When purpose comes under scrutiny: HMRC’s renewed focus on interest deductions

Over the past several months, HMRC has been writing to a number of companies — typically those with open enquiries into the deductibility of interest on acquisition or group financing arrangements — referencing the so-called “unallowable purpose rule” under sections 441–442 of the Corporation Tax Act 2009.

The issue: what is an “unallowable purpose”?

Ordinarily, companies can claim tax relief for interest on loans that serve a business or commercial purpose. But that relief is denied if the loan was entered into for a purpose that isn’t commercial — such as tax avoidance, even if that’s just one of the main purposes.

The difficulty lies in proving what the “real” purpose was. A loan might fund a genuine acquisition, but if the structure was chosen (or deliberately layered) to generate tax deductions, HMRC may argue that the tax benefit was a key motivating factor — and deny relief.

What changed: the 2024 Court of Appeal decisions

In three recent cases — BlackRock, Kwik-Fit, and JTI Acquisitions — the Court of Appeal gave HMRC important legal support. 

The decisions have a common theme: commercial purpose isn’t enough if a tax avoidance purpose was also significant, and contemporaneous evidence carries more weight than after-the-fact explanations.

HMRC’s new approach: more enquiries, more dialogue

HMRC has since updated its manual (at CFM38100 and new CFM38167) and has started writing to companies where it believes these cases are relevant. 

The letters:

• Summarise key points from the judgments
• Invite companies to review their own evidence — particularly documentation created at the time
• Encourage “without prejudice” discussions to resolve matters before escalation

What should companies do?

If you have group financing, acquisition loans, or internal restructures involving significant debt, ask yourself:

• Why was the loan structured this way?
• Was a UK borrower chosen in part because of the tax deductibility of interest?
• Do the documents created at the time support the argument that the loan had a commercial purpose — and that any tax advantage was incidental? 

Even if HMRC hasn’t contacted you yet, this is the time to review your position — before an enquiry lands on your desk.

The unallowable purpose rule has always existed, but the courts have now clarified that a commercial transaction can still fail the test if the form or structure was influenced by tax outcomes. HMRC is now acting on that basis.

angelo@vectigalistax.co.uk
www.vectigalistax.co.uk

This article is for general information only and should not be relied upon as tax advice without tailored guidance.