In early May 2023, HMRC substantively overhauled its guidance starting at CFM38000, on when a company’s relief for Loan Relationships may be restricted because the loan has an “unallowable purpose”: an “unallowable purpose” can be as broad as being “not amongst the business or other commercial purposes of the company” (CTA 2009 s 441, 442)
Perhaps understandably, HMRC spends much of its guidance mulling over whether or not there is a “tax avoidance purpose”, (which can amount to an unallowable purpose in its own right, if the motive has sufficient priority), because it has traditionally been concerned with high-value, complex avoidance scenarios where the usual Loan relationship symmetry is missing; “symmetry” in this context meaning either:
Hence why so many of the “unallowable purpose” scenarios that HMRC considers at CFM38190 consider international relationships, where the UK group member is hoping to get relief for its finance costs.
In my experience, some OMB companies and their advisers do not worry overmuch about the “unallowable purpose” being a significant issue because, while many OMB companies may be members of groups, they tend all to be UK-resident, so both debtor company and creditor company will fall within the symmetry at (2) and both sides of any debt impairment/release will be ignored for tax purposes. So it is often assumed that the company with the impairment will get no relief, but the company enjoying the benefit of any debt release will not have to recognise a taxable credit, either.
Similarly, when considering loans between companies and individuals, and where a Director’s Loan Account (strictly, a loan to a participator) does fall within the scope of Loan Relationships – at least for the company – any hope of relief for a release, etc., was long-since dashed thanks to CTA 2009 s 321A, as introduced by FA 2010 (see also CFM33177).
But not all OMB Loan Relationships are comfortably between fellow group companies, or to participators. And, in particular, the test(s) for “connection” and “control” are peculiar to the Loan Relationships regime. In other words, many non-group companies will not be “connected” under the Loan Relationship rules, and the “unallowable purpose” test may block relief for any impairment, but do nothing to prevent a taxable credit arising in the debtor company (not that we will necessarily care too much about the debtor company, depending on the nature of the link between them). Over the years, I have found David Southern’s book on Loan Relationships to be an excellent resource and the guidance on when parties may be connected specifically for the LR regime – and, just as importantly, when they may not be so – to be most useful.
The tail end of CFM38190 offers a couple of examples that will in broad strokes be quite familiar to smaller family companies and their advisers: loans on non-commercial terms to passion projects of the owner-director(s); or favourable inter-family-company lending, but where the parties are not actually connected, according to the Loan Relationships regime.
It may be that HMRC is becoming more confident in the application of the “unallowable purpose” restriction to more domestic OMB company scenarios. One final saving is that the “unallowable purpose” restriction is not “all-or-nothing”, but potentially subject to a just and reasonable apportionment, so there may be scope in some cases to limit any disallowance that HMRC might look to impose.
For more information on the niceties of Loan Relationships and connected parties, see early Chapter 6 of Taxation of Loan Relationships and Derivative Contracts, by David Southern.
