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The Court of Appeal (CoA) decision in the case of provides insight into how intra-group lending should be considered and supported in the context of the UK transfer pricing rules.

While the overall result of the decision was to uphold the disallowance of the interest deduction due to an ‘unallowable purpose’ under the separate loan relationship anti-avoidance rule, the CoA disagreed with the findings of the Upper Tribunal (UT) with respect to transfer pricing.

Background

LLC5, which was established in the US but tax resident in the UK, was part of an acquisition structure created to facilitate the acquisition by the BlackRock group, a US headquartered business, of the US business of Barclays Global Investors (BGI). Intra-group loans of $4bn were made to LLC5, which claimed UK corporation tax deductions in respect of the associated interest payable. 

Following the completion of the acquisition, LLC5 held non-voting preference shares issued by another BlackRock group company (LLC6), which had acquired the shares in BGI. As LLC5 did not control LLC6, it could not ensure that cash flows in respect of its preference shares would not be diverted. The voting shares in LLC6 were held by LLC5’s immediate parent entity, LLC4.

With respect to the transfer pricing question, both HMRC and BlackRock agreed at the First-tier Tribunal that an independent lender acting at arm’s length would have only made the loans in question if LLC6 and BGI had provided certain covenants. As no such covenants were actually provided, the UT found that the actual terms of the transaction were not comparable to those that would have been agreed by an independent lender. Therefore, it concluded that, under the transfer pricing rules, no tax deduction was available for the interest. This decision was appealed by LLC5.

Transfer pricing – Court of Appeal findings

The CoA disagreed with the UT’s conclusion that the transfer pricing rules would operate to deny a deduction unless relevant covenants were included in the intercompany loan agreement to align it with the way that such an arrangement would have been presented and agreed between independent parties.

Essentially, the CoA has taken a practical approach to the question of how connected party arrangements should be understood, priced and supported by looking at the ‘real world’ facts and circumstances rather than requiring the legal agreements that would underpin a third-party loan to be precisely replicated. Critically for transfer pricing, this includes an acknowledgement that there are times when connected parties do not need to seek the same kind of terms as third parties, for example because of the powers that come from ownership or management oversight. By allowing the net to be ’cast very widely‘ – confirming that informal understandings or non-binding arrangements might be relied upon – the CoA has provided an interpretation of the OECD Guidelines on Transfer Pricing which allows businesses to support positions by reference to the actual facts and circumstances, rather than having to conjecture on the precise terms of equivalent arrangements between independent parties.

What does this mean for businesses?

The CoA’s decision appears sensible. It removes an implied requirement, based on the UT’s decision, for more detailed intra-group loan agreements (potentially including terms that would only ever be relevant hypothetically) and endorses a more practical approach to setting and supporting transfer pricing policies.  

That said, it will still be important for businesses to have a clear understanding of the facts and circumstances relevant to their intra-group arrangements, and they should still be clear on how their pricing policies are set and supported. Best practice continues to be to consider the tax treatment of a loan as it is being agreed, not later on. The decision does not change the transfer pricing requirements or the need for robust comparable data. However, the right governance processes will be needed for this revised approach, together with appropriate evidence to show and support why the relevant policy has been chosen. As HMRC will also be entitled to cast the net widely when assessing the substance of arrangements, robust governance processes will be beneficial should an enquiry seek to read in terms that the taxpayer had not intended.

It should be kept in mind that the LLC5 case has a very specific set of facts and circumstances. However, the decision addresses the transfer pricing considerations in terms of the relevant principles and framework, and so the CoA’s conclusions could be applied more widely. By acknowledging what control of related parties involves – casting the net widely to identify the relevant arrangements for the purposes of applying the transfer pricing rules – the decision could change how businesses support their transfer pricing policies, and this should be addressed in transfer pricing documentation wherever relevant. Whether this decision will have a significant impact remains to be seen, particularly as it is a UK ruling and transfer pricing documentation is typically prepared with the global group in mind. Care should also be taken not to take the principle too far.  In its decision, the CoA specifically warns of the limitation that, ‘[t]his is not a transaction involving specialised goods or services or unique intangibles… where comparability analysis is problematic.’ Businesses will always need to be clear what the economically significant characteristics of a transaction are, and the best way to present them in transfer pricing documentation.

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