Loan Relationships: HMRC Challenges to Corporate Interest Deductions

HMRC has won almost every recent unallowable purpose case that has reached tribunal. For groups with intra-group or acquisition debt, the rule under CTA 2009 ss441-442 is now the single most consequential loan relationships provision in practice, and the June 2025 nudge letters show HMRC is actively mining historic financing structures for it.

The Loan Relationships Framework

The loan relationships regime in Parts 5 and 6 of the Corporation Tax Act 2009 governs how companies bring interest, and other amounts arising from money debts, into account for corporation tax purposes, generally following the accounting treatment subject to specific statutory adjustments. Interest payable is ordinarily deductible as a debit under the loan relationships rules, making debt an efficient way to fund both operating businesses and acquisitions from a tax perspective compared with equity, which is precisely why the regime contains targeted anti-avoidance provisions, of which the unallowable purpose rule is the most significant in current practice.

The Unallowable Purpose Rule

The rule bites on debits, primarily interest expense, but also includes related amounts such as guarantee fees and certain exchange or fair value movements arising on the relationship. Critically, the rule does not require the company to have no commercial purpose at all; a genuinely commercial loan relationship (for example, funding a real acquisition or a real trading business) can still be found to have an unallowable purpose if, alongside that commercial purpose, obtaining a tax advantage is also a main purpose, most commonly where the structure, amount, or terms of the debt go beyond what the commercial objective alone would explain.

Establishing "Main Purpose"

Purpose, for these provisions, is the purpose of the company itself, established by reference to the state of mind of the individuals who took the relevant decisions on the company's behalf, generally the directors (or, in a group context, those directing the relevant group finance function), at the time the company became, or remained, party to the loan relationship. This is a subjective enquiry into actual intention, not an objective "would a reasonable company have done this" test, but the courts and tribunals draw heavily on objective, contemporaneous evidence to determine what that subjective purpose in fact was, since after-the-fact assertions of purpose carry limited weight without documentary support. Where a loan relationship is entered into, or restructured, as part of a wider scheme, tribunals have shown a willingness to look at the purpose of the scheme as a whole in assessing the purpose of the individual loan relationship, rather than treating each drawdown or amendment in isolation.

Just and Reasonable Apportionment

Where an unallowable purpose is established, the statute requires debits to be apportioned on a just and reasonable basis between those referable to the unallowable purpose (disallowed), and those referable to any genuine business or commercial purpose (still deductible). In principle this allows for partial disallowance where a loan relationship has a mixed purpose. In practice, however, recent tribunal decisions have shown that where the tax advantage purpose is found to be the dominant or overwhelming one, particularly in structures where debt was increased, or restructured, specifically to create or inflate a UK interest deduction beyond what the underlying commercial transaction required, the just and reasonable apportionment can result in denial of the deduction in full, on the basis that none of the excess debit is properly referable to any commercial purpose.

Recent Case Law

BlackRock HoldCo 5 LLC v HMRC [2024] EWCA Civ 330

The Court of Appeal upheld HMRC's disallowance of interest deductions on intra-group loans used to fund a US acquisition, applying an unallowable purpose analysis and confirming that where a tax avoidance purpose is a main purpose, apportionment can properly result in full disallowance of the relevant debits, notwithstanding an underlying genuine commercial acquisition.

Kwik-Fit Group Ltd v HMRC [2024] EWCA Civ 434

The Court of Appeal upheld a finding that a restructuring of intra-group loans, carried out to accelerate the use of non-trading loan relationship deficits that would otherwise have been at risk of being unusable, had a tax avoidance main purpose, and that the just and reasonable apportionment could properly disallow the debits referable to that restructuring even though the underlying debt itself was of long standing.

JTI Acquisition Company (2011) Ltd v HMRC [2024] EWCA Civ 652

The Court of Appeal dismissed the taxpayer's further appeal against First-tier Tribunal and Upper Tribunal findings ([2023] UKUT 194 (TCC)) that an intra-group borrowing used to help fund a US acquisition was entered into for an unallowable tax avoidance purpose rather than any commercial purpose, illustrating the courts' continued focus on contemporaneous, board-level evidence of purpose in this line of cases.

The 2025 Nudge Letters

In June 2025, HMRC issued a further round of "nudge" letters to corporate groups, drawing attention to the unallowable purpose rule specifically in the context of intra-group and acquisition financing structures, and inviting recipients to review historic interest deductions and consider whether a voluntary disclosure or amendment was appropriate. Nudge letters of this kind are not formal enquiry notices, but they signal that HMRC holds data (typically from corporation tax returns, group structure charts, and cross-referenced information from other enquiries) suggesting the recipient's financing arrangements share characteristics with structures HMRC has successfully challenged, and groups that ignore a nudge letter without genuine review, only to have HMRC later open a formal enquiry and reach the same conclusion, are likely to find penalty mitigation considerably harder to obtain.

Defending an Enquiry

Because the test turns on the actual, contemporaneous purpose of the decision-makers, the single most important step in any unallowable purpose enquiry is locating and preserving the documentary record from the time the financing decision was made: board minutes and papers, credit committee or investment committee submissions, correspondence with lenders, tax advice obtained at the time (subject to legal professional privilege considerations), and any comparison of the financing structure actually adopted against realistic commercial alternatives that were considered and rejected. Where the loan relationship genuinely funded real commercial activity, on terms not materially different from what an arm's length lender would have required, that evidence directly rebuts an unallowable purpose finding; where the structure or quantum of the debt significantly exceeds what the underlying commercial transaction required, by contrast, that gap is precisely what HMRC and the tribunals have focused on in recent successful challenges.

Practical Steps for Corporate Groups

• Document financing decisions contemporaneously. Board minutes and credit papers should record the commercial rationale for the amount, structure, and timing of debt, not just approve it; this record is decisive years later in an enquiry.
• Benchmark debt quantum against commercial need. Where intra-group debt materially exceeds what would be required to fund the underlying commercial transaction on arm's length terms, treat this as a real risk indicator, not a technicality.
• Review historic structures against BlackRock and Kwik-Fit. Both cases show the Court of Appeal is willing to uphold full disallowance; groups with comparable acquisition or restructuring debt should review exposure proactively rather than wait for HMRC.
• Respond substantively to a nudge letter. A genuine review, followed by voluntary correction where appropriate, materially improves the group's position on penalties compared with waiting for a formal enquiry to reach the same conclusion.
• Take specialist advice before restructuring existing debt. Kwik-Fit shows that even long-standing debt can generate a fresh unallowable purpose finding where it is restructured for a tax-driven reason.

Frequently Asked Questions