The First Tier Tribunal has this week handed down its decision in BlackRock HoldCo 5 LLC v HMRC  UKFTT 443 (TC). The case concerned an appeal by LLC5 in relation to the funding structure adopted by the Blackrock Group to acquire the US part of the Barclays Global Investors ("BGI") business in 2009. Three US LLCs (LLC4, LLC5 and LLC6) were incorporated to give effect to the transaction, with LLC4 and LLC6 being US tax resident and LLC5 being UK tax resident. LLC5 borrowed $4bn from LLC4 to affect the acquisition by acquiring preference shares in LLC6. LLC6 then acquired BGI. Interest on the $4bn borrowing was funded by LLC5 out of the dividends it received from LLC6 who in turn received dividends from BGI.
The issues for the FTT to decide were:
- Transfer Pricing - whether LLC5 would have borrowed on the same terms and for the same amounts from an independent lender as it had from LLC4 and, if not, would LLC5 have borrowed to fund the transaction at all?
- Unallowable Purpose - whether LLC5 had a main tax advantage purpose for being a party to the loan relationships and if so should any (or all) debits be disallowed on a just and reasonable apportionment?
Both parties called expert witnesses to support whether the actual loan differed from the arm's length provision which would have been made between independent parties. Although it was agreed that the actual transaction entered into differed to the transaction that independent parties would have undertaken at arm's length, it was also common ground that a hypothetical lender would have lent $4bn to LLC5 to fund the acquisition of BGI in 2009.
The FTT held that, subject to adding covenants to secure the value of dividend flows from BGI up to LLC5, an independent lender would have entered into the transaction on the same terms as the parties in the actual transaction. Therefore no adjustment under s147 TIOPA 2010 was required.
LLC5 argued that their sole purpose in entering the loan relationship was a commercial one - namely, to facilitate its investment in LLC6 to acquire BGI. The FTT, however, found that LLC5 had two main purposes when borrowing:
- Funding the acquisition of BGI (the “commercial purpose”); and
- Securing the deduction of loan relationship debits for UK tax purposes (the “tax advantage purpose”).
In reaching this conclusion the FTT examined the purposes of LLC5’s (the borrower’s) directors through both witness evidence of a single director corroborated by the available contemporaneous evidence (i.e. board minutes). Taken together, this evidence confirmed that there were main commercial reasons for LLC5 borrowing from its parent (namely, to acquire preference shares in LLC6, a subsidiary).
In finding that the tax advantage purpose was also a main purpose the FTT held that the tax advantage was an "inevitable and inextricable consequence of the loan" and was therefore an important purpose which was thus also a main purpose.
Crucially, in allowing LLC5’s appeal the FTT endorsed the obiter of Judge Beare in Oxford Instruments in reaching the conclusion that, on a “just and reasonable apportionment”, none of the loan relationship debits should be apportioned to the tax advantage purpose. This was because the evidence established that LLC5 would have borrowed to fund the acquisition even if the tax advantage had ceased to exist prior to entering into the transaction. Therefore, the loan relationship debits would have arisen whether or not there was a main purpose of securing a tax advantage.
A few key observations emerge from Judge Brooks’ decision in the FTT:
- the evidence and documents you generate are key - the FTT examined both the contemporaneous documentary evidence and witness testimony to establish the subjective purpose of LLC5 when entering the loan relationship.
- experts’ experience is essential - the FTT preferred the transfer pricing report of Mr Ashley (LLC5’s expert) and commented favourably on his debt capital markets experience, however the Tribunal also observed that neither expert had experience of an independent enterprise making a $4bn loan to a company like LLC5
- a main tax purpose doesn’t always make denying deductions “just and reasonable” - the resounding endorsement of Judge Beare in Oxford Instruments by the FTT confirms that where taxpayers enter into a transaction for a main commercial purpose (and would have done so regardless of the existence of a main tax purpose), s441 should not apply to reduce the debits arising from the loan that funds the transaction.
- purpose matters at the start - the FTT acknowledged that LLC5’s purpose did not change following entry into the loan, therefore it was only required to assess LLC5’s purpose at the outset of the loan relationship (2010).