

The direct effect of this decision is that interest deductions claimed by LLC5 on the Loans are disallowed under the unallowable purpose rule, despite not being restricted under transfer pricing. No new legal precedent beyond the application of existing principles is established. The decision clarifies the approach to hypothetical terms in transfer pricing and the application of subjective purpose in unallowable purpose rules.